Compact of Free Association: Micronesia Faces Challenges to
Achieving Compact Goals (10-JUN-08, GAO-08-859T).
From 1987 through 2003, the Federated States of Micronesia (FSM)
received more than $1.5 billion in economic assistance under the
original Compact of Free Association with the United States. In
2003, the U.S. government approved an amended compact with the
FSM that provides an additional $2.3 billion from 2004 through
2023. The Department of the Interior's Office of Insular Affairs
(OIA) is responsible for administering and monitoring this
assistance. The amended compact identifies the additional 20
years of grant assistance as intended to assist the FSM in its
efforts to promote the economic advancement and budgetary
self-reliance of its people. The assistance is provided in the
form of annually decreasing grants that prioritize health and
education, paired with annually increasing contributions to a
trust fund intended as a source of revenue for the country after
the grants end in 2023. The amended compact also contains several
new funding and accountability provisions intended to strengthen
reporting and bilateral interaction. Among these provisions is a
requirement for the establishment of a joint economic management
committee and a trust fund committee to, respectively, among
other duties, review the FSM's progress toward compact objectives
and assess the trust fund's effectiveness in contributing to the
country's economic advancement and long-term budgetary
self-reliance. In 2003, we testified that these provisions could
improve accountability over the assistance provided but that
successful implementation of these provisions would require
appropriate resources and sustained commitment from both the
United States and the FSM. Drawing on several more recent reports
as well as updated information, this report will discuss the
FSM's economic prospects, implementation of the amended compact
to meet its long-term goals, and potential trust fund earnings.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-08-859T
ACCNO: A82312
TITLE: Compact of Free Association: Micronesia Faces Challenges
to Achieving Compact Goals
DATE: 06/10/2008
SUBJECT: Cost analysis
Economic analysis
Economic development
Economic growth
Economic policies
Federal aid programs
Federal aid to foreign countries
Financial disclosure
Financial management
Foreign aid programs
Foreign economic assistance
Foreign financial assistance
Foreign governments
Foreign policies
International agreements
International economic relations
International relations
Trust funds
Funds management
Budget activities
Cost awareness
Cost estimates
Compact of Free Association with
Micronesia
Federated States of Micronesia
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GAO-08-859T
* [1]Summary
* [2]Background
* [3]Compact of Free Association: 1986-2003
* [4]Amended Compact of Free Association: 2004-2023
* [5]FSM Economic Prospects Remain Limited
* [6]Numerous Factors Hinder Use of Compact Funds to Advance FSM
* [7]FSM Trust Fund May Not Provide Sustainable Income after Comp
* [8]Concluding Remarks and Prior Recommendations
* [9]Contacts and Acknowledgements
* [10]Attachment I: Related GAO Products
* [11]Attachment II: U.S. Assistance to the FSM under the Amended
* [12]Attachment III: Estimated FSM Per Capita Compact Grant Assis
* [13]Attachment IV: Amended Compact Implementation Framework
* [14]Attachment V: FSM Sector Grant Allocations, Fiscal Years 200
* [15]Attachment VI: FSM Unspent Compact Grants by Sector, Fiscal
* [16]Attachment VII: Projections of FSM Account Balance with Thre
* [17]Attachment VIII: Probability of FSM Trust Fund Income Not Re
* [18]Ordering Information.pdf
* [19]Order by Mail or Phone
Testimony
Before the Insular Affairs Subcommittee, House Resources Committee, U.S.
House of Representatives
United States Government Accountability Office
GAO
For Release on Delivery Expected at 11:00 a.m. EST
Tuesday, June 10, 2008
COMPACTOF FREE ASSOCIATION
Micronesia Faces Challenges to Achieving Compact Goals
Statement of David Gootnick, Director
International Affairs and Trade
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GAO-08-859T
Madame Chairwoman and Members of the Subcommittee:
I am pleased to be here today to discuss GAO's recent work regarding the
amended Compact of Free Association between the United States and the
Federated States of Micronesia (FSM).1
From 1987 through 2003,2 the FSM received more than $1.5 billion in
economic assistance under the original Compact of Free Association with
the United States.3 In 2003, the U.S. government approved an amended
compact with the FSM that provides an additional $2.3 billion from 2004
through 2023.4 The Department of the Interior's Office of Insular Affairs
(OIA) is responsible for administering and monitoring this assistance.
The amended compact identifies the additional 20 years of grant assistance
as intended to assist the FSM in its efforts to promote the economic
advancement and budgetary self-reliance of its people. The assistance is
provided in the form of annually decreasing grants that prioritize health
and education, paired with annually increasing contributions to a trust
fund intended as a source of revenue for the country after the grants end
in 2023.5 The amended compact also contains several new funding and
accountability provisions intended to strengthen reporting and bilateral
interaction. Among these provisions is a requirement for the establishment
of a joint economic management committee and a trust fund committee to,
respectively, among other duties, review the FSM's progress toward compact
objectives and assess the trust fund's effectiveness in contributing to
the country's economic advancement and long-term budgetary self-reliance.
