Mission Concluding Statement 

St. Kitts and Nevis: Staff Concluding Statement of the 2017 Article IV Mission

May 12, 2017

An IMF mission visited St. Kitts and Nevis during April 18-May 4 to conduct the 2017 Article IV consultation. [1]

Notwithstanding a difficult international environment, St. Kitts and Nevis’ economy is expected to grow again in 2017 for the 5^th consecutive year. St. Kitts and Nevis’ strong macroeconomic performance owes much to the robust Citizenship-by-Investment (CBI) inflows and their spillovers to the economy, as well as overall prudent macroeconomic policies. Against the background of elevated risks to CBI inflows and risks associated with completion of the debt-land swap, the mission focused on measures to safeguard macroeconomic and financial stability, including by strengthening the fiscal policy framework and reducing reliance on CBI inflows, and necessary reforms to attain sustainable, inclusive growth.

1. Economic performance moderated somewhat in 2016 compared to the recent years . The economy grew at a modest 3.2 percent in 2016, compared to 4.9 percent in 2015, while still exceeding the average growth rate in the ECCU region. The overall fiscal surplus, at 4.2 percent of GDP, deteriorated compared to 2015, owing mainly to lower CBI receipts. The underlying overall balance (that is, the overall balance excluding SIDF grants, CBI-related receipts and due diligence expenditure) remains in deficit, around 3.3 percent of GDP. A combination of lower CBI-budgetary receipts and a larger trade deficit resulted in a significant widening of the current account deficit. At the same time, public debt fell further, projected to reach the 60 percent ECCU debt-to-GDP target by 2018, ahead of ECCU peers.

2. The authorities made significant efforts to strengthen the CBI program, given risks to CBI revenues in a challenging regional and global environment . They have strengthened the due-diligence process with dedicated resources and global collaboration, as this is essential to reduce integrity and security risks, preserve the program’s credibility, and avoid a race-to-the-bottom.

3. The medium-term outlook incorporates conservative assumptions on future CBI flows. Growth is projected to be 2.7 percent for 2017 and is expected to average around 3 percent in the medium term. The projected slowdown in construction would be offset by public investment on infrastructure and higher tourism growth (as source market growth accelerates and new tourism facilities come on stream in 2017-19). The external current account deficit should remain large with CBI inflows tapering off.

4. Risks to the medium-term outlook are broadly balanced. Key risks include further delays in completing the debt-land swap and a sharp drop in CBI inflows due to more acute competition and global security concerns. Other negative risks include a stronger U.S. dollar, a tighter financial environment, a more severe Zika epidemic, and a major natural disaster. Loss of correspondent banking relationships (CBRs) could add to challenges. Softer global climate change policy may exacerbate natural-disaster risks. On the upside, stronger CBI inflows (from ongoing program reforms and tougher immigration policies in the United States on other countries) and weaker oil-prices could support faster growth.

5. The authorities’ 2017 policy priorities focus on preserving the gains in fiscal sustainability while supporting growth and strengthening resilience . The strategy aims at controlling government recurrent spending while scaling up public investment to build resilience, and to support stronger sustainable and inclusive growth. The budget does not propose new taxes, but envisages streamlining concessions over the next 2-3 years and implementing public financial management reform.

6. The medium-term fiscal framework should continue to focus on reducing reliance on CBI inflows in a world of heightened uncertainty. The VAT and import-duty exemptions since 2014 have weakened the fiscal framework. Notwithstanding the large fiscal buffers accumulated, an extreme scenario of a sharp drop in CBI inflows could result in fiscal deficits that erode the buffers as early as 2020 and risk reversing the downward debt trajectory, absent fiscal adjustment. An economic slowdown could further weaken tax performance.

7. A medium-term fiscal framework anchored to a balanced underlying primary-balance target would help increase resilience to sharp drops in CBI inflows, with needed adjustment at about 2.1 percent of GDP paced over 3-5 years . Such a target, along with the ECCB-debt target, could be enshrined in fiscal responsibility legislation that would provide the government with a commitment device to anchor its adjustments. It would safeguard against pressure to deviate from the adjustment path, and save windfall CBI inflows, excluded from the rule, in a contingency fund. Approval of both Cabinets of an action plan to meet the primary balance target at the country level is key.

8. On the revenue side, the tax base should be broadened, including by streamlining tax incentives and continuing to improve tax administration. The revenue loss from tax incentives remains high (at 6.4 percent of GDP—both discretionary and granted by legislation). [2] Tax incentives should be transparent, rule-based, and well-targeted. The Fund supports the authorities’ intention to refine the system and stands ready to assist. Consideration should also be given to updating property valuations and enhancing compliance. Other taxes, including on cigarette, alcohol, and sugary products (consistent with initiatives that CARICOM is exploring) can raise revenue, while contributing to government efforts to reduce noncommunicable diseases.

9. On the expenditure side, containing spending on goods and services and the public wage bill should remain a priority. We welcome the intention to establish a more predictable system for public pay-packages and recommend that pay increases be consistent with budgetary constraints, macroeconomic developments, and regular benchmarking with private sector wages. A ceiling on the public-wage bill could be set, guided by the medium-term fiscal framework anchored to the debt and primary-balance targets. Allocations could be communicated by Cabinet to line ministries within the budget process, taking into account the envisaged qualification- and performance-based incentive system.

