Republic of the Marshall Islands: Staff Concluding Statement of the 2025 Article IV Mission

Republic of the Marshall Islands: Staff Concluding Statement of the 2025 Article IV Mission

September 10, 2025

Washington, DC:

The government of the Republic of the Marshall Islands (RMI) has made strides in addressing the vulnerabilities and challenges it faces as a small, fragile, and remote island state. The recent renewal of the Compact of Free Association with the United States (Compact) offers a window of opportunity to enhance fiscal prudence and press ahead with structural reforms. In that respect, the remarkable progress achieved by the government in its ongoing tax reform is commendable. However, given large development and climate adaptation investment needs and exposure to external shocks, policies should avoid eroding fiscal buffers and unfavorably shifting the balance of spending away from needed capital investments. Policy priorities include advancing fiscal and governance reforms-most notably replacing the Universal Basic Income (UBI) with a more targeted scheme, mitigating AML/CFT vulnerabilities, capacity building, and fostering private sector development. Progress on rolling back past digital initiatives is welcome; current plans to issue a "digital sovereign bond" carry significant risks relative to perceived returns, which cannot be effectively mitigated given lack of pre-requisite capacity. Thus, in the mission's view, the authorities should not proceed with the global launch as planned.

RECENT DEVELOPMENTS, OUTLOOK, AND RISKS

After two years of contraction, the RMI's economy appears to be returning to growth. Growth in FY2024 is estimated at 3 percent, supported by a strong rebound in the fisheries sector and buoyant investment and consumption related to the Micronesian Games, despite delays in Compact grant disbursements. Growth is projected to continue at 2.5 percent in FY2025, before accelerating to 4.1 percent in FY2026, supported by the expected rollout of the UBI scheme and the Extraordinary Needs Distribution (END; another income support scheme established under the new Compact, specifically targeting outer-island residents). Both schemes, financed by now permitted annual drawdowns from the Compact Trust Fund (CTF), were approved in August 2025 by the Trust Fund Committee (TFC). Medium-term growth prospects remain subdued at around 1.6 percent, reflecting structural constraints including continued labor outmigration.

Inflation is expected to remain elevated. Following a peak of 9.3 percent in December 2022, year-on-year inflation gradually eased in line with global commodity prices, reaching 5.7 percent by end-FY2024. Nonetheless, inflation is expected to remain above the historical average of 1.4 percent over the medium term, reflecting wage-driven cost increases following the planned minimum wage increases and the rollout of the UBI.

The fiscal and current account surpluses are projected to decline over the medium term. The 3.6 percent fiscal surplus estimated in FY2024 is projected to decline, and fiscal policy to become expansionary in FY2025 (through income tax relief measures and the carryover of delayed Compact-related spending) and more so in FY2026 (through the rollout of the UBI and END). The current account is projected to narrow but to remain in surplus in the medium term.

The financial system remains underdeveloped, with the recent passage of the Monetary Authority (MA) Act representing a welcome step forward. The RMI operates under a fully dollarized regime with minimal financial linkages to the global system. Credit to the private sector has continued to decline steadily, as banks have shifted toward safer foreign asset holdings, and credit demand remained subdued due to limited investment opportunities. Only one domestic bank maintains a correspondent banking relationship (CBR) with a U.S. bank, and a key financial sector vulnerability remains its potential loss due to ongoing financial integrity concerns. In line with IMF advice, the MA Act was passed in August 2025, with a provision repealing the SOV Act, which had aimed to establish a digital sovereign currency as second legal tender.

The authorities are planning to fully outsource the issuance of a "digital sovereign bond", called USDM1, to U.S.-based and domestic private entities, aiming to raise revenues and improve financial inclusion. USDM1 would be targeted at investors globally, and unlike traditional sovereign bonds, all proceeds are earmarked for the purchase of short-term US T-Bills to serve as collateral. Interest would be accrued continuously in additional USDM1 units. The rate would reflect prevailing T-Bill yields minus administrative costs and a government margin, which the authorities intend to use initially to overcollateralize USDM1 and later to fund priority spending. While the RMI government would legally be the issuer, the cabinet approved a public private partnership with a U.S.-based private entity, MIBOND Global LLC, which, through and in coordination with other U.S.-based and its domestic subsidiary MIFS, would undertake coordinating and administering the issuance and redemption, its collateral and interest payouts, risk management, and all regulatory compliance tasks. Redemption would be available on demand, with the government retaining the right to wind down the project. An oversight committee, including the government, will review the issuance cap regularly, beginning with about US$100,000. The issuance process will be iterative, and demand driven. Bilateral issuance tests with select partners are set to take place as part of a technical pilot by late September 2025. Domestic issuance will be linked to the UBI rollout in November, as USDM1 will be offered as an option for UBI payments. Global issuance will be paced depending on test results and investor demand.

