Public Information Notice: IMF Concludes Discussion on the Eastern Caribbean Currency Union

September 7, 2004


Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

On May 5, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the discussion of regional surveillance on the Eastern Caribbean Currency Union.1

Background

Macroeconomic conditions in the region weakened considerably since the mid 1990s, with the growth of real GDP slowing from an average annual rate of nearly 5 percent during 1980-95 to about 2¼ percent since then. The slowdown in economic activity has reflected increased competition from lower-priced tourist destinations, the global economic slowdown, and the gradual reduction in preferential trade arrangements. Inflation has remained subdued, with consumer prices rising on average by less than 2 percent per year. Economic activity picked up in 2003, as a result of the favorable external environment as tourism and the global economy strengthened, and benefits accrued from the recent depreciation of the U.S. dollar.

The fiscal position of the governments in the region has deteriorated sharply in recent years—due to a combination of adverse exogenous shocks and policy slippages—and resulted in a marked increase in public sector debt. The overall balance of the central government for the ECCU as a whole widened from a deficit of 3 percent of GDP in 1998 to 10½ percent of GDP in 2002. The overall deficit narrowed sharply in 2003 to about 6 percent of GDP, primarily as a result of a reduction in capital spending due to one-off factors such as the completion of some large projects. The current balance improved by 1½ percent of GDP in 2003, but remained in deficit. Consequently, public sector debt grew rapidly to 103 percent of GDP in 2003, and the debt stocks of the countries in the region ranged between 66-163 percent of GDP in 2003.

The external current account deficit remained at 19½ percent of GDP in 2002 and 2003, having increased moderately from 2001 as a result of the weaker economy. Tourism receipts strengthened in 2002 and 2003 but were offset by a rise in imports, in part due to a sharp increase in imports for construction, hotels and communication. In turn, foreign direct investment grew sharply in 2003 and, as in recent years, a positive overall external balance was recorded as overall capital inflows remained robust. Gross international reserves of the Eastern Caribbean Central Bank (ECCB) have continued to rise, to US$540 million at end-2003, and have remained at comfortable levels in recent years.

Monetary aggregates have continued to expand rapidly, relative to the region's output growth rates, despite increasing pressures on the health of the banking system. Broad money grew by 6½ percent in 2002 and by 9½ percent in 2003, as deposits with the banking sector rose despite a reduction in the minimum savings deposit rate from 4 percent to 3 percent in September 2002. Net lending to the public sector contracted sharply, as governments made increasing recourse to external borrowing and government social security funds built up deposits with the banking system. Private sector credit growth—principally loans to individuals, mostly for housing—declined to 2 percent in 2002 and to 1 percent in 2003, as interest rates did not adjust to the excess liquidity in the banking system. Despite the high interest rate spread, the rate of return on bank assets is low. Efforts in the region have focused on strengthening the supervisory and regulatory regimes in both the domestic banking sector and the offshore financial sector. As a result, none of the countries are now included on the Financial Action Task Force's (FATF) listing of noncooperative areas for inadequate anti-money laundering policies in the offshore financial sector.

Executive Board Assessment

Directors noted that since the mid-1990s the region had faced lackluster economic growth associated with a series of adverse shocks, including natural disasters, the dismantling of preferential trade agreements in bananas and sugar, the decline in activity in the offshore financial centers, weaknesses in the global economy, and the effects of September 11. In response to these shocks, the ECCU countries pursued expansionary fiscal policies in an effort to generate growth, create employment, and maintain living standards. However, these policies had also led to a rapid increase in debt levels and a weak fiscal position in many countries.

Directors welcomed the pick up in economic activity in 2003, and urged the authorities to adopt upfront comprehensive measures to strengthen the fiscal position and bring down the debt rapidly, while at the same time undertaking reforms aimed at reinvigorating growth. These reforms should focus on improving the business environment and competitiveness, including through lowering labor costs, providing for greater flexibility and integration of the labor and goods markets, and reducing the role of the public sector. Enhanced regional cooperation could also help broaden markets and provide opportunities to achieve economies of scale. Directors emphasized the need to build consensus and public support for this strategy across the region.

Directors underscored the importance of steps to reduce the sources of vulnerability in the region. They suggested that emphasis be placed on decreasing reliance on traditional agriculture, strengthening underlying fiscal positions, and enhancing the effectiveness of financial sector supervision. It would also be important to strengthen the region's institutional capacity to mitigate the effects of natural disasters, and to develop contingency plans to respond to a sudden deterioration in the global or regional environment.

