Completion Report. Marshall Islands: Public Sector Program Subprograms 1 and 2. Project Number: Loan Number: 2659-RMI, 2950-RMI September 2014

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1 Completion Report Project Number: Loan Number: 2659-RMI, 2950-RMI September 2014 Marshall Islands: Public Sector Program Subprograms 1 and 2 This document is being disclosed to the public in accordance with ADB's Public Communications Policy 2011.

2 CURRENCY The currency of the Marshall Islands is the US dollar ($). ABBREVIATIONS ADB Asian Development Bank CAP comprehensive adjustment program CTF Compact Trust Fund DMF design and monitoring framework DFAT Department of Foreign Affairs and Trade GDP gross domestic product IMF International Monetary Fund MEC Marshalls Energy Company MOF Ministry of Finance PFTAC Pacific Financial Technical Advisory Centre PSC Public Service Commission RMI Republic of the Marshall Islands SOE state-owned enterprise TA technical assistance TRAM tax and revenue reform and modernization US United States NOTES (i) The fiscal year (FY) of the Government of the Marshall Islands ends on 30 September. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2014 ends on 30 September (ii) In this report, "$" refers to US dollars, unless otherwise stated. Vice-President S. Groff, Operations 2 Director General X. Yao, Pacific Department (PARD) Director E. Veve, Urban, Social Development, and Public Management Division, PARD Team leader Team members M. Melei, Country Specialist, PARD H. Everett, Senior Country Specialist, PARD E. Milne, Development Coordination Officer, Republic of the Marshall Islands, PARD C. Tinio, Associate Economics and Statistics Analyst, PARD L. Tora, Country Economist, PARD In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

3 CONTENTS Page BASIC DATA I. PROGRAM DESCRIPTION 1 II. EVALUATION OF DESIGN AND IMPLEMENTATION 2 A. Relevance of Design and Formulation 2 B. Program Outputs 2 C. Program Costs 8 D. Program Schedule and Disbursements 8 E. Implementation Arrangements 9 F. Conditions and Covenants 9 G. Related Technical Assistance 9 H. Performance of the Borrower and the Executing Agency 10 I. Performance of the Asian Development Bank 11 III. EVALUATION OF PERFORMANCE 11 A. Relevance 11 B. Effectiveness in Achieving Outcome 12 C. Efficiency in Achieving Outcome and Outputs 12 D. Preliminary Assessment of Sustainability 12 E. Institutional Development 13 F. Impact 13 IV. OVERALL ASSESSMENT AND RECOMMENDATIONS 13 A. Overall Assessment 13 B. Lessons 14 C. Recommendations 15 APPENDIXES 1. Design and Monitoring Framework Policy Matrix Status of Compliance with Loan Covenants 34 ii

4 ii BASIC DATA A. Loan Identification 1. Country Republic of the Marshall Islands 2. Loan Number 2659-RMI 2950-RMI 3. Program Title L2659 Public Sector Program Subprogram 1 Program Title L2950 Public Sector Program Subprogram 2 4. Borrower Republic of the Marshall Islands 5. Executing Agency Ministry of Finance 6. Amount of Loan 2659 $9,979, (SDR6,413,000) Amount of Loan 2950 $4,893, (SDR3,242,000) 7. Program Completion Report 1492 B. Loan Data Loan Appraisal Date Started None Date Completed None 2. Loan Negotiations Date Started 6 July 2010 Date Completed 9 July Date of Board Approval 17 August Date of Loan Agreement 8 September Date of Loan Effectiveness In Loan Agreement 28 September 2010 Actual 28 September 2010 Number of Extensions None 6. Closing Date In Loan Agreement 28 February 2011 Actual 28 February 2011 Number of Extensions None 7. Terms of Loan Interest Rate 1% for grace period and 1.5% thereafter Maturity (number of years) 24 Grace Period (number of years) 8 8. Terms of Relending (if any)a Interest Rate 1% for years 1 8 and 1.5% thereafter Maturity (number of years) 24 Grace Period (number of years) None a $9,542,445 was onlent to Marshalls Energy Company (MEC).

5 iii 9. Disbursements a. Dates Initial Disbursement Final Disbursement Time Interval 5 October October months Effective Date Original Closing Date Time Interval 28 September February months Category or Subloan b. Amount ($ million) Original Last Allocation Revised Allocation Amount Cancelled Net Amount Available Amount Disbursed Undisbursed Balance Program Total Loan Appraisal Date Started None Date Completed None 2. Loan Negotiations Date Started 25 September 2012 Date Completed 25 September Date of Board Approval 26 November Date of Loan Agreement 13 December Date of Loan Effectiveness In Loan Agreement 21 January 2013 Actual 21 January 2013 Number of Extensions None 6. Closing Date In Loan Agreement 31 December 2013 Actual 31 March 2014 Number of Extensions None 7. Terms of Loan Interest Rate 1% for grace period and 1.5% thereafter Maturity (number of years) 24 Grace Period (number of years) 8

6 iv 8. Disbursements a. Dates Initial Disbursement 8 March 2013 Effective Date 21 January 2013 Final Disbursement 8 March 2013 Original Closing Date 31 December 2013 Time Interval 0 months Time Interval 11 months b. Amount ($ million) Category or Subloan Original Allocation Last Revised Allocation Amount Canceled Net Amount Available Amount Disbursed Undisbursed Balance Program Total C. Program Data Loan Program Cost ($ million) Cost Appraisal Estimate Actual Foreign Exchange Cost Local Currency Cost Total Financing Plan ($ million) Cost Appraisal Estimate Actual Implementation Costs Borrower Financed ADB Financed Other External Financing Total IDC Costs Borrower Financed ADB Financed Other External Financing Total ADB = Asian Development Bank, IDC = interest during construction.

