Compacts of Free Association: Implementation of New Funding and Accountability Requirements Is Well Under Way, but Planning Challenges Remain
Published: 2005-07-11T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: From 1987 to 2003, the United States provided economic aid to the Federated States of Micronesia (FSM) and the Republic of the Marshall Islands (RMI) through a Compact of Free Association. A previous GAO report found little accountability for the assistance provided by the U.S. Department of the Interior under this compact. In 2004, amended compacts with the FSM and RMI went into effect and will provide $3.5 billion in assistance over 20 years, consisting of grants and contributions to trust funds that are to replace the grants after 2023. The amended compacts include funding and accountability requirements that were not present in the original compact. To better understand the status of the compacts' implementation, GAO evaluated actions taken by the U.S., FSM, and RMI governments since fiscal year 2004 to (1) meet funding requirements and plan for the use of this funding, (2) meet accountability requirements, and (3) establish operations to implement the new agreements.
section_title: What GAO Found
paragraphs: In fiscal years 2004 and 2005, the U.S. government signed grant agreements with the FSM and the RMI focused on six sectors, such as health and education, as provided for in the amended compacts. Authorized grant amounts for each year were about $76 million for the FSM and about $35 million for the RMI. Required trust funds were also established. Strategic planning issues impacting the long-term, effective use of funds have not been addressed. The allocations of the grants to the sectors have not been linked to the countries' development goals; the FSM and RMI have not planned for annual required decreases in grant funding; and trust funds have not been invested to maximize interest earnings (though efforts are currently under way to resolve this final issue). The U.S., FSM, and RMI governments have taken actions to meet compact accountability requirements. For example, the FSM and the RMI have provided financial and performance reports, and the U.S. government has withheld funding to ensure compliance with grant requirements. However, a few important accountability requirements have not been met. For instance, the FSM's development plan has not been approved by the U.S. government, and it is unclear whether the U.S. government has assessed the RMI's planning documents. Finally, the FSM has not completed single audits for fiscal years 2003 or 2004, and none of the three governments has submitted its required annual compact spending and development report for fiscal year 2004. The Department of the Interior took a significant step in October 2003 to facilitate implementation and oversight of the amended compacts by opening a new office in Honolulu, Hawaii. However, Interior has not determined how much oversight of compact activities in the FSM and the RMI is necessary, though the current level of on-site review is viewed as insufficient. The FSM and RMI governments have each taken actions to establish centralized compact management offices; the RMI government is progressing more rapidly in these efforts than the FSM government.

section_title: Letter
paragraphs: Since fiscal year 1987, the United States has provided economic assistance  to the Pacific island nations of the Federated States of Micronesia (FSM)  and the Republic of the Marshall Islands (RMI) through a Compact of Free  Association. In 2000, we reviewed the accountability over, and impact of,  this compact funding and determined that the U.S., FSM, and RMI  governments had all provided limited accountability over spending and that  U.S. assistance had resulted in little impact on economic development in  both countries. Funding under the original compact expired at the end of  fiscal year 2003. The U.S. government negotiated new compact provisions  with the FSM and the RMI that established continued U.S. economic  assistance from fiscal year 2004 through fiscal year 2023, with the U.S.  Department of the Interior’s Office of Insular Affairs (OIA) responsible for  providing U.S. assistance and monitoring expenditures. The “amended”  compacts with the RMI and the FSM, which will provide an estimated $3.5  billion in U.S. assistance over 20 years, went into effect on May 1, 2004, and  June 25, 2004, respectively.
The amended compacts are substantially different from the original  compact in that they contain several new funding and accountability  provisions. The amended compacts establish annual funding levels ($92.7  million for the FSM and $57.7 million for the RMI in fiscal year 2004) that  are divided primarily between direct grant assistance, which is targeted to  specific areas, with priority in the health and education sectors, and  contributions to trust funds. U.S. grant funding will decrease annually,  with the amount of the decrement added to U.S. trust fund contributions;  earnings from the trust funds are intended to replace grant assistance when  the latter expires in 2023. In addition, numerous accountability  requirements have been added to the amended compacts, including  requirements for quarterly financial and performance reports and  strengthened bilateral interaction.
To obtain insights regarding initial efforts to implement the amended  compacts, we evaluated actions taken by the U.S., FSM, and RMI  governments since fiscal year 2004 to (1) meet compact funding  requirements and plan for the use of this funding, (2) meet compact  accountability requirements, and (3) establish operations to facilitate  compliance with funding and accountability requirements.
We reviewed the amended compacts as well as the subsidiary fiscal  procedures agreements and trust fund agreements. We further reviewed  grant agreements as well as budgets, financial data, and performance  reports submitted by the FSM and RMI governments to the U.S.  government. We also examined briefing documents created by the U.S.  government in preparation for annual meetings with the two countries. We  assessed the minutes summarizing the discussion and decisions from these  meetings. We held extensive interviews with officials from OIA and the U.S.  Department of State. In addition, we traveled to the FSM (Pohnpei and  Chuuk) and the RMI (Majuro and Ebeye). We had detailed discussions with  FSM and RMI officials from finance, budget, health, education, public  works, and audit agencies, and we also obtained the views of U.S.  government officials working in each country. (See app. I for more detailed  information on our scope and methodology.)
subsections: section_title: Background
paragraphs: Since the FSM and the RMI became sovereign nations, the U.S. relationship  with the two countries has been defined by the original Compact of Free  Association and the subsequent amended Compacts of Free Association.
subsections: section_title: Compact of Free Association, 1986 through 2003
paragraphs: In 1986, the United States, the FSM and the RMI entered into the Compact  of Free Association. This compact represented a new phase of the unique  and special relationship that has existed between the United States and  these island areas since World War II. The compact provided a framework  for the United States to work toward achieving its three main goals: (1) to  secure self-government for the FSM and the RMI, (2) to ensure certain  national security rights for all of the parties, and (3) to assist the FSM and  the RMI in their efforts to advance economic development and self- sufficiency. The first goal was met; the FSM and the RMI are independent  nations and are members of international organizations such as the United  Nations. The second goal was also achieved. At the time that the compact  was negotiated, the United States was concerned about the use of the  islands of the FSM and the RMI as “springboards for aggression” against the  United States, as they had been used in World War II, and the Cold War  incarnation of this threat—the Soviet Union. The compact and its related  agreements established several key defense rights for all three countries.  For example, the compact obligates the United States to defend the FSM  and the RMI against an attack, or the threat of attack, in the same way it  would defend its own citizens. Further, through a compact-related  agreement, the United States secured access to military facilities on  Kwajalein Atoll in the RMI through 2016.
The third goal of the compact—advancing economic development and self- sufficiency for both countries—was to be accomplished primarily through  U.S. direct financial payments to the FSM and the RMI. For 1987 through  2003, U.S. assistance to the FSM and the RMI to support economic  development was estimated, on the basis of Interior data, to be about $2.1  billion. We found previously that many compact-funded projects in the FSM  and the RMI experienced problems because of poor planning and  management, inadequate construction and maintenance, or misuse of  funds. Economic self-sufficiency had advanced but had not been achieved;  although total U.S. assistance as a percentage of total government revenue  fell in both countries, the two nations remained dependent on U.S. funds.  U.S. direct assistance maintained standards of living that were higher than  could be achieved in the absence of U.S. support.
Another aspect of the special relationship between the FSM and the RMI  and the United States involves the unique immigration rights that the  compact grants. Under the original compact, citizens of both nations were  allowed to live and work in the United States as “nonimmigrants” and could  stay for long periods of time, with few restrictions. Further, the compact  exempted FSM and RMI citizens from meeting U.S. passport, visa, and  labor certification requirements when entering the United States. In  recognition of the potential adverse impacts that Hawaii and nearby U.S.  commonwealths and territories could face as a result of an influx of FSM  and RMI citizens, the Congress authorized compact impact payments to  address the financial impact of these nonimmigrants on Guam, Hawaii, and  the Commonwealth of the Northern Mariana Islands (CNMI).
section_title: Amended Compacts of Free Association
paragraphs: In the fall of 1999, the United States, represented by the Department of  State, and the two Pacific island nations began negotiating economic  assistance and defense provisions of the compact that were due to expire  in 2003. The negotiations also addressed immigration issues. Separate  compacts were completed for the RMI and the FSM and went into effect on  May 1, 2004, and June 25, 2004, respectively. Prior to formal  implementation of the amended compacts, the United States provided  funding via a continuing resolution and the Department of the Interior’s  fiscal year 2004 appropriation legislation. According to the Department of  State, the aims of the amended compacts are to (1) continue economic  assistance to advance self-reliance, while improving accountability and  effectiveness; (2) continue the defense relationship, including a 50-year  lease extension (beyond 2016) of U.S. military access to Kwajalein Atoll in  the RMI; (3) strengthen immigration provisions; and (4) provide assistance  to lessen the impact of Micronesian migration on Guam, Hawaii, and the  CNMI.
