Public Information Notice No. 04/128

Public Information Notice: IMF Concludes 2003 Article IV Consultation with St. Lucia

November 15, 2004

On May 5, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with St. Lucia.¹

Background

After a contraction in GDP of over 4 percent in 2001 and only a marginal expansion in 2002, the pace of economic growth accelerated in 2003 to 3.7 percent, driven by a rebound in tourism of close to 17 percent. While growth has been stronger than expected in 2003, St. Lucia has experienced a marked decline in average economic growth during the last decade, reflecting mainly increased competition from lower priced tourist destinations, a maturing tourism product targeting the high-end of the market, and high labor and utility costs. During this period, as the structure of the economy moved away from agriculture to services, persistent high unemployment pointed to rigidities in the labor market. Expansionary fiscal policies were pursued after 1999 in an attempt to revive growth and reduce unemployment, resulting in a steady rise in public debt. Although, at 64 percent of GDP, St. Lucia's public debt at end-2003 was high, it remained well below that of its Eastern Carribean Currency Union partners. However, banking sector prudential indicators are generally weaker than the ECCU average.

Despite the pick-up in growth, the overall economic situation remained difficult in 2003, as an ongoing recovery in the tourism sector has not spilled over to the whole economy. Unemployment remained high (16-18 percent), and bank credit to the private sector is declining (3½ percent decrease estimated in 2003). As countercyclical policies were maintained, the fiscal stance was further relaxed through FY 2003/04. The central government overall deficit is estimated to reach 5.5 percent of GDP in FY 2003/04, up by about ½ percent of GDP (excluding a 2.6 percent of GDP one-off outlay in FY 2002/03). Current revenues are estimated to have increased as a result of the net effect of tax measures and the positive cyclical impact of the ongoing economic recovery. However, rising primary expenditures (excluding the one-off outlay) largely offset those gains, on account of higher payments on current expenditures, including wages. The rise in public debt accelerated in 2003, with a large increase in external borrowing from commercial banks. However, the authorities were successful in reducing interest costs and lengthening maturities through refinancing operations.

Executive Board Assessment

Directors welcomed the ongoing economic recovery, led by a strong rebound in the tourism sector. However, they noted that the recovery is narrowly based, and that prospects for sustained growth remain uncertain, with high and persistent unemployment—stemming in particular from the decline of the banana sector—posing a major social and political challenge. Directors stressed that a sustained recovery will depend on fiscal discipline and perseverance with structural reforms to foster private sector-led growth and diversification and enhance competitiveness.

Directors noted that the attempt to revive growth through the pursuit of expansionary fiscal policy has sharply increased public debt. While recognizing that, owing to a longer history of prudent macroeconomic policies, St. Lucia's public debt is well below that of its Eastern Caribbean Currency Union partners, Directors expressed concern about the vulnerabilities associated with the steep increase in debt in recent years. They emphasized the importance of a strong upfront fiscal adjustment and continued moderation in expenditures to mitigate the country's vulnerability to exogenous shocks.

Against this background, Directors welcomed the authorities' intention to reduce capital outlays in FY 2004/05, but also stressed the need for additional steps to contain current expenditures. Directors urged the authorities to lay out a concrete timetable toward gradual fiscal consolidation, identifying specific measures to rationalize expenditure and strengthen revenue collection. Some Directors noted that the overall wage bill was large, and suggested that a fundamental reform of the public sector would help to reduce it more durably. Directors also recommended accelerated tax reform along the lines proposed by the Tax Reform and Administration Commission of the Organization of Eastern Caribbean Countries, and the prompt establishment of a Revenue Authority. They welcomed the authorities' decision to broaden public support for tax reform by circulating the OECS Tax Reform report for public discussion.

Directors emphasized the need to accelerate structural reforms to enhance long-term economic growth. In this context, they encouraged the authorities to step up their efforts to foster a conducive business environment, while reducing costly tax incentives to investment. They stressed that, in the context of the currency board arrangement, labor market flexibility was required to facilitate adjustment to shocks and preserve competitiveness, and they called for continued wage moderation in the public and private sector, and increased labor productivity. Directors also encouraged the authorities to restructure the water company, increase efficiency in electricity generation, and foster agricultural diversification to support the tourism industry.

Directors expressed concern about the high level of nonperforming bank loans. While noting that St. Lucia banks are appropriately increasing their provisioning for loan losses and exercising caution in new lending, Directors urged the authorities to continue to work closely with the Eastern Caribbean Central Bank to address the issue. They encouraged the authorities to complete divestiture from the Bank of St. Lucia, and ensure adequate supervision of the offshore sector, including by developing and enforcing AML/CFT regulations.

Directors noted that, while some progress was being made to strengthen economic institutions with the assistance of the Caribbean Regional Technical Assistance Center (CARTAC), the consistency and timeliness of economic statistics needed improvement. The authorities were encouraged to enhance reporting under the GDDS, and seek technical assistance through CARTAC and other donors.