Compacts of Free Association: Implementation of New Funding and  
Accountability Requirements Is Well Under Way, but Planning	 
Challenges Remain (11-JUL-05, GAO-05-633).			 
                                                                 
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.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-633 					        
    ACCNO:   A29518						        
  TITLE:     Compacts of Free Association: Implementation of New      
Funding and Accountability Requirements Is Well Under Way, but	 
Planning Challenges Remain					 
     DATE:   07/11/2005 
  SUBJECT:   Accountability					 
	     Allocation (Government accounting) 		 
	     Budget obligations 				 
	     Federal funds					 
	     Federal grants					 
	     Foreign economic assistance			 
	     Foreign governments				 
	     Funds management					 
	     Grant administration				 
	     Grant monitoring					 
	     International agreements				 
	     International cooperation				 
	     Trust funds					 
	     Foreign financial assistance			 
	     Strategic planning 				 
	     Foreign countries					 
	     Compact of Free Association			 
	     Federated States of Micronesia			 
	     Kwajalein Atoll (Marshall Islands) 		 
	     Republic of the Marshall Islands			 

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GAO-05-633

     

     * Report to Congressional Requesters
          * July 2005
     * COMPACTS OF FREE ASSOCIATION
          * Implementation of New Funding and Accountability Requirements Is
            Well Under Way, but Planning Challenges Remain
     * Contents
          * Results in Brief
          * Background
               * Compact of Free Association, 1986 through 2003
               * Amended Compacts of Free Association
                    * Continuing Economic Assistance under Amended Compacts
                    * Accountability Requirements under Amended Compacts
               * Key Differences between Original Compact and Amended
                 Compacts
          * 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
               * U.S. Government Signed Grant Agreements with Both Countries,
                 and Trust Funds Have Been Established
               * FSM and RMI Did Not Spend About One-Third of Authorized
                 Fiscal Year 2004 Funds
               * Strategic Issues Impacting Long-Term Use of Funds Have Not
                 Been Addressed
                    * Grant Allocations Not Tied to Broader Goals
                    * FSM and RMI Have Not Planned for Future Funding
                      Decreases
                    * Trust Funds Have Earned Low Returns
          * United States, FSM, and RMI Have Taken Actions to Meet Key
            Accountability Requirements, Though a Few Requirements Remain
            Uncompleted
               * Most Required Meetings and Consultations Have Occurred
               * Special Grant Conditions Have Been Established
               * Key Reports Have Been Prepared
               * Interior Has Withheld FSM Grants and Initiated a Misuse
                 Investigation
               * A Few Important Requirements Remain Uncompleted
          * OIA Opened New Office in 2003, FSM and RMI Took Steps in 2005 to
            Establish Centralized Compact Offices
               * OIA Opened a Honolulu Field Office to Facilitate Compact
                 Implementation and Monitoring, but Extent of Required
                 On-Site Review Has Not Been Established
               * FSM and RMI Governments Have Taken Initial Steps to Create
                 Central Compact Offices
          * Conclusions
          * Recommendations
          * Agency Comments
     * Objectives, Scope, and Methodology
     * Country Sector Grants, Fiscal Years 2004 and 2005
     * Status of Accountability Requirements, Fiscal Years 2004 and 2005
     * Comments from the Department of the Interior
          * GAO Comment
     * Comments from the Department of State
          * GAO Comment
     * Comments from the Department of Health and Human Services
          * GAO Comment
     * Comments from the Government of the Federated States of Micronesia
          * GAO Comment
     * Comments from the Government of the Republic of the Marshall Islands
          * GAO Comments
     * GAO Contact and Staff Acknowledgments
     * PDF6-Ordering Information.pdf
          * Order by Mail or Phone

                 United States Government Accountability Office

Report to Congressional Requesters

GAO

July 2005

COMPACTS OF FREE ASSOCIATION

Implementation of New Funding and Accountability Requirements Is Well Under Way,
                         but Planning Challenges Remain

                                       a

COMPACTS OF FREE ASSOCIATION

Implementation of New Funding and Accountability Requirements Is Well
Under Way, but Planning Challenges Remain

  What GAO Found

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 (see figure below for fiscal year 2005 grant
allocations). 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.

FSM Sector Grant Allocation of $76 Million RMI Sector Grant Allocation of $34.9
                                    Million

Source: FSM and RMI fiscal year 2005 sector grant agreements and
discussions with an OIA official.

United States Government Accountability Office

Contents

  Letter 1

Results in Brief 3 Background 5 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 16 United States, FSM, and RMI Have Taken Actions
to Meet Key

Accountability Requirements, Though a Few Requirements

Remain Uncompleted 26 OIA Opened New Office in 2003, FSM and RMI Took
Steps in 2005 to

Establish Centralized Compact Offices 31 Conclusions 36 Recommendations 38
Agency Comments 39

  Appendixes

     Appendix I: Appendix II: Appendix III: Appendix IV: Appendix V: Appendix
                                                                          VI:

Appendix VII:

Appendix VIII:

    Appendix IX:

Objectives, Scope, and Methodology 41 Country Sector Grants, Fiscal Years
2004 and 2005 44 Status of Accountability Requirements, Fiscal Years 2004
and 2005 49 Comments from the Department of the Interior 50 GAO Comment 52
Comments from the Department of State 53 GAO Comment 56

Comments from the Department of Health and Human Services 57 GAO Comment
60

Comments from the Government of the Federated States of Micronesia 61 GAO
Comment 65

Comments from the Government of the Republic of the Marshall Islands 66
GAO Comments 69

    GAO Contact and Staff Acknowledgments 70

                                    Contents

Table 1:

  Tables

Table 2:

Table 3:

Table 4: Table 5: Table 6:

U.S. Assistance to Be Provided to the Federated States of      
Micronesia under the Terms of the Amended Compact,             
Fiscal Years 2004-2023                                                   9 
U.S. Assistance to Be Provided to the Republic of the          
Marshall Islands under the Terms of the Amended                
Compact, Fiscal Years 2004-2023                                         10 
FSM Sector Grant Allocations between the Five                  
Governments, Fiscal Years 2004 and 2005                                 44 
FSM Grants by Sector, Fiscal Years 2004 and 2005                        46 
RMI Sector Grants, Including Kwajalein Funding, Fiscal         
Years 2004 and 2005                                                     47 
RMI Grants by Sector, Fiscal Years 2004 and 2005                        48 

Figures Figure 1: Time Line of Key Compact Funding and Accountability      
                     Event Deadlines Associated with One Fiscal Year       14
           Figure 2: FSM and RMI Sector Grant Allocation, Fiscal Year      
                     2005                                                  17 
           Figure 3: FSM and RMI Use of Authorized Sector Grant Funds,     
                     Fiscal Year 2004                                      20 

Contents

                                 Abbreviations

CNMI           Commonwealth of the Northern Mariana Islands                
FPA            Fiscal Procedures Agreement                                 
FSM            Federated States of Micronesia                              
HHS            Department of Health and Human Services                     
JEMCO          Joint Economic Management Committee (FSM)                   
JEMFAC         Joint Economic Management and Financial Accountability      
                  Committee (RMI)                                             
KADA           Kwajalein Atoll Development Authority                       
MTBIF          Medium-Term Budget and Investment Framework (RMI)           
OIA            Office of Insular Affairs                                   
RMI            Republic of the Marshall Islands                            
SEG            Supplemental education grant                                

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A

United States Government Accountability Office Washington, D.C. 20548

July 11, 2005

The Honorable Pete V. Domenici Chairman The Honorable Jeff Bingaman
Ranking Minority Member Committee on Energy and Natural Resources United
States Senate

The Honorable Richard W. Pombo Chairman The Honorable Nick J. Rahall, II
Ranking Minority Member Committee on Resources House of Representatives

Since fiscal year 1987, the United States has provided economic assistance
to the Pacific island nations of the Federated States of Micronesia (FSM)1
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.2 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.3

1The FSM is comprised of the four states of Chuuk, Kosrae, Pohnpei, and
Yap.

2See GAO, Foreign Assistance: U.S. Funds to Two Micronesian Nations Had
Little Impact on Economic Development, GAO/NSIAD-00-216 (Washington, D.C.:
Sept. 22, 2000).

3Whereas the original compact (approved in U.S. Public Law 99-239, Jan.
14, 1986) was one agreement between the U.S., FSM, and RMI governments,
the amended compacts (approved in U.S. Public Law 108-188, Dec. 17, 2003)
are separate agreements between the United States and each of the two
countries.

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.4 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.) 5

4The total amount of funding for grants and trust fund contributions is
fixed for the 20-year period and is provided through a permanent
congressional appropriation.

5Per the compacts' enabling legislation, we will conduct an extensive
review of implementation, oversight, and impact of the amended compacts by
December 2006.

Page 2 GAO-05-633 Compacts of Free Association

  Results in Brief

The U.S. government has signed sector grant agreements with the FSM and
RMI as provided for in the amended compacts, and trust funds have been
established for both countries; however, certain issues call into question
the three governments' planning for the long-term use of funds. For fiscal
years 2004 and 2005, the U.S. government signed sector grant agreements
with the countries in areas such as health and education. FSM grants
totaled about $76 million annually, with the largest grants for health and
education, while RMI grants totaled $35 million annually, with the largest
grants for infrastructure and education.6 In addition, trust funds have
been established for each country to replace grant assistance after 2023.
The FSM and the RMI each did not spend about one-third of their available
compact funds for fiscal year 2004. The FSM did not complete sufficient
planning required to obtain infrastructure grant funds, while the RMI did
not complete plans and certain reforms necessary for the use of some
funding targeted for Kwajalein Atoll. In addition, both countries did not
spend portions of other sector grants.7 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 currently
under way to resolve this issue).

The three governments have taken a number of actions to fulfill key
compact accountability requirements, but a few important requirements have
not been met. The U.S. government held bilateral meetings with both
countries for the past 2 fiscal years to approve grant agreements and held
an additional meeting with the FSM in 2005 to discuss, among other issues,
the FSM's plan for use of infrastructure funding. In addition, the grants
contained numerous special terms and conditions, such as requiring the FSM
and the RMI to collect sector data and establish a framework for

6Although the amended compacts did formally not go into effect until May
and June of 2004, OIA's Compact Coordinator reported that all three
countries agreed to proceed according to compact terms at the beginning of
fiscal year 2004. Fiscal year 2004 signed grant agreements commit the FSM
and the RMI to abide by the terms of the amended compacts and their
related agreements. The FSM and RMI governments use the same fiscal year
as the U.S. government (October through September).

7This funding will remain available for use in future years.

performance measurement. According to OIA officials, the RMI has met most
of the terms and conditions attached to its grants, but the FSM has met
only some of the terms and conditions for its grants. Both the FSM and the
RMI have provided the U.S. government with all required quarterly
performance and financial reports for fiscal years 2004 and 2005. However,
OIA officials viewed the FSM's early performance reports as inadequate,
and FSM and RMI officials reported that they are still learning how to
prepare such reports. Further, the U.S. government has made use of a key
accountability option that allows for the withholding or suspension of
funds; for example, certain compact education funding for the FSM state of
Chuuk has been suspended due to possible misuse. A few important actions
required under the amended compacts have not yet been completed. For
example, the FSM has not completed required audits for fiscal year 2003
and 2004, and none of the three governments has submitted the required
annual compact spending and development report for fiscal year 2004.