7 v 3. Program Performance Report Ratings Implementation Period Development Objectives Ratings Implementation Progress From 1 April 2009 to 31 August 2010 S S Loan Program Cost ($ million) Cost Appraisal Estimate Actual Foreign Exchange Cost Local Currency Cost Total Financing Plan ($ million) Cost Appraisal Estimate Actual Implementation Costs Borrower Financed ADB Financed Other External Financing Total IDC Costs Borrower Financed ADB Financed Other External Financing Total Program Performance Report Ratings Implementation Period Development Objectives Ratings Implementation Progress From 7 June 2011 to 31 December 2013 N/A N/A

8 vi D. Data on Asian Development Bank Missions Loan 2659 Name of Mission Fact-finding Review Program completion review b Date June Sept 7 Oct 2011 No. of Persons 2 1 No. of Person-Days 5 12 Specialization of Members g/d g g d = education specialist and g = program officer. Note: b Desk review. Loan 2950 Name of Mission Fact Finding Review Program completion review b Date 5 16 June No. of Persons 1 - No. of Person-Days 13 - Specialization of Members d - g d = public finance management specialist, g = program officer. Note: b Desk review.

9 I. PROGRAM DESCRIPTION 1. On 17 August 2010, the Asian Development Bank (ADB) approved a program cluster for the Public Sector Program for the Republic of the Marshall Islands (RMI). 1 The program, supported by a policy-based loan, aimed to improve the country s long-term fiscal sustainability. Under subprogram 1, policy actions were designed and the implementation of urgent priority reforms began. Subprogram 2 continued implementing the proposed policy measures ADB characterizes the RMI as a fragile situation since Among the constraints that underlie weak performance and fragility in such situations are weak public sector institutions, limited government capacity, and underdeveloped governance systems. 3 The RMI economy relied heavily on government expenditure and on foreign grants, which funded more than twothirds of government spending. Most foreign grants were provided by the United States (US), mainly under the amended Compact of Free Association These compact grants are to be reduced annually until they end in FY2023. In 2004, the governments of the RMI and the US invested in a compact trust fund (CTF) intended to generate a revenue stream to replace the compact grants after FY2023. However, contributions from the RMI government had fallen short due to its excessive recurrent expenditure and poor revenue performance, which had prevented the generation of the required fiscal surpluses. 5 The value of the CTF was substantially below target, and in 2010 the International Monetary Fund (IMF) recommended that fiscal adjustments begin immediately to close the revenue gap and achieve fiscal surplus In 2009, recognizing the need for reform, the RMI government initiated a comprehensive adjustment program (CAP) to advance public sector reform and promote macroeconomic stability and sustainable growth. Guided by the CAP advisory group, which comprised representatives of both the public and private sectors, the CAP included the preparation of a recovery plan for the state-owned electricity company, Marshalls Energy Company (MEC), and the formation in 2010 of a tax and revenue reform and modernization (TRAM) commission to prepare fiscal reform plans. 7 ADB s public sector program supported critical areas of the government s CAP. 1 ADB Report and Recommendation of the President to the Board of Directors: Proposed Program Cluster, Loan for Subprogram 1, and Technical Assistance Grant Republic of the Marshall Islands: Public Sector Program. Manila. (Loan 2659-RMI, $9,500,000 approved on 17 August 2010). 2 ADB Report and Recommendation of the President to the Board of Directors: Proposed Policy-Based Loan for Subprogram 2 of the Public Sector Program (Marshall Islands) Manila (Loan 2950-RMI, SDR3,242,000 approved on 26 November 2012). 3 ADB Achieving Development Effectiveness in Weakly Performing Countries The Asian Development Bank s Approach to Engaging with Weakly Performing Countries. Manila. 4 The Compact of Free Association defines the relationship that the RMI, as a former US trust territory, entered into with the US and includes the provision by the US of economic assistance, including grants. The first compact was signed in 1986 and amended in 2013 to cover the period up to Fiscal Analysis and Impact of Reforms (accessible from the list of linked documents in Appendix 2, (Report and Recommendation of the President to the Board of Directors: Proposed Program Cluster, Loan for Subprogram 1, and Technical Assistance Grant Republic of the Marshall Islands: Public Sector Program. (Loan 2659-RMI, $9,500,000 approved on 17 August 2010)).) 6 International Monetary Fund Assessment Letter (accessible from the list of linked documents in Appendix 2, (Report and Recommendation of the President to the Board of Directors: Proposed Program Cluster, Loan for Subprogram 1, and Technical Assistance Grant Republic of the Marshall Islands: Public Sector Program. (Loan 2659-RMI, $9,500,000 approved on 17 August 2010)).) 7 Marshalls Energy Company Comprehensive Recovery Plan FY2010 FY2012. Majuro; Government of the RMI Comprehensive Adjustment Program Advisory Group. Final Report. Majuro; Government of the RMI A Holistic Approach to Reforming the Tax and Revenue System. Tax and Reform and Modernization Commission. Majuro.

