Amended Compacts of Free Association: 2004- 2023

In 2003, the United States approved separate amended compacts with the  FSM and RMI that (1) continue the defense relationship, including a new  agreement providing U.S. military access to Kwajalein Atoll in the RMI  through 2086; (2) strengthen immigration provisions; and (3) provide an  estimated $3.6 billion in financial assistance to both nations from 2004  through 2023, including about $1.5 billion to the RMI (see app. The  amended compacts identify the additional 20 years of grant assistance as  intended to assist the FSM and RMI governments in their efforts to  promote the economic advancement and budgetary self-reliance of their  people. Financial assistance is provided in the form of annual sector  grants and contributions to each nation’s trust fund. The amended  compacts and their subsidiary agreements, along with the countries’  development plans, target the grant assistance to six sectors—education,  health, public infrastructure, the environment, public sector capacity  building, and private sector development—prioritizing two sectors,  education and health. In addition, the RMI has not enacted  economic policy reforms needed to improve its growth prospects. The RMI’s economy shows continued dependence on government  spending of foreign assistance and limited potential for expanded private  sector and remittance income. The RMI’s government budget is characterized by limited tax revenue  paired with growing government payrolls. The RMI Faces Challenges to Effectively Implementing Compact Assistance for Its Long-Term Development Goals

The RMI has allocated funds to priority sectors, although several factors  have hindered its use of the funds to meet long-term development needs. Further, despite actions taken to effectively implement compact grants,  administrative challenges have limited its ability to ensure use of the  grants for its long-term goals. However, data deficiencies, report shortcomings, capacity constraints, and  inadequate communication have limited the RMI and U.S. governments’  ability to consistently ensure the effective use of grant funds to measure  progress, and monitor day-to-day activities. Although the RMI has supplemented its  trust fund balance with additional contributions, other sources of income  are uncertain or entail risks. Despite the impact of market  volatility and investment strategy, the trust fund committee’s reports have  not yet assessed the fund’s potential adequacy for meeting the RMI’s long- term economic goals. For example, the RMI received a  commitment from Taiwan to contribute $40 million over 20 years to the  RMI trust fund, which improved the RMI fund’s likely capacity for  disbursements after 2023. The RMI trust fund committee has experienced management challenges in  establishing the trust fund to maximize earnings. As of June 2007,  the RMI trust fund committee had not appointed an independent auditor  or a money manager to invest the fund according to the proposed  investment strategy. However, the RMI faces  significant challenges in working toward the compact goals of economic  advancement and budgetary self-reliance as the compact grants decrease. Largely dependent on government spending of foreign aid, the RMI has  limited potential for private sector growth, and its government has made  little progress in implementing reforms needed to increase investment  opportunities and tax income. Because the trust fund’s earnings are intended as a main source of  U.S. assistance to the RMI after compact grants end, the fund’s potential  inadequacy to provide sustainable income in some years could impact the  RMI’s ability to provide government services. Prior Recommendations

Our prior reports on the amended compacts include recommendations  that the Secretary of the Interior direct the Deputy Assistant Secretary for  Insular Affairs, as chair of the RMI management and trust fund  committees, to, among other things,    ensure that JEMFAC address the lack of RMI progress in implementing  reforms to increase investment and tax income;    coordinate with other U.S. agencies on JEMFAC to work with the the  RMI to establish plans to minimize the impact of declining assistance;    coordinate with other U.S. agencies on JEMFAC to work with the RMI  to fully develop a reliable mechanism for measuring progress toward  compact goals; and    ensure the RMI trust fund committee’s assessment and timely reporting  of the fund’s likely status as a source of revenue after 2023. Appendix II: Estimated FSM and RMI per Capita Compact Grant Assistance for Fiscal Years 1987 – 2023

Appendix III: Amended Compact Implementation Framework

	Annual sector grant budget

FSM/RMI propoe grnt budget for ech ector tht inclde proviion  report to used to: – Monitor gener  –  Expenditre, performnce go, nd pecific performnce indictor  –  Brekdown of peronnel expenditre nd other co  –  Informtion on U.S. federl progr nd other donor  United Ste evuate the propoed ector grnt budget for:   –  Contency with fnding requirement in the compct nd relted –  Identify poitive event thccelerte  performnce otcome nd prolem  encontered nd their impct on grnt  ctivitie nd performnce measureopertion to ensure complince with  grnt condition  Submit nnual report to the U.S.