The U.S. government has made significant progress in establishing
operations to facilitate the amended compacts' implementation and
oversight, and the FSM and the RMI governments have taken initial steps.
In October 2003, OIA opened an office in Honolulu, Hawaii, to facilitate
implementation and provide oversight of the various compact sector grants.
However, OIA has not determined the extent of on-site review in the FSM
and the RMI that is necessary to adequately promote compliance with
compact and grant requirements. 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. During
fiscal year 2004 through mid-April 2005, Honolulu staff spent about 15
percent of their time in the FSM and the RMI. In early 2005, the RMI
government determined that its Office of the Chief Secretary will serve as
the central office responsible for compact issues, overseeing and
coordinating the grants' implementation. The FSM government recently
passed legislation to create a central compact management office to
oversee compact matters and communicate with the U.S. government, although
this office is not yet operating. Further, the RMI has created a unit that
is currently managing infrastructure projects, while the FSM just created
such a unit in June 2005.

In this report, we recommend that the Secretary of the Interior direct the
Deputy Assistant Secretary for Insular Affairs to review the extent of OIA
oversight in the FSM and the RMI that is necessary to promote compact
compliance and, along with officials from the Departments of State and
Health and Human Services (HHS), work with the FSM and RMI governments to
improve oversight and planning.

We provided a draft of this report to the Departments of the Interior,
State, and HHS. We also provided a draft to the FSM and RMI governments.
We received technical comments from the three U.S. agencies and the two
Micronesian governments, which we have incorporated into this report, as
appropriate. We also received formal letters from all parties.
Reproductions of these letters, as well as our responses to the letters,
can be found in appendixes IV through VIII. All letters found our work to
be useful. The Department of the Interior concurred with our
recommendations and expressed 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.

Since the FSM and the RMI became sovereign nations, the U.S. relationship

  Background

with the two countries has been defined by the original Compact of Free
Association and the subsequent amended Compacts of Free Association.

    Compact of Free Association, 1986 through

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 2016.8

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).9

8In a previous report, we discussed the importance of Kwajalein Atoll to
U.S. defense interests in the region. See GAO, Foreign Relations:
Kwajalein Atoll Is the Key U.S. Defense Interest in Two Micronesian
Nations, GAO-02-119 (Washington, D.C.: Jan. 22, 2002).

9In 2001 we reported on the impact of nonimmigrants in Guam, Hawaii, and
the CNMI and the amount of impact funding that has been provided to the
locations. See GAO, Foreign Relations: Migration from Micronesian Nations
Has Had Significant Impact on Guam, Hawaii, and the Commonwealth of the
Northern Mariana Islands, GAO-02-40 (Washington, D.C.: Oct. 5, 2001).

    Amended Compacts of Free Association

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

Continuing Economic Assistance under Amended Compacts

surveys identifying the number of FSM and RMI nonimmigrants in each
location.10

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.11

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.

10American Samoa is also eligible for compact impact funding, and
nonimmigrants from the Republic of Palau are included in the periodic
surveys.

11The amended compacts also authorize an additional $300,000, partially
adjusted for inflation, for fiscal years 2004 through 2023 for the
training of judges and officials of the judiciary in the FSM and the RMI.

Page 8 GAO-05-633 Compacts of Free Association

Table 1: U.S. Assistance to Be Provided to the Federated States of
Micronesia under the Terms of the Amended Compact, Fiscal Years 2004-2023

Budget authority in millions of dollars
                                  Audit grant
                     Annual grants Section 212(b)  Trust fund       
Fiscal year         Section 211 (amount up to)  Section 215          Total 
2004                      $76.2             $.5      $16.0           $92.7 
2005                       76.2              .5       16.0            92.7 
2006                       76.2              .5       16.0            92.7 
2007                       75.4              .5       16.8            92.7 
2008                       74.6              .5       17.6            92.7 
2009                       73.8              .5       18.4            92.7 
2010                       73.0              .5       19.2            92.7 
2011                       72.2              .5       20.0            92.7 
2012                       71.4              .5       20.8            92.7 
2013                       70.6              .5       21.6            92.7 
2014                       69.8              .5       22.4            92.7 
2015                       69.0              .5       23.2            92.7 
2016                       68.2              .5       24.0            92.7 
2017                       67.4              .5       24.8            92.7 
2018                       66.6              .5       25.6            92.7 
2019                       65.8              .5       26.4            92.7 
2020                       65.0              .5       27.2            92.7 
2021                       64.2              .5       28.0            92.7 
2022                       63.4              .5       28.8            92.7 
2023                       62.6              .5       29.6            92.7 

Source: Compact of Free Association, as Amended, Between the Government of
the United States of America and the Government of the Federated States of
Micronesia, U.S. Public Law 108-188.

Note: Within the annual grant amounts, $200,000 will be provided directly
by the Secretary of the Interior to the U.S. Department of Homeland
Security, Federal Emergency Management Agency for disaster and emergency
assistance purposes.

Table 2: U.S. Assistance to Be Provided to the Republic of the Marshall
Islands under the Terms of the Amended Compact, Fiscal Years 2004-2023

Budget authority in millions of dollars
                                                                    Kwajalein
                                 Audit grant              impact      
                Annual grants Section 213(b)  Trust fund  Section     
Fiscal year    Section 211 (amount up to) Section 216          212   Total 
2004                 $35.2            $.5         $7.0    $15.0      $57.7 
2005                  34.7             .5          7.5        15.0    57.7 
2006                  34.2             .5          8.0        15.0    57.7 
2007                  33.7             .5          8.5        15.0    57.7 
2008                  33.2             .5          9.0        15.0    57.7 
2009                  32.7             .5          9.5        15.0    57.7 
2010                  32.2             .5         10.0        15.0    57.7 
2011                  31.7             .5         10.5        15.0    57.7 
2012                  31.2             .5         11.0        15.0    57.7 
2013                  30.7             .5         11.5        15.0    57.7 
2014                  32.2             .5         12.0        18.0    62.7 
2015                  31.7             .5         12.5        18.0    62.7 
2016                  31.2             .5         13.0        18.0    62.7 
2017                  30.7             .5         13.5        18.0    62.7 
2018                  30.2             .5         14.0        18.0    62.7 
2019                  29.7             .5         14.5        18.0    62.7 
2020                  29.2             .5         15.0        18.0    62.7 
2021                  28.7             .5         15.5        18.0    62.7 
2022                  28.2             .5         16.0        18.0    62.7 
2023                  27.7             .5         16.5        18.0    62.7 

Source: Compact of Free Association, as Amended, Between the Government of
the United States of America and the Government of the Republic of the
Marshall Islands, U.S. Public Law 108-188.

