Mission Concluding Statements
Grenada and the IMF
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International Monetary Fund
Grenada--2005 Article IV Consultation
St. George's, May 12, 2005
An IMF mission visited Grenada from April 28 through May 12 to conduct the 2005 Article IV Consultation discussions. Discussions centered on the government's plan to facilitate a speedy economic recovery following Hurricane Ivan, ensure fiscal and debt sustainability, enhance the growth potential, and reduce vulnerabilities to adverse shocks. The mission met with Prime Minister Mitchell, Deputy Prime Minister Bowen, Finance Minister Boatswain, other Cabinet members, Permanent Secretary (Finance) Antoine, other senior officials, members of the Opposition, representatives of the private sector, labor unions, the donor community, and civil society. We are thankful to them for productive discussions which deepened our understanding of the economic challenges facing Grenada.
I. Recent Developments and Outlook
1. Hurricane Ivan was one of the most severe natural disasters in the world recent decades in terms of its economic damage. An IMF study finds that, on average over the last 30 years, the damage to countries hit by natural disasters has been about 2 percent of GDP. The damage from Ivan was more than 200 percent of GDP (approximately EC$2.4 billion). Assessments of the pace of Grenada's recovery and of the challenges that lie ahead, must take into account the enormity of the shock the country suffered.
2. The disruption in output caused by Hurricane Ivan led to a sharp rise in unemployment. The economy contracted by 3 percent last year, a sharp reversal from the 4 percent growth that had been projected pre-Ivan. At least 8 percent of the labor force was displaced from their jobs in the immediate aftermath of Ivan, which raised the unemployment rate last year to over 20 percent. Some of the displaced workers have since been reabsorbed in sectors such as reconstruction and repair work. Women appear to be finding it more difficult than men to find new jobs, but the government and aid agencies are trying to remedy the situation by providing training to women in construction and other skills. For instance, women have accounted for 70 percent of the trainees in some of USAID's employment-training programs thus far.
3. The economy is expected to rebound next year after sluggish growth in 2005. The mission projects growth of only about 1 percent this year, as conditions in the agricultural sector remain depressed and the recovery in tourism is not yet enough to supplement the stimulus from the reconstruction boom. The hotel industry is recovering with nearly 60 percent of rooms having resumed service and more than 80 percent expected to be back up in time for the tourist season starting later this year. In the agricultural sector, farmers have turned to short crops as near-term prospects for nutmeg and cocoa remain bleak. Predicated on the continued recovery of these sectors, and on a continued boost from reconstruction, IMF staff project a strong rebound in growth next year. Inflation is expected to remain subdued within the framework of the Eastern Caribbean Currency Union (ECCU), although prices of construction materials have reportedly shot up by over 20 percent.
4. The fiscal situation is challenging. Extraordinary reconstruction expenditures need to be undertaken, while the revenue base has eroded and the high public debt level tightly limits additional government borrowing. Despite generous assistance from the international community and sustained efforts to reduce non-essential expenditures, the government was not able to close financing gaps for 2004 and could not fully service its debt obligations. Large financing gaps remain in 2005 and beyond. On present policies, the 2005 financing gap is 4.6 percent of GDP, including almost 2 percent of GDP in overdue payments to creditors from last year. Beyond 2005, financing gaps are expected to widen to between 12-15 percent of GDP despite an anticipated recovery in revenues, in large part because reconstruction expenditures remain high and grant commitments are expected to fall off sharply.
5. The external current account deficit is expected to deteriorate sharply in 2005. Reconstruction-related imports will rise while exports and tourism receipts will take time to recover. Sizable capital grant inflows and direct investment are expected. In 2004, substantial foreign grant inflows and insurance payments led to a strong improvement in the external current account deficit to about 17 percent of GDP, even though the balance of trade in goods and services deteriorated markedly after Ivan struck.
6. The banking sector thus far appears to be holding its own. Prudential indicators did not show a deterioration through end-2004, although banks significantly increased loan loss provisions. Liquidity in the banking system has increased from insurance inflows and remittances. However, signs of stress could emerge once banks fully phase out the moratoria on loans that were given after Ivan struck, as the property insurance proceeds that many borrowers have used to stay current on their payments run out, and if unemployed persons have difficulty finding new jobs.
II. Policy Discussions and Recommendations
7. Against this background, policy discussions centered on the government's plan to restore growth and fiscal sustainability. This requires: (i) closing financing gaps in the near and medium term and bringing public debt to sustainable levels; (ii) successful reconstruction and economic recovery and steps to enhance the growth potential; and (iii) reducing vulnerabilities to adverse shocks.
8. The mission recommends that the authorities devise a medium-term macroeconomic framework with fiscal targets for the next 3-5 years that would be based on a broad consensus and approved by parliament. Such a plan could be built around a menu of measures, many of which are already on the agenda of the authorities.
