## 1. Stronger Growth and External Balance on Account of Rising Tourism Inflows ## Source details **Canonical URL:** [1. Stronger Growth and External Balance on Account of Rising Tourism Inflows](https://www.imf.org/-/media/files/publications/cr/2018/cr18179.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18179.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18179.pdf.json) --- ### Context and vulnerabilities - Economy increasingly dependent on tourism following downsizing of banana production in the 1990s. - Key vulnerabilities: narrow economic base, shallow financial system, almost complete reliance on imported fossil fuel, low productivity, weak institutional capacity, and exposure to natural disasters. - Natural disaster and climate change exposure: - Average annual damages exceeding 1 percent of GDP. - In a high CO2 emissions scenario, the average impact of natural disasters would increase from 3½ percent of GDP or more to at least 5 percent of GDP. - Authorities’ policy actions: enhancing tourism potential, tax adjustments (reducing VAT, increasing aviation taxes and road fuel tax), Citizenship-by-Investment Program (CIP) revenue measures, efficiency improvements in the public sector, and investment planning for climate mitigation and adaptation. - Concessional financing secured from Taiwan, Province of China (airport US$100 million; road network US$50 million) — terms to be finalized. ### Current trends and key statistics - Real GDP growth in 2017: 3 percent. - Tourism and related capacity: - Stay-over arrivals grew by 11 percent. - Room stock increased by about 10 percent. - Airlift capacity increased by 5 percent. - External accounts and labor market: - Current account balance: deficit of 1.9 percent of GDP in 2016 to estimated surplus of 1.3 percent of GDP in 2017. - Unemployment: declined from 21.3 percent in 2016 to 20.2 percent in 2017. - Youth unemployment: 38.5 percent. - Labor force participation has fallen (71.4 in 2017; historical series provided). - Inflation: turned positive after two years of oil-price related deflation; consumer prices, end of period: 2.2 (2017 est.). - Fiscal stance FY2017/18: primary surplus declined due to increases in current and capital spending; overall fiscal deficit and public debt continued to rise. ### Banking and financial sector indicators - Nonperforming loans (NPLs): 12.5 percent of total loans in 2017 (NPL ratio in 2017Q4: 12.5 percent). - Credit contraction: credit to the private sector contracting since 2013; credit to private sector (real) growth: -2.0 (2017). - Credit unions: assets and membership grew by 42 percent and 20 percent respectively since 2014; total assets of credit unions ~15 percent of total assets of banks in 2017. - Banking soundness selected indicators: - Regulatory capital to risk-weighted assets (CAR) in 2017: 18.2 percent. - ROAA: 1.2 (2017); ROAE: 27.1 (2017) noted in table (profitability low/volatile). - Provisions for NPLs: 5.5 (2017, millions in table context). ### Outlook and risks - Short-term outlook: favorable—growth buoyant near term supported by large infrastructure investment, tourism-related FDI, and continued tourist inflows. - Medium-term outlook: growth expected to decline gradually as pipeline projects complete; current account deficit to narrow thereafter. - Downside risks dominate: policy uncertainty in major advanced economies, tighter global financing, tax erosion from concessions, risks related to compliance with international tax rules, slow progress on bank weaknesses, growth of non-bank financial sector, and climate change/natural disasters. - External position: broadly consistent with fundamentals and desirable policies but competitiveness challenges persist due to poor business environment and disconnect between wages and productivity. --- ### Fiscal Position, Debt Dynamics, and Adjustment Scenario ### Origins and recent developments - Wage bill increased by 2 percent of GDP from 2007 to 2012 (not including temporary work programs). - GDP revision impact: 2016 nominal GDP increased by 19 percent, public debt ratio fell from 82 percent to 69.2 percent of GDP (fiscal year basis). - Projected public sector debt: 81.3 percent of GDP in 2023. - External debt expected to increase to 74.9 percent of GDP by 2023 (Annex IV). ### Baseline projections (selected, percent of GDP) - Real GDP growth: 2018 3.5; 2019 3.7; 2020 3.1; 2021 2.2; 2022 1.6; 2023 1.5; 2030 1.5 - Grant revenue: 1.4 (2018–2023) and 1.4 (2030) - Interest payments: 3.6 (2018); 3.6 (2019); 3.8 (2020); 4.0 (2021); 4.2 (2022); 4.3 (2023); 5.4 (2030) - Capital expenditure: 5.7 (2018); 6.3 (2019); 4.6 (2020–2023); 4.6 (2030) - Primary balance: -1.0 (2018); -2.1 (2019); -0.2 (2020); -0.1 (2021); 0.0 (2022); -0.1 (2023); -0.1 (2030) - Public sector debt: 72.2 (2018); 74.6 (2019); 75.5 (2020); 77.2 (2021); 79.2 (2022); 81.3 (2023); 96.6 (2030) ### Staff adjustment scenario (2.7 percent of GDP cumulative adjustment over six years) — selected projections (percent of GDP) - Real GDP growth: 2018 3.8; 2019 4.0; 2020 3.5; 2021 2.6; 2022 1.9; 2023 1.9; 2030 1.7 - Grant revenue: 2018 1.4; 2019–2022 1.9; 2023 1.9; 2030 1.4 - Interest payments: 3.6 (2018); 3.6 (2019); 3.7 (2020); 3.9 (2021); 4.0 (2022); 3.9 (2023); 3.6 (2030) - Capital expenditure: 5.7 (2018); 6.8 (2019); 5.1 (2020); 5.1 (2021–2023); 4.6 (2030) - Primary balance: -1.1 (2018); -1.5 (2019); 0.6 (2020); 1.7 (2021); 2.7 (2022); 2.7 (2023); 2.9 (2030) - Public sector debt: 72.2 (2018); 73.6 (2019); 73.4 (2020); 72.9 (2021); 71.7 (2022); 70.5 (2023); 60.0 (2030) - Adjustment measures by year (total percent of GDP): 0.0 (2018); 0.6 (2019); 0.8 (2020); 1.7 (2021); 2.6 (2022); 2.7 (2023) ### Key recommended fiscal measures (staff-estimated contributions where provided) - Reduce the wage bill closer to pre-crisis level by anchoring it to CPI inflation during the adjustment period; measures include general wage control, performance-based pay, attrition, payroll audits, and private sector participation (1.2 percent). - Streamline exemptions to VAT and zero-rated items to reverse the impact of the recent rate cut (0.6 percent). - Eliminate energy subsidies, allow fuel prices to move in line with international prices, and introduce a carbon tax (1.1 percent). - Phase out temporary work programs while increasing targeted social spending; phase-out contribution 0.3 percent and social protection to offset carbon tax impact -0.5 percent. - Build a saving fund for natural disasters of 5 percent of GDP by 2021, financed by CIP revenues, carbon taxation, with governance based on international best practices. - Increase investment in resilience to climate change and natural disasters. - Consider other revenue measures (streamline other tax exemptions; consider sin taxes). ### Distributional and design features - Protect poor households by including targeted social assistance (expected in place by year end). - Memo: 10 percent of carbon tax revenue to offset negative impact on bottom quintile (per table footnote). --- ### Public Financial Management, Fiscal Rule, and PFM Reforms ### Fiscal rule design and role - Enshrine a fiscal rule in fiscal responsibility legislation to define institutional arrangements, coverage of government and fiscal aggregates, implementation procedures (including links with the budget process and escape clauses), automatic correction mechanisms, and sanctions and supporting mechanisms for transparency and accountability. - Possible rule features: - Base the rule on the ECCU debt target for 2030. - Include a cap on the wage bill (in percent of GDP); such a cap proved useful in Grenada. - Accommodate buildup and annual replenishment of a natural disaster fund (estimated at 0.6 percent of GDP) and include clauses linking disbursements to natural disasters. - Savings fund estimates and staff recommendation: - Staff estimates that a savings fund of 8 percent of GDP, replenished on a rolling basis, would be sufficient to cover fiscal costs of natural disasters without incurring additional debt with 95-percent probability (SM/18/131). - Staff recommends a savings fund of 5 percent of GDP, with a strong governance framework, to provide necessary resources for relief and