10. Plans to introduce universal health-coverage (UHC) are commendable, but its fiscal implications should be carefully managed . The design, coverage, and financing of UHC should limit risk to fiscal sustainability. The scheme should be funded from permanent revenue sources to avoid recurrent drains on the budget. The benefit package for the population should ensure the system’s financial viability, and use specific measures to target the poor. Appropriate incentives and regulatory tools should contain costs. Drawing on expertise from PAHO and the World Bank should help tailor the scheme appropriate to the country characteristics.

11. We welcome the commitment to establish a Growth and Resilience Fund (GRF) and stand ready to assist with the modalities. The GRF should have a simple sovereign-wealth-fund structure, with a prudent investment strategy and flows fully integrated with the fiscal framework. We welcome the agreement on the budgetary arrears with PDVSA and near-agreement on NIA debt-restructuring, and support any further liability-management efforts, including reducing outstanding T-bills, accelerating payment of expensive debt, and improving debt terms.

12. Structural reforms to strengthen public financial management need urgent attention. The SIDF’s quasi-fiscal spending should be contained, including by streamlining its activities and integrating with the general government’s consolidated account to facilitate more comprehensive fiscal planning and cash management. Once the GRF is established, the authorities should consider transferring revenue from CBI flows and resulting SIDF deposits to the GRF. The authorities have accepted the need to enhance the oversight of public corporations by enforcing timely reporting of financial statements. The overall public financial management would also benefit from the strengthening of the NIA’s debt and cash management frameworks.

13. Fiscal efforts should address the need to prepare for the inevitable recurrence of natural disasters. A comprehensive risk-management framework focusing on risk reduction and mitigation is critical to building resilience and reducing the fiscal burden of disasters. Natural disaster risk could be assessed and incorporated into budget and debt management frameworks, with investments in risk reduction (e.g., targeted infrastructure projects, early warning systems, and risk maps), and self-insurance (financed through fiscal buffers). Contingent financing plans, risk-transfer arrangements, and encouraging private sector investment in risk mitigation are also essential.

14. The sale of lands under the debt-land swap arrangement must be completed urgently to limit fiscal and financial risks . A clear action plan and timetable with concrete milestones are needed. Completing existing purchase proposals and stepped up marketing to generate sales, including through real-estate agents and the SLSC website, will help establish momentum and remove the policy uncertainty. Cooperation with CIU and SKIPA is welcome and should support these efforts. We welcome the ongoing discussions on the renewal of the dividend-guarantee agreement with banks at renegotiated terms.

15. The authorities should continue strong efforts to reduce CBR risks and maintain the integrity of the CBI-program . The authorities have further improved compliance with international AML/CFT standards and exchange of information, and are jointly working with the ECCB to implement AML/CFT standards. Banks continue to suffer from increasing costs through higher fees, lengthier transactions, and increased due diligence, but open communication and information-sharing between respondent and correspondent banks have helped limit loss of CBRs. Introducing Basel II and the continued implementation of risk-based supervision should also improve perceptions. Careful consideration of amalgamation opportunities can help address volume-of-business concerns and improve risk-management capability.

16. Banks are still burdened by high levels of nonperforming loans (NPLs). Their swift resolution is critical to limit further deterioration, revive credit expansion, and support economic growth. The establishment of the ECAMC will allow for a more efficient collection and disposal of distressed assets. Ongoing efforts to modernize the foreclosure and insolvency frameworks would help maximize recovery. The new collateral appraisal guidelines, credit bureau, and land registry should help contain future losses from NPLs.

17. The authorities should monitor other potential risks, including the implications of a slowdown in CBI inflows for the banking system. While the direct impact may be limited, and even though the local and CBI-related real-estate markets are segmented, and most CBI-properties are self-financed, slower inflows may affect banks through reduced construction activity and its spillover effects on borrowers’ repayment capacity. Authorities should monitor market developments closely and ensure adequate prudential oversight to minimize any potential effects on banks of further slowdown in CBI inflows and the ending of the 5-year holding-period for existing CBI properties.

18. The authorities should adopt a comprehensive strategy to overcome persistent structural challenges that continue to limit the potential for inclusive growth. Ongoing efforts to expedite business registration, establish a dedicated land-registry, credit bureau, and SME partial-credit-guarantee scheme, and revise the foreclosure legislation should improve the weak business environment that lags peers. Alternative investment options under the CBI program could channel funds to renewable energy, health, education, supporting skill development and economic diversification, while also reducing the risk of asset bubbles. Soft-skills training program is welcome; however, time-bound participation should be enforced upon certification, and stipends set below the minimum wage. A substantial rise in the minimum wage (already high compared to non-Caribbean tourist-islands and competitive middle-income countries) should be avoided without increased productivity. Focusing on housing programs for the poorest and emphasis on gender gaps in the National Social Protection Policy should support inclusiveness. Ongoing actions to reduce crime through increased use of CCTV systems and community-related programs are welcome.

19. The authorities welcome Technical Assistance to improve the availability and quality of data with respect to balance of payments, national accounts, and labor market and social statistics. These are key to assessing vulnerabilities and for effective policymaking.

The mission thanks the authorities and technical staff for the warm welcome, constructive discussions, and positive spirit of cooperation.