South Asia Country Briefs | 55 Maldives Construction has taken over tourism as the main driver of 2015 growth since late 2014, the latter affected by a decline in tourist arrivals from Russia and China. The medium- Population, million 0.4 term fiscal plan is anchored by large multi-year public GDP, current US$ billion 3.1 investment projects. Given the lag between infrastructure spending and its growth impact, public debt situation GDP per capita, current US$ 7630.9 is expected to deteriorate in the medium-term—raising Sources: World Bank WDI and Macro Poverty Outlook. the risk of external debt distress to high. A more gradual fiscal expansion and prioritization of investment projects are needed to lift growth to a moderate level while maintaining macroeconomic stability. Contributions to GDP Growth Percent 10 8 6 4 2 0 -2 -4 1Q1 1Q 2 1Q 3 1Q 4 2Q1 2Q 2 2Q 3 2Q 4 3 Q1 3Q 2 3Q 3 3Q4 4 Q1 2 3 4Q4 5 Q1 5Q 2 5Q 3 5Q4 6 Q1 4Q 4Q 201 201 201 201 201 201 201 201 201 201 201 201 201 201 201 201 201 201 201 201 201 Construction Tourism Total Gross Value Added at basic prices Sources: Ministry of Finance, World Bank staff calculations, Joint Bank-Fund Debt Sustainability Analysis Recent Developments food (mainly fish) prices, housing, water, electricity, gas After peaking at 6.5 percent in 2014, growth is expected to and other fuel prices and transport prices. decelerate to 1.9 percent,1 dragged down by a slowdown in tourist arrivals, especially from Russia and China. While Maldives’ high levels of fiscal deficits and public debt pose tourism is still the single largest sector, construction has a significant risk, as the country is structurally spending overtaken tourism as the most important driver of growth, beyond its means. Even though the high costs of public fueled by a surge in both public and private investments. service delivery is inevitable in a multi-island country with scattered population, high levels of public spending in Following the global decline in commodity prices, CPI recent years have been primarily driven by the country’s inflation has trended downward since 2013, and became redistributive model, including the high public sector negative in April 2016 (year-on-year), dragged down by wage bill, pensions, universal health insurance and subsi- dies for food and electricity, and transfers to state-owned enterprises. 1 Staff projections. The official final macroeconomic numbers for 2015 are not yet available. The Based on current trends, staff estimates that revenue and Maldives Monetary Authority monthly bulletin of August 2016 published preliminary estimates for GDP growth, the fiscal deficit and the current account deficit for 2015. Until these numbers public spending have increased to 36 and 44 percent of are final, staff estimates for 2015 are used in this analysis. GDP respectively in 2015, resulting in a fiscal deficit of 8.4 56 | South Asia Economic Focus Fall 2016 | Investment Reality Check percent of GDP. While, net external financing has been tourism sector. Gross official reserves reached USD 623 negative in 2014 and 2015, heavy reliance of domestic million by July 2016, although usable reserves2 are only sources of financing has increased the exposure of the USD 209 million—equivalent to 1.2 months of imports domestic banking system to sovereign risk. In response of goods and services. But this is less of a concern than it to fast rising domestic interest rates, Treasury bill auctions may appear, since the tourism industry has been able to were replaced by a “tap system” fixing interest rates at low supply sufficient quantities of foreign exchange at a stable levels in mid-2014. premium over the de facto fixed exchange rate of 15.4 rufiyaa per dollar. 2016 fiscal policy is expansionary with large public invest- ment projects. Staff projects revenue to reach 35.6 percent of GDP and expenditure 48.9 percent of GDP. Wages are Outlook projected to be frozen in nominal terms, while the budget In the near term, growth is expected to be driven by con- foresees significant reduction in electricity and food sub- struction, fueled by both private sector construction and sidies. The budget includes a number of large multi-year large public investment projects, while tourism growth investment projects: airport expansion, a bridge between is likely to remain subdued because of a slowdown in the capital Malé and Hulhumalé Island and housing con- China, the recession in Russia, the appreciation of the struction in Hulhumalé island. MVR (pegged against the USD) against major currencies. Inflation is projected to remain subdued as long as global The slowdown in tourism in 2015 has led to a decline in commodity prices remain low, with positive impacts on net service exports. While the import bill of petroleum the current and fiscal accounts. products declined thanks to low global commodity prices, it was partially offset by increased imports of transport equipment and building materials driven by the construc- tion boom. The current account deficit is estimated at 8.8 percent of GDP, financed by strong FDI inflows into the 2 Net of short-term foreign liabilities of the central bank to the banking sector. Table: Maldives (annual percent change unless noted otherwise)    2013 2014 2015 p 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 4.7 6.5 2.1 1.9 3.5 3.9 4.6 Private Consumption ... ... ... ... ... ... Government Consumption ... ... ... ... ... ... Gross Fixed Capital Investment ... ... ... ... ... ... Exports, Goods and Services ... ... ... ... ... ... Imports, Goods and Services ... ... ... ... ... ... Real GDP growth, at constant factor prices 4.2 5.9 3.5 ... ... ... ... Agriculture 5.1 0.2 -2.9 ... ... ... ... Industry -7.6 12.9 26 ... ... ... ... Services 6.4 5 -0.1 ... ... ... ... Inflation (Consumer Price Index) 2.3 2.1 1.0 0.4 1.3 2.5 2.8 Current Account Balance (% of GDP) -4.6 -3.9 8.8 -8.0 -7.7 -11.7 -14.6 Financial and Capital Account (% of GDP) 2.6 17.8 11.4 6.7 9.7 16.8 17.7 Net Foreign Direct Investment (% of GDP) 13.0 10.9 9.6 10.6 10.0 10.9 10.8 Fiscal Balance (% of GDP)  -7.4 -9.1 -6.9 -8.5 -13.0 -13.8 -11.9 Debt (% of GDP) 64.8 66.6 63.9 72.1 81.9 91.0 96.9 Primary Balance (% of GDP) -4.9 -6.3 -4.4 -5.5 -10.5 -10.5 -7.7 Source: Maldives Monetary Authority, Ministry of Finance and Treasury, World Bank staff estimates for 2015 and forecasts for 2016-2018. Note: p = preliminary estimate published in MMA bulletin, e = World Bank estimate, f = World Bank forecast South Asia Country Briefs | 57 The planned large increase in front-loaded capital invest- ment has increased the risk of external debt distress to high according to the most recent Debt Sustainability Analysis.3 A more gradual implementation could mitigate this risk but without additional expenditure and revenue measures this could still lead to fiscal deficit of close to 14 percent of GDP with the public debt-to-GDP ratio ap- proaching 100 percent. Risks and Challenges The immediate macroeconomic challenge is to address the fiscal and external imbalances driven by high and rising public spending. The projected fiscal path is not enough to bring public debt-to-GDP trajectory on a de- clining path. Restoring debt sustainability would require significant fiscal consolidation by raising revenue and re- ducing expenditure. Limited international reserves, a high level of public debt and the short maturity of domestic debt adds additional vulnerability. Meanwhile, political risks and a slowdown in countries important for tourism could lead to further reductions in tourism visits, which will put pressure on growth, revenue and the balance of payments. There are limited investment opportunities in the private sector outside tourism, and banks prefer to park their avail- able assets at the central bank and abroad. . 3 Joint World Bank-IMF Debt Sustainability Analysis, included in the IMF Article IV report of May 2016.