The amended compacts’ second objective, continuing the U.S.-RMI defense  relationship, has been addressed, as expiring defense provisions of the  compact have been renewed and U.S. access to Kwajalein Atoll has been  extended. However, one notable difficulty remains regarding this objective;  although the U.S. government negotiated an agreement with the RMI  government that allows for U.S. access to Kwajalein Atoll until 2086, the  RMI government has not reached an agreement with Kwajalein Atoll  landowners (who own the land under use by the U.S. government) that  allows for this long-term access. The U.S. government is not involved in  efforts to negotiate such an agreement, and neither the RMI government  nor the Kwajalein Atoll landowners are actively pursuing resolution of this  issue. The third and fourth objectives have also been addressed. Compact  immigration provisions have been strengthened by, for example, requiring  passports from FSM and RMI citizens entering the United States and  clarifying requirements for bringing FSM and RMI children into the United  States for adoption. Further, the amended compacts’ enabling legislation  appropriates specific annual nonimmigrant impact compensation of $30  million for Guam, Hawaii, and the CNMI for fiscal years 2004 through 2023,  with the distribution of funding between the locations based on periodic surveys identifying the number of FSM and RMI nonimmigrants in each  location.
subsections: section_title: Continuing Economic Assistance under Amended Compacts
paragraphs: The U.S. government intends to achieve its first objective—continuing  economic assistance to advance self-reliance, while improving  accountability and effectiveness under the amended compacts—by  annually providing direct financial assistance, in the form of grant  agreements, to the FSM and the RMI, for 20 years (fiscal years 2004 through  2023) (see tables 1 and 2). Grant assistance to the FSM and RMI is targeted  to six specific sectors—education, health, public infrastructure, the  environment, public sector capacity building, and private sector  development—although the priority sectors are education and health. RMI  grants must also target some funding to Ebeye and other Marshallese  communities within Kwajalein Atoll. The U.S. Congress, in approving the  amended compacts, also authorized a supplemental education grant for  each country. The Congress determined that rather than remaining eligible  for appropriations under certain education and labor program assistance,  such as Head Start and Job Corps, the FSM and the RMI would instead  receive supplemental direct grant assistance.
In addition to providing sector grant funds, the amended compacts provide  for the establishment of trust funds for both countries. While providing the  direct grant assistance, the U.S. government will also contribute to the trust  funds for both countries, and the FSM and the RMI will replace the grant  assistance with trust fund earnings beginning in 2024. In addition, the FSM  and the RMI must each make one-time contributions to its trust fund of $30  million, and other donors can contribute to the funds as well. Except for  the fixed amounts set aside as audit grants, the amounts listed in tables 1  and 2 will be partially adjusted for inflation, with fiscal year 2004 as the  base year. Grant funding can be fully adjusted for inflation after fiscal year  2014 under certain economic conditions. Including estimated inflation  adjustments, total U.S. assistance to both countries combined is projected  at more than $3.5 billion over the 20-year assistance period.
The amended compacts and their subsidiary fiscal procedures agreements  (FPA) also establish numerous new accountability requirements. For  example, under the amended compacts, the United States established a  Joint Economic Management Committee (JEMCO) with the FSM and a  Joint Economic Management and Financial Accountability Committee  (JEMFAC) with the RMI to strengthen management and accountability and  to promote the effective use of the compact funding. Each committee  comprises five members, three from the United States and the other two  from the FSM for the JEMCO and from the RMI for the JEMFAC. The  Departments of the Interior, State, and HHS supply the three U.S.  representatives, with the Department of the Interior representative serving  as Chairman. The FSM and RMI governments select their respective  representatives. The amended compacts require the committees to meet at  least once annually, no later than 30 days before the beginning of the fiscal  year, to review the budgeting and development plans of each of the  governments, approve grant allocations and performance objectives, attach  special conditions to any or all annual grant awards to improve program  performance and fiscal accountability, and evaluate progress made under  the amended compacts. JEMCO and JEMFAC render decisions by majority  vote, except decisions regarding the division of RMI grants, which are  made by consensus. Budget consultations with each country are also  required prior to JEMCO and JEMFAC meetings to ensure that proposed  compact budgets estimate sector grant requirements for the upcoming  fiscal year. In addition, trust fund committees are required to address  issues associated with the operations and investments of the FSM and RMI  trust funds. The trust fund committee for each country is comprised of  representatives from the United States and the FSM or the RMI, and other  contributors may also join the committees. Language contained in the  amended compacts’ enabling legislation states that it is the sense of the  U.S. Congress that U.S. appointees to the trust fund committees “should be  designated from the Department of State, the Department of the Interior,  and the Department of the Treasury.”
The FSM and RMI must also adhere to specific financial and performance  reporting requirements as part of the amended compacts and the FPAs. The  FPAs state that financial management systems must meet several standards  addressing financial reporting, accounting records, internal and budget  controls, cash management, and source documentation, and also specify  applicable procedures regarding real property, equipment, and  procurement where compact funds are involved. As part of their budgeting  process, both countries must submit plans for the division of annual  economic assistance among sectors. Additionally, per the terms of the  FPAs, the FSM and RMI must submit quarterly financial status and cash  transaction reports, and final annual financial reports and single audits  must be completed following the end of each fiscal year. Further, for each  sector grant, the FSM and RMI must submit quarterly performance reports  comparing actual accomplishments with program objectives and  identifying any problems or issues encountered during the reporting  period. The FSM and RMI are responsible for the management and  monitoring of the day-to-day operations of all sector grants and their  activities to ensure compliance with all grant terms and conditions. In  addition, the FSM and RMI must prepare and submit an annual report to  the President of the United States on the use of grant assistance and  describe progress toward mutually agreed-upon program and economic  goals. Similarly, the President of the United States must submit an annual  report to the Congress regarding several issues such as general social,  political, and economic conditions in each country; the use and  effectiveness of financial assistance; status of efforts to increase  investments; and recommendations on ways to increase the effectiveness  of assistance and to meet overall economic performance objectives. (See  fig. 1 for a time line of key funding and accountability events that are  required for each fiscal year.)
OIA staff work closely with Department of State staff in Washington, D.C.  and the U.S. embassies in the FSM and the RMI regarding compact matters.  Department of State officials emphasized to us that they are primarily  responsible for conducting foreign relations with the two countries and  safeguarding U.S. strategic interests in the region, and these objectives  necessarily include involvement in compact issues. An executive order is  currently under preparation that identifies the specific responsibilities of  U.S. agencies regarding compact matters. Further, OIA coordinates with  HHS, a U.S. JEMCO and JEMFAC member, and in February 2005 a senior  official from HHS began work in OIA’s Honolulu field office (which opened  in 2003) and told us that he provides support to the OIA health sector  efforts under the amended compacts, provides technical assistance for an  array of U.S. federal health grants in the Pacific, and works to improve  coordination with other public health entities in the region, such as the  World Health Organization.
section_title: Key Differences between Original Compact and Amended Compacts
paragraphs: The amended compacts differ from the original compact chiefly in that they  provide for direct assistance through sector grant agreements, establish  trust funds, and strengthened accountability and reporting provisions (all  discussed earlier). In addition, unlike the original compact, the amended  compacts do not include a “full faith and credit” guarantee, which had  made it impracticable for the U.S. government to withhold compact funds.  Instead, the FPAs contain provisions that explicitly allow for the  withholding of funds if compact, FPA, or grant requirements are not met.  Further, the FPAs allow for the suspension of funds if the FSM or RMI  engage in gross negligence, willful misconduct, or material breach of terms  and conditions with respect to the use of financial assistance provided  under the amended compacts. In addition, funds can be withheld if the FSM  and RMI do not cooperate in investigations regarding whether funds are  being used for purposes outside what is authorized in the compact.