Notes:

"Kwajalein Impact" funding is provided to the RMI government, which in
turn compensates Kwajalein Atoll landowners, for U.S. access to the atoll
for military purposes.

Beginning in 2014, the total amount of funding provided to the RMI will
increase by $5 million. Of this amount, $3 million is allocated to
"Kwajalein Impact," while an additional $2 million is added to annual
grants to address the special needs of Kwajalein Atoll.

Within the annual grant amounts, $200,000 will be provided directly by the
Secretary of the Interior to the U.S. Department of Homeland Security,
Federal Emergency Management Agency for disaster and emergency assistance
purposes.

Accountability Requirements under Amended Compacts

The amended compacts and their subsidiary fiscal procedures agreements
(FPA) also establish numerous new accountability requirements.12 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.13 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

12There is a so-called "fiscal procedures agreement" with the FSM as well
as the RMI. These agreements are formally known as the "Agreement
Concerning Procedures for the Implementation of United States Economic
Assistance Provided in the Compact of Free Association, as amended,
Between the Government of the United States of America and the Government
of the Federated States of Micronesia" and the "Agreement Concerning
Procedures for the Implementation of United States Economic Assistance
Provided in the Compact, as amended, of Free Association Between the
Government of the United States of America and the Government of the
Republic of the Marshall Islands." These two agreements contain detailed
requirements concerning implementation of the amended Compacts' funding
and accountability provisions.

13While the Departments of the Interior and State have an extensive
history of involvement with compact issues, HHS was interested in direct
involvement with the amended compacts due to the department's long history
of providing assistance to the FSM and the RMI (via programs such as Head
Start, which is now being phased out of both countries) and its desire to
continue its commitment to the islands. The islands remain eligible for a
number of HHS categorical and competitive grant programs for which the
department has an obligation to maintain oversight and accountability.

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 audits14 must be completed
following the end of each fiscal year.15 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

14A "single audit" is a financial and compliance audit, within the meaning
of the Single Audit Act, as amended. See 31 U.S.C. S: 7501 et seq. The
Single Audit Act is intended to, among other things, promote sound
financial management, including effective internal controls, with respect
to the use of federal awards.

15Annual financial reports and single audits are due December 31 and April
1, respectively, following the end of the fiscal year.

Page 12 GAO-05-633 Compacts of Free Association

fig. 1 for a time line of key funding and accountability events that are
required for each fiscal year.)

Figure 1: Time Line of Key Compact Funding and Accountability Event
Deadlines Associated with One Fiscal Year

Sources: U.S. Public Law 108-188, FSM and RMI Fiscal Procedures
Agreements.

Note: Grant funding is provided to each country on a monthly basis, except
for the first month of the fiscal year when funding is provided to cover
the first 2 months of the year. However, infrastructure

    Key Differences between Original Compact and Amended Compacts

projects and projects that are not funded by other grants are paid on the
basis of accrued expenditures.

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.

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

  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

debt payments (especially for the RMI) limited the availability of compact
funds for other uses.

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).

    U.S. Government Signed Grant Agreements with Both Countries, and Trust Funds
    Have Been Established

The U.S. government signed grant agreements with the FSM and the RMI for
fiscal years 2004 and 200516 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.17 The FSM national government, which directly signs grant
agreements with the U.S. government and is the "grantee," provides the

16The U.S. and FSM governments did not sign an infrastructure grant
agreement for fiscal year 2005 until May 2005. Further, the U.S.
government has not signed grant agreements for fiscal years 2004 and 2005
to provide $1.9 million in annual funding to Kwajalein Atoll, nor did the
RMI allocate funding for a public sector capacity building grant in fiscal
year 2004.

17According to an Interior official, the FSM government failed to
initially adjust fiscal year 2005 sector grants to include an inflation
amount of $1,117,200; this amount will be added to grant amounts for
fiscal year 2006.

majority of grant funds to the four FSM states, which are "subgrantees."
RMI grant funding totaled about $35 million annually for the 2 years.18

      Figure 2: FSM and RMI Sector Grant Allocation, Fiscal Year 2005

FSM Sector Grant Allocation of $76 Million RMI Sector Grant Allocation of
$34.9 Million 0%

3%

Public sector Environment capacity building

1%

Private sector

Private sector

1%

Public sector

Environment

capacity building

Kwajalein impact

Infrastructure

Health

Health Education

Education

Infrastructure

Source: FSM and RMI fiscal year 2005 sector grant agreements and
discussions with an OIA official.

Notes:

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.

o  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

18The RMI government has five subgrantees that receive a small amount of
compact funding. These subgrantees are the College of the Marshall
Islands, the Marshall Islands Visitors Authority, the Scholarship Board,
the Land Registration Authority, and the Kwajalein Atoll Joint Utility
Resources. These subgrantees received less than 1 percent of compact grant
funding in fiscal year 2004.

Page 17 GAO-05-633 Compacts of Free Association

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.

o  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

    FSM and RMI Did Not Spend About One-Third of Authorized Fiscal Year 2004
    Funds

Kwajalein Atoll, although grant documents had not been signed as of
mid-May 2005.19 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).

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.

19In addition, a certain portion of the RMI's sector grant funding must be
used on Kwajalein Atoll, as provided for in amended compact sections
211(b)(1) and 211(b)(3).