In 2003, we testified that these provisions could improve accountability
over the assistance provided but that successful implementation of these
provisions would require appropriate resources and sustained commitment
from both the United States and the FSM.6
1The FSM comprises four states--Chuuk, Kosrae, Pohnpei, and Yap--with 50
percent of the FSM population residing in Chuuk state. A list of relevant
GAO reports on the FSM is included in attachment I.
2In this testimony, all years cited are fiscal years (Oct. 1-Sept. 30).
3Under the original Compact of Free Association, the United States also
provided about $579 million of economic assistance to the Republic of the
Marshall Islands (RMI). In 2000, we reviewed assistance under the compact
and determined that the U.S., FSM, and RMI governments had provided
limited accountability over spending and that U.S. assistance had resulted
in little impact on economic development in the FSM and RMI. See
[20]GAO/NSIAD-00-216.
4This figure is based on a Department of the Interior projection included
in its Fiscal Year 2009 Budget Justification. The United States also
signed an amended compact with the RMI that provides about $1.5 billion
from 2004 through 2023.
5According to U.S. officials, the trust fund income is intended to be one
source of income, and the amended compact does not guarantee that the
trust fund will provide the maximum disbursements allowed by the trust
fund agreements.
Today, drawing on several more recent reports as well as updated
information,7 I will discuss the FSM's economic prospects, implementation
of the amended compact to meet its long-term goals, and potential trust
fund earnings.
Summary
The FSM has limited prospects for achieving budgetary self-reliance and
long-term economic advancement, and the FSM government has not yet
implemented policy reforms needed to enable economic growth. The FSM
economy depends on public sector spending of foreign assistance;
government expenditures, over half of which are funded by external grants,
account for about 65 percent of the FSM's gross domestic product (GDP).
The FSM government's budget is characterized by limited tax revenue and a
growing wage bill, and the two private sector industries identified as
having growth potential--fisheries and tourism--face significant barriers
to expansion because of the FSM's remote geographic location, inadequate
infrastructure, and poor business environment. Moreover, progress in
implementing key tax, public sector, land, and foreign investment policy
reforms necessary to improve growth has been slow. For example, although
the FSM has agreed on principles of reform to address its tax system that
has been characterized by experts as inefficient and inequitable, the FSM
government has made limited progress in implementing fundamental tax
reform. Also, the FSM's failure to implement key public sector reforms to
reduce wage and subsidy expenditures resulted in fiscal crisis in Chuuk
and Kosrae. In August 2006, nearly 2 years after the amended compact
entered into force, the FSM Joint Economic Management Committee (JEMCO)
began discussions of economic policy reform and has since approved some
funding to support FSM reform efforts; however, challenges to private
sector growth remain.
6See [21]GAO-03-988T , a testimony before the Committee on Resources,
House of Representatives.
7The amended compacts' implementing legislation instructs GAO to report 3
years following the enactment of the legislation and every 5 years
thereafter on the FSM's use and effectiveness of U.S. financial, program,
and technical assistance as well as the effectiveness of administrative
oversight by the United States. To update information for this testimony,
we met with U.S. and FSM officials and reviewed documentation from, among
other things, the April 2008 technical working group and the FSM's 2007
economic report. We conducted these performance audits in accordance with
generally accepted government auditing standards. See list of related GAO
products in attachment I.
Numerous factors have negatively affected the use of the compact grants
for FSM development goals. The FSM's grant allocations have reflected
compact priorities by targeting education, health, and infrastructure.
However, as of April 2008, the FSM had completed only three infrastructure
projects and approximately 82 percent of the $82.5 million in
infrastructure funds remained unexpended. Lack of progress in this sector
is owed to national and state disagreements over infrastructure
priorities, problems associated with the project management unit, and
Chuuk's inability to secure land leases. Additionally, the FSM has almost
$15 million in unspent funds for other sectors, or around 7 percent of
funds allocated from 2004 to 2007. Furthermore, the FSM's distribution of
grants among its four states has not been based on need, leading to
significant differences in per capita funding, while the FSM's long-term
planning has not taken into account the likely effects of the annual
funding decrement and other budgetary changes. The FSM has also lacked
accountability for the use of compact funds, as demonstrated by weaknesses
in its yearly financial statements and lack of compliance with
requirements of major federal programs. Moreover, the FSM has not
consistently monitored day-to-day grant operations or reported on progress
toward program and economic goals, owing to inadequate data, a lack of
required reporting, and an unwillingness to dedicate the resources
necessary. OIA has conducted administrative oversight of the sector
grants, but its oversight has been constrained by the need to assist the
FSM with its compact implementation activities such as preparing budgets
and addressing financial management problems such as the misuse of compact
funds by Chuuk and Kosrae in 2006 and 2007, respectively.