reconstruction without increasing public debt when disasters occur. - Draft PFM law includes annual flows to the contingency fund of 0.5 percent of revenues (authorities noted this may be small). ### PFM and public investment management priorities - Remaining weaknesses: budget implementation, dissemination of fiscal planning documents, financial information on large parastatals, public procurement, payroll, and other payment controls. - PEFA action-plan measures: - Revise the Public Enterprise Monitoring (PEM) Act and the PFM Act to expand coverage of parastatals. - Clear the backlog and improve annual financial statements of public institutions. - Strengthen procurement planning, operations, and transparency. - Resume the public-sector investment plan (PSIP) and strengthen appraisal and monitoring. - Tax expenditures and incentives: - Increase transparency on tax expenditures; introduce comprehensive budgeting and regular publication. - Rationalize tax incentives and introduce a rules-based approach to minimize discretion and reduce risk of base erosion. --- ### Financial Sector: Immediate Actions, Risks, and Reforms ### Immediate supervisory priorities - Rapid approval of new foreclosure and insolvency legislation is needed for the resolution of NPLs and resumption of bank lending. - Use representation powers on the ECCB Monetary Council to ensure the ECAMC can efficiently collect and dispose of distressed assets. - With imminent implementation of IFRS9 and prudential regulations, indigenous banks’ capitalization must be increased. - Strengthen monitoring and supervision of credit unions and microfinance companies; approve regionally harmonized regulation rapidly. - Swift adoption of the Harmonized Credit Reporting Act and creation of a credit bureau to contain future NPL losses and facilitate intermediation. - Mitigate CBR pressure via strengthened AML/CFT regime, risk-based supervision, governance and due diligence for the CIP, and addressing tax compliance gaps; consider transferring AML/CFT supervisory powers to the ECCB in the medium term. ### Structural vulnerabilities and priorities to boost growth - Main bottlenecks: limited access to credit, weak contract enforcement, high electricity and trading costs; Doing Business ranking deteriorated. - Measures under way: commercial court, e-payment for government services, online trade-license application system. - Recommended: national competitiveness strategy with Compete Caribbean; remove cap for solar energy production; consider lower import duties for raw materials; institute credit bureau; broaden collateral types; regulate non-bank financial sector. - Labor market and education: reform labor code (redundancy procedures, leave practices); upgrade skills through targeted training, apprenticeships, entrepreneurship promotion, and better alignment of education with labor market needs. - Diversification: strengthen tourism backward linkages with agriculture; business processing, ICT, creative industries, and spa and wellness identified as diversification areas. ### Correspondent banking and reputational risks - Loss of CBRs limited for indigenous banks but affected money service businesses and offshore sector. - Fees for many operations increased substantially in the last two years (from 50 to 100 percent in some cases). - Reputational risks from the CIP and international taxation regime changes; St. Lucia has been included by the EU in a “grey list”; authorities committed to adjust rules and practices. --- ### Natural Disaster Resilience: Savings Fund vs Adaptation Investment (Model and Policy Findings) ### Model calibration and disaster parameters - Observed average annual disaster losses in St. Lucia: - Public capital loss: 1 percent of GDP. - Private capital loss: 0.5 percent of GDP. - Depreciation rates: - adaptation capital depreciates at 3% - standard infrastructure depreciates at 6% - Savings fund calibration: a savings fund capitalized at 8 percent of GDP and replenished annually with 0.9 percent of GDP would have a 95 percent chance of non-depletion (footnote). - Baseline calibration includes continuous natural disaster shocks generating observed yearly losses. ### Alternative resilience policies (simulation setup) - Policy 1: Do nothing. - public investment kept at initial level; no reconstruction of lost public capital. - Policy 2: Financial protection. - government receives a grant of 8 percent of initial GDP to build a natural savings fund; fund used exclusively to finance reconstruction; assumed annual interest rate on public debt is 50 basis points lower than under alternatives. - Policy 3: Structural protection. - government receives a grant of 8 percent of initial GDP to invest in adaptation capital; adaptation dampens damages though full reconstruction may be limited; share of adaptation capital in total public capital is 23.5 percent in baseline. ### Key threshold and policy preference - Indifference reconstruction threshold: government must be able to rebuild 85 percent of the destroyed capital (reconstruction fraction = 0.85) for structural protection (Policy 3) to be as effective as financial protection (Policy 2) over 15 years. - Scenario 1 (reconstruction fraction = 0.95): - Policy 3 delivers the lowest output loss; Policy 2 results in GDP about 1.5 percent lower than initial year; Policy 1 leads to loss of GDP of more than 3 percent after 15 years. - Tax revenue increases required: Policy 1 nearly 13 percentage points; Policy 2 about 10 percent of GDP; Policy 3 below 10 percent. - Scenario 2 (reconstruction fraction = 0.75): - Policy 2 (savings fund) preferable; Policy 3 leads to lower GDP level than Policy 2 with a loss of nearly 2 percent after 15 years. - Sensitivity: - If savings fund does not lower sovereign premium by 50 basis points, threshold falls to 83.5 percent. - If public investment efficiency under adaptation is 2.5 percent lower, threshold rises to 96 percent. - If adaptation and standard capital depreciate at same 6 percent, threshold increases to 87 percent. ### Policy-relevant conclusions - Do-nothing policy produces large permanent losses of capital, output, and growth, and large tax increases needed to meet fiscal targets. - Trade-offs: - Financial protection (savings fund) provides liquidity for reconstruction and may lower sovereign borrowing costs. - Structural protection (adaptation investment) reduces damages and can lower private sector cost of capital through resilient public capital. - For St. Lucia, structural protection preferred if reconstruction capacity ≥ 85 percent; otherwise financial protection preferred. - Policies are complementary; optimal resilience strategy likely requires both financial protection and structural protection. --- ### Debt Sustainability, Stress Tests, and Interest-Rate Pass-Through ### Debt sustainability main findings - Public debt is unsustainable under current policies; projected public debt: 81.3 percent of GDP by 2023. - Baseline public debt rises throughout medium term mainly due to primary deficits and positive interest rate-growth differentials. - Primary deficits over the projection period average 0.5 percent of GDP; debt-stabilizing primary surplus is 2.1 percent. ### Stress-test results (selected outcomes) - Growth shock: debt peaks at 86.1 percent in 2023 (5.5 points higher than baseline). - Primary balance shock: debt-to-GDP 83.5 percent by 2023 (2.9 points higher). - Interest rate shock (sustained 633 basis points): debt ratio increases to 88.9 percent by 2023 (8.3 points higher). - Combined macro-fiscal shock: debt exceeds 100 percent of GDP over the medium term; gross financing needs increase by 8.7 percentage points by 2023. - Natural disaster shock (Hurricane Tomas–like in 2019): debt-to-GDP 89.2 percent by 2023 (8.6 points above baseline). - Adjustment scenario (staff policies): debt-to-GDP declines to 66.9 percent in 2023, 13.7 percentage points lower than baseline; gross financing needs decline by 8 percentage points by 2023 to 10.5 percent of GDP. - Contingent liability shock: assuming government assumes 10 percent of banking sector’s total assets and a 1 standard deviation GDP shock, debt-to-GDP increases by 16.2 percentage points in 