Page 19 GAO-05-633 Compacts of Free Association

Figure 3: FSM and RMI Use of Authorized Sector Grant Funds, Fiscal Year
2004 Percentage

1

100

80

60

40

20

0

Infrastructure

                                 ducation ealth

                                   lic sector

                                 ate sector ent

                         Infrastructure Education ealth

                                 ate sector ent

                                      pact

                                    uilding

                                      onm

                                      onm

                                  ajalein imH

                                       H

                                      vir

                               virPubcapacity bE

                                      riv

                                     Privn

                                       n

                                       E

                                       E

                                       P

                                       w

                                       K

                   FSM use of sector grants, fiscal year 2004

                   RMI use of sector grants, fiscal year 2004

Unspent sector grant funds

Spent sector grant funds Sources: FSM and RMI fiscal year 2004 sector
grant agreements, FSM and RMI fiscal year 2004 financial reports.

Notes: The RMI allocated no compact funding for a public sector capacity
building grant in fiscal year 2004. The Kwajalein impact funding ($1.9
million) is specific to the RMI and is authorized in section 211(b)(2)

of that country's amended compact.

     o 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.20
       Further, the FSM has only recently established a required project
       management unit to oversee individual infrastructure projects.21
       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.22
     o 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.23
       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

20At a special JEMCO meeting in March 2005, JEMCO approved portions of the
FSM's infrastructure development plan that contemplate use of compact
infrastructure sector funds for projects within the priorities established
in the FPA.

21The FSM national government executed a contract with a firm on May 19,
2005, to undertake project engineering, management, and administration of
a project management unit. The consultant team established a physical
presence in Pohnpei and became "operational" on June 20, 2005.

22According to an OIA official, Yap officials report that the state held
spending at fiscal year 2003 levels because fiscal year 2004 funds were
not provided by the FSM national government until December. Per a 2004
JEMCO resolution, all FSM health and education carry-over funds, amounting
to approximately $5.3 million, will be spent on health and education
infrastructure projects.

23In addition, rather than receiving funding up-front, infrastructure
projects are reimbursed on an accrued expenditure basis.

    Strategic Issues Impacting Long-Term Use of Funds Have Not Been Addressed

Grant Allocations Not Tied to Broader Goals

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.24

The U.S., FSM, and RMI governments have not addressed several strategic
issues that impact the long-term, effective use of funds.

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

24The SEG for both countries will be partially adjusted for inflation and
is subject to annual appropriations by the U.S. Congress.

Page 22 GAO-05-633 Compacts of Free Association

broad compact development goals such as economic advancement and budgetary
self-reliance.25 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.26 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.27

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

25While the amended compact with the FSM calls for a development plan, the
RMI's amended compact states that the RMI is required to provide the U.S.
government with a "medium-term budget and investment framework."

26Once an overall amount of grant funds is allocated to each government
according to the formula, the five governments then independently
determine how the funds will be allocated across sectors.

27Per the terms of FSM Public Law 13-72, for fiscal years 2005 and 2006,
the distribution of Compact sector grants will be as follows: FSM national
government - 8.65 percent, Chuuk state - 38.57 percent, Pohnpei state -
25.69 percent, Yap state - 16.03 percent, and Kosrae state - 11.06
percent. By comparison, according to the FSM 2000 Population and Housing
Census Report, the population of Chuuk in that year accounted for 50
percent of the FSM population, while Pohnpei accounted for 32 percent, Yap
accounted for 11 percent, and Kosrae accounted for 7 percent. Beginning in
fiscal year 2007 and beyond, a different distribution formula that
provides over 13 percent of total grant funding to the FSM national
government will go into effect, absent an alternative arrangement reached
between the five governments.

FSM and RMI Have Not Planned for Future Funding Decreases

Trust Funds Have Earned Low Returns

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.

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.

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 2024.28 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.29 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.)

28See GAO, Compact of Free Association: An Assessment of the Amended
Compacts and Related Agreements, GAO-03-1007T (Washington, D.C.: July 15,
2003).

29A 7.9 percent rate of return is based on trust funds that are comprised
of both stocks (60 percent of the portfolio) and long-term government
bonds (40 percent of the portfolio).

Page 25 GAO-05-633 Compacts of Free Association

  United States, FSM, and RMI Have Taken Actions to Meet Key Accountability
  Requirements, Though a Few Requirements Remain Uncompleted

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.)

    Most Required Meetings and Consultations Have Occurred

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.30 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. andFSM representatives; these disagreements were decided by a vote,
split between the countries, that adopted the U.S. position.31 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

30Subsequent to JEMFAC approval of grant allocations, the RMI's
legislative body (the Nitijela) altered the allocations between health,
education, and infrastructure. The JEMFAC then conducted e-mail
communication to approve these alterations.

31For example, the FSM delegation strongly advocated the use of compact
funds for land leases and purchases but was overruled by the U.S.
representatives. The U.S. position is that compact funding should not go
to lease or purchase land when ownership is often unclear and property
value has not been established. This issue remains key for the FSM, and
FSM officials told us they intend to continue raising this topic with U.S.
officials. A senior Interior official told us that if the FSM can resolve
ownership and valuation problems, compact funding could potentially be
used for land lease or purchase.

    Special Grant Conditions Have Been Established

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.

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.

    Key Reports Have Been Prepared

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

    Interior Has Withheld FSM Grants and Initiated a Misuse Investigation

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.

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.32 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.33 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

32The impact of this action is unclear. For example, according to a Chuuk
state finance official, the Chuuk government used a portion of the state's
trust fund contributions (which were not yet required to be submitted for
the FSM trust fund) to replace withheld public sector capacity building
funds, and then replaced the trust fund amounts when the public sector
capacity building grant was eventually provided.

