Why per capita development cost in the Maldives is on the rise

This is part two of a three part exploration of the Maldives' Macroeconomic stability and growth. For part one on macroeconomic stability and long-term growth, click here. For part three on achieving fiscal sustainability, click here.

Since 1982, the national development agenda contained broad policies and targets aimed at improving the quality of life, particularly for vulnerable groups, and removing regional disparities to promote private sector led growth and fairer distribution of development dividends. Protecting the environment is the corner stone for sustaining economic growth and ensuring livelihood for Maldivians. The policy response to achieve these goals over the years has yielded mixed results. 

First, on the back of strong performance in tourism (the tertiary sector was close to 70% of GDP)  and sustained fiscal expansion, the country has made commendable achievements in economic growth and human development in the last 4 decades.  Following 20 years of rapid economic growth (11 percent per annum) 1980-1999, growth had plateaued around 5-6 percent during the last 20 years 2000-19. It is also important to note that the economy has also transformed from an economy relying on the primary sector – dominated by fisheries until the 1990s, to a service-based economy driven by a vibrant tourism and support industries. Financing health and education accounting for about 10 percent of GDP between 1980-1999,  increased to more than 12.5  percent during the period 2010-2019.  As a result, despite gaps in the distribution of development dividends, the country has made huge improvements in many areas of development.

According to the Human Development Report 2019, Maldives’ HDI value had reflected an increase of 31.7 percent between 1995 and 2018.  In addition, from being one of the poorest countries in the world in the 1980s, the country’s per capita income had reached more than US$15,000 in 2019. While the country has witnessed these achievements, far reaching challenges still remain, and three broad areas that poses significant growth and distribution and fiscal challenges are discussed here.

Decentralization is seen by many as the solution for reducing regional imbalances and improving income inequity. Despite efforts to reduce regional imbalances by undertaking infrastructure investments in many parts of the country (in health and educational facilities, harbors, sewerage systems and desalination plants and road works, office buildings and regional airports), the steady inflow of population from the atolls and foreign workers to Male’ continues and the capital has long been overcrowded. The enormous amount of land increase around Male’ (including Villimale, Hulhumale phase I and II programs) through reclamation and resettlement, however, has only had limited success.

Meeting demand for housing in the Greater Male’ Region has added to urban congestion and deep rooted fiscal pressure. The ratification of the 2008 Constitution and the subsequent change to the first democratic multi-party elections in November 2008 gave new hope for change. The Decentralisation Act of 2010 led to the formation of the Local Government Authority (LGA) to guardian the new framework.

Reflecting political and institutional hurdles from the Centre, the desired form of local governance envisioned in the 2008 Constitution has sadly not been realized and issues of decentralization remains a grave concern, with the political goal merely an aspiration.

The enterprise landscape of the economy is limited to a few sectors;  of which, led by tourism,  the share of services in GDP (over more than 70 percent of GDP in 2019) rose steadily and the private sector has progressed well over the decades. There are, however, many difficult challenges for the sustenance of long-term development of the private sector. Reflecting the narrow resource and industrial base, private sector performance remains extremely vulnerable to adverse global developments and sensitive to constraints in the investment climate.  These latter areas include inadequacies in the system of maritime and air transport, the lack of access to financing and the effect of crowding out private investments due to the adverse impacts of long-term macroeconomic instability.

Weak legal framework and enforcement capacity, changes in regulatory conditions at short notice without sufficient consultation with stakeholders and increased government bureaucracy severely held back enterprise development. Given these conditions, according to the 2020 World Bank Doing Business Report, the Maldives’ rank has deteriorated in terms of trading across borders to 157 from 155 in 2019.

Improvements in these areas will require a substantial amount of public sector investment, which is already constrained by the large fiscal deficit and the increasing public sector debt burden. Creating adequate fiscal space to finance needed infrastructure and social spending will remain a key challenge. To reduce the high cost of finance, it will be important to (a) keep the fiscal deficit within a range that does not create serious crowding out effects through high interest rates and (b) avoid foreign exchange market pressures created from time to time by poor macroeconomic conditions.