Directors took note of the efforts being made in some countries to strengthen the fiscal situation. They recommended that prompt and significant fiscal consolidation, together with improved debt management, will be needed to reduce the risks to the currency union. Further progress toward fiscal consolidation will require expenditure restraint and effective spending control—in particular over wages and capital projects. On the revenue side, they called for a broadening of the tax base, particularly by a concerted, regional approach to reducing the wide range of tax concessions, and improved tax administration. Directors suggested that consideration should be given to introducing a value-added tax. More effective fiscal management would also be furthered by enhancing transparency and the quality and timeliness of fiscal data. In the most highly-indebted countries additional measures will likely be required—including asset sales and growth-enhancing structural reforms.

Directors encouraged the authorities to ensure the consistency of national fiscal policies with the region's currency board arrangement. In this regard, they expressed concern about the lack of adherence by most countries to the ECCB's fiscal benchmarks and recommended that governments make credible commitments to align their fiscal policies and targets with the requirements of the currency board arrangement. In this connection, Directors welcomed efforts to develop home-grown stabilization programs under the Structural Adjustment and Technical Assistance Project (SATAP), which benefits from technical assistance from the Caribbean Technical Assistance Center (CARTAC).

Directors stressed that preserving the currency board arrangements operated by the ECCB depends on the sustainability of the region's fiscal and debt situation and a sound financial sector which is effectively regulated. Directors supported the conclusions of the Financial System Stability Assessment, which found continued confidence in the financial system, however, they agreed that there is scope for strengthening financial sector supervision. In this regard, Directors encouraged the authorities to implement the Financial Sector Assessment Program recommendations, and suggested that the role of the ECCB in this area should be strengthened, particularly with respect to the domestic banks. Directors looked forward to continued full implementation of AML/CFT measures by all ECCU member countries.

Directors urged the national and regional authorities to strengthen the coverage, timeliness, and quality of the region's statistical data and data-management practices, particularly in the fiscal and debt areas, the national accounts, external sector, and labor markets. They emphasized that data improvements would go a long way toward helping the authorities assess economic and financial conditions, and implement appropriate and timely policies, including the home-grown adjustment programs.

Eastern Caribbean Currency Union: Selected Economic Indicators


 

2000

2001

2002

Prel.
2003

Proj.
2004


(Annual percentage change)

Real sector

Real GDP

2.8

-1.3

0.2

2.4

2.5–3.5

GDP deflator

1.3

1.8

1.0

1.0

1.5

Consumer prices, end of year

3.1

2.0

0.8

1.5

1.5

           

(In percent of GDP) 1/

Public finances

Central government overall balance

-6.4

-7.8

-10.5

-5.9

-5.4

Revenues and grants

27.0

26.4

27.9

28.6

28.4

Expenditure and net lending

33.4

34.2

38.4

34.5

33.8

Total public sector debt

77.7

84.0

101.2

102.8

103.1

(In percent of GDP, unless otherwise indicated)

External sector

Current account balance

-15.5

-16.7

-19.6

-19.5

-19.1

Trade balance

-37.6

-35.4

-34.5

-37.3

-36.6

Travel

28.2

26.2

24.7

27.3

27.8

Exports, f.o.b. 2/

9.7

-15.6

2.4

-5.6

11.0

Imports, c.i.f. 2/

3.1

-8.1

0.4

8.2

4.5

Stayover visitors 2/

0.2

-5.1

2.1

7.5

5.3

(Percentage change)

Money and credit

Net foreign assets 3/

-1.5

7.0

5.9

9.1

2.8

Net domestic assets 3/

12.1

-1.1

0.7

0.7

3.7

Broad money

10.6

5.9

6.6

9.7

6.5


Sources: Data provided by the authorities, and IMF staff estimates.

1/ Excludes Anguilla and Montserrat.
2/ Annual percentage change.
3/ In relation to broad money at the beginning of the period.


1 The regional perspective of such discussions is intended to strengthen the bilateral discussions that the IMF holds with the members in the region under Article IV of the IMF's Articles of Agreement. A staff team visits the region, collects economic and financial information, and discusses with officials in the region the region's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country authorities in the region and this PIN summarizes the views of the Executive Board.





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