How Big is the Debt?

In recent months the FSM foreign debt has come to the attention of the public through press reports and newspaper articles. The purpose of this discussion was to shed light on the question so that the public might have a more accurate and detailed understanding of the true financial standing of the government. We hoped to correct any misunderstandings that may have arisen, while casting a critical eye on FSM investments and the policy that governs this investment.

Until 1989-90, FSM had no external debt at all. Within three years, by Fiscal Year 1992-93, the government had accumulated a debt of $137 million. During this period FSM's fiscal position shifted dramatically: from a 11.6 percent surplus of its gross domestic product -[GDP] in 1988-89, to a deficit of 5.3 percent in 1990-91, and a deficit of 13.8 percent in 1992-93.

Most of the debt was in the form of medium-term, low-interest loans borrowed against Compact Funds. With future Compact Funds as a guarantee, commercial rates were very favorable for the government. The medium-term notes meant that the total repayment was expected within the range of 2-10 years. FSM's debt service ratio in 199293 was 26.1 percent, meaning that the yearly debt payments amounted to this percentage of the nation's total annual exports of goods and services.

FSM's foreign debt position has improved since 1992-93, since some of the principal on the loans has been repaid. The outstanding loans as of the end of September come to $119 million. Even this does not reflect the true picture of FSM's fiscal status, however. Many government officials argue that these so-called "loans" could more accurately be called "advances" on the Compact Funds. The government's policy, in effect, has been to borrow money that it can use for development purposes as opportunities arise. The result is that the government has drawn on its future funds to get money up front so that it can finance projects it feels are important now.

Breakdown of the Loans

1. The following loans were borrowed against Compact Funds between 1990 and 1993.
   • FSM National Govt: $3.76m for fishing; $0 owed now Money was invested in NFC to fund a joint venture on Pohnpei through Carolines Fishing Company [CFC]. Paid off.
   • Chuuk: $10.3m for fishing; entire sum still owed $2m invested in desalination and ice-making plant for Chuuk Fresh Tuna Inc; the remainder is being used for the purchase of purse-seiners on a joint venture with Westpac. $10.3m still owed
   • Pohnpei: $23.8m for fishing; $18.3m still owed
   • Loan includes investment of $8.5 million in CFC, most of which went into purchase of three purse-seiners. Part of the loan was used to construct a fish processing plant, and the rest used to purchase bottom fishing boats from Sweden.
   • Kosrae: $5m for fishing; $2m still owed
   • Used to construct a cold storage facility that was intended for a local fishing corporation; joint venture with foreign company for a 5-year term.
   • Yap: $71m for bond investment; $51.7m still to be paid
   • State used its Compact CIP funds for portfolio investment in bonds guaranteed at 9 percent return; purpose was to provide operational funds for post-Compact years. Made in 1991 when the bond market was good, but the market fell afterwards.
2. US Federal Programs loans
   • FSM Telecom: $41m for expansion; $37m still owed
   • Loan in 1992 from US Department of Agriculture, Rural Electrification Administration [REA]. Terms: 5 percent interest over 35 years. No collateral required; repayment is to come from FSM Telecom profits. Part of the loan ($10m) funded construction of office buildings; the rest funded phone hookup with rural areas on main islands.
3. Asian Development Bank loans (all have been approved, but not yet implemented)
   • FSM National Govt: $6m for fishing
   • Intended to develop long-line fishing industry in FSM through the purchase of one training vessel and six longliners. Micronesian Long-Line Fishing Corporation will be formed and shares offered for sale. Terms: 10 year grace period, 40 year term, interest-free.
   • FSM National Govt: $6m for agriculture
   • Aimed at promoting import substitution, probably on Pohnpei. Terms of the loan not known.
   • FSM National Govt: $6m for water and sewage
   • Purpose is infrastructural development. Feasibility study being done at present; company to be selected and project to be implemented in June 1995. Terms not known.

Review of the Loans

The loans taken out by the FSM offer very favorable terms because the risk of government default is almost nil. Most of the loans, as has been pointed out, were borrowed against development funds guaranteed by the Compact of Free Association. The other major loan, the $41 million loan granted to FSM Telecom, is long-term and is expected to be repaid from the profits of the company. FSM Telecom, thanks to its $0.8 million subsidy, now shows a profit of about $1 million a year. Expectations are that the company will continue to grow even after this subsidy ceases.

Only the FSM Telecom loan and the $6 million loan from ADB for water and sewage are aimed at infrastructural development. All the other loans are intended to develop primary industries in the FSM. All but one of these are targeted at the fishing industry, which is generally recognized as FSM's largest and richest resource. The single exception attempts to expand the agricultural sector, which has been designated as another focus of development. These loans are, therefore, consonant with the policies and priorities set by the FSM Government.