10 2 5. The intended impact of the public sector program was the more efficient and effective provision of services by the public sector to the country s people. The program supported fiscal and structural reforms to achieve its intended outcome of fiscal sustainability, which was expected to generate sustainable medium-term economic growth. Structural reforms aimed to stimulate private sector economic activity, generate domestic employment and incomes, and broaden the local tax base, while tax reforms sought to boost domestic revenue collection and offset the imminent reduction in compact grants from the US. Implementing state-owned enterprise (SOE) reforms and reducing public expenditures were to contribute to improving the fiscal balance. II. EVALUATION OF DESIGN AND IMPLEMENTATION A. Relevance of Design and Formulation 6. The public sector program was relevant at appraisal and remained so at completion. The program was formulated through extensive discussions with the government and development partners. It was also based on the government s own reform program and consistent with the aim of Vision 2018, the RMI s national development plan at the time. 8 The ADB program helped the government initiate the adjustments required for it to achieve long-term fiscal sustainability The program was aligned with ADB s Pacific Approach, , 10 which serves as ADB s country partnership strategy for the RMI, and the RMI country operations business plan, The program applied lessons from earlier ADB programs in the RMI and elsewhere in the Pacific, as well as ADB s approach to engaging with weakly performing countries (footnote 3), notably by (i) adopting a country-led set of policy actions developed in an open and participatory manner, and (ii) initiating long-term policy dialogue and providing targeted technical assistance (TA) support. 8. The program s design and monitoring framework (DMF) was overambitious in both scope and the limited time it allowed for achieving challenging targets, but it reflected the government s program and the pressing fiscal situation the country faced. Given the status of the RMI as a fragile situation, the design reflected expected TA support from ADB and other development partners. The use of a cluster program allowed for ongoing policy dialogue with government over the extended period to be covered by the second subprogram. It also allowed initial actions under subprogram 1 to be built on in subprogram 2. However, achieving the intended program outcome stated in the DMF the government achieves fiscal sustainability would have required more time than even the two subprograms could provide, and it was also highly dependent on factors outside the program s reach and control. As such, it would have been more appropriately identified as the impact than as the outcome. Similarly, the DMF s output 1 the government s fiscal discipline improves over the medium term would more appropriately have been the program s intended outcome, particularly since achieving it was partly dependent on the completion of policy actions needed to deliver other outputs. B. Program Outputs 9. To achieve fiscal sustainability (the outcome), the program aimed to deliver five outputs, Republic of the Marshall Islands The Strategic Development Plan Framework, Vision Majuro. The ADB program adopted the IMF definition of fiscal sustainability, by which fiscal sustainability exists when the balance in the CTF is on track to provide a revenue stream that can replace US compact grant funds in ADB ADB s Pacific Approach Manila. ADB Marshall Islands: Country Operations Business Plan, Manila.

11 3 which are discussed in paras Measures of the achievement of outputs are based on the revised DMF performance indicators under subprogram 2 (Appendix 1). The revisions updated baseline years and targets according to more recent data. 10. Output 1: The government s fiscal discipline improved over the medium term. The output was achieved, with the two subprogram 2 DMF indicators of reductions in key fiscal ratios met. The ratio of current expenditure to gross domestic product (GDP) was 48.0% in FY2013, compared with the baseline budget estimate of 51.6% in FY2011 (and, also, compared with the actual outturn in FY2011 of 48.7%). The ratio of government debt to GDP, which in FY2013 was 51.8%, was reduced from the baseline budget estimate of 60.3% in FY2011 (and, also, from the actual outturn in FY2011 of 60.2%). 11. All policy actions under output 1 were achieved. Action 1.1 of the policy matrix covered six specific budget estimate targets for FY2011 and FY2012: (i) an average budget surplus of about 3.0% over FY2011 and FY2012; (ii) an average annual contribution from the general fund to the CTF of at least 0.5% during the same period, (iii) a reduction in the ratio of wages and salaries to GDP to less than 21.0% by FY2012; (iv) a reduction in the ratio of the subsidies and transfers to GDP to 9.0% by FY2012; (v) a ratio of capital expenditure to GDP of at least 8.0% in FY2011 and FY2012; and (vi) an increase in the ratio of tax revenue to GDP to 16.5% by FY2012. These targets overlap with indicators across several outputs in the DMF. 12 Table 1 below shows targets and completion status for indicators of output 1.1 of the policy matrix and overlapping DMF indicators. Table 1: Comparison of policy actions under output 1.1 and related DMF indicators Policy Matrix (Output 1.1) DMF Indicator and target a Completion status Indicator and target Completion status (i) Average annual budget surplus over FY2011 and FY2012 of approximately 3.0% of GDP Budget: FY2011: 3.8% of GDP FY2012: 3.4% of GDP (ii) On average, an annual contribution from the general fund to the CTF over FY2011 and FY2012 of at least 0.5% of GDP (iii) Reduction in ratio of wages and salaries to GDP to less than 21.0% by FY2012 (FY2010 baseline: 21.8% of GDP) (iv) Reduction in ratio of subsidies and transfers to GDP to 9.0% by FY2012 (FY2010 baseline: 10.1% of GDP) Status: Achieved Budget: FY2011: 0.6% of GDP FY2012: 0.6% of GDP Status: Achieved Budget: FY2012: 18.9% of GDP Status: Achieved Budget: FY2012: 8.6% of GDP Status: Achieved Outcome: Annual contribution from the general fund to the CTF by end-fy2013 of at least 3.0% of GDP (Baseline: 0.6% of GDP in FY2011, est.) Output 2: Ratio of wages and salaries to GDP in FY2013 less than the FY2011 ratio (Baseline: 20.1% of GDP in FY2011, est.) Output 4: Ratio of subsidies to GDP in FY2013 less than the FY2011 ratio (Baseline: 3.0% of GDP in FY2011, est.) Outturn: No transfers were made to the CTF in FY2012 and FY2013 due to fiscal deficits Status: Not achieved Outturn: FY2013: 20.8% of GDP Status: Not achieved b Outturn: FY2013: 5.3% of GDP Status: Not achieved c 12 Alignment of policy actions and DMF outputs, and consistent use of indicators, with targets and baselines, would have been appropriate.

