MALDIVES DEVELOPMENT UPDATE SCALING BACK & REBUILDING BUFFERS May 2024 Scaling Back & Rebuilding Buf fer s Maldives Development Update © [2024] International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy, completeness, or currency of the data included in this work and does not assume responsibility for any errors, omissions, or discrepancies in the information, or liability with respect to the use of or failure to use the information, methods, processes, or conclusions set forth. 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Photo Credits Cover, Parts A.1 and A.2: Erdem Atas May 2024 THE WORLD BANK Scaling Back & Rebuilding Buf fer s Maldives Development Update Preface The Maldives Development Update (MDU) has two main goals. First, it takes the pulse of the Maldivian economy by providing key developments over the past 12 months. Placing these in a global context, and based on these recent developments, it analyzes the outlook over the medium term. Second, every other edition of the MDU provides a more in-depth investigation of selected economic and policy issues. It has a wide audience including policymakers, policy analysts from think tanks or non-governmental organizations, and business and financial sector professionals interested in Maldives’ economic development. The MDU was prepared by Erdem Atas, Karishma Sheriff, Richard Walker (Macroeconomics, Public Sector, Trade and Investment, South Asia Region), and Gregory Smith (Equitable Finance and Institutions). The team is grateful to Nandini Krishnan and Marta Schoch (Poverty), Tatsiana Kliatskova and Ghiles Elkadi (Finance, Competitiveness, and Innovation), Zoe Leiyu Xie, Juan Felipe Serrano Ariza, and Patrick Alexander Kirby (Macroeconomics, Trade and Investment, Prospects Group) for their inputs to the publication. The team thanks Mathew Verghis (Director, Equitable Growth, Finance and Institutions – EFI, South Asia Region), Faris Hadad-Zervos (Country Director for Maldives, Nepal and Sri Lanka), Chiyo Kanda (Country Manager, Maldives and Sri Lanka), and Shabih Ali Mohib (Practice Manager, Macroeconomics, Public Sector, Trade and Investment) for their guidance. Sashikala Jeyaraj and Yasindu Amarasinghe provided valuable administrative support and helped with the format and layout of the report, while Naaif Ahmed led the dissemination efforts. The report was prepared based on published data available on or before April 28, 2024. Data sources include the World Bank, International Monetary Fund, Ministry of Finance, Maldives Monetary Authority, Maldives Bureau of Statistics, Ministry of Tourism, and press reports. Previous report editions: ● October 2023: Maldives Development Update: Batten Down the Hatches https://openknowledge.worldbank.org/server/api/core/bitstreams/4fdca0d7-c521-4bf0-900b- 88fad30ad00econtent ● April 2023: Maldives Development Update: Navigating A Tight Line https://openknowledge.worldbank.org/handle/10986/39627 ● October 2022: Maldives Development Update: Towards Resilient and Affordable Housing https://thedocs worldbank.org/en/doc/49141824db6f3a3b812bad33d5779541-0310062022/maldives- development-update-towards-resilient-and-affordable-housing To receive the MDU and related publications by email, please email infomaldives@worldbank.org. For questions and comments, please email eatas@worldbank.org and rwalker3@worldbank.org. For information about the World Bank and its activities in Maldives, please visit: https://www.worldbank.org/en/country/maldives @WorldBank,@WBMaldives,followhashtag#MDUSM24 www.facebook.com/WorldBankSouthAsia instagram.com/worldbank/ www.linkedin.com/company/the-world-bank May 2024 THE WORLD BANK Scaling Back & Rebuilding Buf fer s Maldives Development Update Abbreviations BML Bank of Maldives CAD Current Account Deficit CAM Communication Authority of Maldives CAR Capital Adequacy Ratio COVID-19 Coronavirus Disease 2019 CPI Consumer Price Index DHS Demographic and Health Survey EMDEs Emerging Markets and Developing Economies FDI Foreign Direct Investment FRA Fiscal Responsibility Act G2G Government-to-government GDP Gross Domestic Product GGST General Goods and Services Tax GHG Greenhouse Gases GoM Government of Maldives HIES Household Income and Expenditure Survey MDU Maldives Development Update MMA Maldives Monetary Authority MoF Ministry of Finance MPI Multidimensional Poverty Index MRR Minimum Reserve Requirement MUDRP Maldives Urban Development Resilient Program MVR Maldivian Rufiyaa NBS National Bureau of Statistics NDA Net Domestic Assets NFA Net Foreign Assets NPL Non-performing Loan ODF Overnight Deposit Facility OLF Overnight Lombard Facility OMO Open Market Operations PIM Public Investment Management PPG Public and Publicly Guaranteed PPP Public Private Partnership PSIP Public Sector Investment Program PSPH Public Sector Pay Harmonization RBI Reserve Bank of India SDF Sovereign Development Fund SDG Sustainable Development Goals SIDS Small Island Developing State SOE State-Owned Enterprise STO State Trading Organization TGST Tourism Goods and Services Tax US$ United States Dollar y-o-y year on year May 2024 THE WORLD BANK Scaling Back & Rebuilding Buf fer s Maldives Development Update Table of Contents Preface....................................................................................................................................................................... Abbreviations............................................................................................................................................................ Table of Contents..................................................................................................................................................... EXECUTIVE SUMMARY........................................................................................................ i A1. ECONOMIC UPDATE....................................................................................................... 1 1. Growth is slowing, whilst inflationary pressures are being contained...............................................................1 2. Fiscal deficits and public debt remain high, leading to liquidity and solvency risks........................................3 3. Household welfare is under pressure from slower growth and fiscal vulnerabilities........................................6 4. A larger current account deficit and rising external financing needs have led to a deterioration in external balances and FX reserves.....................................................................................................................8 5. MMA’s exposure to the sovereign remains high and the exchange rate is under pressure...............................9 A2. OUTLOOK AND RISKS..................................................................................... 12 6. Medium-term growth is forecast to moderate and is subject to major downside risks................................... 12 LIST OF FIGURES Figure ES.1: Arrivals are increasing, but the average duration of stay has declined…................................................................ i Figure ES.2: …and real GDP growth is losing the momentum of the pandemic recovery....................................................... i Figure ES.3: Public debt stock is growing…..................................................................................................................................... ii Figure ES.4: …while MMA continues to finance government spending...................................................................................... ii Figure ES.5: Credit has been recovering and the sovereign-bank nexus shows signs of stabilization…................................ iii Figure ES.6: …although reserves dropped to critically low levels with the rising import bill.................................................. iii Figure ES.7: External debt servicing pressures exist over the next few years…......................................................................... iv Figure ES.8: …yet a sizeable fiscal adjustment is required............................................................................................................. iv Figure A.1: Arrivals are increasing but average duration of stay is still declining…................................................................... 2 Figure A.2: …and real GDP growth is losing its momentum........................................................................................................ 2 Figure A.3: Inflation was elevated in 2023, but price pressures declined towards the end of the year.................................... 2 Figure A.4: Price increases were high in food and beverages.......................................................................................................... 