Finally, the FPAs prohibit the FSM and RMI from issuing negotiable or  transferable obligations evidencing indebtedness or encumbrance of  compact economic assistance funds. In 2000, we found that under the  original compact, the FSM and the RMI issued compact revenue-backed  bonds in order to obtain greater funding in the earlier years of the compact.  The funding was used to retire existing debt, pay for capital projects, and  make financial investments. In later compact years, FSM and RMI bond  debt payments (especially for the RMI) limited the availability of compact  funds for other uses.
section_title: United States Is Providing Compact Funding to the FSM and the RMI, but Strategic Issues Impacting Long-Term Use of Funds Have Not Been Addressed
paragraphs: The U.S. government has signed sector grant agreements with the FSM and  RMI as provided for in the amended compacts, and trust funds for both  countries have been established. The two countries did not spend about  one-third of available funding in fiscal year 2004. Some of this unspent  funding resulted from a lack of planning required to obtain access to  certain grants—the FSM did not complete plans to obtain infrastructure  grant funding and for the RMI did not complete plans and reforms for the  use of funds targeted to address the special needs of Kwajalein Atoll. The  U.S. government has not provided either country with a supplemental  education grant established in the amended compact’s enabling legislation.  Strategic planning issues that impact the long-term, effective use of funds  have not been addressed by the three governments: (1) the allocations of  sector grants are not linked to amended compact development goals such  as the promotion of economic advancement and budgetary self-reliance,  (2) the FSM and RMI have not developed strategic plans to manage  required annual grant funding decreases, and (3) the trust funds have not  been placed with investors that can maximize trust fund earnings (although  efforts are under way to resolve this issue).
subsections: section_title: U.S. Government Signed Grant Agreements with Both Countries, and Trust Funds Have Been Established
paragraphs: The U.S. government signed grant agreements with the FSM and the RMI  for fiscal years 2004 and 2005 in the compact-designated areas of health,  education, infrastructure, environment, private sector, and public sector  capacity building (see fig. 2 for FSM and RMI fiscal year 2005 grant  allocations). FSM sector grant funding totaled $76 million annually for both  years. The FSM national government, which directly signs grant  agreements with the U.S. government and is the “grantee,” provides the majority of grant funds to the four FSM states, which are “subgrantees.”  RMI grant funding totaled about $35 million annually for the 2 years.
The RMI’s public sector capacity building grant was $103,514. This amount accounts for under 1  percent of total grant funding.
While section 211(b)(2) of the amended compact with the RMI provides for an annual $1.9 million (with  a partial inflation adjustment) for Kwajalein impact, these funds have not yet been provided pending  the completion of a spending plan for these funds.
The FSM’s largest grant for fiscal years 2004 and 2005 is in the area of  education. This grant accounted for over a third of total sector grants.  The health sector received the second highest grant amount for 2005, at  23 percent of total grant funding. The FSM has not yet met the goals  outlined in the amended compacts’ enabling legislation, which states  that it is the sense of the U.S. Congress that infrastructure  improvements and maintenance should account for not less than 30  percent of all sector grant funding each year; the amount of funding  intended for infrastructure for 2005 is slightly smaller than the funding  for health grants and also accounted for about 23 percent of grant  funding in that year (a grant in this area was awarded by Interior on May  13, 2005, and accepted by the FSM national government on May 26,  2005). A resolution adopted by the JEMCO during an August 2004  meeting requires the FSM to move to reach the goal of funding  infrastructure at not less than 30 percent of annual compact grant  funding by fiscal year 2006. In addition, the United States agreed to an  FSM request for fiscal year 2004 to spend about 90 percent of its $11.6  million public sector capacity building grant to fund basic government  operations, rather than to support this sector’s principal compact  objective of promoting effective, accountable, and transparent  government. According to a senior OIA official, the FSM needed to use  these grant funds for basic government operations to be able to  adequately support the use of other sector grant funds. As a 2004 grant  condition, the FSM is required to stop funding basic government  operations from Compact grant assistance over a 5-year period.  Similarly, in 2004, the FSM also had to commit to shifting basic  government operations out of its much smaller private sector  development grant—a grant primarily intended to support efforts to  attract new foreign investment and increase indigenous business  activity.
The RMI’s largest grant for fiscal years 2004 and 2005 is in the area of  infrastructure. The RMI has easily met the “sense of the U.S. Congress”  language regarding infrastructure for fiscal years 2004 and 2005, with an  infrastructure grant of about $13.5 million accounting for around 39  percent of total sector grant funding in 2005. The next largest grant is in  the area of education, which represents more than 30 percent of total  grant funding for both years, followed by health grants at 20 percent of  the total funding. An additional grant of $1.9 million authorized in  amended compact section 211(b)(2) (representing 6 percent of total  grant funds in fiscal year 2005) exists specifically to address needs on Kwajalein Atoll, although grant documents had not been signed as of  mid-May 2005. In contrast to the FSM, the RMI allocated no compact  funding to a public sector capacity building grant in fiscal year 2004 and  less than 1 percent of compact sector grant funding to such a grant in  fiscal year 2005. (For a more detailed description of FSM and RMI  sector grant allocations for fiscal years 2004 and 2005, see app. II.)
As provided by the amended compacts, trust funds have been established  for both countries, the earnings from which are to replace sector grants  when grant assistance ends in 2023. According to an OIA official, the RMI  trust fund was incorporated in April 2004, and the FSM trust fund was  incorporated in August of that year. The FSM government contributed $30  million to its trust fund in October 2004, while the RMI government, as of  March 2005, had contributed $26.5 million to its trust fund and was $1  million behind with its scheduled trust fund contributions. As provided in  the amended compacts, the U.S. government has provided $32 million to  the FSM trust fund and $14.5 million to the RMI trust fund for fiscal years  2004 and 2005. In addition, according to a State official, the RMI has signed  an agreement that will provide for a $50 million trust fund contribution  from Taiwan (which has also provided economic assistance to the RMI).
section_title: FSM and RMI Did Not Spend About One-Third of Authorized Fiscal Year 2004 Funds
paragraphs: The FSM and the RMI each did not spend about one-third of authorized  grant funding for fiscal year 2004 (the only completed year under the  amended compacts). Some of this unspent funding resulted from a lack of  planning required to obtain access to certain grants—the FSM did not  complete plans to obtain infrastructure grant funding, and the RMI did not  complete plans and reforms for the use of funds targeted to address the  special needs of Kwajalein Atoll. Further, both countries did not spend  (obligate) some portion of other available sector grants for 2004; the FSM  spent a smaller percentage of each of these grants than the RMI (see fig. 3  for FSM and RMI use of sector grants for fiscal year 2004). These funds  remain available for use in future years.
The FSM did not spend almost $25 million (33 percent) of its authorized  sector grant funding of $76 million for fiscal year 2004. This amount  includes more than $17 million in infrastructure funding (100 percent of  the grant amount) that was not provided to the country because of the  time it has taken the FSM to complete a required infrastructure  development plan that identified infrastructure projects that adequately  integrated state and national priorities. Further, the FSM has only  recently established a required project management unit to oversee  individual infrastructure projects. Finally, the FSM did not spend more  than $7.7 million in other available sector funds (primarily in health and  education); OIA officials have expressed frustration that financial  management practices in the FSM allowed over 10 percent of the  available compact grant funds to go unused for fiscal year 2004. Of this  amount, Yap state had the largest unobligated, or carryover, compact  fund balance, at more than $4 million.
The RMI did not spend about $12 million (35 percent) of its total  authorized grant funds of $35 million. The RMI, which met compact  requirements related to infrastructure spending, did not spend $9.6  million (66 percent) of its infrastructure grant, owing to the time  involved in bidding and initiating infrastructure projects. According to  an OIA official, infrastructure activity is now well under way in the RMI.  Further, the RMI government did not spend $1.9 million targeted for  special needs on Kwajalein Atoll. These funds remain with OIA until the  RMI government submits a plan regarding how the funds will be spent.  The funds will be used by a local government agency, the Kwajalein  Atoll Development Authority (KADA), which has experienced problems  in effectively and efficiently using funds in the past. As of early 2005,  legislation had been passed that contains plans for KADA’s  restructuring, but the agency was not operating. Finally, the RMI had a  carry-over balance of about $750,000 from other available fiscal year  2004 sector grants, chiefly in the education sector (5 percent of funding  under this grant, the RMI’s second largest for 2004, was unspent for the  year).