2023. ### External debt and vulnerabilities - External public debt projected to increase from 69.3 (2017 est.) to 74.9 (2023). - Sensitivity: real depreciation shock most adverse — external debt-to-GDP increases to 109 percent in 2023 (34 points higher than baseline). - Reserve coverage: imputed net international reserves about 17 percent of GDP in 2017, about 3.8 months of imports and 25 percent of broad money (exceeds benchmarks). ### Interest-rate pass-through and public-debt implications (Annex V) - Empirical findings: - US short-term interest rates have full pass-through to St. Lucia’s foreign-currency lending rates. - US short-term interest rates have partial pass-through to instruments issued in local currency. - Public debt simulations (2030 outcomes): - Full pass-through scenario: debt reaches 101.3 percent of GDP by 2030. - Null pass-through scenario: debt reaches 88.4 percent of GDP by 2030. - Difference between scenarios: 13 percentage points of GDP. - Baseline stochastic simulation with partial pass-through: - By 2030, stock of debt would reach between 93.9 and 97.8 percent of GDP (95 percent confidence interval). - Implication: given unsustainable debt path, developments in international interest rates should be cautiously considered in debt strategy to reach ECCU regional debt target of 60 percent of GDP by 2030. --- ### Staff Appraisal and Policy Recommendations (Selected) ### Macro-fiscal and fiscal policy - Short-term growth prospects remain good; medium-term outlook challenging. - Public debt unsustainable under current policies; recommend: - Streamline extensive tax exemptions that undermine the revenue base. - Control government wage bill through wage moderation and public-sector reform. - Replace temporary work programs and non-targeted subsidies with targeted social assistance. - Increase reliance on concessional financing and longer-term instruments to reduce servicing costs and rollover risks. - Adopt a fiscal responsibility framework aligned with ECCU debt target. ### Climate change and disaster resilience - Investment plans under the National Adaptation Plan should be costed and integrated into development plans and fiscal medium-term frameworks; financing strategy should be based primarily on grants. - Financial protection requires a layered approach: self-insurance, insurance, and financial innovation; staff recommend a savings fund of 5 percent of GDP with strong governance. - Recommend introducing a carbon tax gradually with appropriate compensation for low-income households; carbon tax revenue could help finance resilience. ### Financial sector and structural reforms - Rapid approval of foreclosure and insolvency laws; strengthen supervision, capitalization, and resolution frameworks (ECAMC). - Complete credit bureau establishment and harmonized credit-union legislation. - Address reputational risks and AML/CFT gaps; improve CIP due diligence. - Remove structural impediments to boost competitiveness: reduce electricity and trading costs, improve access to credit, reform labor market, and pursue diversification (business processing, ICT, creative industries, spa & wellness). --- *International Monetary Fund staff summary based on the St. Lucia country report content provided (cr18179).* ### 1. Stronger Growth and External Balance on Account of Rising Tourism Inflows _________________ 18 ### 1. Stronger Growth and External Balance on Account of Rising Tourism Inflows ### Context - St. Lucia’s economy is increasingly dependent on tourism following the downsizing of banana production in the 1990s. - Key vulnerabilities: narrow economic base, shallow financial system, almost complete reliance on imported fossil fuel, low productivity, weak institutional capacity, and exposure to natural disasters. - Natural disaster and climate change exposure: - Average annual damages exceeding 1 percent of GDP. - In a high CO2 emissions scenario, the average impact of natural disasters would increase from 3½ percent of GDP or more to at least 5 percent of GDP. - Authorities’ policy actions: enhancing tourism potential (marketing, new international hotel operators), tax adjustments (reducing VAT, increasing aviation taxes and road fuel tax), Citizenship-by-Investment Program (CIP) revenue measures, efficiency improvements in the public sector, and investment planning for climate mitigation and adaptation. ### Current Trends and Key Statistics - Real GDP growth in 2017: 3 percent. - Tourism and related capacity: - Stay-over arrivals grew by 11 percent. - Room stock increased by about 10 percent. - Airlift capacity increased by 5 percent. - External accounts and labor market: - Current account balance: deficit of 1.9 percent of GDP in 2016 to estimated surplus of 1.3 percent of GDP in 2017. - Unemployment: declined from 21.3 percent in 2016 to 20.2 percent in 2017. - Youth unemployment: 38.5 percent. - Labor force participation has fallen. - Inflation: turned positive after two years of oil-price related deflation. - Fiscal stance FY2017/18: primary surplus declined due to increases in current and capital spending; overall fiscal deficit and public debt continued to rise. - Concessional financing secured from Taiwan, Province of China (airport US$100 million; road network US$50 million) — terms to be finalized. ### Banking and Financial Sector - Nonperforming loans (NPLs): 12.5 percent of total loans in 2017. - Credit contraction: credit to the private sector contracting since 2013; legacy NPLs contributing to low profitability. - Eastern Caribbean Asset Management Company (ECAMC) started operating but faces capacity challenges. - New insolvency and foreclosure laws: still under preparation. - Credit unions: assets and membership grew by 42 percent and 20 percent respectively since 2014; total assets of credit unions ~15 percent of total assets of banks in 2017. - Banking soundness indicators (selected): - Regulatory capital to risk-weighted assets (CAR) in 2017: 18.2 percent (memo item series). - NPL ratio change (annual) series showing declines in recent quarters; NPL ratio in 2017Q4: 12.5 percent. - ROA and ROE series show periods of negative profitability and volatility across 2014–2017 quarters. ### Outlook and Risks - Short-term outlook: favorable—growth buoyant near term supported by large infrastructure investment, tourism-related FDI, and continued tourist inflows. - Medium-term outlook: growth expected to decline gradually as pipeline projects complete; current account deficit to narrow. - Fiscal and financial risks: - Without corrective fiscal measures, public sector wage negotiations and rising interest rates will add to expenditure pressures and government debt. - Downside risks dominate: policy uncertainty in major advanced economies, tighter global financing, tax erosion from concessions, risks related to compliance with international tax rules, slow progress on bank weaknesses, growth of non-bank financial sector, and climate change/natural disasters. - External position: broadly consistent with fundamentals and desirable policies but competitiveness challenges persist due to poor business environment and disconnect between wages and productivity. ### Fiscal Position and Debt Dynamics - Origins of deterioration: expansion of public service payroll and wage rises after the GFC; wage bill increased by 2 percent of GDP from 2007 to 2012 (not including temporary work programs). - Public debt trajectory: - Projected public sector debt: 81.3 percent of GDP in 2023. - External debt expected to increase to 74.9 percent of GDP by 2023 (Annex IV). - GDP revision impact: 2016 nominal GDP increased by 19 percent, public debt ratio fell from 82 percent to 69.2 percent of GDP (fiscal year basis). - Staff note on interest-rate passthrough uncertainty; even with no passthrough, debt trajectory would remain unsustainable. ### Policy Recommendations and Adjustment Scenario (Staff) - Overall required adjustment: fiscal adjustment of 2.7 percent of GDP over the next six years to attain ECCU debt target of 60 percent of GDP by 2030. - Key recommended measures (with staff-estimated fiscal contribution where provided): - Reduce the wage bill closer to pre-crisis level by anchoring it to