2 Figure A.5: Global growth in 2023 was better than expected......................................................................................................... 3 Figure A.6: Growth in revenues driven by tourism expansion, GST reforms…......................................................................... 5 Figure A.7: …yet expenditure remains elevated due to capital investments, subsidies and other recurrent spending.......... 5 Figure A.8: Public infrastructure projects and subsidies have driven up spending over the last decade…............................. 6 Figure A.9: …which has led to a sharp increase in the debt stock................................................................................................. 6 Figure A.10: Indirect subsidies benefit poorer households in relative terms…........................................................................... 7 Figure A.11: … but also allocate resources inefficiently to non-poor households...................................................................... 7 Figure A.12: While imports growth has slowed…............................................................................................................................ 8 Figure A.13: …the trade deficit remains high.................................................................................................................................... 8 Figure A.14: CAD largely financed by FDI…................................................................................................................................... 9 Figure A.15: …as reserves dropped with the rising import bill to critically low levels............................................................... 9 Figure A.16: FX pressures have remained elevated….................................................................................................................... 10 Figure A.17: …while MMA continues to finance government spending................................................................................... 10 Figure A.18: Credit and deposits have been recovering and sovereign-bank nexus shows signs of stabilization…........... 11 Figure A.19: …and although banking sector indicators look sound overall, vulnerabilities persist........................................ 11 Figure A.20: Real GDP growth is modest over the medium term….......................................................................................... 14 Figure A.21: …while the size of a fiscal adjustment will depend on a strong commitment.................................................... 14 Figure A.22: Current account deficit is expected to remain elevated due to higher capital imports….................................. 15 Figure A.23: …with increasing external debt servicing pressures over the next few years...................................................... 15 May 2024 THE WORLD BANK Scaling Back & Rebuilding Buf fer s Maldives Development Update LIST OF TABLES Table A.1: Growth outlook is modest and will be supported by tourism, but subject to major downside risks.................. 13 LIST OF BOXES Box 1: Global economic developments.............................................................................................................................................. 3 LIST OF ANNEXES Annex 1: Balance of Payments (percent of GDP)......................................................................................................................... 17 Annex 2: Key Fiscal Indicators (percent of GDP)......................................................................................................................... 18 May 2024 THE WORLD BANK Scaling Back & Rebuilding Buf fer s Maldives Development Update Executive Summary Growth lost the momentum of the post-pandemic recovery in 2023. After a 13.9 percent real GDP growth in 2022, the economy is estimated to have grown by 4.0 percent (y-o-y) in 2023, a rate well below the pre-pandemic trend. The slowdown in growth occurred despite a 12 percent (y-o-y) increase in tourist arrivals, that climbed to an all-time high of 1.88 million in 2023 (Figure ES.1, Figure ES.2). The arrivals from key markets including Russia, India, USA, and Europe remained high and were supported by the reopening of the Chinese market in early 2023. However, rising tourist arrivals did not translate into higher real GDP growth due to a decline in spending per tourist, linked to a reduced average length of stay and success in expanding the guesthouse accommodation options to complement high-end resorts. Moderate economic growth amid high inequality poses risks to lower-income households’ welfare, especially in the outer atolls. Figure ES.1: Arrivals are increasing, but the average Figure ES.2: …and real GDP growth is losing the duration of stay has declined… momentum of the pandemic recovery Number of tourist arrivals (lhs, lines), Days of stay (rhs, columns) Contribution to growth, percentage points 250,000 9.50 30 Agri.&Fish. Manufacturing Construction Trade Tourism 25 2024 2023 Transp. and Comm. Others 200,000 9.00 GDP 20 2022 150,000 8.50 15 2022 2023 2024 10 4.6 4.0 100,000 8.00 5.3 1.9 5 0 50,000 7.50 -5 2022-Q1 2022-Q2 2022-Q3 2022-Q4 2023-Q1 2023-Q2 2023-Q3 2023-Q4 0 7.00 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Ministry of Tourism, WB calculations. Source: National Bureau of Statistics Maldives (NBS), WB calculations. Inflation pressures were driven by increased tax rates and high commodity prices. Inflation rose in early 2023, after the Goods and Services Tax (GST) rate increases became effective in January 2023, alongside continued pressure from high global commodity prices. As a result, consumer prices increased by an average of 2.9 percent (y-o-y) in 2023, well above the pre-pandemic average of 0.5 percent. The largest increases were in food and non-alcoholic beverage prices. Contrastingly, the government managed to ease pressure on utility prices and transportation mostly through the continued provision of blanket subsidies. Large external imbalances have led to a decline in foreign exchange reserves and liquidity pressures. The pandemic crisis saw rapidly rising recurrent and capital spending, plus large fiscal and current account deficits. As a consequence of maintaining a blanket subsidy policy for major consumption items (including fuel, electricity and food) and not having undertaken the planned subsidy reforms, the government continues to face spending pressures. The sharp growth in capital and construction material imports – to support the completion of mega Public Sector Investment Program (PSIP) projects – added further pressure to fiscal and current account balances. Travel sector receipts, which account for 95 percent of services exports, contracted by 9.2 percent of GDP in 2023, despite the growth in tourist arrivals. Merchandise imports remained elevated in 2023, driven by construction and capital goods imports, leading to sustained high trade deficits. As the overall import bill remained high at US$3.6 billion, official reserves fell by 34.9 percent since end-2022, to US$541.8 million as at February 2024. This is sufficient to cover 1.8 months of imports – a drop from 3.0 months of coverage at May 2024 THE WORLD BANK i Scaling Back & Rebuilding Buf fer s Maldives Development Update end-2022 (Figure ES.6). As a result, the current account deficit widened to an estimated 23.4 percent of GDP in 2023. Despite higher tax collection and revenues, overall fiscal performance is weaker on account of the sharp rise in capital spending and subsidies. Total revenue growth was 17 percent (y-o-y) in 2023 – much of this came from the Tourism GST (TGST) and other tourism related revenues1 – while total expenditure grew by 17.9 percent over the same period on an already elevated expenditure base. The increase in expenditure was driven by sustained high levels of capital spending (under the PSIP) on the Greater Malé Connectivity Project; extension of Velana International Airport; new regional airports; housing, water and sewerage projects; and land reclamation projects. Recurrent spending also put pressure on the budget via higher subsidies, elevated Aasandha (health) spending, an increase in the wage bill (related to the implementation of the Public Sector Pay Harmonization (PSPH) policy), and higher debt interest costs. As a result, the fiscal deficit is estimated to have increased to 13.2 percent of GDP. Key reforms for stabilization have not yet been implemented, resulting in the need for a supplementary budget in 2023. The planned subsidy reforms (including