Protecting the environment is critically important for sustaining economic growth and ensuring livelihood for Maldivians. The country is highly vulnerable to the risk associated with climate change, global warming and sea level rise. More than 80 percent of the land area of the country is less than one meter above the mean high tide level  In addition, the islands are also exposed to increasing frequencies in natural hazard like storm surges related to tidal swells, waves/wind and floods.

The Maldives was the only country where the effects of the South Asian Tsunami of 2004, were felt across the country, rather than in certain parts or regions. Total damage estimates are about $470 million. Of the 198 inhabited islands in the archipelago, 53 suffered severe damage, and many more islands of the islands were totally destroyed. Yet, little preparation or progress, in terms of financial planning, have been made to address a similar shock.

Macroeconomic outcomes

In fiscal operations, the revenue base is narrow, and it is directly linked to performance of a single sector – tourism revenue accounting for close to 70% of government revenue in 2019.  The role of State Owned Enterprises (SOEs) is very significant, both from a political and revenue point of view. Their activities range from airport operations, air and sea transport, banking, electricity and water production, distribution and export-import trade, communications and housing finance and development. Many of these enterprises, however, have not generated adequate profits in years (currently at around 2 percent of GDP), yet have engaged in large borrowing backed by government guarantees, creating substantial fiscal risks to the government.

Fiscal outlays, on the other hand, are largely a function of the political perspective of country’s development needs including health and education, social programs such as social security and health insurance, national defense and infrastructure development. Total revenue and grants as a percentage of GDP on average stood at 36 percent during the 20 years 1980-99, but decreased to 29 percent during 20 years ending 2019.  

For the most part of the last 40 years, growth of total expenditure has far exceeded growth of both revenue and GDP. Total expenditure and net lending as a percentage of GDP, on average, stood at 40 percent during the period 1980-99 and decreased slightly to 34 percent during 2000-2019. 

Per-capita fiscal cost of development has been rising steadily from around US$3,205 in 2010 to approximately US$5,000 in 2019, reflecting a 56 percent increase during the period or an annual growth of more than 5.5 percent. The overall deficit to GDP ratio reduced from 14 percent during 1980-99 to around 9 percent during 2000-19, but remained high at around 8-10 percent during the last five years. 

Despite periodic improvements, caused by unfavorable external conditions and sustained expansionary financial policies, the underlying balance of payments position remained weak for the most part over the past 40 years. The persistent current account deficits are characterized by low reserves and high level of external debt,  financed by both concessional and commercial loans and other foreign direct investment flows financing the tourism industry.

Total public debt rose from the equivalent of about 54 percent of GDP during 2000-2019 to 62 percent 2015-19 and had further jumped to around 76 percent in 2018 -19. Annual average growth in total debt has been substantially faster than the growth in GDP. On average, total debt increased by 21 percent, while nominal GDP rose by around 15 percent, and government revenue increased by 26 percent during the period 1980-99. Similarly, total debt increased by 15 percent per annum and nominal GDP rose by 9 percent, while total revenue increased by 16 percent during the period 2000-19. The gap had widened further in 2019 with annual growth in total debt reaching 31 percent, with nominal GDP growing at 13 percent and revenue growth at less than 10 percent.

The consequence of sustained fiscal deficits has contributed to a weak balance of payments position and greater vulnerability to shocks emanating from adverse effects on world trade, environmental disasters and sharply rising public debt. They have, almost always, reduced economic growth, worsened external payment position, added pressure on the exchange rate, led to falling foreign reserves and undermined the credibility of the exchange rate regime. In the final analysis, the result has been to put the country’s economic growth below its potential level and given way to further hikes in debt levels.

In the absence of credible long-term polices, recovery has only been temporary, loss of potential output is in billions of rufiyaa and economic vulnerabilities remain unabated.  Both the 2014 Tsunami and the Covid-19 global pandemic has demonstrated that natural disasters can turn to economic disasters with no prior warning.  With sustained macroeconomic instability long ignored, these shocks can turn life inside out, raising concerns over the sustenance of the fragile development achievements made.

Given the lack of fiscal space or monetary tools to cushion the blow from these shocks, drawing up a credible and comprehensive financial plan that encompasses a range of important issues remain the key challenge facing politicians and financial planners. There exists important linkages between good fiscal policies and politics.

Part three; Achieving fiscal sustainability

Part one; Macroeconomic stability and long-term growth