CPI inflation during the adjustment period; measures include general wage control, performance-based pay, attrition, payroll audits, and private sector participation (1.2 percent). - Streamline exemptions to VAT and zero-rated items to reverse the impact of the recent rate cut (0.6 percent). - Eliminate energy subsidies, allow fuel prices to move in line with international prices, and introduce a carbon tax (1.1 percent). - Phase out temporary work programs while increasing targeted social spending; phase-out contribution 0.3 percent and social protection to offset carbon tax impact -0.5 percent. - Build a saving fund for natural disasters of 5 percent of GDP by 2021, financed by CIP revenues, carbon taxation, with governance based on international best practices. - Increase investment in resilience to climate change and natural disasters. - Consider other revenue measures (streamline other tax exemptions; consider sin taxes). - Design features to protect poor households: - Inclusion of targeted social assistance (expected in place by year end) to protect low-income households when some measures are enacted. - Memo: 10 percent of carbon tax revenue to offset negative impact on bottom quintile (per table footnote). ### Baseline and Adjustment Scenario Projections (Selected rows, in percent of GDP unless otherwise noted) - Baseline (no policy adjustment) scenario: - Real GDP growth: 2018 3.5; 2019 3.7; 2020 3.1; 2021 2.2; 2022 1.6; 2023 1.5; 2030 1.5 - Grant revenue: 1.4 (2018–2023) and 1.4 (2030) - Interest payments: 3.6 (2018); 3.6 (2019); 3.8 (2020); 4.0 (2021); 4.2 (2022); 4.3 (2023); 5.4 (2030) - Capital expenditure: 5.7 (2018); 6.3 (2019); 4.6 (2020–2023); 4.6 (2030) - Primary balance: -1.0 (2018); -2.1 (2019); -0.2 (2020); -0.1 (2021); 0.0 (2022); -0.1 (2023); -0.1 (2030) - Public sector debt: 72.2 (2018); 74.6 (2019); 75.5 (2020); 77.2 (2021); 79.2 (2022); 81.3 (2023); 96.6 (2030) - Adjustment scenario (2.7 percent of GDP cumulative adjustment): - Real GDP growth: 2018 3.8; 2019 4.0; 2020 3.5; 2021 2.6; 2022 1.9; 2023 1.9; 2030 1.7 - Grant revenue: 2018 1.4; 2019–2022 1.9; 2023 1.9; 2030 1.4 - Interest payments: 3.6 (2018); 3.6 (2019); 3.7 (2020); 3.9 (2021); 4.0 (2022); 3.9 (2023); 3.6 (2030) - Capital expenditure: 5.7 (2018); 6.8 (2019); 5.1 (2020); 5.1 (2021–2023); 4.6 (2030) - Primary balance: -1.1 (2018); -1.5 (2019); 0.6 (2020); 1.7 (2021); 2.7 (2022); 2.7 (2023); 2.9 (2030) - Public sector debt: 72.2 (2018); 73.6 (2019); 73.4 (2020); 72.9 (2021); 71.7 (2022); 70.5 (2023); 60.0 (2030) - Adjustment measures by year (total percent of GDP): 0.0 (2018); 0.6 (2019); 0.8 (2020); 1.7 (2021); 2.6 (2022); 2.7 (2023) - Breakdown (examples, percent of GDP): - Compensation items: 0.5 (2018); 0.8 (2019); 1.0 (2020); 1.2 (2021); 1.2 (2022); 1.2 (2023) - Social benefits (including 10 percent of carbon tax revenue to offset impact on bottom quintile): -0.5 each year 2018–2023 - Natural disasters fund (transfer to): -1.4 (2018); -1.5 (2019); -1.6 (2020); -0.9 (2021); 0.0 (2022); 0.0 (2023) - Phase out temporary work programs: 0.3 each year 2018–2023 - Revenue items total: 1.1 (2018); 1.5 (2019); 1.6 (2020); 1.6 (2021); 1.7 (2022); 1.8 (2023) - Broader VAT base: 0.3 (2018); 0.6 (2019); 0.6 (2020); 0.6 (2021); 0.6 (2022); 0.6 (2023) - CCPA-recommended carbon tax: 0.6 (2018); 0.7 (2019); 0.8 (2020); 0.8 (2021); 0.9 (2022); 0.9 (2023) - Eliminate non-targeted LPG subsidy: 0.2 (2018); 0.2 (2019); 0.2 (2020); 0.2 (2021); 0.2 (2022); 0.2 (2023) - Memo item: Natural Disasters Fund building path: 1.4 (2018); 2.8 (2019); 4.3 (2020); 5.0 (2021–2023) ### Financing and Implementation Notes - Under the baseline scenario, the government faces an annualized natural disaster cost of 1 percent of GDP, of which 0.66 percent is not covered by insurance. - In the adjustment scenario, a saving fund of 5 percent of GDP is built in 2018–2020, with annual replenishment costs of 0.56 percent of GDP. - Financing sources listed in staff calculations include CIP, carbon tax, elimination of LPG subsidy, and other measures as indicated in the adjustment scenario tables. _International Monetary Fund staff summary based on the St. Lucia country report content provided._ ### 14. Adopting a fiscal rule would support the adjustment effort, as it did in other ECCU ### 14. Adopting a fiscal rule would support the adjustment effort, as it did in other ECCU countries ### Fiscal rule design and role - Enshrine a fiscal rule in fiscal responsibility legislation to define: - appropriate institutional arrangements; - coverage of government and fiscal aggregates, with due consideration for capital spending; - implementation procedures — including links with the budget process and escape clauses —; - automatic correction mechanisms; and - sanctions and supporting mechanisms for enhanced fiscal transparency and accountability. - Possible rule features: - Base the rule on the ECCU debt target for 2030. - Include a cap on the wage bill (in percent of GDP); such a cap proved useful as a coordination device for public wage negotiations in Grenada. - Accommodate buildup and annual replenishment of a natural disaster fund (estimated at 0.6 percent of GDP) and include specific clauses linking disbursements from the fund to natural disasters. - Savings fund estimates and context: - Staff estimates that a savings fund of 8 percent of GDP, replenished on a rolling basis, would be sufficient to cover fiscal costs of natural disasters without incurring additional debt with 95-percent probability (SM/18/131). - This estimate does not consider insurance coverage already provided by the Caribbean Catastrophe Insurance Facility (CCRIF) and private insurance, which can be approximated at some 3 percent of GDP. - In the staff appraisal, a savings fund of 5 percent of GDP, with a strong governance framework, is recommended to provide necessary resources for relief and reconstruction without increasing public debt when disasters occur. - The draft PFM law includes annual flows to the contingency fund of 0.5 percent of revenues (authorities noted this may be small to accumulate an adequate fiscal buffer). ### Public financial management (PFM) and public investment management - Progress and remaining weaknesses: - The 2017 PEFA report shows progress in several areas, reflecting TA support from CARTAC. - Remaining weaknesses: budget implementation, dissemination of fiscal planning documents, financial information on the large parastatal sector, public procurement, payroll, and other payment controls. - Key PEFA action-plan measures: - Revise the Public Enterprise Monitoring (PEM) Act and the PFM Act to expand coverage of parastatals. - Clear the backlog and improve annual financial statements of public institutions. - Strengthen procurement planning, operations, and transparency. - Resume the public-sector investment plan (PSIP) and strengthen appraisal and monitoring for effective implementation. - Tax expenditures and incentives: - Increase transparency on tax expenditures; introduce comprehensive budgeting and regular publication. - Rationalize the structure of tax incentives and introduce a rules-based approach to minimize discretion and reduce the risk of base erosion. ### Financial sector: soundness, resilience, and supervision - Nonperforming loans (NPLs) and lending: - NPLs have been gradually declining but remain high, reducing banks’ ability and willingness to lend to the private sector. - Some progress on new insolvency and foreclosure laws, albeit slowly. - Capitalization and regulatory changes: - Capitalization levels are low relative to the rest of the region. - Upcoming implementation of prudential regulations and introduction of IFRS9 could require some banks to increase capital to reach regulatory minimums. - Implementation of a regional credit bureau is advancing; adoption of the Harmonized Credit Reporting Act is still pending. - ECAMC and crisis management: - The ECAMC, operating since mid-2017, has shown capacity to act as a receiver for failed banks, but its ability to purchase and/or manage NPLs from regional banks is limited. The ECAMC needs additional resources and stakeholder commitment to become fully operational. - Credit unions and