33Interior's Office of the Inspector General has conducted audit reviews
of FSM and RMI implementation of the amended compacts.

about $9.7 million in cash on hand. Compact payments will be delayed until
the FSM demonstrates its need for additional funding.

A Few Important Despite progress in many areas, a few important
accountability reporting requirements have not been met, preventing the
U.S., FSM, and RMI

    Requirements Remain

Uncompleted governments from fully gauging FSM and RMI performance in
utilizing compact funds and from beginning to assess the impact of compact
funding.

     o 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 2005.34
     o 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.

34The FSM government asked OIA for an extension of this deadline; OIA
declined to allow such an extension. According to an OIA official, the RMI
government has not asked for an extension.

Page 30 GAO-05-633 Compacts of Free Association

  OIA Opened New Office in 2003, FSM and RMI Took Steps in 2005 to Establish
  Centralized Compact Offices

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.35 The RMI has been late
in meeting this requirement; the RMI completed its fiscal year 2004 single
audit in June 2005.36

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.

    OIA Opened a Honolulu Field Office to Facilitate Compact Implementation and
    Monitoring, but Extent of Required On-Site Review Has Not Been Established

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

35In addition, the FSM has not completed is fiscal year 2003 single audit.

36Prior to completion of the single audit, the RMI Auditor General told us
that a preliminary review of the draft fiscal year 2004 single audit
showed that the amended compact is resulting in the emergence of more
compliance issues. For example, more procurement problems are cited now
due to the new fiscal procedures agreement requirements in this area.

Page 31 GAO-05-633 Compacts of Free Association

will be able to travel frequently to the [FSM and the RMI]. 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.37 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.38

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 [OIA] involvement... [E]ffective
oversight by Interior's staff in Hawaii will be critical in realizing the
compact's full potential... [OIA] staff will need to meet regularly with
[FSM] state officials from both the executive branch and the legislatures.
Working more closely with state officials as they develop their budgets
would enable [OIA] 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

37One specialist works on both private sector development and environment
issues. In addition, the Honolulu office has one administrative employee.

38Prior to opening the Honolulu office, OIA had a program coordinator
stationed in the FSM, and in July 2004, OIA hired a program specialist who
is stationed in the RMI. OIA staff at the

U.S. embassies in the FSM and the RMI provide direct contact with the
local and national governments and assist the Honolulu staff as needed.

Page 32 GAO-05-633 Compacts of Free Association

currently do, to provide additional guidance on meeting compact
requirements and conduct site visits. For example:

     o 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.
     o 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.
     o 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.
     o 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.

FSM and RMI Governments 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

    Have Taken Initial Steps to

Create Central Compact 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 Offices early stages of establishing centralized
offices responsible for compact matters.

     o 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.
     o 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 2005.39 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.40

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.41 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

39Since the creation of the board and its office has been slow to start,
the FSM government established in the meantime a Compact Implementation
Taskforce in 2003. The task force is overseen by the vice president and
composed of cabinet members and discusses and follows up on
compact-related issues and reporting requirements. The task force will
continue in its role until the Compact Management Board and its office
becomes operational. According to a FSM Department of Foreign Affairs
official, the task force has met as needed, which has averaged about once
a month, and developed a performance-tracking matrix that lists
implementation issues and actions taken.

40Some FSM national and U.S. government officials have expressed concern
to us that the compact management board and its office may reduce the role
of the FSM president in managing grant matters and conducting
international affairs.

41The FSM national government is the grantee of the compact funds and is
responsible for ensuring compact compliance by the four state governments,
or subgrantees, that receive the majority of Compact funds.

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.

The amended compacts differ significantly from the original compact in

  Conclusions

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

                                Recommendations

issues, which have implications for the FSM's and the RMI's long-term,
effective use of funds.

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:

     o 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,
     o establish a time frame for the completion of required and overdue FSM
       single audits,
     o 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

o  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:

     o establish sector grant levels that will assist in promoting long-term
       development goals such as economic advancement and budgetary
       self-reliance,
     o establish a time frame for the completion of an RMI government plan to
       manage decreasing annual grant amounts in a strategic fashion, and

o  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.

We received technical comments from the Departments of the Interior,

  Agency Comments

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 [email protected]. 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.

David Gootnick Director, International Affairs and Trade Appendix I

                       Objectives, Scope, and Methodology

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

Appendix I Objectives, Scope, and Methodology

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,

Appendix I Objectives, Scope, and Methodology

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.

Appendix II

Country Sector Grants, Fiscal Years 2004 and 2005

Table 3: FSM Sector Grant Allocations between the Five Governments, Fiscal
Years 2004 and 2005

                            Fiscal year 2004            Fiscal year 2005      
                      Sector grant Percentage of   Sector grant Percentage of 
Sector grant and            dollar total sector        dollar total sector 
recipient                         amount grants              amount grants 
Education grant                                 

FSM National 
Government                4,324,122            17    4,511,317          17 
Chuuk                     8,140,265            31    8,804,369          32 
Pohnpei                   7,373,651            28    7,469,772          28 
Yap                       4,243,681            16    4,249,157          16 
Kosrae                    1,883,853             7    2,070,432           8 
Total                    $25,965,572          100 $27,105,047          100 
Health grant                                                       
FSM National                                                       
Government                 553,613              4     763,235            4 
Chuuk                     4,691,707            30    5,595,636          32 
Pohnpei                   5,989,461            39    6,200,560          36 
Yap                       2,881,672            19    3,197,090          18 
Kosrae                    1,326,663             9    1,674,212          10 
Total                    $15,443,116          100 $17,430,733          100 
Infrastructure grant                                               
Total                $17,119,115              100 $17,249,121          100 
Public sector capacity building grant                              
FSM National                                                       
Government                4,287,697            37     608,028            8 
Chuuk                     2,853,813            24    3,001,410          39 
Pohnpei                   1,676,163            14    1,542,488          20 
Yap                       1,831,307            16    1,520,446          20 
Kosrae                    1,013,866             9    1,113,866          14 
Total                    $11,662,846          100    $7,786,238        100 