12 4 (v) Ratio of capital expenditure to GDP of at least 8.0% in FY2011 and FY2012 (FY2010 baseline: 7.7% of GDP) (vi) Increase in ratio of tax revenue to GDP to 16.5% by FY2012 (FY2010 baseline: 19.4% of GDP) d Budget: FY2011: 9.1% of GDP FY2012: 8.1% of GDP Status: Achieved Budget: FY2012: 16.9% of GDP Status: Achieved Output 3: Ratio of tax revenue to GDP on track to reach 16.2% in FY2015 (Baseline: 14.3% of GDP in FY2011, est.) Outturn: FY2013: 16.5% of GDP Status: Achieved e CTF = Compact Trust Fund, est. = estimated, FY = fiscal year, GDP = gross domestic product. Note: a Indicators and targets under output 1 of the policy matrix refer to budget targets (i.e. budget estimates) for FY2011 and FY2012 and not actual budget outturns. b Ratio of wages and salaries to GDP based on actual outturn in FY2011 was 22.1%. Compared to this baseline, the output indicator would have been achieved. c Ratio of subsidies to GDP based on actual outturn in FY2011 was 3.6%. Compared to this baseline, the output indicator would also not have been achieved. d Tax revenues increased in FY2010, resulting in a higher baseline than the target. At the time of program design, the ratio of tax revenue to GDP was estimated to be 16.2%. e Ratio of tax revenue to GDP based on actual outturn in FY2011 was 17.0%. Compared to this baseline, target and outturn are below baseline value. Sources: Asian Development Bank, Government of the Republic of the Marshall Islands, International Monetary Fund. 12. The medium-term direction underlying the program was an increase in the budget surplus to 5.0% of GDP by FY2016, as had been recommended by the IMF. The current projections indicate this target will not be met without further fiscal improvements. Although budget targets were achieved in FY2011 and FY2012, the government recorded the first fiscal deficit since FY2005 in FY2012 (0.8% of GDP), despite favorable growth. The deterioration reflected a 1.1% of GDP increase in transfers to SOEs and a rise in the public wage bill equivalent to 0.5% of GDP. This more than offset the increase in revenue from fishing license fees. The fiscal deficit for FY2013 is estimated to have remained at 0.8% of GDP, with a further increase in transfers to SOEs broadly offsetting a further rise in revenue from fishing license fees. Annual deficits are expected to widen to around 2% of GDP after FY2015 and to persist in the medium term, financed by bilateral and multilateral development partners. Since it was established in 2004, the government made transfers to the CTF in FY2004 to FY2006 and also in FY2011. No transfers were made in FY2012 and FY2013 due to budget deficits. 13. The reduction in the wages and salaries to GDP ratio was below the budget target of 21.0% in FY2013 (20.8%) and FY2014 (20.1%). Further improvement in this ratio is also projected in FY2015. The targeted reduction in the ratio of subsidies and transfers to GDP in the budget estimates was achieved, with 8.6% of GDP in FY2012 below the targeted 9.0%. Similarly, the ratio of capital expenditure to GDP of at least 8.0% in FY2011 and FY2012 was surpassed with budget estimates at 9.1% of GDP for FY2011 and 8.1% of GDP for FY2012. The ratio of tax revenue to GDP was estimated at 16.9% of GDP in the FY2012 budget, slightly above the targeted 16.5%. The government s Budget Coordinating Committee directed line ministries to enforce these fiscal constraints for the FY2013 budget, successfully complying with the policy action Policy actions under the program in support of improved debt management (actions 1.3 and 1.4) have proven successful, the public sector debt management guidelines continue to be followed, and the public sector debt management strategy became effective in FY2013. Government and the SOEs have adhered to the following guidelines: (i) a freeze on new borrowing to fund expenditure of the general government sector of government ministries; (ii) a freeze on the level of nonconcessional borrowing by the 11 SOEs; (iii) a proscription against government lending or loan guarantees to parties outside the public sector; and (iv) the requirement of prior Cabinet approval of any concessional borrowing by SOEs. In its 2013 debt

13 5 sustainability assessment, the IMF noted that publicly guaranteed debt has been on a downward trajectory, declining from 73.7% of GDP in 2002 to 55.9% at the end of FY2012. However, given projected budget deficits after FY2015, the central government debt-to-gdp ratio is expected to increase again in the future to meet deficit financing needs. 15. An amendment to the country s Financial Management Act to enhance fiscal responsibility and debt management was introduced in Parliament in August 2012 (action 1.5). Approval is still pending, and hence implementation has been delayed. The Ministry of Finance (MOF) was optimistic that the debt management and fiscal responsibility legislation bill would be passed in the August September 2014 parliamentary session. Due to the delay, however, the required fiscal and debt management strategies could not be made fully effective, which has hindered effective expenditure control, especially for salaries and wages, and subsidies. This is evident when comparing actual budget outturns for (Table 2) with the budget estimate targets described above, contributing to a measurable deviation in overall fiscal balance outturn. Table 2: Fiscal Performance of the Marshall Islands (in % of GDP), FY2009 FY2015 Item (in % of GDP) FY2009 FY2010 FY2011 FY2012 FY2013 FY2014p FY2015p Total revenue Tax revenue Current expenditure Wages and salaries Subsidies and transfers Subsidies Capital expenditure Fiscal balance (0.8) (0.8) (0.2) (2.0) Annual CTF contribution ($0.12 million) External debt () = negative, CTF = Compact Trust Fund, FY = fiscal year, GDP = gross domestic product, p = projection. Source: Asian Development Bank, Government of the Republic of the Marshall Islands, International Monetary Fund. 16. Output 2: Restraint on recurrent expenditure enforced by the Cabinet. This output was not achieved, based on the DMF s performance indicator related to the ratio of wages and salaries to GDP. This ratio in FY2013 (20.8%) was slightly above the FY2011 baseline of 20.1% and was unchanged in FY2014 (20.1%). However, all output 2 policy actions were carried out successfully. These included an independent review of public expenditure by the CAP advisory group and its preparation of specific actions to restrain recurrent expenditure in the FY2011 and FY2012 budgets. The program then supported the implementation of these recommended actions (action 2.1): (i) a one-off cut in grants and subsidies to 11 SOEs; (ii) a one-time cut in electricity concessions to landowners affected by MEC operations, followed by a freeze; (iii) a one-off cut in travel and per diem expenses, followed by a freeze; (iv) a one-off cut (followed by a freeze) in general fund government operating expenditure on housing leases and rents, electricity, and water, communications, vehicles, fuel, and professional services; (v) a freeze on the wage and salary bill of the civil service, including the elimination of 50 vacant positions to