regulatory risks: - Rapid increase in credit union lending could affect banks via deposits held by credit unions in the banking system. - Expansion of credit unions may be driven by tighter bank credit standards, favorable taxation, and a looser regulatory environment. - The Financial Services Regulatory Authority has implemented risk-based supervision and intensified onsite inspections, but new harmonized legislation on credit unions has not been adopted yet. - Correspondent banking relationships (CBRs) and costs: - Loss of CBRs has been limited for indigenous banks but confined to money service businesses and the offshore sector. - Fees for most operations have increased substantially in the last two years (from 50 to 100 percent in some cases), though banks have not passed the additional cost to customers yet. - Banks reported additional allocation of resources to address AML/CFT requirements and rising cyber security risks. - Legislative changes to transfer AML/CFT supervisory powers to the ECCB are still pending. - Reputational risks: - Reputational risks arise from the Citizenship-by-Investment program (CIP) and international taxation regime changes. - St. Lucia has been included by the EU in a “grey list”; authorities committed to adjust their rules and practices. ### Removing structural obstacles to growth - Main bottlenecks: - Limited access to credit, weak contract enforcement, and high electricity and trading costs. - St. Lucia’s Doing Business ranking has deteriorated steadily in recent years. - Measures under way and recommended: - Implemented: establishment of a commercial court, e-payment for government services, online application system for trade licenses. - Further measures: prepare a national competitiveness strategy with Compete Caribbean; consider removing existing cap for solar energy production to reduce business costs; consider lower import duties for raw materials. - Reforms to institute a credit bureau and broaden collateral types, and appropriately regulate non-bank financial sector to improve access to credit. - Labor market and education: - High structural unemployment, relatively high wages, and disconnect between productivity and wages. - Continued revisions to the labor code, including reform of lengthy and costly redundancy procedures and generous leave practices. - Targeted initiatives: upgrade skills through targeted training programs, promote apprenticeships, encourage entrepreneurship, and better align education with labor market needs. - Diversification and exports: - Strengthen backward linkages of tourism, particularly in agriculture. - Export strategy identifies business processing, ICT, creative industries, and spa and wellness as diversification areas. - Establishment of OJO Labs (the Caribbean’s first Artificial Intelligence Contact Centre) to encourage investment in outsourcing. - Use business incubators to promote entrepreneurship; improve access to regional markets for agro-processing. ### The authorities’ position - Fiscal measures contemplated: - Revenue-enhancing measures: streamline exemptions to VAT, property tax reform, reform taxation of hotel stays, and a new residency program. Some measures contingent on a new system of targeted social assistance to be in place by year end. - On spending: continued wage moderation in the public sector is essential. - Considered measures: savings from privatizations, outsourcing of the largest public hospital, closure of some state-owned enterprises, modernization of government services, and pension reform for public employees not covered by the National Insurance Corporation. - Debt management: focus on lengthening maturity and reducing servicing costs. - Size of required fiscal adjustment: - Authorities estimated the required adjustment at about 1.5 percent of GDP based on a more optimistic view of interest rates and non-inclusion of natural disasters costs in their framework. - They agreed that a fiscal resilience framework, regardless of inclusion of a savings fund, would help sustain the adjustment effort and discussed a Development Policy Loan with the World Bank. - Disaster risk financing and climate resilience: - With World Bank assistance, authorities preparing a Disaster Risk Financing Strategy including insurance (CCRIF) and contingent financing (CAT-DDO); discussions with the World Bank were at an advanced stage. - Authorities noted challenges in building a savings fund of the size proposed by staff and suggested recapitalization of CCRIF supported by donors as a better option. - Noted progress on the renewables program and efforts to secure concessional financing from climate funds and multilaterals. - Financial sector reforms: - Authorities expect new legislation on foreclosure, insolvency, assets to be used as collateral, and credit reporting to be completed during the current fiscal year. - Support full operationalization of the ECAMC and measures to strengthen supervision and minimize CBR-related risks. - Committed to address gaps in compliance with international standards on tax rules by year end. - Structural reforms and competitiveness: - Agreed on addressing structural impediments to boost sustainable growth and reduce unemployment. - Efforts underway to ease access to credit, boost productivity via innovation and technology, and enhance education and skills for youth employability. - Continued focus on expanding tourism while pursuing diversification priority sectors in the new export strategy. ### Staff appraisal: main findings and recommendations - Growth outlook: - Short-term growth prospects remain good; medium-term outlook is challenging due to global risks, natural disasters, fiscal risks, structural bottlenecks, high production costs, and low productivity. - Fiscal policy and consolidation: - Public debt is unsustainable under current policies; large short-term component magnifies financing risks. - Recommended adjustment focus: - Streamline extensive tax exemptions that undermine the revenue base and tax efficiency. - Control the government wage bill through continued wage moderation and public-sector reform. - Replace temporary work programs and non-targeted subsidies with targeted social assistance when feasible. - Increase reliance on concessional financing and shift to longer-term instruments to reduce servicing costs and rollover risks. - Recommend a fiscal responsibility framework to provide operational targets consistent with the ECCU debt target and required discipline. - Climate change and disaster resilience: - Investment plans under the National Adaptation Plan should be costed and fully integrated into development plans and fiscal medium-term frameworks; prepare a financing strategy based primarily on grants. - Financial protection requires a layered approach: self-insurance, insurance, and financial innovation; high public debt implies self-insurance has a key role. - Recommend a savings fund of 5 percent of GDP with a strong governance framework; revenues from CIP, new residency program, and receipts from a carbon tax could finance the fund. - Recommend introducing a carbon tax gradually with appropriate compensation for low-income households; carbon tax would also reduce risks to attaining emission targets. - PFM and public investment: - Continue reforms to broaden coverage of public institutions, enhance timeliness and transparency of financial reporting, and strengthen procurement in line with the updated PFM Action Plan. - Revive the PSIP and strengthen project appraisal and monitoring to enhance public investment efficiency and support resilience-building strategies. - Rationalize tax expenditures across sectors with a transparent rules-based system to reduce base erosion risk and improve revenue predictability. *International Monetary Fund — Country Report content provided in the supplied PDF chapter.