Appendix II Country Sector Grants, Fiscal Years 2004 and

                         (Continued From Previous Page)

                       Fiscal year 2004 Fiscal year 2005

                       Sector grant Percentage of Sector grant  Percentage of 
Sector grant and          dollar total sector         dollar  total sector 
recipient                 amount        grants        amount        grants 
Environment grant                                            

FSM National         
Government                79,477              4      111,421             5 
Chuuk                    378,394             19      502,499            21 
Pohnpei                  666,944             33      688,181            29 
Yap                      595,854             29      791,258            33 
Kosrae                   302,523             15      296,592            12 
Total                $2,023,192             100    $2,389,951          100 
Private sector grant                                              
FSM National                                                      
Government               513,091             14         0                0 
Chuuk                   1,338,874            35     1,403,876           35 
Pohnpei                  525,423             14      657,602            16 
Yap                      613,470             16      989,407            24 
Kosrae                   795,261             21      988,025            24 
Total                $3,786,119             100    $4,038,910          100 
Total sector                                                      
grants               $75,999,960                $76,000,000       

Source: FSM fiscal years 2004 and 2005 sector grant agreements, discussion
with an OIA official.

Notes:

Percentages may not add to 100 due to rounding.

While the authorized amount for FSM fiscal year 2004 grants was
$76,000,000, the actual grants total is $40 smaller than this amount.

Since infrastructure grants for fiscal years 2004 and 2005 have not yet
been allocated to specific projects, the total can not be allocated by
recipient.

While authorized grant amounts total $76.2 million, per the amended
compacts' enabling legislation, $200,000 is provided directly to the U.S.
Department of Homeland Security, Federal Emergency Management Agency for
disaster and emergency assistance purposes.

The FSM government did not add a partial inflation adjustment of
$1,117,200 into its fiscal year 2005 sector grants; this adjustment will
be added to fiscal year 2006 sector grant funding.

The FSM national government supports the College of Micronesia, which has
campuses in all four states, with its compact education grant. For
example, in fiscal year 2005, the FSM national government budgeted over
$3.8 million of its compact education grant for use by the college.

Appendix II Country Sector Grants, Fiscal Years 2004 and

           Table 4: FSM Grants by Sector, Fiscal Years 2004 and 2005

                                  Fiscal year 2004      Fiscal year 2005
                        Sector grant Percentage of Sector grant Percentage of
Sector grant and           dollar total sector        dollar  total sector
recipient                  amount         grant       amount         grant
Education grant       $25,965,572            34  $27,105,047            36
Health grant          $15,443,116            20  $17,430,733            23
Infrastructure grant  $17,119,115            23  $17,249,121            23
Public sector                                   
capacity building                               
grant                   $11,662,846          15     $7,786,238          10 
Environment grant        $2,023,192           3     $2,389,951           3 
Private sector grant     $3,786,119           5     $4,038,910           5 
Total sector grants     $75,999,960         100 $76,000,000            100 

Source: FSM fiscal years 2004 and 2005 sector grant agreements, discussion
with an OIA official.

Notes:

While the authorized amount for FSM fiscal year 2004 grants was
$76,000,000 the actual grants total is $40 smaller than this amount.

While authorized grant amounts total $76.2 million, per the amended
compacts' enabling legislation, $200,000 is provided directly to the U.S.
Department of Homeland Security, Federal Emergency Management Agency for
disaster and emergency assistance purposes.

The FSM government did not add a partial inflation adjustment of
$1,117,200 into its fiscal year 2005 sector grants; this adjustment will
be added to fiscal year 2006 sector grant funding.

Appendix II Country Sector Grants, Fiscal Years 2004 and

 Table 5: RMI Sector Grants, Including Kwajalein Funding, Fiscal Years 2004 and

                       Fiscal year 2004 Fiscal year 2005

                         Sector grant  Percentage  Sector grant Percentage of 
                               dollar     of total       dollar  total sector 
Sector grant                amount sector grant       amount         grant 
Education grant                                              
Total                  $10,748,932          100 $11,566,921            100 
Portion provided to                                                        
Kwajalein                1,100,000           10    1,600,000            14
Health grant                                                 
Total                   $6,894,448          100   $7,064,197           100 
Portion provided to                                                        
Kwajalein                1,000,000           15    1,500,000            21
Infrastructure grant                                         
Total                  $14,700,000          100 $13,485,745            100 
Portion provided to                                          
Kwajalein Atoll          1,000,000            7              
Public sector                                                
capacity building                                            
grant                                                        
Total                           $0            -     $103,514           100 
Environment grant                                            
Total                     $400,000          100     $404,720           100 
Portion provided to                                                        
Kwajalein                  200,000           50      202,360            50
Private sector grant                                         
Total                     $356,620          100     $361,943           100 
Kwajalein impact                                             
Total                   $1,900,000          100   $1,922,420           100 
Total sector grants    $35,000,000              $34,909,460  

Source: RMI fiscal years 2004 and 2005 sector grant agreements,
discussions with RMI and OIA officials.

Notes:

While authorized grant amounts total $35.2 million in fiscal year 2004 and
$34.7 million in fiscal year 2005, per the amended compacts' enabling
legislation, $200,000 is provided directly to the U.S. Department of
Homeland Security, Federal Emergency Management Agency for disaster and
emergency assistance purposes.

The RMI's fiscal year 2005 education grant was increased from $11,141,921
(the amount included in the signed grant agreement) to $11,566,921 by the
RMI's legislature. A subsequent e-mail exchange between JEMFAC members
approved this increase. There is no signed grant agreement for the final
amount.

Appendix II Country Sector Grants, Fiscal Years 2004 and

A portion of the RMI's fiscal year 2005 infrastructure grant will go to
Ebeye for cited projects such as Ebeye elementary school, Ebeye sewer
maintenance, and Ebeye water maintenance, though the specific amount for
Ebeye is not contained in the grant agreement.