14 6 reduce over budgeting for wages; and (vi) a freeze on the compensation for Nitjela (Parliament) members. The FY2013 budget demonstrated continued fiscal restraint in regard to above expenditure items (action 2.2). However, rather than applying targeted line-item cuts depending on the expenditure needs of different ministries and agencies, the government imposed general across-the-board reductions in expenditure of 5.0% for FY2010 and 5.5% for FY2011, with expenditures for FY2012 maintained at FY2011 levels. In this respect, the broader intent of the output was not well-reflected in the performance indicator, and it should have been better defined as a reduction in total recurrent expenditure, which stood at 48.4% of GDP in FY2010, 48.7% in FY2011, 48.7% in FY2012, and 48.0% in FY The program supported work force audits for nine ministries (action 2.3): education, health, public works, finance, foreign affairs, internal affairs, justice, parliament and resources and development. Cabinet endorsed recommendations of the audits relating to reducing budget allocations to civil servant salaries and wages. Implementation started in finance, foreign affairs and public works to improve productivity (action 2.4). This reform will roll out gradually to other ministries. 18. A key implementation action that resulted from the civil service work force audits was the development of a strategic plan in 2013 for the Public Service Commission (PSC), with ongoing TA support from ADB. 13 Implementation started with TA from the Australian Public Service Commission. The activities being implemented include (i) developing key PSC publications, including a public service induction booklet, and updating PSC job descriptions; (ii) conducting a PSC work force planning exercise; (iii) reviewing PSC current processes and recommending improvements, such as review of the personnel action form; and (iv) capacity building for PSC staff on work force planning and helping other ministries and agencies develop job descriptions. A lack of job descriptions was identified by the work force audits as a key contributor to public service inefficiency. The PSC has partnered with the University of South Pacific Majuro campus to develop and provide opportunities for the RMI public service to attend a human resource management training certificate program and public administration master s degree program. Beginning in 2014, PSC staff members have been attending the certificate program. The public administration master s program also began in A new ADB TA is helping the government develop a human resources management information system (footnote 13). 19. Output 3: Ministry of Finance tax revenue increased. The output was achieved, and all policy actions were completed. Tax revenue increased by 4.6% from FY2012 to FY2013, and the FY2013 ratio of tax revenue to GDP was 16.5%, up from a baseline of 14.3% in FY2011. The ratio is currently higher than the target of 16.2% in FY2015 and is projected to remain above 16.2% until In 2010, the TRAM commission completed an independent assessment of the tax system, which was endorsed by the Cabinet. The assessment recommended that the government (i) adopt a broad-based consumption tax replacing existing distortionary taxes; (ii) adopt excises on alcohol, tobacco, motor vehicles, and fuel to replace existing distortionary taxes; (iii) adopt new income tax rates and reduce exemptions to reduce the overall regressivity of the tax system; and (iv) improve compliance by streamlining and consolidating the multiple tax monitoring and collection systems. Tax legislation to effect the reforms was drafted and introduced in Parliament in August 2012 but is still pending (action 3.1). Indications are that it may not be passed in the August September 2014 sitting. The government is planning further consultations on the proposed legislation. Political concerns arising from the approach of November 2015 elections appear to be slowing passage of the tax 13 ADB Strengthening Public Sector Management in the North Pacific. Manila (TA8581-REG for $1,500,000 approved in December Additional cofinancing from the Government of Australia was approved on 2 June 2014).