	Joint management and accountability committees

Appendix IV: RMI Sector Grant Allocation, 2004 through 2006

Appendix V: Probability of RMI Trust Fund Income Not Reaching the Maximum Disbursement Levels Allowed

Market volatility and choice of investment strategy could result in the RMI  trust fund’s inability to disburse the maximum level of income allowed in  the trust fund agreement, or any income, in some years.
Why GAO Did This Study

From 1987 through 2003, the United States provided more than $2 billion in economic assistance to the Federated States of Micronesia (FSM) and the RMI under a Compact of Free Association; approximately $579 million of this economic assistance went to the RMI. In 2003, the U.S. government approved an amended compact with the RMI that provides an additional 20 years of assistance, totaling about $1.5 billion from 2004 through 2023. The Department of the Interior's Office of Insular Affairs (OIA) is responsible for administering and monitoring this U.S. assistance. The amended compact with the RMI identifies the additional 20 years of grant assistance as intended to assist the RMI government in its efforts to promote the economic advancement and budgetary self-reliance of its people. The assistance is provided in the form of annually decreasing grants that prioritize health and education, paired with annually increasing contributions to trust funds intended as a source of revenue for the country after the grants end in 2023. The amended compact also contains several new funding and accountability provisions that strengthen reporting and bilateral interaction. These provisions include requiring the establishment of a joint economic management committee and a trust fund committee to, respectively, among other things, review the RMI's progress toward compact objectives and to assess the trust fund's effectiveness in contributing to the country's long-term economic advancement and budgetary self-reliance. In 2003, we testified that these provisions could improve accountability over assistance but that successful implementation will require appropriate resources and sustained commitment from both the United States and the RMI. Drawing on several reports that we have published since 2005, I will discuss the RMI's economic prospects, implementation of its amended compact to meet long-term goals, and potential trust fund earnings.

What GAO Found

The RMI has limited prospects for achieving its long-term development objectives and has not enacted policy reforms needed to enable economic growth. The RMI depends on public sector spending of foreign assistance rather than on private sector or remittance income; public sector expenditure accounts for more than half of its gross domestic product (GDP). The RMI government budget largely depends on foreign assistance and, despite annual decrements in compact funding to support budgetary expenditures, is characterized by a growing wage bill. Meanwhile, the two private sector industries identified as having growth potential--fisheries and tourism--face significant barriers to expansion because of the RMI's remote geographic locations, inadequate infrastructure, and poor business environment. In addition, RMI emigrants lack marketable skills that are needed to increased revenue from remittances. Moreover, progress in implementing key policy reforms necessary to improve the private sector environment has been slow. Foreign investment regulations remain burdensome, and RMI government involvement in commercial activities continues to hinder private sector development. The RMI has made progress in implementing compact assistance, but it faces several challenges in allocating and using this assistance to support its long-term development goals. RMI grant allocations have reflected compact priorities by targeting health, education, and infrastructure--for example, funding construction of nine new schools. The RMI also has not planned for long-term sustainability of services that takes into account the annual funding decrement. Capacity limitations have further affected its ability to ensure the effective use of grant funds. The RMI currently lacks the capacity to adequately measure progress, owing to inadequate baseline data and incomplete performance reports. Moreover, although accountability--as measured by timeliness in single audit reporting and corrective action plans to single audit findings--has improved, insufficient staff and skills have limited the RMI's ability to monitor day-to-day sector grant operations as the compacts require. Inadequate communication about grant implementation may further hinder the U.S. and RMI governments from ensuring the grants' effective use. The RMI trust fund may not provide sustainable income for the country after compact grants end, potential sources for supplementing trust fund income have limitations, and the trust fund committee has experienced management challenges. Market volatility and the choice of investment strategy could cause the RMI trust fund balance to vary widely, and there is increasing probability that in some years the trust fund will not reach the maximum disbursement level allowed--an amount equal to the inflation-adjusted compact grants in 2023--or be able to disburse any income. The trust fund committee's reporting has not analyzed the fund's potential effectiveness in helping the RMI achieve its long-term economic goals. Although the RMI has supplemented its trust fund income with a contribution from Taiwan, other sources of income are uncertain or entail risk. As of June 2007, for example, the RMI trust fund committee had not appointed an independent auditor or a money manager to invest the fund according to the proposed investment strategy.