In addition, the U.S. government has not provided one grant established in  the amended compacts’ enabling legislation. Neither the FSM nor the RMI  has received a supplemental education grant (SEG) that is to begin in fiscal  year 2005. The Departments of the Interior, Education, Labor, and Health  and Human Services are still finalizing an interagency agreement to  determine how funds authorized under the amended compacts’ enabling  legislation for this grant will be transferred from other agencies to Interior.  The annual SEG amount--$12.23 million for the FSM and $6.1 million for the  RMI--is substantial, compared with the funding amounts provided for other  compact sector grants.
section_title: Strategic Issues Impacting Long-Term Use of Funds Have Not Been Addressed
paragraphs: The U.S., FSM, and RMI governments have not addressed several strategic  issues that impact the long-term, effective use of funds.
subsections: section_title: Grant Allocations Not Tied to Broader Goals
paragraphs: Fiscal year 2004 and 2005 allocation of compact sector grant allocations  were not clearly tied to broad development goals, and therefore the extent  to which existing grants contribute to the FSM’s and the RMI’s long-term  development is unclear. The JEMCO and JEMFAC reviews of sector grant  allocations for fiscal years 2004 and 2005 did not include discussions of  FSM and RMI plans to establish goals regarding the amended compacts’  primary objectives of economic advancement and budgetary self-reliance,  and how grant allocations in each sector will help to achieve these larger  goals. FSM and RMI plans that could assist in this effort are incomplete.  The required development plan for the FSM and the medium-term budget  and investment framework (MTBIF) for the RMI are to be strategic in  nature and identify how the countries will use compact funds to promote  broad compact development goals such as economic advancement and  budgetary self-reliance. However, JEMCO has not considered the FSM  development plan. Further, U.S. officials are unclear as to whether  JEMFAC has approved RMI’s framework plans for the use of grant funds  and have acknowledged that this issue needs attention. U.S. government  officials have noted that the issue of linking the use of grant funds to the  achievement of long-term development goals has not been addressed to  this point.
Further, while the amended compact states that grant funding is provided  to assist the economic advancement of the people of the FSM, the FSM’s  process for internally distributing sector grant funding does not address  national sector priorities or consider sector disparities between the FSM  states. Compact funds are allocated among the five FSM governments—the  FSM national government and the four state governments—primarily  according to a formula used under the original compact. In addition to  providing funds to the four states, the formula established funding to the  FSM national government, which resulted in a funding allocation  percentage for Chuuk and Pohnpei states that is notably lower than their  percentage of the FSM’s population. An FSM law enacted in January 2005  establishes a very similar distribution among the five governments.
Although the U.S. government has signed grant agreements for fiscal years  2004 and 2005 that provide for the distribution of funds to the five  governments according to this formula, U.S. government officials have  stated that this formula may not result in grant allocations that reflect  national needs. For example, there are currently substantial differences in  sector per capita funding in the FSM states. We calculated that the Yap  state compact education grant provides at least twice as much funding per  student as the Chuuk state education grant, and almost three times as  much funding per person regarding health grants. The extent to which such  variances between states benefit the nation or reflect differences in state  needs is not clear.
section_title: FSM and RMI Have Not Planned for Future Funding Decreases
paragraphs: Lack of strategic planning in both countries to address necessary grant  decreases could result in funding allocations that do not facilitate the most  critical and effective use of remaining compact resources. For example, the  FSM and the RMI have not developed a strategy to manage the annual  sector grant decreases—for the FSM, $800,000 starting in fiscal year 2007  and for the RMI, $500,000 since fiscal year 2005—mandated in the amended  compacts. A senior RMI official told us that although the government  recognizes that the decrements should be of major concern, government  officials are not addressing the problem. Likewise, a senior FSM official  reported that although the government has created a task force to examine  ways to increase tax revenues to, among other things, compensate for lost  compact grant funding, no plan is currently being devised to determine  how to respond to the annual decreases. This official also noted that such  issues are up to each of the five governments to address as they see fit.
In addition, the FSM has no strategic plan to shift basic government  operations expenditures from the public sector capacity building grant to  local revenues. Although the FSM, according to the terms of a grant  condition, provided OIA with a document that calculates percentage  decreases of these expenditures from the grant through 2009, there is no  additional plan describing the policy steps that will be taken or the  agencies and activities that will be affected. Funding for this grant began  decreasing in fiscal year 2005, and some officials have expressed concern  over the consequences of reduced compact funding to support routine  government activities.
section_title: Trust Funds Have Earned Low Returns
paragraphs: The FSM and RMI trust funds are earning low returns on trust fund  contributions, raising concerns about the future adequacy of the trust  funds to ultimately replace grant assistance. All trust fund contributions  are currently in commercial bank accounts earning up to 2.63 percent in  interest, because neither trust fund has been placed with an investment  advisor that will work to maximize returns. According to an OIA official,  this circumstance has resulted from the time it took the FSM and the RMI  to approve the amended compacts as well as the process involved in  selecting an investment advisor and placing funds with money managers. In  February 2005, the RMI trust fund committee selected a trust fund  investment advisor; no advisor has been selected for the FSM as of mid- May 2005, although the process to select one is under way.
This situation is important in the context of our prior analysis that raised  questions about the sufficiency of the trust funds to generate earnings that  could replace compact grants beginning in 2024. For example, assuming  an annual return of 7.9 percent realized by the trust funds at the beginning  of fiscal year 2004, we projected that the FSM trust fund earnings by 2048  would be inadequate. However, future earnings in excess of 7.9 percent  could counterbalance the slow start for the trust funds. The FSM appears  to be in a weaker position relative to the RMI, in that it has not selected a  trust fund investment advisor and has not yet obtained additional  contributions from other donors.
Regarding a separate trust fund issue, U.S. membership in the FSM and  RMI trust committees is not yet aligned with language contained in the  amended compacts’ enabling legislation, which states that it is the sense of  the U.S. Congress that U.S. appointees to the trust fund committees “should  be designated from the Department of State, the Department of the Interior,  and the Department of the Treasury.” Current U.S. government trust fund  committee participants are from the same U.S. agencies that participate in  the JEMCO and JEMFAC: the Departments of the Interior, State, and Health  and Human Services. An OIA official noted that an effort is under way to  eventually include the Department of the Treasury as an additional member  of the RMI trust fund committee when Taiwan contributes to the RMI trust  fund and can become a member of the committee. (The trust fund  agreements allow additional donors to become members of the committees  but also require a U.S. majority vote in trust fund committees; therefore,  the U.S. government will add another member if Taiwan joins the RMI trust  fund committee.)
section_title: United States, FSM, and RMI Have Taken Actions to Meet Key Accountability Requirements, Though a Few Requirements Remain Uncompleted
paragraphs: The U.S., FSM and RMI governments have taken several actions to fulfill  key accountability requirements, such as meeting annually to approve  grants, establishing special grant terms and conditions, and preparing  various reports. Further, the U.S. government has withheld grant funding  for noncompliance with compact and grant requirements and initiated an  investigation into the possible misuse of compact funds in the FSM state of  Chuuk. However, a few important requirements, such as the preparation of  annual compact spending and development reports, remain uncompleted.  (See app. III for a table listing requirements that have and have not been  met.)
subsections: section_title: Most Required Meetings and Consultations Have Occurred
paragraphs: In August 2003 and 2004, the U.S. government held bilateral meetings with  the FSM through JEMCO and with the RMI through JEMFAC to discuss and  approve fiscal year sector grants allocations. The minutes for the August  2004 JEMCO and JEMFAC meetings showed a discussion of committee  procedures and approval of specific sector grant levels. JEMCO and  JEMFAC have focused on grant approval and performance assessment,  while other committee duties, such as reviewing other donor assistance or  audit findings, have received limited attention. Although the JEMFAC  meetings with RMI reached consensus on grant issues, the JEMCO  meetings with the FSM showed areas of strong disagreement between the  U.S. and FSM representatives; these disagreements were decided by a vote,  split between the countries, that adopted the U.S. position. The FSM  government sent a letter to the U.S. government expressing frustration over  the 2004 JEMCO meeting and the manner in which decisions were reached.  Special meetings can be called by three JEMCO or two JEMFAC members.  A special bilateral meeting with the FSM was held in Honolulu on March 11,  2005, to discuss grant management problems regarding one of the FSM  subgrantees, Chuuk state, and a special JEMCO meeting was held that  same day to reach decisions regarding the FSM infrastructure development  plan and the use of fiscal year 2004 carry-over funds.