fuel and electricity) that aimed to reduce expenditures by 3 percent of GDP in 2023, were not implemented. The higher capital and recurrent spending and subsidy bill led the government to seek approval for an MVR 6.5 billion (US$422 million, 6.4 percent of estimated GDP) supplementary budget in 2023, which was to be financed through domestic and external sources. However, more challenging conditions for domestic financing, and limited access to affordable sources of external borrowing has led to an accumulation of expenditure arrears. Figure ES.3: Public debt stock is growing… Figure ES.4: …while MMA continues to finance government spending PPG in US$ million and percent of GDP (rhs) MVR million, percent (rhs) External debt Domestic debt 16,000 Claims on central government 70 Total PPG debt (RHS) Advances to CG (rhs) 9,000 160 14,000 Claims on central government 60 (% of total assets) (rhs) 8,000 140 12,000 50 million MVR 7,000 120 10,000 40 6,000 8,000 100 30 5,000 6,000 80 4,000 20 4,000 60 3,000 10 2,000 2,000 40 0 0 1,000 20 Jan-19 May-19 Sep-19 Jan-20 May-20 Sep-20 Jan-21 May-21 Sep-21 Jan-22 May-22 Sep-22 Jan-23 May-23 Sep-23 Jan-24 0 0 2019 2020 2021 2022 2023 Source: Ministry of Finance, World Bank calculations. Source: MMA, World Bank calculations. The Maldives Monetary Authority (MMA) continued to finance the budget deficit throughout 2023, while the growth in banks’ exposure to the sovereign stabilized. Repeated debt exchange operations in 2023, through the securitization of MMA’s advances for budget needs,2 have expanded its total exposure to central government. While the growth of advances slowed in December 2023, the overall exposure continued to increase – reaching MVR 14.6 billion, or 59.6 percent of MMA assets, in January 2024 (Figure ES.4). Since November 2023, banks’ exposure to the central government has showed some signs of stabilization, ending 2023 at 30 percent of total assets – a similar level recorded at the end of 2022. At the same time, credit to 1Other tourism related revenues include import tax, green tax, airport service charges, airport development fees, and resort rents. 2The Ministry of Finance (MOF) has securitized most of the advances received from the MMA over the 2020–2023 period under the exemption of certain clauses of the Fiscal Responsibility Act (FRA). The temporary suspension of FRA was terminated by the end of 2023. May 2024 THE WORLD BANK ii Scaling Back & Rebuilding Buf fer s Maldives Development Update the private sector grew by 9.3 percent in 2023, with growth observed in personal loans and business lending, while deposit growth has firmed up, increasing from 1.6 percent year-on-year in July 2023 to an average of 7.6 percent in the latter half of the year (Figure ES.5). The high risk of debt distress, and associated refinancing risks, leave the Maldivian economy vulnerable to domestic and external shocks. Total public and publicly guaranteed (PPG) debt rose to US$8.0 billion or an estimated 122.9 percent of GDP3 in 2023, compared to US$7.0 billion or 114.5 percent of GDP the year before (Figure ES.3). Domestic debt increased to 72.2 percent of GDP4 in 2023 from 62.1 percent of GDP in 2022, as tighter global financial conditions compelled government to depend more on domestic finances. External and externally guaranteed debt accounted for the remainder of the stock (50.7 percent of GDP). Additional fiscal risks from guaranteed and on-lent loans, as well as trade payables, subsidies, and capital injections to state-owned enterprises (SOEs), were estimated at about US$2.5 billion or 45 percent of GDP in 20195. Therefore, Maldives’ fiscal space is limited, leaving the country vulnerable to shocks. Figure ES.5: Credit has been recovering and the Figure ES.6: …although reserves dropped to sovereign-bank nexus shows signs of stabilization… critically low levels with the rising import bill Percent, percentage change (rhs) Official reserves US$ million and months of import cover (rhs) Claims on Central Government Months of imports (rhs) and SOEs (% of assets) Months of imports (net ST liabilities) Credit Growth (YoY, %) Official Reserves 40 Deposit Growth (YoY, %) 45 1,200 Reserves net ST liabilities 7 1,000 6 30 35 5 20 25 800 4 10 15 600 3 400 0 5 2 200 1 -10 -5 Dec-20 Dec-21 Dec-22 Dec-23 Jun-20 Jun-21 Jun-22 Jun-23 0 0 2019 2020 2021 2022 2023 Mar-24 Source: MMA, World Bank calculations. Source: MMA, World Bank calculations. Debt service costs are projected to increase over the medium-term. The country is projected to pay, on average, about US$512 million of external debt servicing annually over the 2024–25 period (Figure ES.7). PPG debt service costs are then projected to spike to US$1.07 billion in 2026, which includes bullet payments for the US$500 million Sukuk and US$100 million private placement. Meeting such requirements will depend on the state of global markets and the path of Maldives’ reforms; and will be made easier if government can secure a credit enhancement measure for a liquidity management or as part of a debt for nature deal. A large multi-year fiscal consolidation is urgently required to ensure fiscal and debt sustainability, combined with structural reforms. Maldives needs to ‘rebuild buffers’ and increase resilience to future shocks. A large fiscal adjustment is critical to maintain standards of living and sustain growth. Along with careful liquidity management since end-2023, the government’s announcement of a homegrown fiscal reform agenda is a positive start, and its implementation is expected to begin in May 2024. A notable reduction in and better targeted spending, and more effective revenue mobilization are crucial for safeguarding Maldives’ debt and fiscal sustainability. As reflected in the fiscal reform agenda, reforms to subsidies and Aasandha, reforms to SOEs, including improvements in their corporate governance and financial viability, and a solid public 3 Based on World Bank’s latest macroeconomic forecasts. 4 Based on World Bank’s latest macroeconomic forecasts. 5 See Maldives Public Expenditure Review (2022) for details. May 2024 THE WORLD BANK iii Scaling Back & Rebuilding Buf fer s Maldives Development Update investment management framework are crucial to bring the budget closer to balance, replenish buffers against future shocks, and lower the cost of growth-enhancing investments. In addition, revenue mobilization can be improved by diversifying the tax base and mobilizing more domestic sources of revenue, reducing informality, and enhancing the tax morale and equity of the tax system. Figure ES.7: External debt servicing pressures Figure ES.8: …yet a sizeable fiscal adjustment is exist over the next few years… required External debt service projections for PPG debt, US$ million Percent of GDP Principal and other payments Fiscal Balance Primary Balance 1200 Interest payments Official reserves 0 1000 -2 800 -4 -6 600 -6.0 -8 -7.2 400 -8.3 -8.3 -10 -9.6 -9.5 200 -12 -11.0 -12.0 -12.2 0 -14 -13.2 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2022 2023e 2024f 2025f 20206f Source: Ministry of Finance and World Bank calculations. Source: MMA, World Bank calculations. Note: 2024 official reserves is the level as of February 2024. Medium-term prosperity will be driven by tourism; although while external and fiscal vulnerabilities persist, downside risks cloud the forecast. Real GDP growth is projected to be 4.7 percent in 2024, followed by 5.2 percent growth in 2025, supported by the completion of Velana International Airport that is expected to lead to a rise in tourist arrivals. The baseline projections for the medium term are, however, lower than the forecasts in October 2023, reflecting the following factors: (i) an expected fiscal adjustment (Figure ES.8) – including the negative impact on real household incomes from the planned subsidy reforms6 and a fall in government consumption and investments; and (ii) more moderate tourist spending with a growing preference for guesthouses over high-end resorts. Inflation is projected to rise to 7.5 percent in 2024, largely due to the planned subsidy reforms. Heightened external and fiscal vulnerabilities, along with difficulties in liquidity management, pose downside risks to the economic outlook. An inability to access reasonable financing, resorting to external borrowing at increasingly expensive terms, and failing to implement planned fiscal reforms will leave the country vulnerable to a fiscal or debt sustainability shock. Furthermore, developing alternative growth drivers to limit dependency on tourism, reducing the state’s involvement in the economy, and supporting private sector job creation remain crucial for the Maldives’ growth strategy