Kwajalein impact refers to funding authorized in section 211(b)(2) of the
amended compact between the United States and the RMI.

           Table 6: RMI Grants by Sector, Fiscal Years 2004 and 2005

                                  Fiscal year 2004      Fiscal year 2005
                                      Percentage   Sector grant Percentage of
                        Sector grant      of total       dollar  total sector
Sector grant        dollar amount sector grants       amount        grants
Education grant       $10,748,932            31  $11,566,921            33
Health grant           $6,894,448            20   $7,064,197            20
Infrastructure        $14,700,000            42  $13,485,745            39
grant                                                        
Public sector                                   
capacity                                        
building grant                       $0       0      $103,514            0 
Environment grant        $400,000             1      $404,720            1 
Private sector           $356,620             1      $361,943            1 
grant                                                              
Kwajalein impact        $1,900,000            5     $1,922,420           6 
Total sector grants     $35,000,000         100 $34,909,460            100 

Source: RMI fiscal years 2004 and 2005 sector grant agreements, fiscal
years 2004 and 2005, discussions with RMI and OIA officials.

Notes:

While authorized grant amounts total $35.2 million, per the amended
compacts' enabling legislation, $200,000 is provided directly to the U.S.
Department of Homeland Security, Federal Emergency Management Agency for
disaster and emergency assistance purposes.

The RMI's fiscal year 2005 education grant was increased from $11,141,921
(the amount included in the signed grant agreement) to $11,566,921 by the
RMI's legislature. A subsequent e-mail exchange between JEMFAC members
approved this increase. There is no signed grant agreement for the final
amount.

Kwajalein impact refers to funding authorized in section 211(b)(2) of the
amended compact between the United States and the RMI.

Appendix III

Status of Accountability Requirements, Fiscal Years 2004 and 2005

                                             FSM                  RMI
                                         FY 2004  FY 2005  FY 2004   FY 2005
Compact budget by sector grant          Yes   Yes       Yes      Yes
Budget consultations with U.S.          Yes   Yes       Yes      No
government                                              
JEMCO/JEMFAC meetings                   Yes   Yes       Yes        Yes
Quarterly financial reports             Yes   Yes       Yes        Yes
Quarterly performance reports by sector Yes   Yes       Yes        Yes
Annual financial reports                Yes   N/Aa      Yes       N/Aa
Annual compact report to the U.S.       No    N/Aa      No        N/Aa
President                                               
Single audit reports                    No    N/Aa      Yes       N/Aa
Approved FSM Development Plan or        No    Noc       Unknownd  Unknownd 
Approved RMI Medium-Term and                            
Investment Framework (MTBIF)b                           
Approved FSM Infrastructure             Noe   Yese      Yes       N/Af
Development Plan and                                    
RMI Infrastructure Development and                      
Maintenance Plan                                        

Source: Annual FSM and RMI budgets, required FSM and RMI quarterly and
annual reports, JEMCO/JEMFAC minutes, development plan documentation, and
interviews with U.S., FSM, and RMI officials.

Note: N/A = Nonapplicable. aThese reports will be due after the end of
fiscal year 2005. bPortions of the development plan or MTBIF that address
the use of grant funds require U.S.

concurrence.

cThe FSM submitted a development plan to the U.S. government in fiscal
year 2005; this plan has not yet been considered by JEMCO. dMTBIF
documents have been prepared, however it is unclear whether the JEMFAC has
approved

such documentation. eAt a special JEMCO meeting in March 2005, JEMCO
approved portions of the FSM's infrastructure

development plan that contemplate use of compact infrastructure sector
funds for fiscal years 2004 and 2005 projects within the priorities
established in the FPA. fOnce required documentation was submitted and
approved, subsequent fiscal year 2005

documentation was not required.

Appendix IV

Comments from the Department of the Interior

Note: GAO comment supplementing those in the report text appears at the
end of this appendix.

See comment.

Appendix IV Comments from the Department of the Interior

            Appendix IV Comments from the Department of the Interior

The following is GAO's comment on the letter from the Department of the
Interior dated June 13, 2005.

We recognize that the Department of the Interior has supported the

  GAO Comment

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.

                                   Appendix V

                     Comments from the Department of State

Note: GAO comment supplementing those in the report text appears at the
end of this appendix.

Appendix V Comments from the Department of State

                                  See comment.

Appendix V Comments from the Department of State

                Appendix V Comments from the Department of State

The following is GAO's comment on the letter from the Department of State
dated July 1, 2005.

We agree that the amended compacts and their subsidiary agreements

  GAO Comment

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).

Appendix VI

Comments from the Department of Health and Human Services

Note: GAO comment supplementing those in the report text appears at the
end of this appendix.

Appendix VI Comments from the Department of Health and Human Services

                                  See comment.

Appendix VI Comments from the Department of Health and Human Services

     Appendix VI Comments from the Department of Health and Human Services

The following is GAO's comment on the letter from the Department of Health
and Human Services dated June 7, 2005.

We have made the requested corrections. Specifically, we now use the term

  GAO Comment

"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.

Appendix VII

Comments from the Government of the Federated States of Micronesia

Note: GAO comment supplementing those in the report text appears at the
end of this appendix.

Appendix VII Comments from the Government of the Federated States of
Micronesia Appendix VII Comments from the Government of the Federated
States of Micronesia Appendix VII Comments from the Government of the
Federated States of Micronesia

                                  See comment.

Appendix VII Comments from the Government of the Federated States of Micronesia

The following is GAO's comment on the letter from the government of the
Federated States of Micronesia dated June 27, 2005.

The report notes that the FSM government submitted a document to OIA

  GAO Comment

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.

Appendix VIII

Comments from the Government of the Republic of the Marshall Islands