In addition, the amended compacts require budget consultation meetings  before the compact budgets are submitted and the formal JEMCO and  JEMFAC meetings are held. These consultations were held with the FSM  before the 2005 JEMCO meeting. However, no consultations were held with  the RMI because that government was late in providing a draft budget to  the U.S. government; a budget was not provided until 1 week before the  JEMFAC meeting. Budget consultations were held with both countries in  2003 in preparation for fiscal year 2004.
section_title: Special Grant Conditions Have Been Established
paragraphs: JEMCO and JEMFAC specified additional accountability requirements by  including special terms and conditions that were included in the fiscal year  2004 and 2005 individual grants agreements. These special terms and  conditions ranged widely, from requiring information on the three FSM  health insurance programs to requiring that both countries submit  appropriate environmental performance measures and baseline data for  approved activities to OIA.
According to OIA officials, the RMI met most of the special grant terms and  conditions attached to the country’s grants; however, the FSM met only  some of its specific terms and conditions. For example, according to OIA  staff, the FSM has had difficulty identifying useful performance baseline  data for most sectors because of information disorganization and  fragmentation. OIA officials reported that the FSM was unable to satisfy  more conditions because of a lack of skilled staff in all four FSM states and  the national government. They stated that the staff members with  responsibility for sector grant compliance did not always have the requisite  level of understanding or skill to make sure that problems were being  addressed.
section_title: Key Reports Have Been Prepared
paragraphs: The FSM and the RMI have submitted their annual compact budgets to the  U.S. government, as well as all quarterly financial and performance status  reports, and annual financial reports. OIA has asked for FSM to revise its  budgets to include more specific data, such as the number of people  working on a particular program. OIA officials have found the FSM’s 2004  quarterly financial and performance reports to be in need of improvement,  while such reports from the RMI were viewed as adequate. A senior HHS  official noted that the FSM has had significant difficulty in providing  standardized performance data between the states that can be compared.  FSM officials told us that the national government does not assess the  quarterly performance reports prepared by the five governments and  simply compiles them for transmission to OIA. Both countries have  submitted financial and performance reports to the U.S. government on  time, and Pohnpei and Chuuk states have withheld pay for officials  responsible for performance reports that were not provided on time to the  FSM national government.
OIA has been working with the FSM to improve and standardize the FSM’s  performance reporting format; and, as of the first quarter of fiscal year  2005, all FSM governments were using a uniform reporting format that was  approved by OIA. Officials in both countries told us that the requirement to  produce performance reports was a positive step and would help to create  a linkage between expenditures and their impact. However, the officials  acknowledged that they are still in the process of learning how to generate  such reports, and that, although the reports have the potential to be used as  a management tool, the governments are not yet able to use the reports in  this capacity.
section_title: Interior Has Withheld FSM Grants and Initiated a Misuse Investigation
paragraphs: In several instances, the U.S. government has not provided compact funds  to the FSM or RMI in order to ensure compliance with compact  requirements, and accountability over sector grants. In two instances, OIA  withheld compact funding from the FSM when the country was slow to  meet grant conditions. Further, OIA suspended FSM funding due to  possible misuse in another situation. Finally, in an effort to ensure prudent  financial operations, OIA has delayed providing FSM and RMI grant  funding due to cash management concerns. A Department of State official  noted that the FSM and RMI governments are definitely taking note as the  U.S. government makes use of this new tool to ensure the appropriate use  of compact funding.
In the first instance, in approving FSM use of most of its public sector  capacity-building grant funds for basic government operations rather than  for the principal compact objectives for this sector, as mentioned earlier,  JEMCO also adopted a grant condition for the fiscal year 2004 public sector  capacity building grant. This condition required a “transition plan” by  March 2004 explaining how these expenses would be removed from this  grant. When the FSM did not provide such a plan, OIA withheld FSM public  sector capacity-building grant funding, totaling approximately $1.9 million  in May and June 2004 combined. After the FSM provided the plan to the  U.S. government in July, OIA released the funding. The second, similar  instance occurred simultaneously with a much smaller grant. JEMCO  attached a special grant condition to the FSM’s private sector development  grant, requiring that the FSM provide a 5-year transition plan for shifting  basic government operating costs away from this grant to local revenues.  When the FSM did not provide the plan on time, OIA withheld about  $630,000 of sector funding in May and June 2004 until the FSM provided a  plan in June 2004.
Further, as of March 2005, OIA suspended the Chuuk education grant’s  meal service program funding, because of questions surrounding the  delivery of meals to students. The program was allocated almost $1 million  in fiscal year 2005. Because OIA staff were unable to verify that food  purchased by the program was received by the Chuuk Education  Department or served to students, OIA has suspended—following a  bilateral meeting that addressed this issue—$80,380 each month until the  FSM national government reports on corrective actions to ensure that the  meal service program operates effectively. As of May 2005, this issue, which  was uncovered during a field visit to Chuuk by an OIA Honolulu office  employee, had not been resolved. OIA also contacted Interior’s Office of  the Inspector General for a follow-up investigation to determine whether  Chuuk is misusing compact grant funds. According to a senior OIA  official, the FSM national government is cooperating with this  investigation.
Finally, OIA took action in response to FSM and RMI cash management  issues (an area not directly related to fulfillment of grant conditions or  misuse of funds). OIA delayed payments to the FSM and the RMI in August  2004, when the required third-quarter cash transactions report showed that  both countries had notable excess grant sector funding that had not been  spent. OIA subsequently resumed funding when the governments reported  that they needed cash to meet their obligations. OIA also stopped payments  to the FSM in May 2005 when an OIA review showed that the FSM had  about $9.7 million in cash on hand. Compact payments will be delayed until  the FSM demonstrates its need for additional funding.
section_title: A Few Important Requirements Remain Uncompleted
paragraphs: Despite progress in many areas, a few important accountability reporting  requirements have not been met, preventing the U.S., FSM, and RMI  governments from fully gauging FSM and RMI performance in utilizing  compact funds and from beginning to assess the impact of compact  funding.
Required broad annual reports summarizing compact spending and  progress in meeting development goals have not been completed by any  of the three governments. The U.S. government has not provided its  fiscal year 2004 report from the President to the U.S. Congress, due in  December 2004, though a draft is being circulated for interagency  approval. Similarly, the FSM and the RMI have not submitted fiscal year  2004 reports to the U.S. President, although they were due in February  2005.
Key development planning efforts remain incomplete, as mentioned in  the previous section. These plans were due no later than 90 days after  the amended compacts went into effect. The FSM has prepared a  development plan, and the FSM Congress approved transmittal of this  plan to the U.S. government in May 2005. JEMCO has not yet considered  the plan. The RMI has provided the U.S. government with a required  medium-term budget and investment framework, as well as a policy  framework paper and annual plans for each sector, but it is unclear  whether the JEMFAC has approved RMI planning documentation  addressing the use of grant funds. OIA officials have provided  contradictory views; while one senior official reported that the RMI’s  approach was approved during the 2003 bilateral meeting, another  official disagreed, and no record exists to document this meeting. No  subsequent action has been taken to approve the RMI’s planning efforts.  A senior OIA official noted that this particular issue has not received the  attention it requires.
