Belize -- 2006 Article IV Consultation, Preliminary Conclusions of the IMF Mission
August 29, 2006
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
1. Belize's economy has reached a critical juncture. Over the past decade, the country enjoyed better-than-average growth, as well as price and currency stability. However, this performance rested to a large extent on overly expansionary policies that pushed public borrowing and the external current account deficit to unsustainable levels. The government has taken commendable steps in the last year and a half to begin correcting these imbalances, including through substantial fiscal adjustment and monetary tightening. Yet, despite these efforts, important vulnerabilities still remain and need to be addressed quickly to avert the risk of an external payments crisis, protect the country's currency peg, and set the stage for a durable recovery of growth and employment. The discussions with the authorities focused on the development of a policy framework that would achieve these objectives.
The remaining imbalances
2. Since the last Article IV consultation the authorities have tightened macroeconomic policies substantially. During FY05/06 (April-March), revenue measures and cuts in capital expenditures helped reduce the overall deficit of the central government to about 3½ percent of GDP from almost 9 percent of GDP in the previous year. The primary surplus rose to about 3 percent of GDP, implying a cumulative improvement of almost 9 percent of GDP since FY02/03. The Central Bank of Belize (CBB) also took additional steps to contain the expansion of money and credit by channeling social security deposits to the central bank and increasing the cash and liquid assets reserve requirements by one percentage point each on three occasions.
3. However, these steps alone are not yet sufficient to place the economy on a sustainable path. While bilateral financing, better-than-expected exports, and foreign direct investment are helping to close the foreign financing gap for the current year, international reserves remain very low at less than one month of imports. Under current policies, the mission estimates on a preliminary basis that in 2007 Belize's net balance of payments financing needs will reach about 10 percent of GDP, and remain high thereafter at about 6 percent of GDP during 2008-11 and more than 10 percent during 2012-15. Foreign financing of this magnitude may not be forthcoming, given Belize's high external public debt burden; and, even if it could be obtained, its high cost would worsen the debt dynamics and leave the economy vulnerable to adverse shocks. At the same time, fully closing such large financing gaps through further fiscal and monetary tightening would not be feasible without severely disrupting economic activity.
Returning to sustainability
4. The authorities have recognized the critical nature of their financial situation and have expressed a firm commitment to restoring sustainability. In this context, they recently announced the intention to approach their external private sector creditors to seek debt service relief.
5. In the mission's view, a credible plan for returning to fiscal and external viability, safeguarding the currency peg, and creating conditions for durable economic growth would have to contain at least three key elements:
Policies to address immediate risks: To mitigate the risk that external payments difficulties arise while a medium term framework is being formulated and consultations with creditors take place, ongoing efforts to secure bilateral and multilateral lending should be combined with a tightening of macroeconomic policies.
A sustainable medium-term framework: There is a need to design and implement a macroeconomic framework, which-together with possible relief from a debt operation-closes the large projected medium-term financing gaps and reduces the public debt burden to safer levels.
Supportive structural reforms: A comprehensive package of fiscal, monetary and financial sector reforms should be implemented to facilitate the required medium-term effort and increase the resilience of the economy against adverse shocks.
Addressing immediate risks
6. The low level of reserves warrants a tighter macroeconomic policy stance in the short term. While the foreign financing gap for 2006 is largely closed, further steps to contain demand and reduce balance of payments pressures are still justified because of very large financing needs next year and the importance to demonstrate policy commitment as creditors are being approached. In this regard, the most recent increase in reserve requirements (effective September 1) is welcome, although the authorities need to monitor monetary developments closely and take additional action if this proves insufficient to mop up excess liquidity. In the fiscal area, the better-than-expected budget execution during March-June should be maintained during the remainder of the fiscal year to achieve a primary surplus of at least 3½ percent of GDP. To this end, restraint in current and capital expenditures remains critical, along with a successful implementation of the General Sales Tax (GST), which has so far been satisfactory. The authorities should continue to resist pressures to dilute the GST base and remain prepared to adopt corrective actions should its revenue yield fall short of projections.
Developing a sustainable medium-term framework
7. The authorities' commitment to fiscal and balance of payments sustainability should be reflected in a credible medium-term macroeconomic framework. In this context, the framework should aim at eliminating balance of payments and fiscal financing gaps over the next five years, significantly reducing the debt burden, and allowing for a recovery of international reserves.
8. The medium-term framework could build upon a combination of additional fiscal effort, continued monetary restraint, and relief from the envisaged debt operation. To illustrate this point, the mission simulated an active scenario that comprises both a front-loaded fiscal effort to raise the primary surplus to about 4½ percent of GDP during 2007-09 and about 4 percent of GDP thereafter, and monetary restraint to keep the expansion of commercial bank credit below nominal GDP growth. This adjustment seems feasible without compromising the prospects for economic growth, and would require that the authorities save the bulk of currently projected petroleum revenues. In addition, current government expenditure-particularly the public wage bill-would need to rise at a significantly lower rate than nominal GDP. On the assumption that debt service relief from private creditors will become available, this package could achieve the goals of filling the financing gaps, gradually reducing the public debt burden and replenishing international reserves.
9. A swift and successful completion of the intended debt operation would be a critical component of the outlined framework. The mission commends the government for pursuing agreement on this matter in the context of a close and constructive dialogue with its private creditors.
Supportive structural reforms
10. To help maintain the required fiscal effort over a prolonged period of time, the authorities should undertake a broad set of supportive structural fiscal reforms, including:
o Modernizing tax administration: After the GST-implementation phase is completed, the authorities should seek to strengthen their tax administration, including through a reorganization away from tax types and toward business processes and common functions, such as taxpayer services, audit, and collection enforcement.
o Tax reform: To support the buoyancy of the tax system in the medium term, the authorities should streamline their system of fiscal incentives, including by eliminating business tax holidays under the Fiscal Incentives Act, terminating import duty exemptions for specific organizations, and converting import licenses into tariffs. To ensure a more stable level of revenues, the authorities should also substitute the revenue replacement duty on fuels with a specific excise tax, and establish an automatic adjustment mechanism for fuel prices.
o Pension reform: The non-contributory pension plan for public servants (PSP) harbors substantial liabilities for the government budget in the future, and the authorities should consider a phase-out of the PSP for new entrants (who would still be covered by the general social security system) and parametric adjustments, such as introducing a contribution from beneficiaries, increasing the years of required service, and/or raising the retirement age.
11. A further strengthening of governance and transparency is also needed to control contingent liabilities. The mission welcomes recent steps in this area, including the reform of the Finance and Audit Act, greater dissemination of economic and fiscal data, and inquiries into the dealings of the Social Security Board (SSB) and the Development Finance Corporation (DFC). Priority actions in the immediate future should include improving risk management at the SSB, avoiding financial slippage at Belize Water Services, and winding down the activities of the DFC in an orderly way. To avoid further liabilities to the government, the DFC should be allowed to collect without interference on its loan portfolio.
12. In the monetary area, the authorities should strengthen their capability to implement monetary policy. Currently, the principal instruments of credit policy are the cash reserve and liquid assets requirements, which have not always been effective in curbing excess liquidity. This suggests that the CBB might benefit from broadening its monetary instruments, possibly with technical assistance from the IMF. To increase monetary control, the authorities should also consider eliminating-in due course-the government's overdraft at the CBB.
13. Significant progress has been made in strengthening bank supervision, but further steps to foster a sound and resilient financial sector should be taken. Several of the recommendations of the IMF's 2003 assessment have been implemented, including a significant increase in resources to conduct bank supervision. However, the authorities still need to strengthen the operational independence of the supervisors and must urgently increase the resources for insurance supervision. In addition, loan-loss provisions in the banking system are too low by international standards and should be raised through regulatory action.
From challenge to opportunity
14. Belize's economic and financial situation will leave little room for slippage in implementing the outlined policy framework. Even in the mission's illustrative active policy scenario international reserves would remain low and the debt burden high for several years, and substantial vulnerabilities and risks would persist in the event of adverse shocks. Revenue estimates from oil are also subject to a wide margin of error because they depend on a large number of uncertain technical and policy parameters. More generally, there is some risk that unreasonable expectations of oil revenue develop, notwithstanding the fact that the reserves that have been proven so far and the envisaged production levels are relatively limited. In the circumstances, it will be critical for policymakers to manage these risks and to stay "ahead of the curve" by adjusting early to any changes in the domestic and external environments.
15. The mission believes that the authorities-and more broadly the country-can rise to the challenge and achieve a return to sustainability and durable growth. During the consultation, the authorities shared the thrust of the suggested policy framework and reforms. Given the importance of strong ownership for encouraging creditor support and maintaining policy discipline and commitment over a prolonged period of time, the mission encourages the authorities to promote a broad social and political consensus on the basic tenants of their policy approach.