15 7 reform legislation, and its implementation may be delayed until FY2016. Meanwhile, the government has increased tax revenue by streamlining tax administration and improving compliance with support from the Pacific Financial Technical Advisory Centre (PFTAC), and, until August 2014, from Australia s Department of Foreign Affairs and Trade (DFAT). 20. Output 4: Performance of selected state-owned enterprises improved. The DMF targets under output 4 were not achieved. In FY2012, transfers to SOEs increased by 1.2% of GDP from 3.6% to 4.8%. The National Telecommunication Authority was unable to meet its repayment obligations during the year, and the government was required to step in. A further increase in transfers to SOEs occurred in FY2013, with the ratio of subsidies to GDP reaching 5.3% i.e., higher than the baseline of 3.0% in FY2011 (and also higher than the budget outturn for FY2011 of 3.6% of GDP) rather than lower, as intended. According to ADB s 2014 Finding Balance comparative study of SOEs in the Pacific region, the consolidated rate of return on equity of SOEs in FY2012 remained negative at 11.3%, with an average of 5.6% during FY2002 FY Still, all output 4 policy actions were completed. The government has continued annual reporting on SOE performance, and the RMI take part in ADB s assessment of SOE performance in the Pacific (footnote 14) (action 4.1). In April 2012, Cabinet approved a set of good practice principles for SOE management to formalize the governance framework. The Cabinet also endorsed in principle new SOE legislation that provides the statutory guidelines needed to better control and monitor SOE operations. The legal drafting was completed, with support from ADB s private sector development initiative regional TA, and was introduced in Parliament during the September 2012 session (action 4.2). 15 There are indications from government that SOE legislation will be approved during the August September 2014 parliament session. When passed, the legislation will require board restructuring to improve governance, which had a positive impact on SOE performance in comparable situations in other Pacific countries. The target had been achievement of a positive rate by MEC improved its performance, while implementation of time-bound recovery plans was initiated for the Majuro Water and Sewer Company, the Marshall Islands Shipping Corporation, the Tobolar Copra Processing Authority, and the Kwajelein Atoll Joint Utility Resources Corporation (action 4.3). Implementation of these plans is at various stages, and any improvement in performance that may have occurred is not yet evident. 22. A key program achievement was the successful implementation of the comprehensive recovery plan for MEC (action 4.4). The program was successful in helping MEC (i) restructure its board to reduce membership from 10 to 7 and engage members with private sector and/or commercial experience to represent customer interests; (ii) adopt new procurement policy, new financial management and reporting policies, and a new vehicle policy; (iii) adopt a revised tariff template; (iv) strengthen procurement procedures; (v) achieve full board independence from political influence; (vi) create a statement of plans that set out strategic direction and performance targets; and (vii) achieve full cost recovery. The majority of the subprogram 1 loan funds were onlent to MEC to retire a commercial debt to the Bank of Guam. In 2010, Cabinet and the MEC board endorsed further actions to restructure MEC s debt, including the deferral of principal repayments of an existing loan with the Rural Utility Services of the US Department of Agriculture and establishing a debt servicing sinking fund with the MOF (action 4.5). The interest and cash flow savings from the restructuring were used to strengthen the financial position of 14 ADB Finding Balance 2014: Benchmarking the Performance of State-Owned enterprises in Island Countries. Manila. 15 ADB. Pacific Private Sector Development Initiative Phase II. Manila (TA 7430 REG, approved on 10 December 2009, for $12 million).

16 8 MEC and finance priority steps under the comprehensive recovery plan. The debt servicing sinking fund is managed by the MOF, and accumulated funds have been set aside by MEC to service its new loan from the government. 23. MEC also established a repair and maintenance account designed to hold sufficient funds for maintenance and repair needs (action 4.6). The initial benefit for MEC has been improved fuel efficiency in its generation operations. As well as yielding ongoing savings on fuel purchases of about $1.0 million a year, this has resulted in an improved quality of electricity supply. In FY2013 MEC produced an operating profit for the first time in 10 years $2.1 million. The return on assets for MEC in FY2012 was 1.7%, an improvement from 22.1% in FY2008 and 0.0% in FY2010. The company still carries negative shareholders funds and hence has an average return of equity during FY2002 FY2012 of 7.6%, compared with 9.2% during FY2002 FY Output 5: Effective stakeholder participation in public sector reform initiatives ensured by Cabinet. The output was achieved, and the related policy action successfully completed (action 5.1). The government initiated public consultations to develop a country-led and broadly supported set of policy actions. The consultations involved the public sector, development partners, the private sector, civil society, academia, and women's organizations. Public consultations continued to ensure effective stakeholder participation in public sector reform initiatives, and this has been particularly important for the progress of tax reforms. A key initiative supported by the program was the first development partners meeting held in December 2010, with a second such meeting held in August Public consultations, awareness programs, and other initiatives are ongoing and serve not only as informationsharing mechanisms but also to build ownership of the reform initiatives. C. Program Costs 25. ADB provided program cluster loans of $14.5 million for the two subprograms. The majority of the $9.5 million subprogram 1 loan funds were onlent to MEC to repay a high-interest loan it held with the Bank of Guam. 16 MEC used the cash flow savings from loan repayments to refurbish a generator and significantly increase its megawatt output, which resulted in the reduction in fuel usage of about 14% (paras ). The program also helped partly offset the costs of the budget s overall financing requirement, in amounts equivalent to 0.76% of GDP in FY2012 and 0.75% in FY2013. D. Program Schedule and Disbursements 26. The loan agreement for subprogram 1 was signed on 8 September 2010 and became effective on 28 September The loan was fully disbursed on 5 October The first subprogram was closed on 28 February The loan agreement for subprogram 2, signed on 13 December 2012, became effective on 21 January 2013, and the loan was fully disbursed on 8 March The second subprogram was closed on 31 March The appraisal disbursement schedule was realistic. The loan proceeds for subprogram 1 and 2 were disbursed to the RMI according to ADB s simplified disbursement procedures and related requirements for program loans. 17 There were no delays or need for corrective action by the borrower or ADB. 16 Under subprogram 1, $8,542,445 (89.9%) was initially onlent to MEC, followed by an addendum to the subsidiary loan agreement dated 08 September 2010 that provided an additional $1,000,000 onlent to MEC. 17 ADB Simplification of Disbursement Procedures and Related Requirements for Program Loans. Manila.

