Public Information Notice: IMF Concludes Article IV Consultation with St. Kitts and Nevis
December 4, 2000
|Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.|
On October 23, 2000, the Executive Board concluded the Article IV consultation with St. Kitts and Nevis.1
St. Kitts and Nevis is a small, open economy that is heavily dependent on tourism and other services, and some light manufacturing. In recent years, the economy has greatly reduced its dependence on its traditional base of sugar production. After a period of rapid growth in the early to mid 1990s, economic growth in St. Kitts and Nevis slowed in recent years, mainly as a result of hurricanes in 1998−99 that inflicted severe damage to infrastructure. Growth is beginning to rebound, led by recovery in construction, tourism, and manufacturing. The exchange rate peg to the U.S. dollar and strict limits on central government borrowing from the regional central bank, the Eastern Caribbean Central Bank, have helped maintain inflation at low levels, averaging below 2 percent in recent years.
The central government's deficit rose gradually in the early to mid 1990s, reflecting a large across-the-board rise in spending, only partly offset by revenue improvements. Reflecting the effects of Hurricane Georges, the deficit nearly doubled to 6½ percent of GDP in 1998. Higher current spending late in the year reflected a substantial increase in relief and reconstruction activities. The deficit narrowed to about 5¾ percent of GDP in 1999, mainly reflecting capital expenditure restraint, but again widened sharply in the first half of 2000.
Although the social security system has recently recorded surpluses of about 4¾ percent of GDP a year, the main public enterprise—the St. Kitts Sugar Manufacturing Corporation—continues to generate losses (reaching about 3½ percent of GDP a year), which are mainly being financed by the government-owned National Bank.
Despite the effects of Hurricane Georges, the external current account deficit narrowed to 16½ percent of GDP in 1998 from 21 percent of GDP in 1997, owing mainly to strong tourism receipts before the hurricane hit and an increase in insurance transfers following the hurricane. Large foreign direct investments in the hotel sector led to a balance of payments surplus of 2¾ percent of GDP in 1998. The current account deficit rose sharply to 26 percent of GDP in 1999, as a result of a deterioration in tourism receipts and sugar exports, and higher imports associated with post-hurricane reconstruction. However, continuing strong direct foreign investment led to an overall balance of payments surplus of 1 percent of GDP. As a consequence of higher public sector deficits, partly reflecting large air and sea port investment projects, external public debt almost doubled from end-1995 to end-1999, with external debt service rising from about 5¼ percent of exports of goods and services in 1995 to 11¼ percent in 1999.
Offshore financial services have been a growing sector, especially in Nevis. The laws provide for a high degree of confidentiality and for income tax exemption. St. Kitts and Nevis has been concerned about strengthening the supervision of the offshore financial service sector, and the recent international initiatives against weak regulatory and supervisory practices in offshore financial centers have given further impetus to the authorities' efforts.
The government has committed itself to developing the tourist industry as the linchpin of the economy in the future, with some diversification into light manufacturing, offshore financial services, and other services. Ongoing investments in the hotel industry in 2000 should spearhead a pick-up in economic activity, with real GDP growth projected at 3¾ percent. Inflation is likely to remain low.
The recent modest economic upturn has been accompanied by a further worsening of the fiscal situation. The authorities have recently taken strong measures to contain expenditures, including freezing civil service employment. Recent revenue measures include an increase in electricity and water tariffs, and a substantial increase in regulated retail gasoline prices. With these measures, the central government deficit is projected to be contained to 8½ percent of GDP in 2000.
The government is currently deciding on the future of the sugar industry and a course of action to stem the industry's losses. The National Bank has been given a mortgage on government-owned sugar land to protect the interests of the bank's depositors (including the social security fund).
The external current account deficit is projected to increase to about 34½ percent of GDP in 2000, as a result of higher imports associated with large investments in the hotel sector. Growth in service exports will begin to pick-up toward the end of the year. Buoyed by large direct investments in hotels, the capital account surplus is projected to lead to a small overall balance of payments surplus. St. Kitts and Nevis's imputed reserves with the ECCB have grown consistently since 1997. Nevertheless, competitiveness remains a key concern for this service-based economy.
Executive Board Assessment
They noted that in recent years hurricanes have severely damaged infrastructure and adversely affected tourism. Also, the sugar sector is in decline and recording heavy losses. Largely reflecting these factors, growth has weakened and the public sector's deficit and its level of indebtedness have risen substantially in relation to GDP. Directors stressed the importance of forestalling the threat of adverse debt dynamics in which rising debt and interest payments would increasingly strain the budget and hold back growth. Against this background, they welcomed the measures taken by the authorities to improve the fiscal position and to make the economy more resilient to exogenous shocks. Directors saw as the main challenge in the period ahead the need to build on what has already been done to create a diverse, competitive, and financially stable economy.
Directors commended the authorities' plans to reduce the public sector deficit progressively and substantially through a combination of revenue and expenditure measures, thereby reversing the undesirably rapid growth in public debt in recent years. They welcomed the fiscal measures taken in 2000, including price increases for gasoline, water and electricity tariffs. They emphasized the need to curtail public spending, and urged the authorities to proceed with civil service reform and to exercise restraint in granting wage increases. They also emphasized the need to broaden the tax base, while taking account of local conditions.
Directors noted the bleak prospects for the sugar industry, which has become a significant drain on the budget, and absorbs a substantial share of bank credit. They encouraged the authorities, in their pursuit of a lasting and generally acceptable solution, to explore all possibilities, including reallocation of land and labor now absorbed by sugar production to other uses while ensuring adequate social protection for those affected. Directors supported efforts to develop alternative employment opportunities in other types of agriculture and in tourism, although a few Directors advised against over-dependence on the latter.
Directors noted that the stability of the domestic banking system had, over time, supported growth of the economy. They also took note of the possible impact on the banking system arising from the problems of the sugar sector, and urged that any arrangements adopted to address these problems be fully transparent. In addition, Directors called for greater supervision of commercial banks' investments in real estate.
Directors noted the rapid growth of the offshore financial sector. They stressed that the authorities must step up efforts to enhance supervision, combat money laundering, and investigate financial crimes, and urged them to adopt a regulatory and supervisory framework for the offshore financial sector that meets international best practices. Directors welcomed the start that the authorities have made in addressing these issues, including their request for an FSAP-type assessment of financial sector vulnerabilities. They encouraged the provision of appropriate Fund technical assistance in this area.
Directors considered that the exchange rate system operated by the Eastern Caribbean Central Bank has served the country well in maintaining macroeconomic stability and low inflation. To preserve competitiveness and promote the needed diversification of the economy, Directors saw determined pursuit of structural reform measures as essential. These measures should include training and other means to raise productivity, as well as steps to increase flexibility in labor and product markets. Directors encouraged the authorities to harmonize the tariff structure with the common external tariff of the CARICOM area and to eliminate quantitative import restrictions.
Directors emphasized the importance of strengthening the statistical base, including labor statistics, to permit a fuller assessment of economic developments. They suggested that the authorities seek Fund technical assistance to address these data deficiencies.