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Maldives Prepares to Address Economic Vulnerabilities, Urgent Fiscal Reforms Critical to Mitigate Risks

22 May 2024

Maldives Development Update 2024

The Maldives Development Update (MDU) has two main goals. First, it takes the pulse of the Maldivian economy by providing key developments over the past 12 months. Placing these in a global context, and based on these recent developments, it analyzes the outlook over the medium term. Second, every other edition of the MDU provides a more in-depth investigation of selected economic and policy issues. It has a wide audience including policymakers, policy analysts from think tanks or non-governmental organizations, and business and financial sector professionals interested in Maldives’ economic development.

Click here to download the latest Maldives Development Update (May, 2024).

RECENT ECONOMIC DEVELOPMENTS

In 2023, the number of tourist arrivals reached a record-breaking figure of 1.88 million. Nevertheless, this did not result in higher GDP growth due to lower per-tourist spending and shorter stays. The Maldivian economy is estimated to have grown by 4% in 2023. Domestic inflation, at 2.9% in 2023, remained higher than the historical average of 0.5%. Price increases were experienced in the food, education, restaurant, and lodging services sectors. Food inflation could increase poverty by 0.4 percentage points, with atolls experiencing even higher rates.

Travel export receipts fell 6.8%, while merchandise imports remained elevated at $3.5 billion. This resulted in a current account deficit of 23.4% of GDP. High import costs and external debt repayments also weighed heavily on gross reserves, which fell to $551.1 million in January 2024.

Failure to implement planned subsidy reforms, combined with rising recurrent and capital spending, resulted in a sharp increase in total expenditure and a fiscal deficit of 13.2% of GDP in 2023.

CHALLENGES

Tourism, which accounts for a quarter of the Maldives' economy, has experienced slower growth in 2023 due to a decline in average duration of stay and lower tourist spending. This slowdown has exposed underlying economic vulnerabilities in the Maldives.

These vulnerabilities stem from persistent large current account and fiscal deficits. The country relies heavily on imports while having limited official reserves, creating an unsustainable imbalance. Government support for struggling state-owned enterprises (SOEs), along with blanket subsidies, high capital spending, and a public health program, further exacerbate these pressures.

While these subsidies and in-kind transfers are crucial for boosting household incomes, their unsustainable nature raises concerns. When fiscal pressures mount, the Maldivian people's well-being could be negatively impacted. Additionally, infrastructure projects, although promising long-term growth, were financed through non-concessional external borrowing and sovereign guarantees. The rising cost of borrowing abroad has forced the government to turn towards domestic sources, increasing the domestic financial sector’s vulnerability to government debt.

The government recently announced its commitment to a fiscal reform agenda to address these economic vulnerabilities. This agenda includes reforms to subsidies, SOEs, the public health insurance scheme (Aasandha), and reprioritizing capital spending. These reforms offer a path towards a more resilient Maldivian economy.

OUTLOOK

The economy is projected to grow by 4.7% over the medium-term, supported by tourism, a decrease from the pre-pandemic average of 7.4%. This growth is based on expected fiscal adjustments, including subsidy reforms and reduced public expenditure and investments. This slowdown also means slower poverty reduction in 2024.

The fiscal deficit is expected to remain high in 2024 due to ambitious spending plans .The proposed fiscal reform package is expected to help but a more sustainable fiscal path requires a larger adjustment, particularly through cuts in non-essential capital and untargeted recurrent spending.

Inflation is expected to rise due to the removal of blanket subsidies, potentially driving poverty by 2.5 percentage points. The current account deficit is expected to remain high due to commodity price pressures and capital imports for infrastructure projects. Rising external financing needs, including debt servicing, are expected to sustain pressure on foreign exchange reserves.

Major downside risks include a shock to the tourism sector, limited domestic and external financing, and a widening current account deficit. To maintain macroeconomic stability, a major fiscal adjustment and a multi-year reform plan are required, along with a targeted transfer mechanism to offset welfare losses among vulnerable groups.

Implementing the government's fiscal reform agenda is essential to sustaining economic growth in Maldives. The World Bank remains committed to supporting Maldives in these reform efforts. This includes developing a targeted mechanism to support the poor and the vulnerable, phasing out the broad-based subsidy system that is currently inefficient, addressing weaknesses in state-owned enterprises, enhancing the efficiency of health spending, and improving the strategic planning of investments.