Risks to the outlook are mostly tilted to the downside. Externally, the elevated global risks, most notably rising trade barriers, prolonged policy uncertainty, and volatile commodity prices, could increase the RMI's balance of payments and fiscal pressures, raising living costs beyond the baseline assumptions. More frequent natural disasters pose a significant threat to the economy. Domestically, the expansion of the Decentralized Autonomous Organizations (DAOs) registry operations and premature implementation of new largely untested policy initiatives (USDM1, UBI) could have adverse macro-fiscal and financial integrity implications. Withdrawal of the last CBR could disrupt trade, remittance, and grant flows. Continued labor outmigration poses long-term challenges for economic development.

POLICY DISCUSSIONS

Fiscal Policy: Leveraging the New Compact Effectively

Given the ongoing recovery and the improvement in the medium-term fiscal outlook following the Compact renewal in FY2024, fiscal policy support in FY2025-FY2026 is appropriate, but its scale is excessive. The new Compact provides US$2.3 billion over 20 years starting in FY2024 (54 percent higher than under the previous Compact). Furthermore, the CTF, originally designed to support fiscal self-sufficiency after the expiration of the Compact, has been restructured to allow capped annual withdrawals, putting the onus on the authorities to preserve such buffer. Given the RMI's vulnerabilities and uncertainty over future Compact renewals, a careful and sustainable fiscal path would be needed to maintain appropriate fiscal buffers. Particularly, large permanent expansions in current fiscal spending, as envisaged with the UBI and END programs (equivalent to 8.1 percent of GDP and 6.0 percent of GDP, respectively in FY2026), pose macro and fiscal risks, while unfavorably shifting the balance of expenditure away from needed capital investment and eroding fiscal buffers.

Given RMI's significant developmental needs and exposure to external shocks, the authorities should replace the UBI at the first available and feasible opportunity with a more targeted scheme to ensure more effective uses of the CTF resources. The UBI scheme, approved for FY2026 and expected to be rolled-out in November 2025, aims at addressing rising cost-of-living pressures and curtailing outmigration. While the initiative could strengthen income security, it poses a significant and permanent fiscal cost, erodes fiscal buffers, and crowds out needed investments. It also poses significant macroeconomic risks that require close monitoring. In particular, the large fiscal injection would add to aggregate demand and could fuel inflationary pressures. The scheme may also raise reservation wages and dampen labor supply, potentially eroding private sector competitiveness. To mitigate these risks, the authorities should closely monitor inflation trends, coordinate with importers to ensure adequate inventories, and support labor force participation through training and active labor market programs. Yearly monitoring and evaluation of the scheme is imperative. Scaling back the UBI to a more targeted scheme to those who need it the most, ideally in next year's proposal to the TFC, would help preserve fiscal sustainability and achieve the desired developmental impact. In this respect, it would be important that design and administrative synergies between the UBI and the targeted END are built-in from the onset of the programs. The IMF stands ready to support the authorities in improving administrative capacity, with support from development partners, to develop a better targeted and fiscally sustainable scheme.

Inefficient and poorly targeted subsidies to SOEs should be gradually phased out with the END serving as an alternative supportive measure. Over the past five years, SOE subsidies have averaged 6.2 percent of GDP, well above regional benchmarks, and have often supported entities with limited commercial viability and weak governance. Particularly, the authorities should consider gradually replacing the inefficient and fiscally burdensome Copra Support Program with the END. While the authorities do not currently envisage doing so, they expressed broad interest in exploring options for subsidy reform to unlock efficiency gains. To ensure liftoff of such politically sensitive reform and facilitate a smooth transition, the authorities should support displaced workers through targeted social protection and retraining programs.

Timely implementation of phase two of tax reform, scheduled for FY2027, is critical to reducing dependence on volatile non-tax income and creating fiscal space for climate adaptation and development priorities. RMI's tax revenue remains below potential; staff estimates RMI's tax capacity at 17-19 percent of GDP, compared to the current level of around 14-16 percent of GDP. The planned transition from the gross revenue tax to a value-added tax (VAT) and business profit tax, alongside excise tax reforms, is expected to reduce distortions and broaden the tax base while maintaining revenue neutrality in the medium term. To further close the tax potential gap, particularly to support climate investment, additional policy measures, including gradual VAT rate increases beyond the initial 12 percent, are warranted.

The RMI's debt is sustainable and assessed to be at moderate risk of debt distress, improved from the previous high-risk assessment in 2023. Debt has declined from 74 percent of GDP in FY2002 to about 17.3 percent in FY2024. While the RMI's economy is highly vulnerable to weather-related natural disasters in the medium to long term, the sustained inflows of Compact-related grants and implementation of the Fiscal Responsibility and Debt Management Act 2020 support the upgrade in the rating. At the same time, additional risks remain. The authorities have recently proposed to International Financial Institutions a concessional loan of approximately US$300 million (99 percent of GDP) to finance the construction of hospitals and the revitalization of port facilities, with the future Compact funding to be set aside for repayment. Such large debt-financed projects, if fully implemented, would crowd out investments in needed adaptation capital and pose risks to debt sustainability. In addition, the planned issuance of USDM1 presents a significant challenge and uncertainty to the debt sustainability analysis.