in the long term. 6 As per approved government budget for 2024. May 2024 THE WORLD BANK iv Scaling Back & Rebuilding Buf fer s Maldives Development Update A1. Economic Update 1. Growth is slowing, whilst inflationary pressures are being contained Economic growth After a 13.9 percent real GDP growth in 2022, the economy is estimated to have grown has slowed despite by 4.0 percent in 2023. The slowdown occurred despite a 12 percent (y-o-y) increase robust tourist in tourist arrivals, climbing to an all-time high of 1.88 million in 2023. Compared to arrivals… 2022, the tourism sector’s nominal receipts contracted by 6.8 percent (y-o-y) as an increasing number of visitors opted for guesthouses over high-end resorts, while the annual average stay fell to 7.5 days from 8.0 days. …supported by Tourist arrivals continue to grow in 2024 at a remarkable pace of 14.3 percent (y-o-y) the return of as of mid-March. However, the average stay of 7.8 days in 2024 remains lower than Chinese tourists and the 8.8 and 8.0 days recorded (during the same period) in 2022 and 2023. Chinese continued arrivals arrivals lead the list, contributing 12 percent of visitors. Meanwhile, arrivals from from Russia and India have declined sharply from 11 percent of visitors to only 6 percent in the same Europe… period. Growth in arrivals from Russia, Western Europe, and new markets such as the USA and Central Europe remain strong (Figure A.1). …but tourism and Lower receipts from the tourism sector contributed to slower growth of services other major sectors in 2023 at 3.5 percent from 14.7 percent in 2022, while industry and agriculture have experienced a also experienced much slower growth than in 2022. Although a small sector of the slowdown. economy, fisheries grew by 5.6 percent over the same period, which was important for those people whose livelihoods depend on the sector (Figure A.2). May 2024 THE WORLD BANK 1 Scaling Back & Rebuilding Buf fer s Maldives Development Update Figure A.1: Arrivals are increasing but average Figure A.2: …and real GDP growth is losing its duration of stay is still declining… momentum Number of tourist arrivals (lhs, lines), Days of stay (rhs, columns) Contribution to growth, percentage points 250,000 9.50 30 Agri.&Fish. Manufacturing Construction Trade Tourism 25 Transp. and Comm. Others 2024 2023 200,000 9.00 GDP 20 2022 15 150,000 8.50 2022 2023 2024 10 4.6 4.0 5.3 100,000 8.00 1.9 5 0 50,000 7.50 -5 2022-Q1 2022-Q2 2022-Q3 2022-Q4 2023-Q1 2023-Q2 2023-Q3 2023-Q4 0 7.00 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Ministry of Tourism, WB calculations. Source: National Bureau of Statistics Maldives (NBS), WB calculations. Inflation remained Inflation in Maldives rose in early 2023, following the impact of the GST rate increases elevated, driven – that became effective in January 2023 – combined with the pressure from higher by increased GST global commodity prices. As a result, consumer prices increased by an average of 2.9 rates and higher percent (y-o-y) in 2023, well above the historical average of 0.5 percent. This increase commodity prices... was more pronounced in the atolls (3.4 percent) than in Malé (2.6 percent), largely driven by higher prices of food and beverages (Figure A.3 and A.4). …but was moderated Government managed to ease pressures on utility and transportation prices through by government blanket subsidies. It increasingly intervened in markets to control prices via the supply interventions. of goods (food in particular) through the State-Owned Enterprises (SOEs). It also intervened in the parallel exchange rate market to prevent depreciation. Inflation started easing from the Q42023, with the moderation in global commodity prices, falling to 0.9 percent (y-o-y) in January 2024 as price increases slowed in all sectors. Figure A.3: Inflation was elevated in 2023, but price Figure A.4: Price increases were high in food and pressures declined towards the end of the year beverages Year-on-year change in consumer price index (CPI), percent Contributions to CPI growth, percentage points Republic Male' Atolls Transport Health Furnishing Housing and Utilities Food & Bev. Inf. & Comm. 6 Education Restaurants and Accom. Others CPI 5 5 4 4 3 3 2 2 1 1 0 -1 0 Mar-22 Apr-22 May-22 Jun-22 Jul-22 Aug-22 Sep-22 Oct-22 Nov-22 Dec-22 Jan-23 Feb-23 Mar-23 Apr-23 May-23 Jun-23 Jul-23 Aug-23 Sep-23 Oct-23 Nov-23 Dec-23 Jan-24 Feb-24 Apr-23 Jul-23 Oct-23 Feb-23 Mar-23 May-23 Jun-23 Aug-23 Sep-23 Nov-23 Dec-23 Jan-24 Feb-24 -2 Source: Maldives Bureau of Statistics, WB calculations. Source: Maldives Bureau of Statistics, WB calculations. May 2024 THE WORLD BANK 2 Scaling Back & Rebuilding Buf fer s Maldives Development Update Box 1: Global economic developments Global economic activity is slowing as the post-pandemic recovery wanes and both monetary and fiscal policy weigh on growth. However, the global slowdown has been less severe than expected, with consensus forecasts upgraded for many major economies (Figure A.5). Near-term prospects are diverging though, with growth in advanced economies as a whole and in China projected to slow in 2024, while aggregate growth is set to improve in developing economies with strong credit ratings. Figure A.5: Global growth in 2023 was better than China’s economy is experiencing subdued growth in expected the property sector, as major property developers have Percent defaulted on their debts. In the United States, recent 8 2023 growth forecast as of Dec.2022 data point to continued strength as inflation slows. 2023 growth, latest estimates Quarterly GDP growth has repeatedly surpassed market expectations, leading to an upgrade in estimated 6 annual growth for 2023. 4 Geopolitical risks have risen as a result of conflicts in the Middle East but are still lower than the levels reached during previous periods of global turmoil. Despite 2 volatility in the commodities markets triggered by the conflicts, average oil prices in 2024 are projected to decline on the back of adequate oil supplies and slowing global 0 activities. Metal prices are also set to decline in view of sluggish demand from major economies, notably China. -2 The softening commodities prices will likely ease fiscal United States Euro area China India and external sector pressures in the Maldives. Source: Consensus Economics. Monetary policy tightening appears to have peaked globally, with subsequent easing of policy interest rates likely to proceed at a measured pace. This, together with softening inflation, could keep real policy rates elevated for an extended period. Countries with weak credit ratings – approximately one in four emerging and developing economies, including the Maldives– are struggling to adjust to the recent period of global monetary tightening and will continue to face prohibitively high financing costs. Some have been forced to default on sovereign debts because they have effectively lost access to market-based financing. These countries remain vulnerable to new interest rate shocks, which could trigger a renewed period of capital outflows, currency depreciation, and surging inflation. Source: World Bank SARCE team. 2. Fiscal deficits and public debt remain high, leading to liquidity and solvency risks The fiscal deficit The fiscal deficit widened further in 2023 to an estimated 13.2 percent of GDP from continues to grow… 12.0 percent of GDP in 2022 (see Annex 2). With the support of goods and service tax (GST) rate hikes in early 2023,7 revenues grew by 17 percent (y-o-y), leading to a revenue collection of 32.2 percent of GDP compared to 29.8 percent of GDP in 2022. This was, however, offset by a sizeable expenditure growth of 17.9 percent (y-o-y) to an estimated level of 46.4 percent of GDP in 2023. …despite revenue GST collection grew by 35.8 percent (y-o-y) in 2023 to an estimated 13.0 percent growth supported by of GDP from 10.2 percent of GDP in 2022, largely from higher tourist arrivals and GST reforms…. an increase in the Tourism GST rate. Other tourism related revenues8 grew by 2.4 percent (y-o-y) in 2023, falling slightly to 8.1 percent of GDP from 8.5 percent of GDP in 2022 (Figure A.6). 7 The domestic goods and services tax was increased from 6 percent to 8 percent; and the tourism goods and service tax was increased from 12 percent to 16 percent in early 2023. 