The streams of U.S dollars that the three freely associated states will receive under their renewed bilateral agreements with the United States will go a long way if they implement stringent fiscal and debt policies and improve the management of public funds.
This was the focus of a report published in the Asian Development Bank’s Pacific Economic Monitor, which examined, among other Pacific nations, the state of the economies of the Marshall Islands, the Federated States of Micronesia and Palau.
Collectively known as “freely associated states,” the three Pacific Island nations separately signed the Compacts of Free Association with Washington earlier this year. The renewed economic provisions of COFA will channel a total of $7.1 billion to these countries over 20 years. In exchange, the U.S will retain access to these countries’ airspace and waters.
Under the new agreements, the development assistance is provided through direct budget support and increased funding for education, the environment, climate change adaptation, health and infrastructure development.
“The development assistance under the new COFAs will dramatically increase fiscal resources for the North Pacific economies,” reads the report authored by Cara Tinio and Kaukab Naqvi.
Tinio and Naqvi’s report, which forms part of the Pacific Economic Monitor’s August 2024 edition, noted the new COFA agreements promise more generous grants and increased contributions to the Compact Trust Funds, offering vital fiscal opportunities for the FAS governments and potentially large economic benefits.
The authors pointed out that the influx of fresh resources must be accompanied by strict adherence to sound fiscal policy and careful handling of the public purse strings.
“While the additional resources can enhance spending on essential social, infrastructure and climate adaptation initiatives as well as reduce debts, North Pacific governments must uphold sound fiscal and debt policies and implement reforms to improve [public fiscal management] capacity,” they said.
The authors advised the governments of the Marshall Islands, FSM and Palau should continue prioritising reforms “aimed at bolstering revenue mobilisation and enhancing expenditure efficiency” to elevate the quality of public services.
It is crucial for the ADB to work closely with the FAS governments to help them overcome any stumbling blocks that could prevent them from realising the full benefits of the new COFA agreements, the authors said. They noted that part of the ADB’s mandate is to promote economic development and resilience in the Pacific.
They suggested that collaboration with the Marshall Islands, FSM and Palau should involve a tailored approach, addressing the specific needs of each country and maximising the impact of interventions by various development partners, including the ADB.
“To support this, it is essential to enhance and improve the policies of these countries, maintaining the momentum of reforms to overcome persistent constraints and promote sustainable economic growth,” they said.
The authors acknowledged that FAS economies face unique challenges in managing public finances despite ongoing efforts by their governments to improve public service quality and fiscal management.
For instance, Palau’s economy faces increased debt and historically high inflation. The Marshall Islands and the FSM remain highly vulnerable to external shocks, including fluctuations in global commodity prices and extreme climate events.
“To address these issues effectively, both enhancements in public service quality and further fiscal reforms are necessary,” the authors said, adding that past experiences highlight the need to strengthen capacity and accelerate public fiscal management reforms to fully harness the growth-enhancing opportunities from COFA resources.
Against the backdrop of these challenges, the FAS governments must ensure that the use of COFA funds is carefully planned to “enhance government operations, expand productive public investments, and support more inclusive and sustainable growth and development,” they said.
As to how these governments can enhance their public fiscal management practices, the ADB outlined a four-pronged approach: upgrading public investment management, enhancing the quality of public investment, improving risk management, and addressing capacity constraints, such as promoting quality education and skills across the entire workforce. The authors noted that development partners, including the ADB, can play a significant role in helping the FAS economies strengthen the management of public finances and investments.
President Joe Biden signed the new COFAs on 09 March. This is the third iteration of this 20-year agreement. The previous cycle, which recently
expired, provided a total of $161.5 million per year to the FAS economies, equivalent to 20.9 percent of their average combined GDP during the Compact II period.