* ### 33. Financial sector policies need to address promptly legacy issues and emerging risks. ### 33. Financial sector policies need to address promptly legacy issues and emerging risks. ### Immediate financial sector actions and supervisory priorities - Rapid approval of new foreclosure and insolvency legislation is needed for the resolution of NPLs and the resumption of bank lending. - Authorities should use their representation powers on the ECCB Monetary Council to ensure that the ECAMC can efficiently collect and dispose of distressed assets. - In view of the imminent implementation of IFRS9, and of prudential regulations on provisioning and valuation, indigenous banks’ capitalization must be increased. - The rapid rise of lending from credit unions and microfinance companies calls for strengthened monitoring and supervision of these entities and a rapid approval of the regionally harmonized regulation. - A swift adoption of the Harmonized Credit Reporting Act and the creation of a credit bureau would help contain future losses from NPLs and facilitate financial intermediation. - CBR pressure would be mitigated by sustained efforts in strengthening the AML/CFT regime, including by risk-based supervision; reinforcing governance, transparency, and due diligence procedures of the CIP; addressing gaps in compliance with international tax rules; and deepening collaboration and information sharing between respondent and correspondent banks. - In the medium term, transferring AML/CFT supervisory powers to the ECCB would further reduce these risks. ### Structural impediments and diversification to boost sustainable growth - Addressing structural impediments and increasing economic diversification would boost sustainable growth and reduce external vulnerabilities. - This requires enhancing a weak investment climate and reducing labor market rigidities that delink productivity and wages. - Improving access to credit, including by completing the credit bureau, and reducing the comparatively high costs of trading and energy should remain priorities. - Training apprenticeship programs and better aligning the education system with labor market needs would help reduce structural unemployment, particularly among the youth. - Strengthening tourism backward linkages with agriculture, and developing sectors where economies of scale are less important, including business processing outsourcing, ICT, creative industries, and spa & wellness, are identified as promising avenues to increase diversification. ### ECCB governance and safeguards - The 2016 update safeguards assessment found that the ECCB continues to maintain a governance framework that provides for independent oversight. - Transparency in financial reporting has been maintained and the external audit mechanism is sound. - The ECCB has restructured the internal audit function and established an independent risk management unit in line with leading international practice. ### Data and statistical issues - Statistics are broadly adequate for surveillance. - However, the lack of historical data on the external sector based on BPM6 hampers the assessment of the external position. *cr18179 - 33. Financial sector policies need to address promptly legacy issues and emerging risks.* ### 37. Staff recommends that the next Article IV Consultation for St. Lucia take place on the ### Staff recommends that the next Article IV Consultation for St. Lucia take place on the standard 12-month cycle. ### Growth, tourism, inflation, and external balance - Stronger growth and external balance are attributed to rising tourism inflows and completion of major hotel projects. - Tourism and construction helped reduce unemployment. - Inflation has picked up on the back of higher fuel prices, only partially offset by lower food prices. - The current account moved into a small surplus (Figure caption: "...while the current account moved into a small surplus."). ### Financial sector: persistent weaknesses - Credit of commercial banks continued to decline in 2017. - Progress in reducing NPLs was slow. - Provisioning continued to increase in indigenous banks. - Bank capitalization recovered slightly, but profitability is still very low; rising U.S. interest rates may help profitability if they pass-through to the local market. - Key banking system indicators (Table 5 highlights): - Total assets: 130.5 (2017, in millions) - Gross loans: 76.1 (2017, in millions) - NPLs (o/w): 9.5 (2017) - Provisions for NPLs: 5.5 (2017) - CAR (indigenous banks): 18.2 (2017) - ROAA and ROAE show low/volatile profitability (ROAA 1.2 (2017); ROAE 27.1 (2017) noted in table). ### Fiscal baseline and adjustment scenarios (Central Government, percent of GDP / EC$) - The proposed adjustment scenario centers on: - Containing current expenditure. - Increasing capital expenditures for adaptation to natural disasters. - Reversing recent revenue losses and increasing grants to finance enhanced adaptation investment. - Delivering a higher primary surplus and overall fiscal surpluses consistent with the 2030 debt target. - Figure 3 components (percent of GDP, labels shown as Baseline vs Adjustment): - Current Expenditure: 21 ... 26 (chart labels showing years; exact values shown as sequences in figure). - Capital Expenditure: 0 ... 8 (baseline vs adjustment shown in chart). - Total Revenue, inc. Grants: 15 ... 29 (baseline vs adjustment shown). - Primary Balance: -5 ... 4 (baseline vs adjustment shown). - Overall Balance: -7 ... 0 (baseline vs adjustment shown). - Public Debt: 0 ... 120 (baseline vs adjustment shown). - Table 1 selected fiscal figures (percent of GDP unless otherwise specified): - Revenue: 23.3 (2014), 23.6 (2015), 24.3 (2016), 24.3 (2017 est.), projected 24.9 (2018), 24.8 (2019), 24.8 (2020), 25.0 (2021), 25.0 (2022), 25.0 (2023). - Expenditure: 26.7 (2014), 26.3 (2015), 26.0 (2016), 29.2 (2017 est.), projected 27.1 (2018), 28.8 (2019), 29.9 (2020), 28.1 (2021), 28.4 (2022), 28.5 (2023), 28.7 (2023 repeated). - Primary balance, excl. ND cost: 0.2 (2014), 0.8 (2015), 1.8 (2016), -2.5 (2017), 0.6 (2018), -0.4 (2019), -1.5 (2020), 0.5 (2021), 0.6 (2022), 0.6 (2023). - Central government debt (incl. guaranteed): 70.7 (2014), 67.8 (2015), 69.2 (2016), 70.7 (2017 est.), projected 72.2 (2018), 74.6 (2019), 75.5 (2020), 77.2 (2021), 79.2 (2022), 81.3 (2023). ### External competitiveness and structural weaknesses - Tourism appears competitive in the Caribbean, which is the most expensive region globally; other exports remain very low, indicating structural weaknesses. - Structural reforms suggested by figure captions as potential growth boosters include: - Deeper trade integration. - Greater human capital. - Greater ease of doing business. - Less debt, lower crime, lower disaster damage. - Constraints identified: low overall Doing Business ranking with particularly poor financial indicators; high electricity cost. ### Labor market and unemployment - Unemployment remains high by international standards despite recent decline. - Employment and labor force participation declined in 2017. - Youth unemployment remains very high; gender gap in unemployment narrowed slightly. - Strong growth reduced the gap between unit labor costs and productivity, but further narrowing is needed to align wages with regional levels. - Labor market indicators (Table 6): - Unemployment rate: 20.6 (2010), 21.2 (2011), 21.4 (2012), 23.3 (2013), 24.4 (2014), 24.1 (2015), 21.3 (2016), 20.2 (2017). - Youth unemployment rate: 33.6 (2010), 35.3 (2011), 33.9 (2012), 39.6 (2013), 41.8 (2014), 41.0 (2015), 38.4 (2016), 38.5 (2017). - Labor force participation rate: 67.9 (2010), 69.1 (2011), 71.0 (2012), 71.0 (2013), 71.9 (2014), 72.2 (2015), 72.8 (2016), 71.4 (2017). ### Key macroeconomic and balance of payments figures - Output and prices (Table 1, annual growth and projections): - Real GDP (at market prices): 3.6 (2014), -0.9 (2015), 3.4 (2016), 3.0 (2017 est.), projections 3.5 (2018), 3.7 (2019), 3.1 (2020), 2.2 (2021), 1.6 (2022), 1.5 (2023). - Consumer prices, end of period: 3.7 (2014), -2.6 (2015), -3.0 (2016), 2.2 (2017 est.), projections 1.4 (2018), 1.5 (2019), 1.5 (2020), 1.5 (2021), 1.5 (2022), 1.5 (2023). - Unemployment rate (% annual average): 24.4 (2014), 24.1 (2015), 21.3 (2016), 20.2 (2017 est.). - Balance of payments (Table 3, percent of GDP and US$ millions): - Current account balance (percent of GDP): 3.4 (2014), 6.9 (2015), -1.9 (2016), 1.3 (2017 est.), projections -1.5 (2018), -2.5 (2019), -1.1 (2020), 0.0 (2021), -0.3 (2022), -0.2 (2023). - Exports of goods and