The FSM's trust fund may not provide sustainable income for the country
after compact grants end--a potential outcome that the FSM trust fund
committee has not yet addressed. Market volatility and the choice of
investment strategy could cause the FSM trust fund balance in some years
to fall short of the maximum disbursement level allowed--an amount equal
to the inflation-adjusted compact grants in 2023--or to be unable to
disburse any income. Moreover, the probability of shortfalls increases
over time. The trust fund income could be supplemented from several
sources, including funding from other donors, increased tax revenue, or
securitization. However, the FSM has not attracted other donors, its
limited development prospects constrain its ability to raise tax revenues,
and securitization--issuing bonds against future U.S.
contributions--carries the risk of lower fund balances and reduced income.
Furthermore, because management challenges affecting the FSM trust fund
committee delayed the fund's investment, the fund remained in a
low-interest savings account for 22 months. Additionally, despite the
likely impact of market volatility and investment strategy on the trust
fund balance, the trust fund committee has not assessed the fund's
potential adequacy as a source of revenue after the compact grants end in
2023.
Our previous reports on the amended compacts recommended, among other
things, that Interior's Deputy Assistant Secretary for Insular Affairs
ensure that the compact management committee addresses the FSM's lack of
progress in implementing economic reforms; work with the FSM to develop
plans for minimizing the impact of the declining grants; work with the FSM
to fully develop a reliable mechanism for measuring progress toward
compact goals; and ensure the trust fund committee's timely reporting on
the fund's likely status as a source of revenue after 2023. Interior
generally concurred with our recommendations and has taken some actions in
response to several of them, although key challenges to effective compact
implementation remain unaddressed.
Background
Compact of Free Association: 1986-2003
In 1986, the United States entered into its original Compact of Free
Association with the FSM.8 The compact comprised a framework for the
United States to work toward achieving three main goals: (1) to secure
self-government for the FSM, (2) to ensure certain national security
rights for all parties, and (3) to assist the FSM in its efforts to
advance economic development and self-sufficiency. Under the original
compact, the FSM also benefited from numerous U.S. federal programs, and
their citizens were allowed to live and work in the United States as
nonimmigrants and to stay for long periods of time.
Although the original compact's first and second goals were met, the FSM
did not achieve economic self-sufficiency. The FSM gained independence in
1978, and key defense rights were established. However, the compact's
third goal was to be accomplished primarily through U.S. direct financial
assistance totaling about $1.5 billion from 1987 through 2003.9 Although
U.S. financial assistance maintained higher income levels than the FSM
could have achieved without support, FSM estimated per capita GDP at the
compact's close did not differ substantially, in real terms, from its per
capita GDP in the early 1990s.10 In addition, we found that the U.S. and
FSM governments provided little accountability over compact expenditures
and that many compact-funded projects encountered problems related to poor
planning and management, inadequate construction and maintenance, or
misuse of funds.11
8Under the initial Compact of Free Association, the United States also
entered into a compact with the RMI, with a similar set of goals and
compact framework.
Amended Compact of Free Association: 2004-2023
In 2003, the United States approved an amended compact with the FSM that
(1) continues the defense relationship; (2) strengthens immigration
provisions; and (3) provides an estimated $2.3 billion to the FSM for 2004
through 2023 (see attachment II). The amended compact, which took effect
in June 2004, identifies the additional 20 years of grant assistance as
intended to assist the FSM in its efforts to promote the economic
advancement and budgetary self-reliance of its people. Financial
assistance is provided in the form of annual sector grants and
contributions to the trust fund. 12 The amended compact and its subsidiary
agreements, along with the FSM's development plan, target the grant
assistance to six sectors--education, health, public infrastructure, the
environment, public sector capacity building, and private sector
development--prioritizing two sectors, education and health.13 To provide
increasing U.S. contributions to the FSM's trust fund, grant funding
decreases annually and will likely result in falling per capita grant
assistance over the funding period and relative to the original compact
(see attachment III). For example, in 2004 U.S. dollar terms, FSM per
capita grant assistance will likely fall from around $1,352 in 1987 to
around $562 in 2023.
9This estimate represents total nominal outlays. It does not include
investment development funds provided under section 111 of Public Law
99-239 or the cost of compact-authorized federal services.
10In fiscal year 2003 dollars, estimated FSM per capita GDP was around
$2,150 in 2003, compared with an average of around $2,120 in 1991-1995.
See [22]GAO-06-590 .
11See [23]GAO/NSIAD-00-216 .
12U.S. contributions to trust funds were conditioned on the FSM making its
own required contribution. The FSM made its required initial contribution
of $30 million to its trust fund on October 1, 2004, one day after the
September 30, 2004 deadline.
13In the compacts' implementing legislation, Congress also suggested that
the FSM allocate for infrastructure improvement and maintenance at least
30 percent of its total sector grant allocation.