Required audits that OIA intends to use to gauge compact compliance in  specific areas such as procurement, remain outstanding or have been late.  Single audits for fiscal year 2004 were due on April 1, 2005. The FSM has  not completed its fiscal year 2004 single audit. The RMI has been late in  meeting this requirement; the RMI completed its fiscal year 2004 single  audit in June 2005.
section_title: OIA Opened New Office in 2003, FSM and RMI Took Steps in 2005 to Establish Centralized Compact Offices
paragraphs: In October 2003, OIA took a significant step toward facilitating  implementation and oversight of the amended compacts by opening a  Honolulu field office to manage compact issues. However, OIA has not  conducted a review to determine the extent of oversight of compact  activities in the FSM and the RMI that would adequately promote  compliance with compact requirements, though officials from all three  governments told us that OIA staff should be spending more time in the two  countries. Staff are currently spending about 15 percent of their time in the  two countries. The FSM and the RMI governments have subsequently acted  to create or identify central offices responsible for compact matters. The  RMI government is progressing more quickly than the FSM government in  this regard, and it has also taken other actions to facilitate compact  implementation, such as creating an infrastructure project management  unit.
subsections: section_title: OIA Opened a Honolulu Field Office to Facilitate Compact Implementation and Monitoring, but Extent of Required On-Site Review Has Not Been Established
paragraphs: In October 2003, OIA opened a new Honolulu field office specifically  intended to facilitate implementation and oversight of the amended  compacts, although OIA has not determined how much on-site review of  compact activities in the FSM and the RMI is necessary. During the  congressional approval process for the amended compacts in 2003, in  addressing why OIA should open an office in Honolulu rather than placing  OIA staff in the FSM and the RMI, the Deputy Assistant Secretary for  Insular Affairs reported to the House Committee on International  Relations, Subcommittee on Asia and the Pacific, that “The Honolulu team  will be able to travel frequently to the . While travel  costs are high from Honolulu, additional travel costs are offset by not  having to supply permanent housing, post differential, home leave, and  education for dependents that come with foreign posts.”   The office has  five professional staff—specialists in health, education, infrastructure,  private sector development, the environment, and financial management— that provide program and financial expertise along with a knowledge and  understanding of the region, and work with the OIA Compact Coordinator  in Washington, D.C. The Honolulu staff perform activities such as  analyzing FSM and RMI budgets and other required reports, traveling to the  islands to discuss and review expenditures and performance with FSM and  RMI government officials and conduct site visits, providing briefings and  advice to OIA and State officials regarding progress and problems, and  providing support for bilateral meetings.
However, in conjunction with establishing the Honolulu office, OIA did not  determine the extent of on-site review of compact activities in the FSM and  the RMI that would adequately promote compliance with compact and  grant requirements. OIA fieldwork in the FSM and the RMI is necessary to  ensure accountability over funds and compliance with compact and grant  requirements, and is one of the principle reasons why the office was  established in Honolulu. According to a cable from the U.S. Ambassador to  the FSM “The constant flow of compact-related queries highlights the need  for continued, intensive hands-on  involvement… ffective  oversight by Interior’s staff in Hawaii will be critical in realizing the  compact’s full potential…  staff will need to meet regularly with   state officials from both the executive branch and the legislatures.  Working more closely with state officials as they develop their budgets  would enable  staff to spot and resolve problems well before budgets  are finalized… Oversight by e-mail is not an option.”
Officials from all three countries told us that while they view the creation  of OIA’s Honolulu office as a positive development, they believe that the  Honolulu staff should spend more time in the FSM and the RMI than they  currently do, to provide additional guidance on meeting compact  requirements and conduct site visits. For example:  The Deputy Assistant Secretary for Insular Affairs told us that he is not  satisfied with the amount of on-site review that his staff is able to  conduct but that his office must deal with the budget available to it. The  OIA Compact Coordinator and staff from the Honolulu office report that  on-site time in the field is inadequate and does not allow for detailed  reviews of federal funds in the various remote islands.
The U.S. Ambassadors to the FSM and the RMI both told us that OIA  Honolulu staff should have the resources to conduct more work in the  two countries. For example, more on-site work by OIA staff with  country budget and finance issues is needed, as well as sufficient time to  conduct site visits to schools.
The HHS official that participates in the JEMCO and the JEMFAC noted  the value of OIA on-site review in Chuuk and said that there needs to be  more on-the-ground work.
FSM and RMI officials also noted a need for additional on-site review  and inspection by OIA staff, including site visits to schools in Pohnpei  and infrastructure projects that are under way in the RMI.
For fiscal year 2005, the OIA Honolulu office has a travel budget of  $170,000, and for fiscal years 2004 and 2005 (through mid-April), staff in  OIA’s Honolulu office spent about 15 percent of their total work time  reviewing compact-related activities in the islands. OIA officials report that  they are allocating their travel based on available funds for travel, while the  OIA Honolulu office reports that they have had no input into the  preparation of OIA’s budget or the allotment process. Examples of the  impact of on-site review include the previously mentioned visit to Chuuk  state by OIA Honolulu staff that uncovered possible misuse, as well as  meetings OIA program specialists have held in the islands to discuss key  issues, such as standardizing and improving both financial and  performance measurement reporting, with FSM and RMI officials.  According to OIA officials, the office has no assessment under way to  establish if this amount of time spent in the FSM and the RMI meets  oversight needs. While OIA officials believe the funding for on-site review  is insufficient, the department has not supported increased funds for this  purpose.
section_title: FSM and RMI Governments Have Taken Initial Steps to Create Central Compact Offices
paragraphs: Both the FSM and the RMI are seeking to centralize their government  contact with the U.S. government and provide for day-to-day management  of grant operations, as required in the FPAs. Although the RMI is making  more rapid progress than the FSM in this area, both countries are in the  early stages of establishing centralized offices responsible for compact  matters.
In early 2005, the RMI government identified the Office of the Chief  Secretary as the official point of contact for all communication and  correspondence between the U.S. government and the RMI government  concerning compact sector grant assistance. The Chief Secretary is the  head of RMI public service and will coordinate and direct the various  ministries receiving compact funding with respect to the FPA and  compact provisions. The Chief Secretary will also work closely with the  RMI Economic Policy, Planning, and Statistics Office to develop the  annual budget and sector portfolios and quarterly and annual  monitoring and evaluation reports. While the Office of the Chief  Secretary will provide oversight and coordination, the Chief Secretary  has reported that most of the daily activities and compliance will be  conducted by the ministries themselves. The Chief Secretary has  outlined his plan to coordinate with agencies and reported to us that he  will hold weekly meetings with all secretaries to address compact  implementation issues, review reports on specific issues, and provide  guidance to the ministries and agencies of the RMI government on  compact matters.
The FSM Congress recently enacted legislation to establish a Compact  Management Board and a supporting Office of Compact Management.  The board will consist of seven members; the FSM President will  appoint two members, each state will appoint one member, and the final  member will be the head of the Office of Compact Management.  Whereas the board will be responsible for actions such as formulating  JEMCO guidelines for FSM members, the compact office will be  responsible for daily communications with JEMCO and the United  States with regard to JEMCO and compact matters. A senior FSM  official told us that although he expects compact office staff to  undertake actions such as compliance visits to the FSM states, he does  not expect the constitution of the board to be completed and the office  ready to function until October 2005. Although there are ongoing  differences between the FSM executive and legislative branches over  which branch the compact office should be accountable to, the FSM  Congress appropriated $100,000 in 2005 for the operation of the  board.
Although both countries have taken steps to provide for a centralized  approach to addressing compact implementation and day-to-day  management of grant operations, neither government’s efforts in this  important area are yet under way, and the ultimate effectiveness of such  efforts is unknown. The FPAs state that the FSM and RMI are responsible  for the management and monitoring of the day-to-day operations of all  sector grants to ensure compliance with all applicable grant terms and  conditions; however, officials from both countries told us that this issue  had not received much attention. Further, a senior FSM government official  told us that the national government is not monitoring the day-to-day  implementation of the compact by the states. Notably, a senior OIA  official emphasized that the FSM’s and the RMI’s partnership with OIA in  monitoring compact implementation is key to the success of the amended  compacts.
The RMI has also made more rapid progress than the FSM in managing  implementation of its infrastructure grant. The RMI government hired a  foreign firm to be the project management unit that designs and oversees  individual infrastructure projects and work is under way. Following an  extensive survey to assess the state of RMI education and health  infrastructure and determine priority infrastructure projects, several  contracts have been awarded, for example, for the construction and  maintenance of schools and a hospital. The FSM just established a project  management unit in June 2005. Per a JEMCO resolution, such a unit must  be established in order to receive infrastructure grant funds.