Financial Sector and Financial Integrity Issues: Mitigating AML/CFT Vulnerabilities

Weaknesses in the AML/CFT framework pose material risks to financial integrity and stability. The 2024 FATF/APG Mutual Evaluation Report (MER) identified elevated cross-border money laundering and terrorism financing (ML/TF) risks associated with the offshore corporate registry and the emerging DAO sector. The opacity and limited oversight of these sectors, as well as the lack of a comprehensive and detailed assessment of associated ML/TF risks, create significant AML/CFT vulnerabilities. Institutional constraints, including weaknesses in implementing beneficial ownership requirements, fragmented AML/CFT supervision, and insufficient market entry controls, further undermine effective mitigation of ML/TF risks. These persistent AML/CFT gaps could threaten access to CBRs, with adverse implications for remittances, development finance, and trade. The authorities should steadily implement the national Strategic Implementation Plan prepared with the APG in 2025.

The risks posed by a global launch of USDM1 appear to be disproportionally higher than the perceived gains and cannot be mitigated given lack of prerequisite capacity. USDM1's ability to meet its objectives appears to be constrained by structural and market limitations:

• Revenue prospects are uncertain, as US T-Bill yields may fall below expectations and USDM1's global uptake faces competition and regulatory uncertainty.
• Furthermore, USDM1's contribution to financial inclusion appears limited in the near term, given the lack of adequate digital infrastructure. Domestically, USDM1 will be offered as an option for UBI payments, alongside bank transfers and checks. However, take-up is highly uncertain as the option would not likely serve UBI's objective of cost-of-living support given questionable functionality as a means of exchange and considerable operational challenges.

At the same time, this initiative gives rise to a wide range of risks:

• USDM1 may entail fiscal risks in the event of redemption pressures due to loss of investor confidence. The latter could be triggered by price volatility of T-Bills or more likely by operational and cybersecurity vulnerabilities, possibly amplified by inadequate legal regulatory framework for USDM1. The issuance may additionally pose a risk of non-compliance under the IDA's Sustainable Development Finance Policy (SDFP), subject to the terms of the Non-Concessional Borrowing ceiling (if applicable) for the RMI in FY2026.
• Furthermore, to date, no in-depth risk assessment has been conducted on the potential misuse of USDM1 or its potential client pool. At present, the authorities do not appear to be equipped with appropriate expertise, tools, or technological abilities to supervise entities involved, analyze potentially suspicious transactions, and combat illicit activity involving USDM1, adding to risks of losing access to CBRs.

In the mission's view, the authorities should not proceed with the planned global launch given the lack of institutional readiness, ownership, understanding, and ability to effectively mitigate associated risks. They should also consider whether the policy objectives could be better achieved through alternative, less risky measures-such as the ongoing tax reform and strengthening digital infrastructure and promoting the use of mobile and online banking.

Structural Policies: Lift Potential Growth and Enhance Economic Resilience

Despite uncertainty regarding the pace of climate shocks, acting on adaptation needs now is imperative to unlock growth potential. Adaptation actions include atoll-specific strategies, with urban centers focusing on coastal barriers and future relocations, semi-urban atolls investing in both hard and soft infrastructure, and rural atolls initially implementing nature-based and low-cost solutions. Simulation results show that resilient infrastructure investments and effective public investment management (PIM) can significantly reduce GDP contraction following natural disasters and recurring sea-level rise (SLR) shocks. Tax reform, featured by a permanent increase in the VAT rate, helps facilitate infrastructure restoration against persistent SLR and boost private investment and long-term growth despite dampened consumption. It can also help boost residents' confidence in the nation's long-term development prospects and alleviate the strong trend of labor outmigration.

The high costs of adaptation investments underscore the urgent need to mobilize additional financing both domestically and internationally. The RMI has access to a variety of climate finance windows but faces difficulties in preparing bankable projects in line with donors' requirements. Moving forward, revenue mobilization can create fiscal space to fund climate investments, and enhanced PFM and PIM will help attract external climate financing. Given the limited financial envelope, prioritizing adaptation actions is vital for the country's future resilience.

Improving governance and digital infrastructure and further diversification can help enhance the business climate, foster private sector development, and support medium-term growth. Overcoming governance challenges would help transform strategies into effective policies, regulations, and outcomes. Advancing reforms in the main identified areas of weakness including fiscal governance, the regulatory framework, and AML/CFT is imperative. Improving digital connectivity, where the RMI lags its peers, can help unlock new pathways for growth. Further diversification efforts, either by investing in higher value-added activities in fisheries, or in exploring new industries such as sustainable tourism, are needed.

Improve the Quality of Macroeconomic Data-Foster Better Policy Making

Strengthening both the timeliness and quality of macroeconomic data remain priorities. Timely publication of high-quality macroeconomic statistics and improving consistency across sectors remain priorities-this would provide a robust basis for policy making. Thus, the mission engaged with the authorities and Graduate school USA on opportunities to support the government's efforts to improve data quality and availability, including through ongoing IMF capacity development.

The IMF mission team would like to thank the authorities and counterparts in public enterprises, the private sector, and development partners for their warm hospitality and for candid and engaging discussions. The team looks forward to maintaining constructive policy dialogue and to supporting the authorities through continued engagement in capacity development.