A. Reducing Fiscal and Debt Imbalances
9. Filling large financing gaps in 2005 and beyond will require burden sharing by all stakeholders. In particular, it will take a combination of (i) the authorities' efforts to address fiscal imbalances and implement growth-enhancing policies, including further privatization; (ii) creditor support in the form of a cooperative debt restructuring agreement; and (iii) donor support. Such a concerted effort contributed to address the enormous gap in 2004 post-Ivan. Burden sharing is needed as the gaps in 2005 and beyond are too large to be filled by any of these three channels alone.
10. The 2005 budget shows the government's determination to do its share to fill the financing gaps. The budget contains revenue measures that will yield over 2 percent of GDP.
• A special levy on incomes has been instituted for a five year period. Outstanding issues such as the detailed structure of this levy should be resolved with expediency.
• The retail price of fuel had remained fixed since December 2000 despite a 50 percent increase in the world price of oil since then. The authorities have decided to raise retail prices by EC$1 (about 15 percent).
• Excise taxes on alcohol and tobacco were raised, although the yield from these taxes will likely be offset by the reduction in taxes on certain vehicle tires and brakes.
11. Further fiscal effort of EC$70-90 million (5−6 percent of GDP) per year in 2006 and beyond is needed to contribute to filling financing gaps in those years. We encourage the government to continue to hold extensive national consultations with the population. This would help to build ownership of the fiscal effort that is needed to fill financing gaps and to unlock support from creditors and donors. The mission discussed a number of possible revenue-enhancing and expenditure-reducing measures, many of which were already being contemplated by the government.
12. The following measures could contribute to raising revenues.
• Reducing tax concessions: Grenada has been granting very generous concessions over the past decade. The costs in terms of revenue forgone-over EC$140 million (11 percent of GDP) in customs revenue forgone and about EC$35 million (3 percent of GDP) in corporate income tax forgone each year-has been one of the highest in the ECCU. Concessions should be nondiscretionary, transparent, and subject to a fixed upper limit in EC dollar terms and a clear expiration date. Existing concessions and their implementation should be reviewed carefully with a view to phasing out concessions. Given the size of the financing gaps, this is a good opportunity to explain to foreign investors the government's inability to extend concessions.
• Improving collection of taxes and fees. The mission recommended a menu of administrative measures, including strengthening the administrative capacity of the Lands and Surveys Department, enhancing the audit capacity of the Inland Revenue and Customs and Excise Departments, and tightening enforcement at Customs. A CDB-financed project is expected to commence later this year to improve internal auditing and enforcement procedures at Customs and intensify anti-smuggling efforts.
• Restoring tax collections from retail fuel prices: Even after the recent increase, retail fuel prices will remain substantially below world prices, with the effective tax rate on fuel imports substantially below the effective tax rate on most imports. Retail prices should be adjusted more frequently both to yield urgently needed government revenues and to promote fuel conservation. At the same time, it is essential to protect the most vulnerable groups of society from the impact of fuel price increases; this is better done through well-targeted subsidies for these groups than through a blanket subsidy for everyone.
13. Steps are also needed to curtail expenditures.
• Realize greater efficiency in capital expenditures. Capital expenditures should be carefully prioritized, keeping in mind the implementation capacity of line ministries and available financing. Spending on capital items should be limited to the extent possible.
• Keep the wage bill aligned to inflation and productivity growth. With the 8 percent increase in this year's wage bill, the cumulative increase over the last 5 years has exceeded 40 percent. These increases have far outstripped the rate of inflation and growth in productivity. A tripartite agreement among labor, business and the government to limit wage growth would be a welcome contribution to the nation's fiscal effort.
14. Carrying out the needed fiscal effort will require donor-supported technical assistance. The administrative capacity of the Ministry of Finance and the Customs & Excise Department needs to be boosted. At the Ministry of Finance, additional staff are needed for economic management and revenue administration. Bringing Customs and Inland Revenue on a common data platform would contribute to the revenue effort.
Cooperative agreements with creditors
15. Reducing public debt to a safer level is a matter of economic urgency and social responsibility. The total stock of outstanding public and publicly-guaranteed debt at end-2004 was EC$1.5 billion, or about EC$15,000 per person.
16. As part of its burden-sharing approach, the government hopes to strike a cooperative agreement with creditors to restructure debt and help close financing gaps. The damage inflicted by Hurricane Ivan rendered the public debt, which was already high before the hurricane, unsustainable. In January 2005, the government appointed professional legal and financial advisors to assist it in reaching an agreement with commercial creditors that reduce debt service and the net present value (NPV) of the debt, so that the government could thereafter reasonably be expected to meet it debt-service obligations falling due.