In addition, the FSM and RMI are each working to improve their accounting  software systems. The RMI government has adopted a new accounting  software system that meets with OIA’s approval and is currently being  reviewed within the RMI to ensure that it allows for compliance with  compact FPA requirements. Further, the RMI Ministry of Finance has hired  fixed-asset and procurement specialists and established a satellite office in  Ebeye to handle the specific needs of that area. The FSM, which currently  has three different accounting software programs spread among the four  states and the national government, is in the process of purchasing a  unified accounting system. It will install the program and train each  government’s personnel to satisfy compact reporting requirements.
section_title: Conclusions
paragraphs: The amended compacts differ significantly from the original compact in  that they target funding to identified priority areas; require grant  agreements; substantially increase accountability requirements to include  new dimensions, such as performance measurement; and allow for the  withholding of funds for noncompliance with compact or grant  requirements. Diligent and sustained effort by the U.S., FSM, and RMI  governments will be required to adapt fully to this new approach for  providing and accounting for U.S. economic assistance to the FSM and the  RMI.
Within this new environment, all three countries have demonstrated a  commitment to meeting new compact funding and accountability  requirements. The U.S. government has undertaken notable actions during  the early stages of compact implementation that reflect its commitment. It  has embraced new accountability options in the amended compacts by, for  example, requiring data that will facilitate performance measurement and  suspending funds as a result of possible misuse. Further, by holding  infrastructure funding until the countries provide sufficient infrastructure  project and identification management, the U.S. government has taken a  new approach to ensuring the effective use of compact funds. In addition,  by establishing a Honolulu field office and investing in staff to provide  monitoring and oversight, OIA has demonstrated its commitment to  successful implementation of the amended compacts. Such staff are  critical to conducting work in the field to monitor performance and  financial accountability, as OIA’s review of education expenditures in the  FSM state of Chuuk has demonstrated. However, officials from all three  governments believe that more OIA field work is in order. OIA needs to  determine the extent of on-site work in the FSM and the RMI necessary to  adequately promote compliance with amended compact and grant  requirements.
The FSM and the RMI have also acted to meet compact requirements,  although many of these actions are in an early stage. Both countries have  taken steps to establish centralized offices responsible for ensuring  compact implementation and day-to-day oversight; however, it is too early  to assess how well these offices will meet this goal. Further, both countries  have responded in a positive fashion to many new reporting requirements.  For example, the FSM and the RMI expressed a desire to provide useful  performance reports and have been responsive to working with OIA to  strengthen and improve this new approach to accounting for compact  funds. In addition, both countries have been timely in providing quarterly  financial and performance reports. While both countries are moving to  meet compact requirements, to date the RMI is progressing more quickly  than the FSM in spending authorized grant funding, meeting special grant  conditions, preparing adequate required reports, taking steps to centralize  compact management, and selecting an investment advisor who can work  to maximize trust fund returns.
Although the three governments’ commitment to meeting compact  requirements is clear, challenges for future performance exist. The failure  of all three governments to complete required annual compact spending  and development reports means that, for the first year under the amended  compacts, there is no assessment of the use of U.S. assistance and initial  performance in key areas such as health and education. Similarly, the lack  of timely single audits deprives the United States of a key source of  information on the FSM’s and the RMI’s compliance with detailed compact  requirements. Additionally, the FSM’s difficulties in preparing a national  infrastructure development plan to obtain substantial infrastructure grant  funding demonstrate the difficulty the country is having integrating state  and national priorities and using compact funds to advance national goals.  Finally, it is unclear why strategic issues, such as the need for planning to  use compact funds to achieve long-term economic advancement or to  address annual grant decreases, are not being actively considered by all  three governments, regardless of the early stage of the amended compacts’  implementation. The U.S. government has not pursued resolution of these  issues, which have implications for the FSM’s and the RMI’s long-term,  effective use of funds.
section_title: Recommendations
paragraphs: To effectively use Interior staff resources and to maximize the  effectiveness of U.S. monitoring of compact expenditures, we recommend  that the Secretary of the Interior direct the Deputy Assistant Secretary for  Insular Affairs to determine, relative to other office responsibilities, the  extent of OIA on-site review in the FSM and the RMI of compact activities  that is required in order to adequately promote compliance with compact  and grant requirements.
To improve grant administration and oversight and to facilitate planning for  the effective use of compact funding, we recommend that the Secretary  direct the Deputy Assistant Secretary for Insular Affairs, as Chairman of  the Joint Economic Management Committee, in coordination with other  U.S. agencies that participate in this committee, to work with the FSM  government to take the following four actions:  establish sector grant levels for each of the five governments that are  consistent with national priorities and will assist in promoting long-term  development goals such as economic advancement and budgetary self- reliance,  establish a time frame for the completion of required and overdue FSM   establish a time frame for the completion of FSM government plans to  manage decreasing annual grant amounts and to shift basic government  operations under the public sector capacity building to local revenues in  a strategic fashion, and  outline specific actions that the FSM government will take in managing  and monitoring day-to-day sector grant operations to ensure compliance  with all grant terms and conditions.
To improve grant administration and oversight and to facilitate planning for  the effective use of compact funding, we recommend that the Secretary  direct the Deputy Assistant Secretary for Insular Affairs, as Chairman of  the Joint Economic Management and Financial Accountability Committee,  in coordination with other U.S. agencies that participate in this committee,  to work with the RMI government to take the following three actions:  establish sector grant levels that will assist in promoting long-term  development goals such as economic advancement and budgetary self- reliance,  establish a time frame for the completion of an RMI government plan to  manage decreasing annual grant amounts in a strategic fashion, and   outline specific actions that the RMI government will take in managing  and monitoring of day-to-day sector grant operations to ensure  compliance with all grant terms and conditions.
section_title: Agency Comments
paragraphs: We received technical comments from the Departments of the Interior,  State, and HHS, as well as the FSM and RMI governments. The RMI  submitted particularly extensive technical comments that stressed, among  other things, that government’s detailed strategic planning efforts and  provided suggestions to improve the factual accuracy of this report. We  incorporated technical comments into our report, as appropriate. We also  received formal comment letters from all parties. All letters found our work  to be useful, although the RMI remarked that the report overstated long- term strategic planning issues, provided insufficient emphasis on economic  components of the amended compact that have not been fully  implemented, and included passages that were in need of factual  correction. The Department of the Interior concurred with our  recommendations and stated its intention to implement them. State, HHS,  and the FSM government did not comment on our recommendations to  Interior. The RMI government stated that some of the recommendations  did not reflect the purpose or intent of the amended compact.
In addition to providing copies of this report to your offices, we will send  copies of this report to other appropriate committees. We will also provide  copies to the Secretaries of the Interior, State, and Health and Human  Services, as well as the President of the Federated States of Micronesia and  the President of the Republic of the Marshall Islands. We will make copies  available to other interested parties upon request.
If you or your staff have any questions regarding this report, please contact  me at (202) 512-4128 or gootnickd@gao.gov. Contact points for our Offices  of Congressional Relations and Public Affairs may be found on the last  page of this report. GAO staff who made major contributions to this report  are listed in appendix IX.
section_title: Objectives, Scope, and Methodology
paragraphs: The Chairman and Ranking Minority Member of the House Committee on  Resources, and the Chairman and Ranking Minority Member of the Senate  Committee on Energy and Natural Resources requested that we report on  the progress of initial efforts to implement the amended compacts. This  report evaluates actions taken by the United States, Federated States of  Micronesia, and the Republic of the Marshall Islands governments since  fiscal year 2004 to (1) meet funding requirements and plan for the use of  this funding, (2) meet accountability requirements, and (3) establish  operations to facilitate compliance with funding and accountability  requirements.
To identify actions taken by the three governments to meet funding  requirements, we reviewed the amended compacts as well as the  subsidiary fiscal procedures agreements and subsidiary trust fund  agreements to identify such requirements as well as expectations of the  U.S. Congress in this area. We reviewed all fiscal year 2004 and 2005 grant  agreements with both countries, including special terms and conditions  included in these agreements, and identified instances where no grant  agreement had been signed. We examined annual financial data prepared  by the FSM and the RMI to determine the amount of funding that was not  spent for fiscal year 2004 and what sectors were affected by this  circumstance. We discussed the FSM and RMI data with an Office of  Insular Affairs official who has used this information, and determined that  the data are sufficiently reliable for the purposes of our report. We also  corroborated our calculations of unspent funds with this official. We did  not review funding provided to Kwajalein landowners in exchange for U.S.  military access to Kwajalein Atoll. This funding is for landowner use and is  not included as part of U.S. economic assistance that is subject to sector  grants and accountability requirements.