8 Other tourism related revenues include import tax, green tax, airport service charges, airport development fees, and resort rents. May 2024 THE WORLD BANK 3 Scaling Back & Rebuilding Buf fer s Maldives Development Update … as expenditure Total expenditure growth in 2023 was driven by high capital spending (14.9 percent of remained elevated. GDP), an elevated subsidy bill (3.6 percent of GDP), and Aasandha (health) spending (2.3 percent of GDP) (Figure A.7). Interest payments, which grew substantially by 64.1 percent (y-o-y) in 2022, grew further by 7.9 percent (y-o-y) in 2023 and remained elevated at MVR 3.7 billion (US$242 million) or 3.7 percent of GDP. This far exceeded the annual average between 2014–2019 of MVR 1.3 billion (US$85 million) or about 2 percent of GDP. Capital expenditure The Greater Malé Connectivity Project, Velana International Airport extension, new expanded in 2023, regional airports, housing, water and sewerage, and land reclamation projects drove while planned an increase in capital spending by 27.5 percent (y-o-y) in 2023. In addition, previously subsidy reforms were planned and budgeted subsidy reforms for fuel, electricity, food, and sanitation – that not implemented… aimed to reduce expenditures by 3 percent of GDP in 2023 – were not implemented. …leading to Higher spending led the government to seek approval for an MVR 6.5 billion (US$422 overspending, a million or 6.4 percent of estimated GDP) supplementary budget in 2023, which was supplementary to be financed through domestic and external sources. However, more challenging budget, and a conditions for domestic and external financing left a financing gap of US$200 million financing gap in (2.8 percent of GDP) in 20239. 2023… …whilst the If implemented, the 2024 budget – which aims to accelerate spending on mega approved 2024 infrastructure projects10 alongside proposed subsidy reforms – would result in a fiscal budget comes deficit of over 10 percent of GDP. According to official forecasts, implementation of with an additional the approved 2024 budget would require closing a financing gap of US$550 million11. financing gap. When considered alongside tightened global financial conditions, existing high debt stock, and a reliance on domestic and external commercial borrowing, this has raised concerns about government’s liquidity and solvency as well as the implications for broader economic stability. 9 https://edition.mv/news/32907 10 The Velana International Airport Terminal Expansion Project and the Greater Male’ Connectivity Project are currently the largest development projects in Maldives. Election related promises are expected to result in other infrastructure projects such as regional airports and social housing. 11 The authorities issued a Request for Proposals to finance the approved 2024 Budget on January 9, 2024. https://www.finance.gov. mv/media/announcements/request-for-proposals-central-government-financing-2024 May 2024 THE WORLD BANK 4 Scaling Back & Rebuilding Buf fer s Maldives Development Update Figure A.6: Growth in revenues driven by tourism Figure A.7: …yet expenditure remains elevated due expansion, GST reforms… to capital investments, subsidies and other recurrent y-o-y change, in percent spending y-o-y change, in percent 60 Other revenues 50 Aasandha Subsidies Interest cost Business and Property tax Salaries and wages Other recurrent spending Other Tourism Revenues 40 Capital Expenditure Total Expenditure Tourism GST 40 General GST Total Revenues and Grants 30 20 20 10 0 0 -20 -10 2022- 2022- 2022- 2022- 2023- 2023- 2023- 2023- 2022- 2022- 2022- 2022- 2023- 2023- 2023- 2023- Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Source: Ministry of Finance, World Bank calculations. Source: Ministry of Finance, World Bank calculations. Note: Other Tourism Revenues consists of import duties, green tax, airport service charges/departure tax, airport development fees and resort rents. Public debt far Total public and publicly guaranteed (PPG) debt rose to US$8.0 billion or an estimated exceeds the size of 122.9 percent of GDP in 2023,12 compared to US$7.0 billion or 114.5 percent of the economy… GDP the year before, due to elevated borrowing to finance the fiscal deficit and infrastructure projects (Figure A.8). Domestic debt increased to 72.2 percent of GDP13 in 2023, from 62.1 percent of GDP in 2022, as tighter global financial conditions compelled government to depend more on domestic finances. As a result, outstanding external debt only grew by a mere 3.3 percent (y-o-y) in 2023 to US$3.3 billion or 50.5 percent of GDP14 (Figure A.9). …with growing While a US$500 million, 5-year Sukuk issuance in 2021 and an extension of a privately external liquidity placed US$100 million bond due in 2023 addressed immediate refinancing risks, these needs arising in the have led to an increase in interest costs over the medium term. Additionally, total near term debt servicing is expected to spike in 2026 to around US$1.0 billion as these debt instruments mature. High financing needs, coupled with low external buffers, place further liquidity pressures on government that will require a major fiscal adjustment and/or new sources of external financing. 12 Based on World Bank’s latest macroeconomic forecasts. 13 Based on World Bank’s latest macroeconomic forecasts. 14 Based on World Bank’s latest macroeconomic forecasts. May 2024 THE WORLD BANK 5 Scaling Back & Rebuilding Buf fer s Maldives Development Update Figure A.8: Public infrastructure projects and subsidies Figure A.9: …which has led to a sharp increase in have driven up spending over the last decade… the debt stock Public expenditure as a share of GDP PPG in US$ millions and percent of GDP (rhs) 50 PSIP Pensions Interest Payments External debt Domestic debt Administrative expenditure Total PPG debt (RHS) 9,000 160 Grants, Contributions and Subsidies 40 Salaries, wages and allowances 8,000 140 12 7,000 120 30 2 6,000 4 100 3 2 5,000 2 6 80 20 4,000 5 60 10 3,000 5 10 2,000 40 11 10 1,000 20 0 0 0 2014 2023* 2019 2020 2021 2022 2023 Source: Ministry of Finance, World Bank calculations. Source: Ministry of Finance, World Bank calculations. *2023 figures were calculated with WB’s growth projections. 3. Household welfare is under pressure from slower growth and fiscal vulnerabilities Households face Maldives is a small island economy that relies heavily on revenues from international economic pressures high-end tourism, which is then redistributed to the population via generous public from the economic spending. This redistributive model of welfare is vulnerable to economic and fiscal challenges… contraction, as evident during the COVID-19 pandemic. …and compensation Unless a targeted income support measure is implemented, the proposed fiscal reforms for welfare losses of may pose a burden for the poor and vulnerable, who will need to be compensated vulnerable groups to avoid large welfare losses. While these reforms will help restore fiscal stability, will be crucial. they imply a disproportional welfare loss on the bottom of the population. This is because a larger share of poorer households’ incomes is dependent on cash and in- kind transfers received from the government – in the form of universal access to health and education – as well as indirect subsidies. A targeted direct Welfare losses from the removal of subsidies will affect most of the population. cash transfer Without a targeted direct cash transfer mechanism, the impact on welfare is expected mechanism is critical to be higher among households in the poorest decile. The contribution of subsidies to offset welfare to household income remains high among vulnerable households at the bottom of losses from the the distribution, at 10.1 and 8.4 percent for the bottom and second bottom deciles, removal of blanket respectively (Figure A.10). The impact is expected to be even higher in 2023 as subsidies. international prices for subsidized goods (diesel, food) have increased over the past four years and the expenditure on subsidies has almost tripled between 2019 and 2023. At the same time, however, blanket subsidies are an inefficient way to allocate resources. Hence subsidy removal creates the opportunity to recycle fiscal savings into more targeted, pro-poor interventions. For example, 56 percent of total public spending on subsidies went to households in the top six deciles (Figure A.11). Therefore, the government’s ongoing efforts to establish a targeting mechanism to replace indirect subsidies is welcome, and will be a major tool to ensure that vulnerable populations are not disproportionately affected by the reform. May 2024 THE WORLD BANK 6 Scaling Back & Rebuilding Buf fer s Maldives Development Update Figure A.10: Indirect subsidies benefit poorer Figure A.11: … but also allocate resources households in relative terms… inefficiently to non-poor households Indirect subsidies as a share of income before taxes by income decile Share of total spending on subsidies going to each income decile 12% 14% 10.1 12.0 12.0 12% 10% 10.0 11.0 10.0 10.0 10.0 Share