At a Glance
Maldives, a country of around 550,000 people dispersed across 185 islands, is an upper-middle-income country with a robust growth trajectory. The economy has recovered to pre-pandemic levels in 2022 and, with rising tourist arrivals, is expected to maintain a strong growth and poverty reduction trajectory. Overall, sustained growth performance in the last decade has significantly reduced poverty, and Maldives performs well on poverty outcomes compared to its regional, income, and small island peers. The economy is heavily dependent on tourism which has been the main driver of economic growth in Maldives and the dependence on tourism makes the country highly vulnerable to macroeconomic and external shocks. Commodity price volatility is driving inflation and exerting pressure on fiscal and external balances, through costlier imports and higher subsidies. In addition, existing high debt stock of the public sector, the government’s aim to undertake sizeable infrastructure investments through external non-concessional borrowing, and presence of high number of subsidies have led Maldives to be exposed to elevated fiscal vulnerabilities. Public debt is expected to remain high, warranting continued efforts to reduce fiscal deficits, including comprehensive subsidy reforms while mitigating impacts on the vulnerable.
Key Conditions and Challenges
Tourism, which accounts for almost one-third of the economy, has seen a rapid recovery following the pandemic. Despite the war in Ukraine, arrivals from Russia remain strong and growing arrivals from India and Gulf countries have compensated for lower arrivals from Europe and China. However, heavy reliance on tourism and limited sectoral diversification remain a key structural challenge as Maldives is highly vulnerable to macroeconomic shocks.
As an economy that is heavily import-dependent, Maldives is facing significant external and inflationary pressures due to the sharp rise in global commodity prices. This is putting pressure on public finances given the government’s blanket provision of food and fuel subsidies to help contain domestic price increases, continued high levels of capital expenditure, and an inefficient public health insurance scheme. Untargeted austerity measures pose risks to poverty, particularly in the atolls where 90 percent of the poor live, as past welfare gains have been driven by a strong redistributive model. The latter includes universal access to basic health and education services, public sector employment and pensions, health insurance, price controls and subsidies, and income support programs. Additional challenges to welfare include differential access to economic opportunities in Male relative to the atolls, and overcrowding affecting poorer urban households in Male.
To promote development, Maldives has scaled up infrastructure investments since 2016. This has boosted construction activity, tourism capacity, and medium-term growth prospects. Although these investments have contributed towards poverty reduction and better living standards, financing of these large investments through non-concessional sources and sovereign guarantees has led to growing fiscal vulnerabilities. Recently, increased cost of external borrowing has also compelled government to turn towards domestic financing sources, which is crowding out the private credits and leading to a concerning rise in the exposure of the financial sector to the sovereign. Public and publicly guaranteed debt stock and debt servicing risks are expected to remain elevated in the medium-term.
Recent Economic Developments
The economic growth, in real terms, was estimated to be 12.3 percent (y-o-y) in 2022. With the support of robust tourist arrivals that reached 1.68 million in 2022 – only 1.6 percent lower than the pre-pandemic high, a broad-based improvement took place particularly for the tourism, real estate, transport, and trade sectors. However, higher global commodity prices led to rising domestic inflation, which reached an average of 2.3 percent (y-o-y) in 2022, higher than the historical average of 0.5 percent. Price increases were particularly acute in the food, transport, health, and restaurant services sectors.
Despite growth in tourism earnings, the current account deficit widened considerably to an estimated 24.6 percent of GDP in 2022, due to far costlier imports of oil and capital goods. High import costs and external debt repayments put significant pressure on gross reserves, which fell to less than US$500 million (or 1.8 months of imports) in October 2022, before recovering to over US$800 million (3 months of import) by the end of the year due to a US$200 million currency swap deal with India.
Public finances remain under pressure. Blanket subsidies for energy and food commodities, together with sustained levels of high capital spending, led to an increase in the fiscal deficit to 14.5 percent of GDP in 2022. This was despite several austerity measures to lower administrative costs and the public sector wage bill. Over 80 percent of the deficit was covered by domestic sources, with MMA’s asset exposure to government rising to 48 percent of its total financial assets at end-2022, from 43 percent at end-2021. With ongoing plans to complete key infrastructure projects, and continued inflationary pressures, government may find it increasingly difficult to finance the subsidy program in its current form. Better targeting of tax and transfer instruments would help mitigate a negative impact of subsidy reforms on the poor.
Outlook, Risks, and Challenges
The economy is expected to grow by 6 percent on average in the medium-term, supported by robust tourism performance. The return of Chinese tourists together with arrivals from India and Russia are expected to lead to 1.8 million arrivals in 2023 (7.1 percent y-o-y increase). Going forward, tourism will be further supported by the expansion of Velana International Airport (likely to be completed by 2025) and investments in new resorts.
The recent increase in GST rates is expected to help narrow the fiscal deficit. Yet, public debt levels remain high. Additional fiscal adjustment is required to address fiscal vulnerabilities, particularly through expenditure rationalizations on capital expenditure, subsidies, and pharmaceutical spending. Meanwhile, recovery in demand, elevated global commodity prices, and the GST rate hike are expected to increase inflation in 2023, warranting tighter macroeconomic policy mix. Subsidy reform to target the poor and vulnerable is needed to reduce the fiscal burden.
The current account deficit is expected to remain elevated. High commodity prices and necessary capital imports driven by the government’s ambition to complete ongoing infrastructure projects and commence projects in outer Atolls are expected to lead to a high current account deficit over the medium-term. Despite a recent decline in oil prices, rising external financing needs – including debt servicing – are expected to sustain pressure on official reserves.
Downside risks persist. Tourism could be adversely impacted by further global shocks. Any further widening of the current account deficit could put additional pressure on official reserves. Government faces external debt servicing payments of about US$340 million on average over the next three years amidst tightening global financing conditions. Stronger-than-expected tourism with the return of Chinese tourists offers upside potential to the outlook. In the absence of any pandemic relief measures, the poverty rate would have risen to 19.9 percent in 2020. With the recovery in economic growth, poverty rates are expected to drop to 2.1 percent in 2023.
Reforms are needed to improve the fiscal outlook and ensure debt sustainability. More effective revenue mobilization measures, coupled with reforms to Aasandha and existing subsidy programs, and better investment management are critical to bring down the high level of public debt, replenish fiscal buffers against future shocks, and lower the cost of growth-enhancing investments, especially with large debt service obligations coming due in 2026.
Last Updated: Apr 06, 2023