Under the amended compact, annual grant assistance is to be provided
according to an implementation framework with several components (see
attachment IV). For example, prior to the annual awarding of compact
funds, the FSM must submit a development plan that identifies goals and
performance objectives for each sector. The FSM government is also
required to monitor day-to-day operations of sector grants and activities,
submit periodic financial statements and performance reports for the
tracking of progress against goals and objectives, and ensure annual
financial and compliance audits. In addition, the U.S. and JEMCO are to
approve annual sector grants and evaluate the countries' management of the
grants and their progress toward program and economic goals. The amended
compact and subsidiary trust fund agreement also provide for the formation
of an FSM trust fund committee to, among its other duties, hire a money
manager, oversee the fund's operation and investment, and provide annual
reports on the fund's profitability.
FSM Economic Prospects Remain Limited
The FSM economy shows limited potential for developing sustainable income
sources other than foreign assistance to offset the annual decline in U.S.
compact grant assistance. Moreover, the FSM has not enacted economic
policy reforms needed to improve its growth prospects.
The FSM's economy shows continued dependence on government spending of
foreign assistance and limited potential for expanded private sector and
remittance income.
o Total government expenditures in 2006, over half of which were
funded by external grants, accounted for about 65 percent of GDP.
o The FSM's government budget is characterized by limited tax
revenue paired with growing government payrolls. For example, FSM
taxes have consistently provided less than 25 percent of total
government revenue; however, payroll expenditures have increased
as a percentage of total government spending, from 38 percent in
2000 to 45 percent in 2006.
o The FSM development plan identifies fishing and tourism as key
potential private sector growth industries. However, the two
industries together provide only about 6 percent of employment.
Further, according to economic experts, growth in these industries
is limited by factors such as the FSM's geographic isolation, lack
of tourism infrastructure, inadequate interisland shipping,
limited pool of skilled labor, and growing danger of overfishing.
o Although remittances from emigrants could provide increasing
monetary support to the FSM, evidence suggests that FSM emigrants
are currently limited in their income-earning opportunities
abroad, owing to inadequate education and vocational skills.
Although the FSM has undertaken some efforts aimed at economic
policy reform, it has made limited progress in implementing key
tax, public sector, land, and foreign investment reforms that are
needed to improve its growth prospects. For example:
o Tax reform. After several years of national policy dialogue to
address a tax system that economic experts describe as inequitable
and inefficient, the FSM established a tax reform executive
steering committee in December 2005. The committee endorsed key
elements of tax reform recommended by experts and the FSM's Tax
Reform Task Force, such as a value-added tax (VAT), a net profit
tax, and a unified tax authority. In April 2007, the committee
endorsed a 3-year implementation plan. However, as of April 2008,
legislation required for implementing these measures had not yet
been passed.
o Public sector reform. Although the FSM has endorsed public
sector reform aimed at reducing wage and subsidy expenditures,
limited progress has been made in addressing annual fiscal
deficits, which amounted to about 5 percent of GDP in 2005 and
2006. Slow progress in implementing public sector reforms,
combined with a lower level of grant assistance, precipitated
fiscal crises in Kosrae and Chuuk. Fiscal adjustment programs were
subsequently created for the two states based on, among other
things, reductions-in-force wage savings and increased state tax
rates. Kosrae completed its adjustment program in 2007, but
Chuuk's implementation of its program began only recently.14
Moreover, all FSM governments continue to conduct a wide array of
commercial enterprises that require subsidies.
o Land reform. In attempts to modernize a complex land tenure
system, the FSM has established land registration offices.
However, these offices have lacked a systematic method for
registering parcels, instead waiting for landowners to voluntarily
initiate the process. Continued uncertainties over land ownership
and land values create costly disputes, disincentives for
investment, and problems regarding the use of land as an asset.
o Foreign investment reform. Economic experts and private sector
representatives describe the overall climate for foreign
investment in the FSM as complex and nontransparent. Despite
attempts to streamline the process, foreign investment regulations
remain relatively burdensome, with reported administrative delays
and difficulties in obtaining permits for foreign workers. Some
FSM states also require a certain percentage of local ownership in
foreign investment.
Although the FSM development plan includes objectives for economic
reform, JEMCO did not begin to address the country's slow progress
in implementing these reforms until August 2006, 2 years into the
amended compact. Further, while JEMCO recently approved some
funding to support FSM efforts at public sector reform,15 key
challenges to improving private sector growth remain.
Although the FSM has allocated compact grants to the sectors
targeted by the compact, immediate problems in some sectors
persist, and several factors have hindered the FSM's use of the
funds to meet long-term development goals. In addition,
administrative deficiencies have limited the FSM's ability to
account for its use of the grants for these long-term goals.
Further, although OIA has monitored early compact activities,
program implementation challenges have hampered its oversight.