of Prefiscal Income 8.4 9.0 10% 8% 7.3 9.0 Share of benefit 8% 7.0 6% 5.4 4.7 6% 3.8 4% 3.4 2.7 4% 1.0 2% 1.2 2% 0% 0% 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 Decile Household Prefiscal Income Decile Household Prefiscal Income Source: HIES 2019, WB calculations. Source: HIES 2019, WB calculations. Close monitoring The repercussions of higher prices following fiscal reforms could impact the of labor markets is labor market by increasing costs for employers and eroding the purchasing power needed to mitigate of wages, which is expected to be compensated by targeted cash transfers. In any negative Q42023, price pressure intensified in all business sectors; businesses in construction, impacts… transportation, and communication expected prices to keep increasing in Q1202415. Youth unemployment among those aged 18 to 35 is higher at 6.1 percent and the NEET rate (not in education, employment, or training) is 19 (23) percent among young Maldivians aged 15 to 24 (aged 18 to 35), but higher among women (22 percent among women aged 15 to 24 and 34 percent among women aged 18 to 35). Closely monitoring labor markets and welfare during any fiscal adjustment will be key to inform an appropriate policy response. …which includes on Impacts on foreign and national employees in the tourism sector will also need to be expatriate workers. monitored. Overall unemployment is low among Maldivians, at about 3 percent of the working-age population. Still, a large share of the population is out of the labor force (36 percent, of which 19 percent belong to the potential labor force category)16. Foreigners make up 26 percent of the total population in Maldives and most of them are employed, primarily in the tourism sector. Compensation measures such as a revision to minimum wage to offset price increases faced by migrant workers, especially among the most vulnerable (e.g., domestic workers), could be considered. 15 https://www.mma.gov.mv/documents/Quarterly%20Business%20Survey/2023/QBS-Q4-2023.pdf 16 Potential Labor Force comprises individuals actively seeking employment, even though job opportunities are not readily available (un- available jobseekers), an individuals who are not currently seeking employment but are available and ready to commence work (available non-jobseekers). https://census.gov.mv/2022/wp-content/uploads/2023/09/Umemployment-Census-2022.pdf May 2024 THE WORLD BANK 7 Scaling Back & Rebuilding Buf fer s Maldives Development Update 4. A larger current account deficit and rising external financing needs have led to a deterioration in external balances and FX reserves The current account The CAD, which was 16.7 percent of GDP (US$1 billion) in 2022, widened to an deficit (CAD) estimated 23.5 percent of GDP in 2023 (just over US$1.5 billion), following a 9.1 widened in 2023. percent GDP contraction in services exports (see Annex 1). Travel sector receipts, which account for 95 percent of services exports, contracted by 9.2 percent of GDP in 2023. Merchandise imports on the other hand remained elevated at US$3.6 billion driven by construction related imports to support PSIP projects (Figure A.12), leading to sustained high trade deficits (Figure A.13). Figure A.12: While imports growth has slowed… Figure A.13: …the trade deficit remains high Contribution to import growth, in percent US$ million 80 1,200 Trade Balance Imports Exports Food items Furniture Electronic Petroleum 1,000 Transport equip Construction & Capital Others Total Imports 800 60 600 400 40 200 0 20 -200 -400 0 -600 -800 -20 -1,000 Q1- Q2- Q3- Q4- Q1- Q2- Q3- Q4- Q2- Q3- Q4- Q1- Q2- Q3- Q4- Q1- 2022 2022 2022 2022 2023 2023 2023 2023 2022 2022 2022 2023 2023 2023 2023 2024 Source: MMA, World Bank calculations. Source: MMA, World Bank calculations. The widening CAD Net FDI grew by an estimated 8.7 percent (y-o-y) to US$796 million (or 12.1 percent was largely financed of GDP) covering 72 percent of the CAD in 2023. The government did not issue any by FDI... international securities during the year and depended on the MMA’s official reserves and bilateral budgetary support for foreign exchange needs to cover the remainder of the CAD (Figure A.14). … and pressures on The widening CAD and rising debt obligations led to a fall in official reserves to official reserves have US$588.6 million at end 2023 and currently stands at US$ 541.8 million, as of March intensified, making 2024 (sufficient to cover 1.8 months of imports). Although short-term liabilities (i.e., Maldives yet more coming due within the next 12 months) declined to US$428.1 million in March 2024 vulnerable to external from US$564.4 million a year earlier, the usable reserves are sufficient to cover only shocks. 0.4 months of imports, creating external vulnerabilities and testing the country’s ability to service its external debt (Figure A.15). 17 World Bank estimates. May 2024 THE WORLD BANK 8 Scaling Back & Rebuilding Buf fer s Maldives Development Update Figure A.14: CAD largely financed by FDI… Figure A.15: …as reserves dropped with the rising Percent of GDP import bill to critically low levels Official reserves US$ million (lhs) and months of import cover (rhs) Net Other investments Net Portfolio investments Months of imports (rhs) Net FDI Secondary income Primary income (rhs)ST liabilities) Months of imports (net Balance on Goods & Services Current Account Balance Months Reserves Official of imports (net ST liabilities) 1,200 Reserves net ST liabilities Official Reserves 7 40 1,200 Reserves net ST liabilities 7 30 1,000 6 20 1,000 6 5 800 10 5 800 4 0 600 4 -10 600 3 400 3 -20 2 400 -30 2 200 1 -40 200 1 0 0 -50 2019 2020 2021 2022 2023 Mar-24 2019 2020 2021 2022 2023 0 0 2019 2020 2021 2022 2023 Mar-24 Source: MMA, World Bank calculations. Source: MMA, World Bank calculations. Note: 2023 figures are based on World Bank GDP estimations 5. MMA’s exposure to the sovereign remains high and the exchange rate is under pressure Policy rates have The Maldives Monetary Authority (MMA) has kept the minimum reserve requirement been unchanged (MRR) unchanged at 10 percent of average local currency deposits, since the last since June 2021, increase from 7.5 percent in June 2021, while the MRR for foreign currency deposits despite inflationary has been maintained at 10 percent since October 2022. In addition, the interest rate pressures. corridor has also been maintained in the same band, with the overnight deposit facility (ODF)18 and overnight Lombard facility (OLF)19 unchanged at 1.5 and 10 percent, respectively. Foreign exchange Reduced FX earnings from tourism relative to GDP, and the rising import bill have (FX) pressures have led to a reduction in official FX reserves and rising FX pressures. The exchange rate is been elevated. currently pegged at MVR 15.39 per USD, nearing its upper threshold and far from the MRV 12.85 mid-point (Figure A.16). MMA’s international FX reserves are increasingly earmarked for imports and public sector debt servicing, limiting FX supply to the official market. Consequently, a volume of FX trading is occurring in the parallel market, where rates are 15-17 percent higher than the official market. Rising public sector Repeated debt exchange operations in 2023 through securitizations20 expanded borrowing in 2023 MMA’s total exposure to central government. While MMA advances to the central weighed on MMA’s government slowed down, the overall exposure continued increasing, reaching MVR balance sheet. 14.6 billion, or 59.6 percent of MMA assets, in January 2024 (Figure A.17). 18 MMA commenced the ODF for commercial banks on 23 March 2010, whereby banks can place their excess funds at MMA overnight. This facility carries the lowest rate in the system, below the deposit rate offered to commercial banks’ customers. The ODF rate is 1.5 percent per annum, effective 1 September 2014. 19 The MMA introduced OLF to commercial banks on 9 May 2010, allowing for banks to borrow from the MMA on an overnight basis, mainly to avoid disruptions in the payments system and to meet the MRR level. This facility carries the highest rate in the system, above the overnight lending rates among commercial banks. The OLF rate is 10 percent per annum, effective 1 September 2014. 