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Cablegate: Maldives Still Faces Serious Economic Challenges

VZCZCXRO1989
OO RUEHBI RUEHCI
DE RUEHLM #0902/01 2660348
ZNR UUUUU ZZH
O 230348Z SEP 09
FM AMEMBASSY COLOMBO
TO RUEHC/SECSTATE WASHDC IMMEDIATE 0552
INFO RUEHIL/AMEMBASSY ISLAMABAD PRIORITY 8945
RUEHKT/AMEMBASSY KATHMANDU PRIORITY 7183
RUEHNE/AMEMBASSY NEW DELHI PRIORITY 3322
RUEHCG/AMCONSUL CHENNAI PRIORITY 9510
RUEHKP/AMCONSUL KARACHI PRIORITY 2525
RUEHCI/AMCONSUL KOLKATA PRIORITY 0417
RUEHBI/AMCONSUL MUMBAI PRIORITY 6811
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY

UNCLAS SECTION 01 OF 03 COLOMBO 000902

SENSITIVE
SIPDIS

DEPARTMENT FOR EEB JENNIFER PETERSON AND TANYA SPENCER
DEPARTMENT PLEASE PASS TO DEPARTMENT OF TREASURY MALACHY
NUGENT/ATTICUS WELLER
DEPARTMENT PLEASE PASS TO USTR MICHAEL DELANEY/VICTORIA
KADER

E.O. 12958: N/A
TAGS: ECON EFIN ELAB PGOV
SUBJECT: MALDIVES STILL FACES SERIOUS ECONOMIC CHALLENGES
WITH AN IMF AGREEMENT

REF: COLOMBO 805


1. (SBU) Summary. Although the Government of the
Maldives (GOM) has reached a staff level agreement for an IMF
loan package, the GOM still faces serious fiscal and balance
of payments issues in the near term. President Nasheed, who
has been in office for under a year, appears to be in
complete accord with standard IMF medicine. The Nasheed
administration already had extremely ambitious plans to
drastically downsize the civil service, privatize state owned
enterprises, and reform taxes. Several private sector
contacts reported that the government sets great goals but
there is little implementation to meet these targets. The
GOM has fixed its exchange rate to the U.S. dollar, resulting
in an overvalued local currency, exacerbating the balance of
payments problem. Finally, the GOM requests USG technical
assistance on areas such as designing privatization programs,
selling government bonds, and implementing direct taxes.
Post endorses these requests. End Summary.

Political Background: A New Government Faces Stiff Challenges

2. (SBU) President Nasheed came into office in November
2008 after former President Gayoom had ruled the Maldives for
30 years. Outside contacts agree that President Nasheed and
his cabinet are generally well educated and sincerely believe
in their ambitious reforms. Minister of Economic Development
Mohamed Rasheed told econoff that the GOM plans to reduce the
government civil service (currently the Maldives largest
employer) from 33,000 to 18,000 employees. In addition,
Minister of Finance and the Treasury Ali Hashim proudly
stated that the GOM wants to get out of the business of the
private sector by privatizing all state owned enterprises,
including the airport, electricity, water and others. These
proposed reforms are currently before the Parliament. The
government has passed a new labor law regulating hours,
workplace safety and permitting unions, which never existed
before.

3. (SBU) President Nasheed faces a difficult domestic
political environment. After 30 years of autocratic rule,
the Maldivian institutions are weak and politicized. Despite
raising government salaries prior to the May 2009
Parliamentary elections (see reftel), the opposition party
led by former President Gayoom won the most seats, and the
opposition now controls the Parliament. A third country
diplomat noted that aside from a few appointments, President
Nasheed has not been able to pass any bills through the new
Parliament.

Serious Economic Situation Remains

4. (SBU) The Maldives still has a serious balance of
payments crisis, as described in reftel, with less than one
month foreign exchange of import cover. According to the
Maldives Monetary Authority (MMA) the GOM holds $43 million
USD in foreign exchange reserves, which has declined
recently. The government budget deficit continues to rise,
as government expenditures have increased 25% in 2009, while
government revenue has fallen 22%. The GOM is financing 70%
of the deficit through domestic financing, primarily
monetization as the MMA provides money to GOM. The
government external debt will increase to 45% of GDP by the
end of 2009, and debt payments have grown from 5% of
Maldivian exports of goods and services in 2007 to a
projected 10% in 2009. The MMA projects that the government
deficit for 2009 will fall to 7% of GDP in 2009, despite a
projected 21% drop in revenue, and 16% growth in
expenditures, since the government is counting on
substantial income from the privatization of state owned
enterprises.

5. (U) The Maldives sources of foreign exchange are also
coming up short. In the critical tourism sector, tourist
arrivals fell by 10% in the first six months of the year

COLOMBO 00000902 002 OF 003


compared to 2008, although the decline appears to be slowing.
MMA experts thought that tourist spending has declined
further, since the resorts attracted tourists with special
discount packages. The second most important industry is
fishing, but the fish catch is down, apparently due to
climate changes, as revenue from fish exports has fallen by
45% in 2009. The Maldives has at least 70,000 expatriate
workers, so there are net remittance outflows of $10 million
per year, further draining scarce foreign exchange.