It is no accident that the government rush to obtain loans began about 1990. This was near the end of the first five-year period of the Compact, a phase that would focus on infrastructure buildup, according to the FSM National Development Plan. It signaled a turn toward investment in productive industry. It was also at the verge of the first stepdown in Compact funding. The states had to get serious about economic development very quickly, and they responded by investing heavily in the fishing industry. Fishing was everyone's great hope for the future, needless to say. The Compact Funds were money in the bank, or at least almost in the bank. Why not use it while opportunities were present!

Was the money invested wisely? There is no doubt that mistakes were made in the hurry to take advantage of what looked like good investment opportunities. They were honest mistakes for the most part, understandable mistakes that may have at times stemmed from FSM's lack of experience in the fishing industry. One of the costliest seems to have been the heavy investment in purse-seiners in Yap and Pohnpei. Other investments may turn out better. At the present time, however, the investments are not generating the income that is needed to make up for the decrease in government funds from the US.

The investments made on Compact Funds have taken a huge bite out of the total development money available to FSM under the Compact. Pohnpei and Yap have committed all their development money up to the year 2001; the other two states still have some unspent funds. FSM will have to seek the financial backing for further development opportunities from abroad. The nation is now forced to rely on foreign investment once again, and it may have to liberalize its policies to lure well-heeled foreign business partners. Almost all the money that FSM once had to invest is now tied up.

What Experience Night Teach Us

FSM seems to have learned to take a second critical look at what might seem at first sight to be "easy" loans. A case in point is the $3.3 million loan that the Republic of China offered FSM last year for a convention center. Since a convention center is not generally regarded as an urgent need here, FSM attempted to negotiate so that the money could be used for a multi-purpose building at the site of the new College of Micronesia-FSM. FSM is insistent, quite correctly, that it rather than the donor should determine its development priorities.

FSM foreign loan policy is clear. All loans to states negotiated by the FSM National Government must be approved by the FSM Congress. Initiatives for loans from a foreign government, however, need not be taken to Congress for approval. FSM Finance Department is charged with coordinating the use of Compact Funds, but foreign loans are not subject to this department's oversight. Although the states may object at times to this supervision by the national government, its purpose is to promote rather than stifle the growth of the states. This system demands a sense of partnership between the states and the national government. Once they see themselves as adversaries, the checks that are meant to protect states from bad investments will break down.

One would think that the states might learn from past mistakes and avoid low-probability schemes like the purchase of an expensive fishing fleet that is costly to maintain and difficult to staff. Yet, Chuuk's recent decision to invest in purse-seiners makes one wonder whether there is effective communication between the states at all. Are the states learning from one another's successes and mistakes? The states may be so engaged in competing with one another for fisheries projects, someone remarked, that they do not share with one another the kind of information that could help others avoid the pitfalls they faced.

At some point, the FSM will have to determine what its investment policy will be with respect to fishing. Should it attempt to purchase fishing boats of any size, given the cost of buying vessels, the problem of securing local fishermen willing to fish at a commercial level, and the fluctuations in the tuna market? Should FSM concentrate exclusively, as some recommend, on providing service industries (sale of fuel and ice, ship repairs, etc) for foreign fishing boats? Or should FSM, like Ting Hong, target marketing and the management as its area of specialization? Opinion among the discussants varied widely. One person suggested letting someone else do the fishing because the real profits are in the marketing, as is clear from the Ting Hong operation. Someone else expressed doubts as to whether FSM had the marketing expertise. His preference was to let Ting Hong and others do the marketing but to tax them heavily. A third participant wanted FSM to cease licensing foreign vessels, to purchase its own fishing boats and hire foreign crews, and to get in on the fishing profits from the bottom up.

Conclusion

The foreign debt status of FSM is not as dreadful as the numbers that are bandied about might suggest. Most are, in effect, drawdowns on future Compact Funds. The loans are aimed at creating a fishing industry in which FSM can profit, and so are in complete accord with development priorities. The timing of the loans roughly coincided with the first stepdown in Compact Funds and the realization that states would have to act soon to generate funds by the end of the Compact. What is recorded as a "debt" can be seen as an investment opportunity seized.

If some of the investments proved to be failures, we ought not be too critical of the government on this account since we are all tyros in the area of commercial fishing. FSM is learning that a wise choice of business partners is as important as any other factor in the selection of investment possibilities. If we can be critical of anything, it is the apparent failure of states to learn from one another's mistakes. They sometimes seem to be so absorbed in competing with one another that they will work with almost any outside interest to steal a march on their sister states.