20 The Ministry of Finance (MOF) has securitized most of the advances received from the MMA over the 2020–2023 period under the exemption of certain clauses of the Fiscal Responsibility Act (FRA). The temporary suspension of FRA was terminated by the end of 2023. May 2024 THE WORLD BANK 9 Scaling Back & Rebuilding Buf fer s Maldives Development Update Figure A.16: FX pressures have remained elevated… Figure A.17: …while MMA continues to finance USD million, MVR government spending MVR million, percent 15.43 MVR per USD (rhs) 16,000 Claims on central government 70 Advances to CG (rhs) 15.41 14,000 Claims on central government 60 (% of total assets) (rhs) 15.39 12,000 50 15.37 million MVR 10,000 15.35 40 8,000 15.33 30 6,000 15.31 20 4,000 15.29 2,000 10 15.27 15.25 0 0 Jan-19 May-19 Sep-19 Jan-20 May-20 Sep-20 Jan-21 May-21 Sep-21 Jan-22 May-22 Sep-22 Jan-23 May-23 Sep-23 Jan-24 Jan-19 May-19 Sep-19 Jan-20 May-20 Sep-20 Jan-21 May-21 Sep-21 Jan-22 May-22 Sep-22 Jan-23 May-23 Sep-23 Jan-24 Source: MMA, World Bank calculations. Source: MMA, World Bank calculations. Credit and deposit Credit to the private sector grew by 9.3 percent (y-o-y) at the end of 2023, with growth are trending growth observed in personal loans and business lending. The growth in personal up… loans reflected larger credit card debt and financing for consumer durable goods. Meanwhile, deposit growth has firmed up, increasing from 1.6 (y-o-y) in July 2023 to an average of 7.6 percent in the latter half of the year (Figure A.18). …whilst banks’ Banks’ exposure to the public sector showed some signs of stabilization in the second exposure to the half of 2023, ending the year at 30 percent of total banking sector assets, a similar public sector remains level recorded 12 months earlier. However, direct exposure to SOEs (some of which high. have known financial difficulties) were 5.3 percent of banking sector assets, growing by 49.7 percent in 2023 (Figure A.18). Although the At 50.5 percent, as of end-2023, the banking system’s capital adequacy ratio is banking sector is well above the regulatory minimum of 12 percent. However, this ratio overstates well capitalized, the financial strength of banks due to the zero-credit risk weight applicable to all vulnerabilities government exposures (including FX-denominated ones) on banks’ books and the persist. absence of any provisions on government exposures. Non-performing loans (NPLs) have been steadily increasing from 7.5 percent in mid-2023 to 8.3 percent at the end of the year. At the same time, provisioning for NPLs has been diminishing, ending the year at 58.6 percent of NPLs (Figure A.19). Furthermore, at -10.5 percent, the net open position in foreign exchange has plunged further into negative territory, deepening the exposure of banks’ balance sheets to FX exchange risk in the event of a potential Maldivian rufiyaa devaluation. May 2024 THE WORLD BANK 10 Scaling Back & Rebuilding Buf fer s Maldives Development Update Figure A.18: Credit and deposits have been Figure A.19: …and although banking sector recovering and sovereign-bank nexus shows signs of indicators look sound overall, vulnerabilities persist stabilization… Percent Percent Claims on Central Government Regulatory capital to risk-weighted assets and SOEs (% of assets) 120 Nonperforming loans to total gross loans Credit Growth (YoY, %) Provisions to nonperforming loans 40 Deposit Growth (YoY, %) 45 100 30 35 80 20 25 50.7 50.5 60 46.8 46.3 46.4 44.7 10 15 40 0 5 20 -10 -5 Dec-20 Dec-21 Dec-22 Dec-23 Jun-20 Jun-21 Jun-22 Jun-23 0 2018 2019 2020 2021 2022 2023 Source: MMA, World Bank calculations. Source: MMA, World Bank calculations. May 2024 THE WORLD BANK 11 Scaling Back & Rebuilding Buf fer s Maldives Development Update A2. Outlook and Risks 6. Medium-term growth is forecast to moderate and is subject to major downside risks Growth outlook The economy is projected to grow by 4.7 percent on average over the medium term – moderates to 4.7 lower than the pre-pandemic average of 7.4 percent (Table A.1). The moderation in the percent over the forecasts (Figure A.20) reflects: (i) an expected fiscal adjustment – including the impact medium term… on real household incomes from the planned subsidy reforms as per Budget 2024, and a fall in government consumption and investments; and (ii) reduced spending per tourist following the successful expansion of guesthouses accommodation options to complement high-end resorts. …while external and External and fiscal vulnerabilities, along with increased debt risks pose downside risks fiscal vulnerabilities to the economic outlook. Failure to implement planned fiscal reforms, while obtaining persist… new external debt at expensive terms, could lead to a fiscal or debt sustainability shock. Sustaining macroeconomic stability will require a major fiscal adjustment and implementation of a multi-year reform plan (Table A.1). …and downside The global economic outlook is dimmed by slower growth, high commodity prices, risks to the global and ongoing geopolitical conflicts. Major economies including China are projected economic outlook to experience an extended slowdown due to financial and fiscal distress, with risks cloud medium-term tilted towards the downside. The existence of these global uncertainties, as well as growth prospects. any additional global shocks, poses risks to Maldives’ economic outlook, especially if there is a slowdown in countries that are key sources of tourists, such as China. Stronger tourism performance would provide some upside. May 2024 THE WORLD BANK 12 Scaling Back & Rebuilding Buf fer s Maldives Development Update Table A.1: Growth outlook is modest and will be supported by tourism, but subject to major downside risks 2022 2023e 2024f 2025f 2026f Real GDP Growth, at constant market prices 13.9 4.0 4.7 5.2 4.1 Agriculture 3.1 3.2 3.0 2.8 2.7 Industry 25.2 8.5 2.0 4.7 1.8 Services 14.7 3.5 5.1 5.4 4.5 Inflation (Consumer Price Index) 2.3 2.9 7.5 6.5 5.0 Current Account Balance (% of GDP) -16.7 -23.4 -19.4 -18.0 -14.3 Fiscal Balance (% of GDP) -12.0 -13.2 -12.2 -11.0 -9.5 Primary Balance (% of GDP) -8.3 -9.6 -8.3 -7.2 -6.0 Debt (% of GDP) 114.5 122.9 122.1 119.7 118.4 Source: World Bank estimates and forecasts as of March 2024. Inflation is projected Inflation is projected to rise to 7.5 percent in 2024, largely due to the planned subsidy to rise due to the reforms, that are expected to be implemented in 2024, and the spillover effects. planned removal of Inflation is expected to decline to 6.5 percent in 2025 and 5.0 percent in 2026 but is subsidies. subject to downside risks that may result from oil price shocks or global production cuts. Fiscal deficits are The fiscal deficit is expected to remain elevated in 2024, as the approved 2024 Budget expected to remain includes ambitious spending plans with an estimated financing gap of over US$700 elevated in 2024 million (Figure A.21). The macroeconomic projections rely on the assumption that the despite planned financing gap will be closed by external financing, which has not been identified yet. fiscal reforms… While subsidy reforms are already included in the budget, the fiscal deficit projections also consider planned Aasandha reforms supported by the bulk procurement of medicines that are likely to decrease health spending. …and moderate over The global economic outlook is dimmed by slower growth, high commodity prices, the medium term. and ongoing geopolitical conflicts. Major economies including China are projected to experience an extended slowdown due to financial and fiscal distress, with risks tilted towards the downside. The existence of these global uncertainties, as well as any additional global shocks, pose risks to Maldives’ economic outlook, especially if there is a slowdown in countries that are key sources of tourists, such as China. A stronger tourism performance would provide some upside. May 2024 THE WORLD BANK 13 Scaling Back & Rebuilding Buf fer s Maldives Development Update Figure A.20: Real GDP growth is modest over the Figure A.21: …while the size of a fiscal adjustment medium term… will depend on a strong commitment Year-on-year growth, percent Percent of GDP 16 Mar-2024 forecast Sep-2023 forecast Fiscal Balance Primary Balance 0 14 13.9 -2 12 10 -4 8 -6 6.5 -6.0 6 5.2 5.5 -8 -7.2 4 4.7 5.2 -8.3 -8.3 4.0 4.1 -10 -9.5 -9.6 2 -12 -11.0 0 -12.0 -12.2 -14 -13.2 2022 2023e 2024f 2025f 2026f 2022 2023e 2024f 2025f 20206f Source: Ministry of Finance and World Bank projections. Source: Ministry of Finance and World Bank projections The CAD is Imports of capital goods to complete ongoing and planned infrastructure projects expected to remain and global commodity price pressures are expected to keep the CAD elevated over substantially the medium term (Table A.1). The CAD is projected to moderate slightly in 2025, elevated. followed by a more meaningful decline in 2026, as larger investment projects are wound up and capital spending declines (Figure A.22). Persistently large CADs and external debt servicing needs will continue to exert pressure on the balance of payments and official reserves. External financing External debt and fiscal vulnerabilities remain a