17. The authorities are also requesting substantial debt relief from their official creditors. They have approached their major bilateral creditors, including Taiwan (Province of China), Kuwait, Libya and the Paris Club creditors.
18. The mission emphasized the need to follow best practices in implementing the debt strategy.
• The mission emphasized that any restructuring agreement should: (a) be transparent; (b) be nested in a comprehensive medium-term economic plan that is formulated and fully owned by the government; (c) involve a close and continuous dialogue with all creditors; (d) ascertain and incorporate to the extent possible the preferences of creditors with respect to new debt instruments; and (e) treat comparably the different creditor groups.
• To maintain an open dialogue with creditors and share information freely with them, the authorities and their financial advisors have made their debt sustainability analysis available on the government's website (www.gov.gd). The authorities should seek to maintain a constructive dialogue with private creditors and launch an exchange offer in a timely fashion.
B. Reconstruction and Growth
19. A well-functioning Agency for Reconstruction and Development (ARD) is necessary to ensure success in Grenada's reconstruction efforts and to help in restoring the economy's growth potential. ARD was set up to: create an improved policy and institutional framework for reconstruction; mobilize additional resources; strengthen the implementation capacity of line ministries; collect and analyze data to monitor implementation of projects; and report back to stakeholders, particularly the donor community. Although incorporated in November 2004, ARD was officially launched, and attained a critical mass of staff, only in mid-March 2005. It is too soon, therefore, to assess the agency's effectiveness. The agency is working to address problems arising from a clear delineation of responsibilities between it and the line ministries.
20. Greater effort is needed to put in place the mechanisms for transparency and accountability in the use of donor funds and in operations of the ARD.
• To our knowledge, the Reconstruction and Development Fund has been established but not as yet been funded. All transactions and operating expenses of ARD should be on the budget and transparently reported.
• The government should make public the periodic reports made by the internal auditor to the Board of Directors of ARD to apprise the donor community of the problems that arise in the operations or finances of ARD and the steps being taken to remedy them.
Transparency and frequent reporting can help ensure continued disbursement of pledged donor funds, which is critical to implement the authorities' capital expenditure plans.
21. The IMF's baseline scenario assumes strong medium-term growth for Grenada of about 4 percent a year. This reflects the belief that the reconstruction, as well as other efforts, will help realize the country's tremendous growth potential. As in the ECCU region in general, some priorities for growth-enhancing policies are:
(i) Improving the investment climate-Diagnostic reviews have identified a number of steps that could be taken such as changes in the investment code, changes in customs regulations to speed up custom clearance, and strengthening the institutional capacity of Grenada Industrial Development Corporation to serve as a "one-stop-shop" to promote private investment. A recent World Bank report "OECS-Towards a New Agenda for Growth," provides useful guidance in this regard.
(ii) Increasing the contribution of the service sector-Apart from further developing the tourism sector, which is likely to remain the mainstay of the economy, other areas where Grenada has already established a presence such as foreign direct investment in medical education could be expanded.
(iii) Tapping the diaspora-Even by comparison to the ECCU, Grenada has very high rates of skilled emigration, which has over time created a large diaspora. We welcome the authorities intent to find more systematic ways to tap into this diaspora to garner funds for reconstruction and productive investment and to build networks for trade and tourism promotion.
C. Reducing Vulnerabilities to Adverse Shocks
22. Financial sector stability is a prerequisite for sustained growth. Therefore, close attention should be paid to the health of the financial sector. In particular, the authorities should:
• Ensure, in conjunction with the ECCB, that effective bank supervision, including onsite inspections, takes place at this critical time. Prudential indicators for all financial institutions should be closely monitored for early detection of signs of stress as a full evaluation of portfolios is completed;
• Implement the recommendations of the Financial Sector Assessment Program (FSAP), including giving ECCB licensing authority and enforcement power by passing the Uniform Banking Act;
• Resolve without delay the issue of the unregulated bank-action on this has been urged by the ECCB for a number of years;
• Ensure passage of Grenada Authority for the Regulation of Financial Institutions Act (GARFIN) so as to strengthen supervision of non-bank financial institutions including insurance.
23. The approach of the hurricane season serves as a reminder to intensify disaster-preparedness and mitigation initiatives. The government has undertaken some public education to build awareness and strengthen enforcement of construction codes, including through the Natural Disaster Management Agency (NaDMA). It is encouraging to note that new construction by aid agencies and the Housing Authority are reportedly resistant to category 3 hurricanes. The authorities also intend to investigate the cost-efficacy of regional catastrophe insurance pools as a risk transfer mechanism and explore interest for risk-pooling in the region.
IMF EXTERNAL RELATIONS DEPARTMENT