Compact 2024: What’s ahead for Marshall Islands and FSM?

A key question for people in the Marshall Islands and the Federated States of Micronesia is whether trust funds established by their respective Compacts of Free Association with the United States will be able to match Compact grants that end in 2023. It’s an increasingly serious issue with neither trust fund meeting investment benchmarks at the halfway mark of the Compact funding agreements.

The discussion also raises questions about a general lack of government reform in both of these countries that have long-term relations with the U.S. and remain heavily dependent economically on the U.S. government. A variety of outside advisors have urged the islands to bolster the trust funds with additional investments from funds that could be saved through reform.

Both trust funds are below benchmarks largely because funding was not invested the first two years of the then-new Compacts in the 2004-2005 period when U.S. and global stock markets were high. Global economic volatility in recent years has produced several bad investment years, including 2011, when the funds lost tens of millions of dollars.

The U.S. government has made clear that neither the terms of the amended Compact nor the terms of the Compact Trust Fund Agreement (CTF) make any commitment about the trust funds being able to make distributions of any specific size in 2024. In essence, the U.S. position can be summed up by saying: These are trust funds with no guarantees — whatever amount is there in 2023 is what the islands have to work with.

Nevertheless, it is obvious, too, that it is hardly in the interests of the United States to see island governments fall apart for insufficiency of funding when US grants under the Compact end with year 2023.

The key issue is transition from grants to the trust fund on October 1, 2023. Recently released economic reports on the FSM and Marshall Islands (RMI) by the Graduate School USA’s Pacific Islands Training Initiative estimates that FSM Compact grants will be USUS$83 million in 2023 and RMI Compact grants will be US$38 million. Both countries will be looking to their trust funds to replace this grant funding, with U.S. grants today accounting for about 60 percent of the government budgets in both north Pacific nations.

An International Monetary Fund evaluation of the RMI’s trust fund two years ago projected it would be able to provide only about 60 percent of the 2023 Compact grant funding for FY2024 — a situation that, if it eventuated, would cause economic chaos and the collapse of many government services in the islands given their dependency on U.S. funding.

‘Concern about potential CTF distribution levels — which is already intense — will likely grow,’ said the Graduate School USA’s ‘FSM FY2012 Economic Review’ released in October.

The Graduate School USA is funded by the U.S. Department of Interior and provides technical assistance to the RMI, FSM and Palau. In addition to producing detailed annual economic reviews of the three nations, it also evaluated the FSM and RMI trust funds based on their ‘sufficiency’ for providing ‘a smooth and sustainable transition from U.S.-appropriated annual sector grant to fully inflation-adjusted annual Compact Trust Fund distributions.’

The current sufficiency estimate for the FSM trust fund at the end of FY2023 is US$1.68 billion. ‘In order to be precisely ‘on-track’ to achieving that level as of June 30, 2013, the value would have had to have grown to approximately US$411 million,’ said the report. ‘However, the actual value of the (FSM) trust fund at that date is estimated at US$306 million.’

Graduate School USA’s report projected that the FSM trust fund would need to grow at an annual rate of 12.7 percent to achieve the sufficiency estimate by the end of 2023. Given that the rate of return since inception of the trust fund has been only 5.2 percent, ‘this rate of growth is remotely plausible but highly unlikely, and, as such, there is a strong likelihood of an unfavorable outcome at the end of the accumulation period,’ the report said.

The RMI’s trust fund is closer to being on the mark, but still below the ‘on track’ value of US$213 million. As of June 30 this year, it was valued at US$194 million. The sufficiency estimate for the RMI trust fund is US$745 million. The RMI fund would need to grow at an annual rate of 8.8 percent through 2023 to meet the sufficiency estimate, a growth rate that is ‘certainly achievable,’ said the Graduate School USA’s report. But, it added, ‘considerable risk of a less favorable outcome exists.’ The RMI’s trust fund has averaged 4.8 percent growth since 2006, so would need to nearly double this to meet the US$745 million goal by the end of 2023.

The Marshall Islands has two advantages over the FSM when it comes to the trust fund:

• With the U.S. military lease of Kwajalein Atoll for its Reagan Test Site continuing beyond 2023, some Compact grant funding will also continue when grant funding ends. The Graduate School USA report estimates that about US$9.6 million of the estimated US$38 million (or about 25 percent) of sector grants will continue beyond 2023 pursuant to the military use and operating rights agreement governing use of Kwajalein. That agreement runs to 2066 with a U.S. option to extend an additional 20 years.

• The Republic of China (Taiwan) is an additional contributor to the RMI’s trust fund and by 2023, will have injected about US$40 million into the fund.

Other than the annual reviews by the Graduate School USA and the issuance of an annual report by the Compact Trust Fund manager, there is little transparency in the operations and management decisions governing investments. The decision in the late 2000s, for example, to have Goldman Sachs manage the Marshall Islands investments led to extremely high management fees — fees that were cut by nearly 50 percent when Goldman was dropped two years ago in favor of Mercer, another U.S.-based fund manager.

The Graduate School USA report was complimentary of the FSM and RMI trust fund committees’ decisions to switch to Mercer, but at the same time urged the FSM and RMI to seek ‘periodic, professional review of the Compact Trust Fund Committee’s chosen approach and allied providers.’

Leaders in both countries have expressed concerns to the U.S. government about slow growth of their trust funds. The RMI has suggested that the U.S. continue Compact grants through 2025 — two additional years to make up for the two years at the outset of the Compact when funds for the trust fund were not invested. This request has not gained any traction to date.

The IMF and Graduate School USA are among outside advisors urging the FSM and RMI to carry out fiscal reforms so they can invest more money in their trust funds. If they were to do so in a significant and ongoing way, it would likely help the islands gain U.S. government help to address probable shortfalls in the sufficiency of both trust funds.