To identify issues that impact planning for the use of compact funds, we  discussed planning efforts with U.S., FSM, and RMI government officials  and also identified issues through our own analysis (such as the use of the  distribution formula in the FSM). We then reviewed such issues by  examining documents such as FSM and RMI legislation and documentation  provided to the U.S. government (such as the FSM’s transition plan to shift  ineligible spending under the public sector capacity building grant to local  revenues). To identify FSM education spending per capita, we used FSM  education grant data and divided grant amounts provided to each state by  the student population for each state—the latter data were provided to us  by OIA, which received them directly from the FSM. To identify FSM health  spending per capita, we assessed health grant amounts against FSM  population data. We determined that these data were sufficiently reliable  for the purposes of our report.
To identify actions taken by the three governments to meet accountability  requirements, we reviewed the amended compacts as well as the  subsidiary FPAs to identify such requirements. We also reviewed the  briefing documents created by the U.S. government in preparation for the  annual bilateral meetings with the two countries, as well as the minutes  and resolutions, when available, related to the meetings. We further  reviewed FSM and RMI documents—such as budget justifications and  portfolios, quarterly financial forms and performance reports, and annual  financial reports—submitted by the FSM and RMI governments to the U.S.  government to confirm compliance with accountability reporting  requirements. We discussed the sufficiency of such reports with OIA  officials. We also examined FSM and RMI laws and letters exchanged  between the FSM and U.S. governments.
To identify actions the three governments have taken to establish  operations to facilitate compliance with funding and accountability  requirements, we reviewed the amended compacts and FPAs to identify  specific monitoring responsibilities. In the case of the OIA Honolulu office,  we reviewed senior management statements regarding the purpose and  function of this office and job descriptions for all staff. To identify the  extent of Honolulu office staff travel to the FSM and the RMI, we obtained  the travel records and start dates of all five program specialists and  discussed this information with OIA officials to ensure that the data was  sufficiently reliable for our use. We calculated the percentage of time spent  conducting on-site review in the two countries over fiscal years 2004 and  2005 (through mid-April) time span and compared this to the total work  time for the program specialists. We obtained OIA travel budget data for  the Honolulu office from OIA officials. We reviewed FSM and RMI laws that  address structural changes to compact management, as well as unclassified  cables from the Department of State.
To address all objectives, we held extensive interviews with officials from  the U.S. Department of the Interior (Washington, D.C., Honolulu, Hawaii,  the FSM, and the RMI) and the Department of State (Washington, D.C., the  FSM, and the RMI). We also interviewed officials from the U.S. Department  of Health and Human Services (Washington, D.C., and Honolulu, Hawaii).  We traveled to the FSM (Pohnpei and Chuuk) and the RMI (Majuro and  Ebeye). We had detailed discussions with FSM (national, Pohnpei, and  Chuuk governments) and RMI officials from foreign affairs, finance,  budget, health, education, public works, and audit agencies. Further, we  met with the presidents of the FSM and the RMI. We also met with officials  from the U.S. Army Kwajalein Atoll to discuss compact implementation  issues. We met with representatives from private sector businesses within  the Marshall Islands and with leaders from the Micronesian Seminar, a  nonprofit organization in Pohnpei, FSM that provides public education on  current FSM events, to obtain their views on compact implementation and  development issues. We also met with officials from the Interior Inspector  General’s Office (Guam, Honolulu, Hawaii, and Washington, D.C.) to  discuss ongoing investigations in the FSM and RMI.
We conducted our review from August 2004 through May 2005 in  accordance with generally accepted U.S. government auditing standards.  We requested written comments on a draft of this report from the  Departments of the Interior, State and Health and Human Services, as well  as the governments of the FSM and RMI. All comments are discussed in the  report and are reprinted in appendixes IV through VIII. Further, we  considered all comments and made changes to the report, as appropriate.
section_title: Status of Accountability Requirements, Fiscal Years 2004 and 2005
paragraphs: Compact budget by sector grant  Budget consultations with U.S.  government Quarterly performance reports by sector Annual compact report to the U.S.  President Approved FSM Development Plan or  Approved RMI Medium-Term and  Investment Framework (MTBIF)
Approved FSM Infrastructure  Development Plan and  RMI Infrastructure Development and  Maintenance Plan N/A = Nonapplicable.
section_title: Comments from the Department of the Interior
paragraphs: The following is GAO’s comment on the letter from the Department of the  Interior dated June 13, 2005.
subsections: section_title: GAO Comment
paragraphs: We recognize that the Department of the Interior has supported the  creation of the OIA Honolulu field office to assist in compact  implementation.  However, officials from OIA have stated that budgetary  constraints have prevented staff from conducting sufficient on-sight review  in the FSM and the RMI and that the department has not supported  increased funds for this purpose.
section_title: Comments from the Department of State
paragraphs: The following is GAO’s comment on the letter from the Department of State  dated July 1, 2005.
subsections: section_title: GAO Comment
paragraphs: We agree that the amended compacts and their subsidiary agreements  contain no commitments regarding the level of revenue that will be  generated by the trust funds, and they do not speak of the revenue from the  trust funds as “replacing” annual U.S. grant assistance after fiscal year  2023. However, for the sake of assessing the possible difficulty of  transitioning from grant assistance to trust fund earnings, we have  performed calculations based on U.S., FSM, and RMI trust fund  contributions and various rates of return, to forecast the possibility that  trust fund earnings will fully replace grant assistance beginning in 2024 (see  p. 25).
section_title: Comments from the Department of Health and Human Services
paragraphs: The following is GAO’s comment on the letter from the Department of  Health and Human Services dated June 7, 2005.
subsections: section_title: GAO Comment
paragraphs: We have made the requested corrections.  Specifically, we now use the term  “health grant” to characterize this particular compact sector grant  throughout the report, and we have deleted the footnote describing travel  to the FSM and the RMI by the HHS representative stationed in Honolulu.
section_title: Comments from the Government of the Federated States of Micronesia
paragraphs: The following is GAO’s comment on the letter from the government of the  Federated States of Micronesia dated June 27, 2005.
subsections: section_title: GAO Comment
paragraphs: The report notes that the FSM government submitted a document to OIA  that calculates percentage decreases for basic government operations  expenditures from the FSM’s public sector capacity building grant through  2009. We also note that there is no additional plan describing what policy  steps will be taken or the agencies and activities that will be affected by the  decreases. Therefore, we do not believe that this schedule can be  construed as a “strategy” that identifies where spending decreases will  occur and how they will be managed.
section_title: Comments from the Government of the Republic of the Marshall Islands
paragraphs: The following are GAO’s comments on the letter from the government of  the Republic of the Marshall Islands dated June 28, 2005.
subsections: section_title: GAO Comments
paragraphs: 1. We made several factual corrections to the report, based on the RMI’s  technical comments (see comment 5). 2. The RMI’s technical comments emphasize the government’s detailed  strategic planning efforts. We do not dispute that the RMI government  has undertaken planning initiatives regarding the use of compact funds  in each sector. Our point remains that (1) it is unclear whether JEMFAC  has approved RMI planning documentation addressing the use of grant  funds and (2) there have been no bilateral discussions addressing how  the RMI will achieve the amended compact’s stated goals of economic  advancement and budgetary self-reliance. 3. Our recommendations, which are intended to further ensure planning  for the effective use of compact funding, are directed to the  Department of the Interior. In its formal comment letter, Interior  concurred with the recommendations and stated its intention to  implement them through the department’s internal budget and planning  process and, to the extent possible, through the joint economic  management committees. 4. We intend to review the trust funds, the supplemental education grant,  and the judicial training funding in more detail during subsequent work. 5. Per an agreement with the RMI government, we are not reproducing the  RMI’s technical paper. However, we have used comments in the paper  to make factual corrections to the report.
section_title: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
paragraphs: In addition to the contact named above, Emil Friberg, Leslie Holen, Eddie  Uyekawa, Reid Lowe, Kendall Schaefer, and Mary Moutsos made key  contributions to this report.