In 2004 through 2008, the FSM targeted compact grants largely
according to compact priorities,16 allocating 35 percent of the
funds for education, 27 percent for infrastructure, and 22 percent
for health (see attachment V). However, the FSM has completed only
three infrastructure projects, and more than $67 million of the
$82.5 million (approximately 82 percent) allocated for
infrastructure grants in 2004 through 2007 remains unspent. Lack
of progress in this sector is owed to national and state
disagreements over infrastructure priorities, problems associated
with the project management unit, and Chuuk's inability to secure
land leases.17 Unspent funds for other sector grants from 2004 to
2007 amounts to an additional $14.9 million, or around 7 percent
of funds allocated (see attachment VI).
Additionally, numerous factors have limited the government's use
of compact funds to meet long-term development needs. For example:
o Lack of government consensus. Interior and State officials
reported that the FSM's weak federal structure inhibits compact
grant implementation. Because each state has its own constitution
and authority over budgetary policies, the FSM central government,
which is represented on JEMCO, does not control the majority of
compact funds and has been unable to secure agreement from the
state governments regarding the use of compact funds.
o Lack of needs analysis. The allocation of FSM grants among its
four states is not needs based and has resulted in significant
differences in per capita funding, creating varying levels of
government services across the states. 18 For example, in 2006,
Yap state received approximately $1,963 in education funding per
student, while Chuuk state received $626 per student. More
recently, in 2007, the national government's share of grant
funding increased from 8.65 percent to 10 percent and the
allocation of compact funds to the four states decreased.
o Lack of planning for declining U.S. assistance. A lack of viable
plans to address the annual decrement in compact funding and the
elimination of nonconforming uses of the public-sector capacity
building (PSCB) grant could limit the FSM's ability to sustain
current levels of government services.19 JEMCO required the FSM in
2004 to develop a plan to eliminate funding for the nonconforming
uses of the PSCB by 2009. While FSM officials indicated that they
plan to replace the PSCB funds with local monies, recent tax
revenues have largely stagnated and, in 2006, the FSM requested
that the deadline for its elimination of nonconforming funding be
extended to 2011. OIA indicated that the steps the FSM takes
toward overall public sector reform will affect whether it
recommends to JEMCO to approve this request.
o Lack of accountability over compact funds. The FSM's
accountability for its use of compact funds has been limited.
Although the timeliness of the FSM's single audits has
improved--in 2006, only Chuuk and the national government
submitted audit reports after the deadlines--auditors have
continued to find weaknesses with financial statements and lack of
compliance with requirements of major federal programs. For
example, the lack of audited financial statements for several
subgrantees led the auditors to render qualified and disclaimed
opinions.20
The FSM has failed to consistently monitor day-to-day sector grant
operations or report on progress.
o Inadequate authority. The FSM's first effort to monitor and
report on compact progress was through the Office of Compact
Management (OCM), which lacked the authority and resources to
carry out its function. In 2007, the FSM created a Statistics,
Budget and Overseas Development Assistance and Compact Management
(SBOC) office. According to OIA, the SBOC may have a role in
conducting compact coordination, ensuring sector-by-sector
compliance, and providing technical assistance to the states.
Nonetheless, as of April 2008, SBOC had not addressed performance
problems, such as missing reports and data, and had failed to hold
the FSM governments accountable for not meeting JEMCO resolutions
and grant requirements.
o Data deficiencies. Although the FSM established performance
measurement indicators, a lack of complete and reliable data
prevents the use of these indicators to assess progress. For
example, the FSM provided the first complete set of education
indicators in 2007. However, OIA found that the data were not
consistently reliable for monitoring scholastic improvements,
owing to problems in establishing baselines and collecting data
for all of the indicators. Likewise, determining performance in
the health sector was difficult due to a lack of standardized data
collection.
o Report problems. The FSM continues to have difficulty in
submitting its required annual report to the U.S. President on
time. As of April 2008, the FSM had not begun work on the 2007
annual report to the U.S. President, which was due in February
2008, and it submitted the 2006 annual report 10 months late. The
quarterly reports have also been regularly incomplete or
inconsistent, preventing their use for monitoring progress. Most
recently, OIA rejected the FSM's 2007 fourth quarter reports,
stating that most of the submitted forms were completely blank or
missing data.
o Capacity constraints. The FSM has not allocated available
compact resources to develop the capacity for, and to provide,
regular monitoring of sector grants. As a result, the skills
necessary to improve financial and programmatic reporting are
lacking. For example, the FSM's single audit reports for 2005 and
2006 showed that the FSM's ability to account for the use of
compact funds was limited, as shown by weaknesses in its financial
statements and lack of compliance with requirements of major
federal programs. The FSM's Compact Fiscal Adjustment and
Transition Plan, in August 2006, reiterated that capacity
weaknesses continue, especially in the areas of financial
management, economic planning, and statistics.