concern for Maldives in the short risks are growing and and medium term. The shortfall in external financing in early 2024 and low level are highly sensitive of reserves have put Maldives in a difficult situation. Annual average debt servicing to global conditions. needs are projected at US$512 million in 2024 and 2025, followed by a spike of US$1.07 billion in 2026 (Figure A.23). This includes bullet payments for the US$500 million Sukuk and US$100 million private placement. The country’s ability to repay or roll over its external debt will remain dependent on the state of global markets, as well as the availability of credit enhancement measures, for liquidity management or debt for nature deals. External buffers Despite government efforts to transfer a portion of revenues to the Sovereign remain limited. Development Fund (SDF), which was designed to pay off some of the maturing debt, the fund’s balance remains too small in comparison to medium-term external debt servicing needs. Additionally, the SDF Bill, which was expected to bring more clarity to the purpose of the SDF and define its functions more clearly, was rejected by Parliament with no reason provided. A multi-year fiscal The PPG debt to GDP is forecast to remain at over 118 percent (Table A.1). Such high reform program levels of public debt, and associated refinancing risks, make the Maldivian economy with a strong fiscal vulnerable to domestic and external shocks. Low external and fiscal buffers, mean adjustment path is that fiscal adjustment is required to mitigate debt sustainability risks. Thus, despite urgently required. somewhat robust growth prospects, prudent debt management remains a top priority to improve fiscal sustainability, lower the cost of growth-enhancing investments – especially with large debt service obligations coming due (Figure A.23) – and ensure a more resilient economy going forward. May 2024 THE WORLD BANK 14 Scaling Back & Rebuilding Buf fer s Maldives Development Update Figure A.22: Current account deficit is expected to Figure A.23: …with increasing external debt remain elevated due to higher capital imports… servicing pressures over the next few years Percent of GDP External debt service projections for PPG debt, US$ million 0 Principal and other payments 1200 Interest payments Official reserves -5 1000 800 -10 600 -15 -14.3 400 -16.7 -20 -18.0 200 -19.4 0 -25 -23.4 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2022 2023e 2024f 2025f 20206f Source: Maldives Monetary Authority and World Bank estimates. Source: Ministry of Finance, Maldives Monetary Authority and World Bank calculations. Note: Data as of August 2023, do not include debt service costs of pipeline loans – neither non-concessional nor commercial. Thus, debt servicing costs of the outer years may be underestimated. Fiscal reforms have In line with the new MTFS, the authorities recently announced a fiscal reform been announced, agenda21 that aims to reduce expenditure by: (i) eliminating fuel, electricity, food and and their success will sanitation subsidies, and replacing them with a targeted cash transfer mechanism depend on effective by July 2024;22 (ii) changing the coverage policy of health services for high-income implementation. earners, and implementing measures to reduce drug costs (such as bulk procurement of medicines from India and other countries, which also requires an upgrade in the storage capacity of STO);23 (iii) reducing and prioritizing the PSIP envelope; and (iv) improving the efficiency and viability of SOEs with spending cuts and market- based pricing adjustments24. Implementation of these reforms will require strong commitment and effective communication with all Maldivians. The reform plan also needs to be accompanied by an effective mechanism to offset welfare losses among the vulnerable groups. The bottom line remains that without the implementation of a meaningful fiscal adjustment program, public debt could rise alarmingly fast over the medium term, and short-term solvency and liquidity risks will remain real. Reducing the Maldives’ heavy dependance on tourism leaves the country vulnerable to external dependency on shocks, emphasizing the need for some structural diversification of the economy. tourism remains a In addition, private sector development is hindered by government’s heavy presence challenge. in the non-tourism economy via SOEs. Offering new tourism products, such as environmentally friendly eco-tourism options may enhance within tourism sector diversification, which could further benefit those living in outer atolls and inhabited 21 On 5 February 2024, yet the adjustment plan has not been shared with the public. 22 According to the approved budget, this is expected to result in expenditure savings of around MVR1.5 billion or around 1.3 percent of projected GDP in 2024. To mitigate negative welfare impacts of subsidy reforms on vulnerable groups, the government plans to provide direct cash transfers that correspond to around half of subsidy-related savings. 23 The bulk procurement measures will lead to an estimated 0.3 percent of GDP spending reduction in 2024. 24 The government is considering SOE reforms and a reprioritization in infrastructure spending, but the details of these measures are yet to be announced. May 2024 THE WORLD BANK 15 Scaling Back & Rebuilding Buf fer s Maldives Development Update islands. Better infrastructure, enhanced connectivity, and favorable rents for resort developments could enhance tourism in the Northern and Southern Atolls. An upcoming new submarine cable is expected to enhance digital connectivity in Maldives, potentially leading to greater job opportunities. However, any infrastructure investments must be well sequenced and planned, and consider the country’s current debt vulnerabilities. Boosting the fisheries sector by expanding fish processing and cold storage facilities – as well as opening new export markets and reducing the state’s footprint in the sector that leads to market distortions – could help reduce the country’s high dependency on tourism. Additional avenues for diversification, trade, and growth also need to be explored. May 2024 THE WORLD BANK 16 Scaling Back & Rebuilding Buf fer s Maldives Development Update Annex 1: Balance of Payments (percent of GDP) 2020 2021 2022 2023e Current Account Balance -35.9 -8.7 -16.3 -23.5 Balance on Goods and Services -17.9 9.6 3.2 -2.4 Merchandise Trade Balance -39.2 -40.2 -47.4 -44.7 Merchandise Exports 7.0 5.4 6.5 6.7 o/w fish exports 4.2 2.7 2.4 2.3 o/w jet fuel re-exports 1.4 1.9 3.1 3.0 Merchandise Imports 46.1 45.6 53.9 51.4 o/w fuel 7.1 8.7 13.5 11.5 Merchandise Imports 46.1 45.6 53.9 51.4 o/w fuel 7.1 8.7 13.5 11.5 o/w capital and construction goods 15.1 14.2 18.0 17.4 Services Trade Balance 21.3 49.8 50.6 42.3 Service Exports 41.3 70.6 76.3 67.2 o/w travel services (tourism) 37.7 67.0 73.1 63.7 Capital Account Balance 0.0 0.0 0.0 0.0 Net borrowing (balance from current and capital a/c) 35.9 -8.7 -16.3 -23.5 Financial Account Balance (excluding reserves and related items) 34.7 11.5 13.8 20.7 Direct Investment, net 11.9 12.3 11.9 12.1 Portfolio Investment, net -1.3 5.4 -1.3 -0.5 o/w general government debt issuance 0.0 5.9 0.0 0.0 Other Investment, net 24.1 -6.2 3.2 9.1 Net Errors and Omissions 6.6 -6.2 2.9 -0.5 OVERALL BALANCE 5.5 -3.4 0.4 -3.2 FINANCING Official Reserves (- increase) -5.5 3.4 -0.4 3.2 May 2024 THE WORLD BANK 17 Scaling Back & Rebuilding Buf fer s Maldives Development Update Annex 2: Key Fiscal Indicators (percent of GDP) 2020 2021 2022 2023e Total Revenue and Grants 26.6 26.4 30.0 33.0 Total Revenue 25.0 25.1 29.8 32.2 Tax Revenue 19.2 18.2 20.5 23.8 o/w Import Duties 4.0 3.5 3.7 3.4 o/w Business and Property Tax 6.4 3.4 4.5 5.1 o/w Tourism Goods and Services Tax 3.9 6.5 6.9 8.6 o/w General Goods and Services Tax 3.7 3.1 3.3 4.4 o/w Airport Service Charges 0.5 0.6 0.9 1.0 o/w Green Tax 0.6 1.0 1.0 1.0 Non-Tax Revenues 5.8 6.9 9.3 8.4 o/w Airport Development Fees 0.8 1.0 0.9 1.0 o/w Property Income 1.2 2.6 2.0 1.7 Grants 1.7 1.3 0.4 0.5 Total Expenditure 43.4 35.3 42.0 46.4 Recurrent Expenditure 28.6 24.3 29.5 31.5 o/w Personal Emoluments 14.4 10.7 9.8 10.0 o/w Pensions, Retirement Benefits, and Gratuities 2.7 2.0 1.9 1.9 o/w Goods and Services 7.4 6.9 5.2 5.7 o/w Grants, Contributions, and Subsidies 8.0 7.2 8.9 9.6 o/w Interest Payments 2.8 2.6 3.6 3.9 Non-Tax Revenues 5.8 6.9 9.3 8.4 o/w Airport Development Fees 0.8 1.0 0.9 1.0 o/w Property Income 1.2 2.6 2.0 1.7 Primary Fiscal Balance -14.0 -6.3 -8.3 -9.6 Overall Fiscal Balance -16.8 -8.9 -12.0 -13.4 May 2024 THE WORLD BANK 18 Scaling Back & Rebuilding Buf fer s Maldives Development Update May 2024 THE WORLD BANK 19