services (percent of GDP): 65.0 (2014), 64.1 (2015), 59.4 (2016), 63.6 (2017 est.), projected 62.9 (2018), 62.8 (2019), 62.8 (2020), 63.2 (2021), 63.4 (2022), 64.1 (2023). - Tourism (percent of GDP): 51.3 (2014), 49.9 (2015), 46.9 (2016), 50.7 (2017 est.), 49.3 (2018), 49.0 (2019), 48.9 (2020), 49.3 (2021), 49.3 (2022), 49.5 (2023). - Net imputed international reserves (millions of US$): 235.3 (2014), 308.7 (2015), 353.6 (2016), 379.6 (2017 est.), projected 397.1 (2018), 415.3 (2019), 432.4 (2020), 449.5 (2021), 467.7 (2022), 486.6 (2023). - Gross external debt (percent of GDP): 82.1 (2014), 72.4 (2015), 70.1 (2016), 69.3 (2017 est.), projected 71.0 (2018), 72.0 (2019), 72.4 (2020), 73.1 (2021), 73.9 (2022), 74.9 (2023). ### Monetary and credit developments - Broad money (M2) growth (12-month percent change): 1.2 (2014), 5.8 (2015), 2.3 (2016), 0.2 (2017), projection 4.8 (2018). - Credit to private sector (real): -9.9 (2014), -5.8 (2015), -4.8 (2016), -2.0 (2017), projections -1.5 (2018), -1.6 (2019), 3.1 (2020), 2.2 (2021), 1.6 (2022), 1.5 (2023). - Monetary survey (Table 4, end-period levels in millions of EC dollars): - Net foreign assets: -305.2 (2014), 268.4 (2015), 486.3 (2016), 820.0 (2017), projection 897.2 (2018). - Broad money (M2): 2,887.9 (2014), 3,054.7 (2015), 3,125.0 (2016), 3,132.4 (2017), projection 3,282.1 (2018). - Interest rate environment (Table 4 end-of-period rates): - ECCB policy rate: 6.50 (2014), 6.50 (2015), 6.50 (2016), 6.50 (2017). - US policy rate: 0.13 (2014), 0.13 (2015), 0.39 (2016), 0.97 (2017). - Weighted average lending rate: 8.54 (2014), 8.35 (2015), 8.15 (2016), 7.9 (2017). ### Staff recommendation (explicit) - Staff recommends that the next Article IV Consultation for St. Lucia take place on the standard 12-month cycle. *Source: IMF staff report excerpts and figures for St. Lucia (cr18179).* ### Annex I. Implementation of Previous Staff Advice ### Annex I. Implementation of Previous Staff Advice ### Progress on Prior Recommendations - Renewable energy - Government committed to attain 35 percent of energy through renewable sources by 2024. - Progress has been made on the implementation of the solar energy component. - Staff recommendation: Implement renewable energy initiatives; remove obstacles preventing more widespread adoption of solar energy and the passing of savings to final users. - Ports and customs - First stage of establishing a border control agency was completed. - An online entry system was introduced to clear goods, considerably shortening the process. - Staff recommendation: Continue modernization of port operations and customs; reduce costs to trade, including costs of port operations and import duties. - Labor and education - Authorities have indicated their intention to reform the education system, but no concrete steps have been taken. - Staff recommendation: Address skills mismatches and improve labor productivity by revising the national curriculum to match market demands and provide better training opportunities. - Fiscal adjustment and rules - Staff advised urgently developing and implementing a credible, medium-run adjustment strategy to achieve commitment to the regional debt target of 60 percent of GDP by 2030. - Recommended five-year adjustment equivalent to 4.4 percentage points of GDP based on: eliminating tax concessions; anchoring wage growth to CPI inflation; attrition; reduction in non-essential transfers and subsidies; reduction in goods and services spending; and restructuring debt to reduce interest rates. - Outcome: No fiscal adjustment was undertaken, but the shortfall from the reduction in VAT was partly compensated with increases in aviation taxes and the road fuel tax. Wage increases for 2006-18 triennial are yet to be negotiated with unions. - Staff recommendation: Adopt a fiscal rule to strengthen the commitment and support the adjustment. - Progress: The ECCB Monetary Council is discussing the adoption of fiscal rules in all ECCU countries. The draft PFM law contains provisions that strengthen the budget process, including the preparation of a medium term macroeconomic and fiscal framework. - Staff recommendation: Refrain from excessive increase in airport taxation. - Outcome: Airport taxation was increased significantly less than initially planned. - Financial sector reforms - Establishment and operationalization of the Eastern Caribbean Asset Management Company (ECAMC): The ECAMC started operating in July 2017, but faces capacity challenges in purchasing and managing bank assets. - Adoption of a new insolvency legislation: Insolvency bill has not been passed yet. There has been progress on its draft and needed amendments in accompanying legislation. - Adoption of a new insurance bill to improve regulation at regional level: No progress. - Risk-based supervision and Basel II for banks and non-banks: In progress. The Financial Services Regulatory Authority (FSRA) has implemented a Risk Based Supervision Manual for all regulated entities in Saint Lucia which includes Credit Unions. *IMF staff compilation based on authorities’ reports and staff assessments.* --- ### Annex II. Risk Assessment Matrix (RAM) ### Key risks, likelihood, impact/time horizon, and policy responses - Global/External - Policy and geopolitical uncertainties (↓↑) - Relative Likelihood: Medium/High - Impact/Time Horizon: High/ST - Policy response: Pursue fiscal adjustment to attain sustainability and reduce debt rollover risks. - Weaker global growth (↓) - Relative Likelihood: Medium/High - Impact/Time Horizon: High/MT - Policy response: Address cost and structural competitiveness disadvantages, including high dependence on hydrocarbon fuels, high energy prices, and other bottlenecks that weigh on businesses. - Tourism-related FDIs do not materialize (↓) - Relative Likelihood: Medium - Impact/Time Horizon: High/MT - Policy response: Diversify the economy and reduce its dependence on tourism. - Cyber-attacks and pressure on traditional bank business models (↓) - Relative Likelihood: Medium - Impact/Time Horizon: Medium/MT - Policy response: Prepare appropriate crisis management plans. Strengthen financial sector regulation and supervision. - Tighter global financing conditions (↓) - Relative Likelihood: High - Impact/Time Horizon: High/ST - Policy response: Pursue fiscal adjustment to attain sustainability and reduce debt rollover risks. Continue efforts to strengthen compliance with AML/CFT and tax transparency standards. - Domestic - Better than expected CIP revenues (↑) - Relative Likelihood: Low - Impact/Time Horizon: Medium/MT - Policy response: Use additional resources to reduce debt, build fiscal buffers, and invest in resilience. Ensure the effectiveness of the CIP’s due diligence process. - Disorderly fiscal adjustment (↓) - Relative Likelihood: Low - Impact/Time Horizon: High/MT - Policy response: Implement adequate fiscal adjustment to ensure debt sustainability. - Financial sector weakness (↓) - Relative Likelihood: Medium - Impact/Time Horizon: Medium/MT - Policy response: Promptly implement remaining elements of the ECCU strategy to strengthen indigenous banks. Enhance regulatory and supervisory frameworks for non-banks. - Natural disasters (↓) - Relative Likelihood: Medium - Impact/Time Horizon: High /ST, MT - Policy response: Build fiscal buffers, invest in resilience, and ensure financing, including with risk-transfer instruments, with the assistance of the World Bank. *The RAM shows events that could materially alter the baseline path. “Short term” (ST) = within 1 year; “medium term” (MT) = within 3 years.