OIA has carried out various duties as administrator of the amended
compact grants but has not addressed the FSM's worsening
compliance with compact reporting requirements, and several
challenges continue to hamper its compact oversight. For example,
in monitoring the sector grants, OIA determined that Chuuk, in
2006, and Kosrae, in 2007, had each misused approximately $1
million in compact funds through the commingling of compact and
general funds. OIA required both states to repay the misused
funds, a requirement met in 2007. However, OIA has generally
failed to hold the FSM accountable for not submitting required
reports, including 2006 and 2007 quarterly performance reports and
the annual report to the U.S. President, and for not meeting
requirements imposed as grant conditions by JEMCO. Additionally,
OIA's oversight continues to be constrained by time-consuming
demands associated with poor compact implementation. For example,
because the FSM state and national government budgets are not
presented in unified format or linked to performance measures, OIA
reports that it has continued to spend an inordinate amount of
time reviewing them for the JEMCO meetings.
FSM trust fund balances in 2023 could vary widely owing to market
volatility and choice of investment strategy, preventing trust
fund disbursements in some years. Moreover, the FSM's ability to
supplement its trust fund balance with additional contributions or
other sources of income is uncertain and entails risks. Further,
the FSM's trust fund committee has faced challenges in managing
the fund's investment and has not evaluated the fund's adequacy as
a source of future revenue.
Market volatility and investment strategy could have a
considerable impact on projected trust fund balances in 2023 (see
attachment VII). Our analysis indicates that, under various
scenarios, the FSM's trust fund could fall short of the maximum
allowed disbursement level21--an amount equal to the
inflation-adjusted compact grants in 2023--after compact grants
end, with the probability of shortfalls increasing over time (see
attachment VIII).22 For example, under a moderate investment
strategy, the fund's income is about 30 percent likely to fall
short of the maximum distribution by 2031; however, this
probability rises to almost 70 percent by 2050. Additionally, our
analysis indicates a positive probability that the fund will yield
no disbursement in some years; under a moderate investment
strategy, the probability is around 19 percent by 2050.
FSM trust fund income could be supplemented by sources such as
other donors, increased taxes, and securitization. However, this
potential is uncertain.
o Other donors. The trust fund agreement allows the FSM to seek
funding from other donors; however, the FSM has not yet received
other contributions.23
o Increased taxes. The FSM's limited development prospects
constrain its ability to raise tax revenues to supplement the
fund's income.
o Securitization. Securitization--issuing bonds against future
U.S. contributions--could increase the fund's earning potential by
raising its balances through bond sales. However, securitization
could also lead to lower balances and reduced fund income if
interest owed on the bonds exceeds investment returns. In October,
2007, the committee contracted for a study of securitization.24
The FSM trust fund committee has experienced management challenges
in establishing the trust fund to maximize earnings and has not
yet evaluated the fund's adequacy as a source of future revenue.
Contributions to the trust fund were initially placed in a
low-interest savings account and were not invested until 22 months
after the initial contribution. The months when the fund remained
in a low-interest account prior to investment likely reduced its
potential investment earnings significantly; we estimate this loss
at $720,000 per month, after taking into account stock market
investment fees.25 As we reported in June 2007, contractual delays
and committee processes for reaching consensus and obtaining
administrative support contributed to the time taken to establish
and invest funds. The committee has since hired an Executive
Administrator in September 2007, and some steps were taken to
improve committee processes; however, the Administrator reports
that communication and administrative delays remain. Also, despite
the likely impact of market volatility and investment strategy,
the trust fund committee's reports have not yet assessed the
fund's potential adequacy as a source of revenue for meeting the
FSM's long-term economic goals.
Since enactment of the amended compact, the U.S. and FSM
governments have made efforts to meet new requirements for
implementation, performance measurement, and oversight. However,
after 5 years--one quarter of the amended compact's duration--the
FSM faces significant challenges in working toward the compact
goals of economic advancement and budgetary self-reliance. The FSM
economy shows continued dependence on government spending of
foreign assistance. However, despite the budgetary impact of
declining annual grant assistance, the FSM has made little
progress in implementing key reforms needed to improve tax income
or increase private sector investment opportunities. The FSM has
also been unable to utilize more than $67 million in
infrastructure and almost $15 million in other sector grant
monies. Moreover, persistent deficiencies in needs assessment,
long-term planning, and financial accountability continue to
hinder the U.S. and FSM governments and JEMCO from ensuring
effective implementation of those grants that have been spent.
Although OIA has carried out various duties as administrator of
compact grants, U.S. and FSM monitoring of grant operations
remains deficient owing to continued problems with oversight
authority in the FSM, consistently poor data and reporting, and
unaddressed capacity constraints. Further, the FSM trust fund
committee has yet to assess the potential status of the trust fund
as an ongoing source of revenue after compact grants end in 2023.
Because the trust fund's earnings are intended as a main source of
U.S. assistance to the FSM after compact grants end, the fund's
potential inadequacy as a source of sustainable income in some
years could impact the FSM's ability to provide future government
services.
To maximize the benefits of compact assistance, our prior
reports26 include recommendations that the Secretary of the
Interior direct the Deputy Assistant Secretary for Insular
Affairs, as chair of the FSM management and trust fund committees,
to take a number of actions, including the following:
o ensure that JEMCO address the lack of FSM progress in
implementing reforms to increase investment and tax income;
o coordinate with other U.S. agencies on JEMCO to work with the
FSM to establish plans to minimize the impact of declining
assistance;
o coordinate with other U.S. agencies on JEMCO to work with the
FSM to fully develop a reliable mechanism for measuring progress
toward compact goals; and
o ensure the FSM trust fund committee's assessment and timely
reporting of the fund's likely status as a source of revenue after
2023.
Interior generally concurred with our recommendations and has
taken actions in response to several of them. However, unless the
challenges we identified are addressed, the U.S. and FSM are
unlikely to meet compact goals of the FSM's economic advancement
and budgetary self-reliance.
Mr. Chairman and members of the subcommittee, this completes my
prepared statement. I would be happy to respond to any questions
you may have at this time.
For future contacts regarding this testimony, please call David
Gootnick at (202) 512-3149 or [24][email protected] . Individuals
making key contributions to this testimony included Emil Friberg,
Jr. (Assistant Director), Ming Chen, Julie Hirshen, Reid Lowe,
Mary Moutsos, Kendall Schaefer, and Eddie Uyekawa.
Compacts of Free Association: Trust Funds for Micronesia and the
Marshall Islands May Not Provide Sustainable Income,
[25]GAO-07-513 (Washington, D.C.: July 15, 2007).
Compact of Free Association: Micronesia and the Marshall Island's
Use of Sector Grants, [26]GAO-07-514R (Washington, D.C.: May 25,
2007).
Compacts of Free Association: Micronesia and the Marshall Islands
Face Challenges in Planning for Sustainability, Measuring
Progress, and Ensuring Accountability, [27]GAO-07-163
(Washington, D.C.: Dec. 15, 2006).
Compacts of Free Association: Development Prospects Remain Limited
for the Micronesia and the Marshall Islands, [28]GAO-06-590
(Washington, D.C.: June 27, 2006).
Compacts of Free Association: Implementation of New Funding and
Accountability Requirements is Well Under Way, but Planning
Challenges Remain, [29]GAO-05-633 (Washington, D.C.: July 11,
2005).
Compact of Free Association: Single Audits Demonstrate
Accountability Problems over Compact Funds, [30]GAO-04-7
(Washington, D.C.: Oct. 7, 2003).
Compact of Free Association: An Assessment of the Amended Compacts
and Related Agreements, [31]GAO-03-988T (Washington, D.C.: June
18, 2003).
Foreign Assistance: Effectiveness and Accountability Problems
Common in U.S. Programs to Assist Two Micronesian Nations,
[32]GAO-02-70 (Washington, D.C.: Jan. 22, 2002.
Foreign Relations: Migration From Micronesian Nations Has Had
Significant Impact on Guam, Hawaii, and the Commonwealth of the
Northern Mariana Islands, [33]GAO-02-40 (Washington, D.C.: Oct. 5,
2001).
Foreign Assistance: U.S. funds to Two Micronesian Nations Had
Little Impact on Economic Development, [34]GAO/NSIAD-00-216
(Washington, D.C.: Sept. 22, 2000).
Source: Pub. L. No. 108-188.
Notes:
The annual grant amounts include $200,000 to be provided directly
by the Secretary of the Interior to the Department of Homeland
Security, Federal Emergency Management Agency, for disaster and
emergency assistance purposes. The grant amounts do not include
the annual audit grant, capped at $500,000.
These dollar amounts shall be adjusted each fiscal year for
inflation by the percentage that equals two-thirds of the
percentage change in the U.S. gross domestic product implicit
price deflator, or 5 percent, whichever is less in any one year,
using the beginning of 2004 as a base. Grant funding can be fully
adjusted for inflation after 2014, under certain U.S. inflation
conditions.
Note: Compact grant assistance under the original compact
decreased in 1991, 1996, and 2001 and increased in 2002 and 2003
to equal an average of the funding provided during the previous 15
years. Compact grant assistance under the amended compacts
(2004-2024) decreases annually. U.S. contributions to the FSM's
compact trust fund increase by the same amount as the grant
decrement. Funding for compact-authorized federal services and
trust fund contributions is not included.
Notes: The chart depicts results from 1,000 trial runs. The change
from one year to the next may not always be monotonic, but the
general time trend is clear. As the number of trial runs increase,
the time trend becomes smoother.
14Chuuk's debt levels currently amount to about $37 million, and the
anticipated time required to complete its adjustment program, including
the servicing of this debt, is 5 to 7 years. Chuuk's efforts to reduce its
public sector workforce are ongoing. Although Chuuk has reduced the work
week for certain public sector employees, the list of positions for
elimination has not yet been published.
Numerous Factors Hinder Use of Compact Funds to Advance FSM Development Goals
15In August 2007 and February 2008 respectively, JEMCO approved use of
public-sector capacity building grant funds to provide one-year's annual
salary as a buy-out to support public sector reforms in Kosrae and Chuuk.
16The priority for infrastructure spending was designated by a sense of
the U.S. Congress laid out in the Compact's enabling legislation.
17Additionally, only Pohnpei has contributed to the FSM infrastructure
maintenance fund. None of the other states have made their required
contribution to this fund and are therefore unable to use it.
18The FSM distributed overall compact funding among its four states
according to a formula established in an FSM law enacted in January 2005
and in force through 2006 that allotted a set percentage to each state and
the national government without fully accounting for states' differing
population sizes or funding needs. The states decide their own
distribution of funds between the sectors, from their allocation.
19The FSM has been using PSCB funds to support basic government
operations, rather than for the grant's intended purpose to support the
efforts of the FSM to develop internal expertise needed to build an
effective, accountable, and transparent government.
20A "qualified" opinion is given when the auditor finds conditions, such
as a lack of supporting evidence or a restriction on the scope of the
audit. An auditor issues a "disclaimer" of opinion when unable to perform
all of the procedures necessary to complete an audit, indicating the
reliability of the financial statements is not known. An "adverse" opinion
is given when the auditor concludes that the financial statements are not
fairly presented. Pohnpei and Kosrae states' reports for 2006 contained an
unqualified opinion on the financial statements. However, other reports
contained qualified, adverse, or disclaimed opinions.
FSM Trust Fund May Not Provide Sustainable Income after Compact Grants End
21The FSM trust fund agreement specifies that in 2024 and thereafter, the
FSM trust fund committee may disburse amounts up to the annual grant
assistance in 2023, fully adjusted for inflation, provided that this
amount is available.
22Our methodology for projecting the trust fund income is base on a
technique known as Monte Carlo simulation. We built a Monte Carlo
simulation model--based on the trust fund agreements, contributions to
date, and historical returns of the market--to project the trust fund's
likely income levels given market volatility as well as historical returns
of various asset classes, including large company stocks, treasury bills,
and international stocks from 1970 to 2005. See [35]GAO-07-513 .
23 In contrast, in May 2005, the RMI and Taiwan reached an agreement that
Taiwan will contribute a total of $40 million to the RMI's trust fund from
2004 to 2023.
24We previously reported that some members of the trust fund committee
believe that securitization could bring great financial benefits, as a
company that performs securitization had asserted in presentations to the
committee. Others raised concerns of whether the trust fund could pursue
securitization under the current amended compact and trust fund agreement
or whether amendments to the agreement would be required. See
[36]GAO-07-513 .
25From October 2004 through August 2006, the FSM trust fund--with an
October 2005 balance of approximately $80 million--earned about 3 percent
interest, compared with potential stock market earnings of about 15
percent. See [37]GAO-07-513 .
Concluding Remarks and Prior Recommendations
26 [38]GAO-05-633 , [39]GAO-06-590 , [40]GAO-07-163 , [41]GAO-07-513 ,
[42]GAO-07-514R .
Contacts and Acknowledgements
Attachment I: Related GAO Products
Attachment II: U.S. Assistance to the FSM under the Amended Compact,
2004-2023
(Dollars in millions)
Fiscal year FSM grants (Section 211) FSM trust fund (Section 215)
2004 $76.2 $16.0
2005 76.2 16.0
2006 76.2 16.0
2007 75.4 16.8
2008 74.6 17.6
2009 73.8 18.4
2010 73.0 19.2
2011 72.2 20.0
2012 71.4 20.8
2013 70.6 21.6
2014 69.8 22.4
2015 69.0 23.2
2016 68.2 24.0
2017 67.4 24.8
2018 66.6 25.6
2019 65.8 26.4
2020 65.0 27.2
2021 64.2 28.0
2022 63.4 28.8
2023 62.6 29.6
Attachment III: Estimated FSM Per Capita Compact Grant Assistance, Fiscal
Years 1987-2023
Attachment IV: Amended Compact Implementation Framework
Attachment V: FSM Sector Grant Allocations, Fiscal Years 2004-2008
Attachment VI: FSM Unspent Compact Grants by Sector, Fiscal Years 2004 to
2007
Attachment VII: Projections of FSM Account Balance with Three Possible
Investment Strategies
Attachment VIII: Probability of FSM Trust Fund Income Not Reaching the
Maximum Disbursement Levels Allowed, Fiscal Years 2024-2050
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