17 9 E. Implementation Arrangements 27. The original implementation arrangements were adequate to deliver program outputs, but the program steering committee provided for in the original design as the oversight body was not established. The lack of central oversight that resulted may have contributed to the limited success in achieving the outputs. In its stead, a committee was established specifically for the human resource component, facilitated by the PSC. The government s budget committee monitored progress of fiscal targets and other public financial reforms, while the MEC board monitored progress on the MEC comprehensive recovery plan. The MOF was the executing agency and was responsible for (i) overseeing all policy, legal, and regulatory actions to be undertaken in connection with the program; and (ii) ensuring that all policy reforms set out in the policy matrix were duly carried out in a timely manner. The MOF was also responsible for program administration, disbursements, and maintenance of all program records. 28. Implementation was also affected by a general election that was held partway through the program in November 2011 and led to a change of government. This contributed to slow progress in facilitating approval of legislation needed to implement proposed reforms. While other developments partners were providing complementary TA, none of the joint development partner dialogue that had proved important elsewhere in promoting government buy-in for reforms occurred around the program. Post-program monitoring efforts continue, particularly through the IMF Article IV missions. Ongoing TA projects have been helping the government maintain the momentum of the policy measures beyond completion of the program (section G below). F. Conditions and Covenants 29. The covenants under the loan agreements were complied with (Appendix 3). No covenants were modified, suspended, or waived during the program period. The program used ADB s policy-based program modality and was based on the development policy letters and policy matrices for the two loans. All policy actions relating to the subprogram loans identified in the design and monitoring frameworks and agreed with the government were complied with. As contained in the development policy letters for subprogram 1 and subprogram 2, the RMI government made specific assurances of its commitment to the public sector program on (i) tax reform, (ii) enforcement of restraint on recurrent expenditure, (iii) SOE reform, and (iv) effective stakeholder participation in public sector reform initiatives. G. Related Technical Assistance 30. The total TA of $900,000 also approved by ADB for support of the public sector program helped implement it. 18 The TA has the same envisioned impact, outcome, and outputs as the program. It successfully supported several initiatives, including (i) FY2012 budget preparation to ensure that the government met various expenditure budget targets and that the process was in line with broader medium-term fiscal targets; (ii) preparation of public sector debt management strategy and fiscal responsibility and debt management legislation by amending the Financial Management Act 1990; (iii) a review of the landowners electricity concession scheme; (iv) preparation of standard operating procedures to improve MOF processes; (v) work force audits and planning with PSC; (vi) preparation of an SOE policy; (vii) implementation of MEC s comprehensive recovery plan; (viii) preparation of strategic plans for Majuro Water and Sewer Company, the Marshall Islands Shipping Corporation, and the Tobolar Copra Processing 18 ADB Republic of Marshall Islands: Supporting the Public Sector Program. Manila. Manila (TA 7578 RMI, $600,000, approved on 17 August 2010). An additional $300,000 for the TA was approved on 6 June 2011.

18 10 Authority; (ix) the holding of the first development partners meeting in December 2010; and (x) establishment of a development coordination office for ADB in RMI, which facilitated interaction with the government and ensured that progress under the program continued. 31. Despite successful completion of these activities, the five TA outputs were not fully achieved. The TA (i) improved the government s fiscal discipline over the medium term, (ii) improved performance of MEC, and (iii) facilitated effective stakeholder participation and consultation, as envisaged. Output 2 to restrain recurrent expenditure was not achieved, however. Output 4 was achieved in that tax revenue remained above baseline and target and tax administration improved, but the benefits of the reforms have yet to be fully realized because the proposed tax regime is not yet in effect due to the delay in parliamentary approval of the relevant legislation (para. 19). Debt management and SOE reforms have also been delayed, pending approval of the SOE and fiscal responsibility legislation. The TA outcome to achieve fiscal sustainability was not achieved. However, the TA is rated successful because it provided the support necessary to implement the government s public sector program and meet the policy conditions for subprogram The program was also supported by other ADB regional projects and TA operations. A grant project, funded under the Japan Fund for Poverty Reduction and approved in 2010, supported MEC s reforms to improve demand-side and supply-side efficiencies and so contributed to the successful implementation of MEC s comprehensive recovery plan. 19 A Pacific region economic management TA project approved the same year helped develop the fiscal management model adopted and used during the FY2013 budget process. 20 ADB s 2011 regional TA for private sector development in the Pacific supported the drafting of the SOE legislation, incorporating key components of the SOE policy (footnote 15). 33. The program was also supported by other development partners, such as the government of Australia, which provided assistance through the DFAT, and the PFTAC. 21 The PFTAC and (until August 2014) a DFAT-financed tax adviser helped the government develop the tax reforms and draft the relevant legislation tabled in Parliament. In 2013, the PFTAC helped the MOF develop a comprehensive medium-term public financial management road map that included measures to strengthen the budgeting framework, the accounting system, debt management, and revenue administration. The RMI s fiscal and economic performance is wellmonitored by ADB s Asian Development Outlook and Pacific Economic Monitor processes, the IMF s Article IV missions, and by the Pacific Islands Training Initiative of Graduate School USA. 22 H. Performance of the Borrower and the Executing Agency 34. The performance of the borrower and the executing agency is rated less than satisfactory. Government s own CAP was recognized as ambitious and challenging to 19 ADB Proposed Grant Assistance to the Marshall Islands for Improved Energy Supply for Poor Households. Manila. (G9148-RMI, approved on 6 August 2010, for $1.76 million financed by the Japan Fund for Poverty Reduction). 20 ADB Pacific Economic Management Enhanced Economic Management (Subproject 2). Manila (TA 7681 REG, approved on 6 December 2010, for $1 million). 21 ADB supports the operation of the Pacific Financial Technical Assistance Centre through ADB Technical Assistance for Pacific Financial Technical Assistance Centre Manila (TA 7832-REG approved on 9 June 2011 for $1.0 million). 22 The Graduate School USA s Pacific Islands Training Initiative has worked with the RMI s government since 2006 to assist with a comprehensive annual update of finance and economic statistics. The RMI economic reports can be accessed at

19 11 implement, it also contained some internal inconsistencies which were carried through to the public sector program. The MOF performed satisfactorily in the development of the reforms, the drafting of the relevant legislation, and engaging key stakeholders during the initial (TAsupported) consultative process on planned legislation. Unfortunately, this consultative effort was not sustained and widespread political buy-in was not maintained, the result being that much-needed reform legislation has been before parliament for two years. Legislation for tax reform (7 bills), SOE reform (1 bill), and the strengthening of debt management and fiscal responsibility (1 amendment bill) were introduced in Parliament in August and September 2012, but are not yet approved. In August 2014, the MOF stated that it was optimistic that the pending SOE legislation would be passed by Parliament in the August September 2014 session. Taxation legislation is likely to be delayed at least until the January 2015 session, pending further consultations, and a scheduled November 2015 election may cause even further delay (para. 19). The political process is beyond the control of the executing agency, but it should have better recognized that it could put the program s success at risk. Greater and sustained bipartisan consultation should have been undertaken on the objectives and the need for the program and the passage of the legislation. I. Performance of the Asian Development Bank 35. The performance of ADB is rated less than satisfactory. As noted in para. 8, the program s design, particularly its intended impact and outcome, were overly ambitious in light of the limited capacity of the government and the likely slow pace of reform in a small island state. Furthermore, the public sector program design had some deficiencies, in parts using less appropriate indicators (for example, paras. 15 and 16) and inconsistent baselines and targets for DMF indicators and related policy actions. ADB s staff at headquarters, ADB s country liaison office in RMI, and its TA teams assisted the government in implementing the program, but provided insufficient support for sustaining reform momentum. ADB staff actively monitored the program s progress and ensured completion of policy actions. Assistance provided under the related TA, other ongoing projects, and regional TA projects was deemed valuable by the government to the successful completion of the policy activities. III. EVALUATION OF PERFORMANCE A. Relevance 36. The public sector program is rated relevant. The urgent need for reform was widely recognized, and the program was designed and worked to meet it. It was fully aligned with the RMI government s initiatives, including the formation of the CAP advisory group and the TRAM commission to prepare fiscal reform plans, develop strategies to mitigate the impact of the global financial crisis, advance public sector reform, and promote macroeconomic stability and sustainable growth. The CAP advisory group and the TRAM commission no longer exist, and implementation of the reforms has been transferred to the responsible divisions of the MOF, the PSC, and the concerned SOEs. The program is also aligned with ADB s strategy for the RMI, which focused on macroeconomic and strategic management (para. 7). 37. The original triggers under subprogram 1 and for subprogram 2 remained unchanged for the most part. In response to the prolonged approval process for the reform legislation, the main adjustments were those made to the triggers related to the proposed bills. This was changed in the policy matrix for policy actions 1.5 (fiscal responsibility amendment bill) and 4.2 (SOE bill) from a requirement of endorsement of the legislation by Parliament to simple introduction of the legislation in Parliament. Policy action 3.1 (tax reform bills) was expanded to include introduction of legislation into Parliament as evidence that implementation of time-bound

20 12 actions were on track. Adjustments were also made to provide specific details for some of the policy actions. 38. Policy measures were relevant to addressing the challenges the RMI and its government would face in their efforts to achieve fiscal sustainability beyond the end of the country s compact relationship with the US. The relevance of the program increased during implementation, with the RMI s fiscal situation not allowing scheduled transfers into the CTF that would support RMI s move toward self-reliance. It is therefore critical that the reform momentum achieved under the program is maintained and initiated reforms are fully implemented. B. Effectiveness in Achieving Outcome 29. The program is rated less than effective in achieving the envisaged outcome of fiscal sustainability. Performance in delivering the outcome was to be measured by the following indicators and targets: the CTF was to be assessed by the IMF to be on track to achieve FY2023 targets under the baseline scenario, and the annual contribution from the general fund to the CTF was to be at least 3.0% of GDP by the end of FY2013. Neither has occurred. 30. According to the IMF, the RMI would need to reach a budget surplus target of 5% of GDP by FY2016 to ensure that the CTF was on track to replace the compact grants in FY2024. The current projections indicate this target will not be met unless greater fiscal improvements occur. The targeted annual contribution from the general fund to the CTF of at least 3% of GDP (or about $5.6 million) was not achieved. Although the FY2011 and FY2012 budgets included a fiscal surplus above 3% of GDP (with that, targets were met under the program), a fiscal deficit of 0.8% of GDP was recorded in FY2012 and FY2013. No transfers were made to the CTF, and the situation is not likely to improve, with annual deficits expected to widen to around 2% of GDP after FY2015. C. Efficiency in Achieving Outcome and Outputs 31. The Public Sector Program is rated less than efficient. The government met the preconditions for release of funds on time, but the program s intended outputs were not fully achieved mainly due to the continuing delay in parliamentary approval of key legislation needed to fully implement reforms (paras. 15, 19 and 21). The program s design did not take the lengthy parliamentary process into account or the political opposition likely to confront the proposed reforms. Some program outputs were over ambitious and therefore highly unlikely to be achieved during the program period. The program was less than efficient in achieving the intended outcome of fiscal sustainability. Indeed, this outcome could have been achieved more directly (and hence efficiently) by simply directing the loan funds into the CTF itself, although this would not have facilitated sustained changes in the country s financial management that could lead to heightened CTF contributions. D. Preliminary Assessment of Sustainability 32. The program is rated less than likely to be sustainable. This will remain the case unless the legislation introduced in Parliament to allow for full implementation of reforms is approved. As noted in paras. 15 and 21, the government has stated that it is optimistic that the legislation for fiscal responsibility and SOE reforms will be approved and it expects this to happen during the August September 2014 Parliament session. However, the government is less optimistic that the tax reforms legislation will be approved. It is planning further consultations to garner political support, with the aim of having it passed before the November 2015 elections. If