* --- ### Annex III. External Sector Assessment ### Overview and constraints - Overall assessment - Driven by strong performance of tourism, St. Lucia’s external position has improved since last year and is assessed as broadly in line with fundamentals and recommended policies. - Structural constraints: high structural unemployment; disconnect between wages and productivity; high costs of energy and trading; poor access to credit—these limit non-tourism related exports and point to the need for structural reforms to improve competitiveness and strengthen the external position further. ### Balance of Payments — Background and Outlook - BPM6 transition and data revisions - Shift to BPM6 data dramatically improves 2014-2016 current account balances. - ECCB published 2014-2016 BOP estimates in July 2017 and discontinued BPM5. - With BPM6, current account moved from large deficits to large surpluses in 2014 and 2015, driven by services (updated tourist expenditure surveys and inclusion of students at offshore universities). - CARTAC mission indicates further adjustment to historical data is expected due to incorrect estimates of re-exports and possible double-counting of exports of alcoholic beverages. - Expected correction: reduction in the current account balance of about 2.2 to 3.1 percent of GDP. - 2017 performance and drivers - After a deficit of -1.9 percent in 2016, staff projects a current account surplus of 1.3 percent of GDP for 2017 (ECCB had not yet published 2017 BOP). - Tourism performance drivers in 2017: - 10-percent expansion of hotel room stock owing to the completion of the 470-room Royalton hotel and several renovation/expansion projects. - Addition of four direct flight routes, expanding seat capacity by 5 percent. - Cruise ship segment recovery, which grew by 14 percent after a large drop in 2016. - United States remained the most important market with about half of total arrivals; arrivals from Europe experienced the strongest growth. - Trade deficit roughly stable at about 25.2 percent of GDP due to expansion in duty-free shopping of cruise-ship passengers and imports of food and hotel supplies. - Medium-term outlook - Tourism expected to remain strong due to pipeline of major hotel investment projects and completion of a berth allowing docking of vessels up to 5000 passengers. - External position expected to worsen in the medium-term due to investment-related imports. - Trade balance will worsen significantly because of anticipated pick-up in imports related to planned infrastructure and hotel investment projects. - Combined with slight worsening of net income balances and steady net current transfers, a significantly negative current account balance is expected for the upcoming years, before returning closer to balance in 2021 when most investment projects are expected to be completed. - Risks: some hotel investment not materializing, lower than expected growth in major tourist source markets, and natural disasters. ### Exchange Rate Developments and Competitiveness - Real effective exchange rate (REER) - REER continued to depreciate in 2017. - REER had been appreciating since 2011 due to nominal appreciation of the U.S. dollar to which the E.C. dollar is pegged; REER started to depreciate in 2015 and trend persisted into 2017 driven mostly by the US dollar depreciation, boosting competitiveness. - EBA-lite and REER model results (2017) - CA-regression approach yields a CA norm of -3.0 percent of GDP. - Applying an adjustment of 2.7 percent of GDP to the cyclically adjusted actual current account balance of 2.2 percent of GDP implies: - Current account gap of 2.5 percent. - Real exchange rate undervaluation of 5.6 percent. - External sustainability approach: - Current net IIP of -46.3 percent of GDP. - Targeted reduction of public external debt to 29.4 percent of GDP by 2030. - Net IIP target set at -41 per cent in 13 years yielding a CA norm of -3.7 percent, pointing to an undervaluation of 7.3 percent. - REER model points to an overvaluation of 5 percent. - Non-price competitiveness indicators - Indicators point to a weak competitive position: narrow exports base, high unemployment, low output growth outside tourism/construction. - World Bank Doing Business ranking fell from 86 in 2017 to 91 in 2018. - Poor scores on getting credit, insolvency, and trading across borders, reflecting high costs of port operations. - High unit labor costs and a marked disconnect between wages and productivity—partly reflecting large share of public sector employment and strong unions—weigh on external competitiveness. ### Reserves - Imputed net international reserves held at the ECCB - Reserve coverage about 17 percent of GDP in 2017. - Corresponds to about 3.8 months of imports and 25 percent of broad money. - Benchmarks: 3 months of imports and 20 percent of broad money—reserves exceed both benchmarks. - Decline in import coverage from 5.1 in 2016 driven by switch to BPM6 data, particularly about twice as large services imports compared to BPM5 data. *IMF staff assessment and EBA-lite model estimates for 2017.* --- ### Annex IV. Debt Sustainability Analysis ### Main conclusion - St. Lucia’s public debt continues to be unsustainable under current policies with external debt following a similar upward trajectory. - Public debt is projected to reach 81.3 percent of GDP by 2023. - External debt projected to increase by about 5 percentages points to 74.3 percent of GDP. - Financing needs generated under current policies are projected to double over the next 5 years. - Baseline debt path is vulnerable to unfavorable shocks from real interest rates, real GDP growth, the primary balance, and natural disasters. ### Background and recent developments - Historical debt increase - Gross public debt increased from 19.6 percent of GDP in 1990 to 70.7 percent of GDP in 2017. - During 2006-2017, debt climbed by 14.2 percent of GDP, of which 8.7 percentage points were due to worsening primary balances. - Since 2001, St. Lucia recorded primary deficits every year except during 2008-09 and more recently in the last few years. - Financing composition - Over past decade, government reliance on domestic financing increased. - Share of domestic debt rose from 29 percent of total debt in 2005 to 57 percent in 2017. - Non-bank financial institutions, including the national insurance scheme, and commercial banks are the largest holders of domestic debt. - Short-term debt increased substantially, accounting for 17 percent (less than one year) and 57.5 percent (less than five years) of total debt. - GDP revision effects - Comparison with previous DSA (2017 Article IV) shows improved debt ratios due to revisions to national accounts series; following the revision, debt-to-GDP ratio fell by some 10 percentage points. ### Baseline projections and assumptions - Key baseline assumptions - Growth and Inflation: - Real economic activity projected to grow by 3.5 percent in 2018 and 3.7 percent in 2019, and to gradually decline before reaching potential rate of 1.5 percent in 2023. - Inflation projected to converge to 1.5 percent over the medium term, reflecting changes in the terms of trade. - Primary Balance: - Primary balance expected to deteriorate from a surplus of 0.6 percent of GDP in 2017 to a deficit of 1 percent of GDP in 2018 (including estimated uninsured costs of natural disasters of 0.7 percent of GDP) and remain close to that level in the medium term. - Baseline debt path outcome - Under baseline assumptions public debt rises throughout the medium term to reach 81.4 percent of GDP by 2023, largely reflecting primary deficits from 2018 onwards and positive interest rate-growth differentials. - Primary deficits over the projection period average 0.5 percent of GDP, while the debt-stabilizing primary surplus is 2.1 percent. ### Risks and sensitivity - Heat map and fan charts - Debt level and gross financing needs exceed the benchmark for emerging market economies. - Debt profile subject to high risks due to high share of public debt held by non-residents. - Asymmetric fan chart (negative shocks to growth, real interest rate, and primary balance) shows debt could reach almost 100 percent of GDP by 2023 if economic conditions deteriorate. - Forecast bias - Projection bias in baseline macro assumptions explained by revision to GDP series; revised GDP shows much slower growth for 2012 than previously estimated, generating a large forecast error. - Significant forecast errors for the primary balance in 2014-2016 also explained by the GDP revision. Inflation forecast errors are comparable with those of other countries. *Debt sustainability analysis prepared by Anne Marie Wickham using the IMF framework for market access countries.* ### 8. Shocks and Stress Tests (Figure A4 and A5) ### 8. Shocks and Stress Tests (Figure A4 and A5) ### