IMF PROGRAM HITS ROUGH WATERS IN THE MALDIVES

UNCLAS SECTION 01 OF 04 COLOMBO 000107

SENSITIVE
SIPDIS

DEPARTMENT FOR EEB JENNIFER PETERSON AND TANYA SPENCER
DEPARTMENT OF TREASURY FOR MALACHI NUGENT, ATTICUS WELLER
AND MARY BRENNAN
USTR FOR MICHAEL DELANEY AND MICHAEL FELDMAN

E.O. 12958: N/A
TAGS: CE EAID ECON ETRD PGOV SOCI
SUBJECT: IMF PROGRAM HITS ROUGH WATERS IN THE MALDIVES

REF: A. 2009 COLOMBO 892

B. 2009 COLOMBO 1002


1. (SBU)SUMMARY: An IMF staff mission is currently in the
Maldives reviewing progress toward IMF benchmarks before
releasing the second tranche of funds. The review will be
difficult. The IMF negotiated a very tough agreement with
the Maldives with ambitious deficit-reduction targets. The
Government of the Maldives, in large part due to a difficult
political situation, has been fighting to keep government
wage reductions in place but has increased electricity rates.
There has been limited progress in other areas to reduce
government positions and increase revenue through new taxes.
Top government officials hope that the IMF will be tolerant
with the Maldives. Indeed, due to limited tax-collection
expertise, the Maldives needs time to begin realizing
revenue, even when (or if) the new taxes are approved by the
Maldivian Parliament. END SUMMARY.

IMF Review Mission


2. (SBU) An IMF staff mission is in the Maldives February
9-22 to conduct its first review under the IMF program
whether the Maldives is meeting its performance criteria,
indicative targets, and structural benchmarks. The results
of the review will be completed by March for the IMF board to
vote whether to release the second tranche of IMF funds. The
IMF has agreed to provide a readout of the staff mission to
post.

Tough Love from the IMF


3. (SBU) The January 2010 IMF Staff report recounts how far
the Maldives has gotten off track since 2004. "Government
expenditures almost doubled as a share of GDP between 2004
and 2008 and, without adjustment, are on course to reach 69
percent of GDP by end 2009. A key driver has been the wage
bill, stemming from large wage increases and a build-up in
the number of public-sector employees ( public employment
and the wage bill are now very high by international
standards." Indeed, the IMF projects that, without
adjustments, the GOM budget deficit will be 33 percent of GDP
in 2009, 28 percent in 2010, and stretch out to over 20
percent deficit-to-GDP ratio through at least 2014.


4. (SBU) The IMF negotiated a very tough adjustment program
with the Maldives, which the IMF estimates will reduce
government deficit to GDP ratios from 33 percent in 2009 to
18 percent in 2010 and 4.25 percent in 2011. As a
precondition to the IMF agreement, on October 1, 2009, the
Civil Service Commission of the Maldives agreed to cut
government salaries by an average of 14 percent. Under the
agreement, the pay rates will be restored when the GOM
domestic revenue reaches 7 billion Rf (approximately 55
million USD),which the IMF projected would occur in 2011.
IMF Representative Dr. Koshy Mathai agreed that a wage cut
was extraordinary for an IMF program, but the ballooning wage
bill forced the IMF to require this precondition. The GOM
also agreed to reduce 9,000 'redundant' government employees
(out of over 30,000 total) by the end of 2010. The original
IMF staff report estimated that wage and staff reductions
would decrease the government's wage bill from 28 percent of
GDP in 2009 to 17.5 percent in 2011.


5. (SBU) The IMF projects that its program will reduce the
GOM budget deficit by 14.6 percent in 2010, 20.8 percent in
2011, and 18.8 percent in 2012. On the expenditure side, the
IMF program counts on the wage reduction for 3.7 percent of
GDP reduction in 2010, but by 2011 wages are to be restored.
The IMF projects that cutting staff redundancies will
contribute 4.2 percent of GDP and increasing electrical
tariffs will chip in 2.5 percent of GDP. On the revenue
side, the IMF expects an airport tax and business profits tax
to be implemented by year end 2009, an ad valorem tax on
tourism by October 2010, and a general sales tax by 2011.
The IMF is counting on the airport tax raising 0.9 percent of
GDP, the business profits tax contributing 1.6 percent of GDP

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in 2010 and 2.9 percent thereafter, the ad valorem tax
increases revenue by 1.1 percent of GDP in 2010, and
approximately 5 percent of GDP thereafter. The general sales
tax should start generating 2.3 percent of GDP revenue in

2011.

IMF Program Hits the Reality of the Maldivian Political System

6. (SBU) The Government of the Maldives has been at a
stand-off since parliamentary elections in May 2009, which
resulted in the opposition party winning two more seats in
parliament than President Nasheed's party. President Nasheed
sincerely wants to push through many market reforms, but most
of his plans have been stymied by the opposition. The
parliament has only passed one bill related to the economic
crisis since the 2009 parliamentary elections (to increase
the airport departure tax).


7. (SBU) Government salary reductions, an absolute
precondition of the IMF program, have become embroiled in
local politics. Ahmed As-Ad, Minister of State for Finance
and Treasury, told econoff that with the GOM proposed budget
would have a 14.8 percent government deficit, but if the
wages were restored, the deficit would increase to 19 percent
of GDP. The Civil Service Commission of the Maldives has
claimed that the projected government revenues have reached 7
billion Rf, so the wages should be restored immediately. The
Parliament also supports restoring the wages and did so in
the budget. The Ministry of Finance has held firm, insisting
on the wage reductions, despite a demonstration outside the
Ministry of Finance led by the Civil Service Commission.


8. (SBU) The GOM has also hiked electricity rates by 33
percent, which should account for a 2.3 percent reduction in
the government deficit. The GOM has a subsidy program,
permitted under the IMF program, but consumers are clamoring
for additional subsidies.


9. (SBU) There appears to have been little progress in staff
reductions, although the IMF expects 9,000 staff reductions
by the end of 2010. Ministry of Labor officials are
developing a plan to offer staff different severance packages
to leave government service, including substantial loans,
long-term training, or help to establish a small enterprise.
The GOM hopes to receive donor assistance to finance the
severance program, but Ministry of Finance officials said
that the World Bank was reluctant to do so because they have
had poor repayment rates for similar loans in other
countries. (NOTE: The GOM is holding a large donor's
conference on March 28 in the Maldives to coordinate and seek
assistance. END NOTE.) Therefore, GOM staff reductions are
still very much in the planning stages. As described in
reftel, staff reductions will be very difficult politically
when the GOM employs over 10 percent of the citizens of the
Maldives, and a much higher percentage of the voting age
population (see reftel B). Vice President Mohamed Waheed
commented that it would be very difficult for the private
sector to absorb all of the excess government workers. Other
post contacts have pointed out that many government workers
wwould be reluctant to leave their secure employment in
air-conditioned offices in Male for work on the resort
islands.


10. (SBU) Aside from the airport tax, the GOM has promised to
implement a business profits tax and an ad valorem tax on
tourists. The GOM has implemented the airport tax, which is
designed to provide 0.8 percent of GDP in additional revenue.
According to the IMF schedule, the GOM was to have enacted
the business profits tax by year end 2009, and it should
contribute 1.6 percent of GDP in 2010. The Asian Development
Bank helped draft a business profits tax law in 2004, but the
new tax has never been approved by the parliament. Minister
of State for Finance and the Treasury As-Ad noted that the
parliament is in recess until February 28, but he hopes that
parliament will pass the Business Profits Tax bill soon.
As-Ad hopes that the GOM can begin to collect the business
profits tax revenue for the last half of 2010, even if they
did not get the full year. A private sector contact was much

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more skeptical when the business profits tax would be
approved or when real revenue could be collected. The IMF
plans for the GOM to implement the ad valorem tax on tourism
by October 2010, but this seems much further off. The GOM
currently charges an 8 USD per night bed tax, which is easy
to calculate and collect, regardless of whether the hotel
costs 50 or 5,000 USD per night. A senior GOM official told
econoff that it would be difficult for the GOM to approve any
new taxes in 2010 and the ad valorem tax was "unlikely to
happen."


11. (SBU) The GOM is counting on substantial income from
privatization, but it is unclear when or if additional
government projects can be privatized. The GOM successfully
sold a stake in the telecommunications company for 40 million
USD in October 2009 and hopes to privatize the airport in

2010. Mathai of the IMF stated that the 2010 Maldives budget
assumes revenue of 1.3 billion Rf from privatizations (100
million USD or 7 percent of GDP) in privatization revenue.
The GOM included a similar amount of privatization revenue in
their 2009 budget, but only received the telecommunications
revenue.

Technical Constraints Will Limit New Tax Collections

12. (SBU) The GOM will need to improve its technical capacity
to collect the business profits tax and ad valorem tax, which
will take time to develop. The Maldives currently collects
import duties (65 percent of revenue),the flat 8 USD bed tax
on tourist (20 percent of revenue),and assorted other taxes
such as lease payments for resort islands, royalties on
foreign direct investment and foreign businesses, and a bank
profits tax. Maldivian companies, such as traders and
restaurants, do not pay any taxes, other than import duties
which are already included in the local prices. An advisor
for the US Treasury found that the Maldives Department of
Inland Revenue primarily has a cashier function, collecting
fixed amounts, rather than auditing businesses. The banks
profits tax is analogous to the business profits tax, but
there are only six banks in the Maldives, and it is unclear
how thoroughly they are audited. For example, at one point
the Department of Inland Revenue realized that they were six
years behind in auditing the banks for the bank-profits tax.
The DIR caught up in four to six weeks, raising the question
of the level of their audit. The US Treasury advisor thought
that there were capable people in the DIR, but they were not
trained to do proper audits. The Asian Development Bank
plans to provide technical assistance to train the DIR, but
the Treasury advisor thought that it would be useful to phase
in the tax, giving the DIR and the Maldivian private sector
time to comply, since local businesses and the DIR had
limited expertise to date. Although this suggestion makes
sense from a tax collection angle, it would introduce another
delay into the IMF schedule.

The IMF Changes its Tune


13. (SBU) Post previously reported how difficult it would be
for the Maldives to meet the proposed IMF targets (see reftel
B). IMF representative Mathai now realizes that it would be
very challenging, since although the GOM had good intentions,
given the political circumstances it would be very hard for a
new democracy to make these types of budget and employment
cuts. Mathai asked whether the USG had any budget-support
funding to ease the transition. Econoff explained that no
USG funds had been allocated for this purpose.

COMMENT


14. (SBU) Minister of State for Finance and Treasury As-Ad
realizes that the Maldives is behind schedule, and he pleaded
that the IMF should "show some tolerance" for the GOM in its
efforts to meet the very difficult targets. The GOM is
already facing heat for complying with the preconditions on
the wage rollback and the increasing electricity prices, and
it has yet to face the real pain of the IMF program
adjustments. Although the GOM clearly has to make radical
adjustments in its government spending, the IMF does need to

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show some tolerance as the GOM tries to implement this
demanding IMF program.

FOWLER
FOWLER