Strong Medicine from the IMF

6. (SBU) The Maldives has reached a staff level agreement
for $60 million, which could rise to as much as $78 million.
Note. Despite press reports that the IMF assistance package
could reach $100 million, MMA officials report that the IMF
said that only $78 million could be provided at most. End
Note. The IMF program is for 30 months, although it could be
extended. The IMF board will vote whether to approve the
Maldives assistance package in late October, and approval is
expected.

7. (SBU) The IMF staff agreement imposes very strict
medicine. The IMF targets include: 1) the MMA must
immediately stop monetizing the government deficit by
providing money directly to the government, and the
government must finance its deficit on commercial terms. The
GOM plans to sell government bonds to close the deficit for
September; 2) the government must privatize state owned
enterprises such as the airport, and utilities such as
electricity and water; 3) the GOM should reduce the
government civil service by 5,000 employees; 4) the GOM must
approve a banking act by December 2010. The government owns
75% of the Bank of the Maldives, and there are also five
foreign banks present in the Maldives. The level of
non-performing loans has increased from an average of 2% in
2007 to 20% for the Bank of the Maldives and a 7% average for
the other banks; and 5) amend the law governing the MMA to
provide more independence for the MMA.

Achieving the IMF Targets Will Be Very Difficult

8. (SBU) The most pressing challenge for the GOM is
financing government operations for September, since they can
no longer borrow from the MMA. Minister of Finance and the
Treasury Hashim told Econoff that he has an approximate $8
million budget gap for September. The Bank of the Maldives
may fill the immediate gap by purchasing government bonds on
"commercial terms". Minister Hashim has stopped GOM capital
spending and has sought large reductions in government
salaries and benefits. Minister Hashim stated that if he
could make it through September he would be ok. In the
medium term, the GOM plans to increase the tourist tax from
$15 to $45 per head (this is called a "green tax:" and 80% of
the revenue is for environmental programs), and initiating a
business profits tax and a value added tax, all by 2010.

9. (SBU) The second greatest challenge is implementing
privatization of state owned enterprises (SOE). Last year
the government offered to privatize the airport, but there
were no bidders. It does appear that the GOM will privatize
the telecommunications service, since the international bank
HSBC has agreed to act as an underwriter and apparently the
GOM has a bidder. However, privatization of the SOEs will
be difficult, both because the government has little or no
experience in these complex financial transactions, and the
global financial crisis has greatly reduced the available
capital for investment.

10. (SBU) The head of the local chamber of Commerce and
several government officials also worry that new taxes will
impose substantial new costs, harming the private sector.
The GOM,s new labor law has increased employers wage costs
by more than 20%, since the law now regulates hours and
requires overtime for work in excess of 48 hours per week.
In addition, the government has passed a new pension program

COLOMBO 00000902 003 OF 003


to move from a defined benefit plan to a defined
contribution. The pension plan increases taxes by 14% of the
employee,s salary (7% paid by the employee and 7% by the
employer (both the government and the private sector).

11. (SBU) Our private sector contacts strongly support the
overall goals of the government, but they see grave
deficiencies in planning and implementation. For example,
the government provided large wage increases to government
employees before the Parliamentary elections but never
bothered to determine the total cost. Similarly, the
government wants to substantially reduce government salaries
and benefits, but a GOM official noted that under the new
labor law the government could violate labor contracts by
unilaterally reducing government wages and benefits. The new
labor law also provides the right to strike, which could
create problems if the government substantially retrenches
its work force or privatizes the SOEs. Finally, a private
sector contact noted that despite all the talk of retrenching
the public service, the number of public employees has
actually grown.

An Underlying Problem: The Fixed Exchange Rate

12. (SBU) The GOM has fixed its exchange rate to the U.S.
dollar ($1/12.8 Rufiyaa) since 2001, and the currency appears
to be substantially overvalued. Although the GOM has little
trade with the U.S., the GOM chose to peg its currency to the
dollar because international commodities such as oil are
priced in dollars and their European tourists understand
prices in fixed dollar terms. The MMA thought that the fixed
peg had worked well to promote tourism, and they were loath
to change it, although they understand that it was a factor
in deteriorating foreign exchange reserves. In addition, the
GOM foreign debt is denominated in dollars, so if the GOM
devalued its currency it would substantially increase its
foreign debt in rufiyaa terms.

Many Requests for USG Government Assistance

13. (SBU) The GOM ministries requested USG technical
assistance in virtually all of their meetings with econoff.
The most critical needs appear to be help implementing
privatization of SOEs, the sale of government bonds, and
increasing tax revenue through new taxes. Government
officials, particularly lower down in the bureaucracy, have
little expertise in these areas.

14. (SBU) Comment. The GOM is facing enormous challenges
with a new democracy, weak institutions, opposition control
of the Parliament, downturns in their primary tourism and
fishing industries, and the difficulty in attracting
investment capital to privatize SOEs. Although a number of
these problems were created by the GOM, Post believes that
USG technical assistance could be very helpful for the GOM as
they attempt these ambitious reforms. The GOM is trying to
do the right thing, but right now they do not appear to have
the necessary technical abilities to pull it off. End
Comment.
BUTENIS

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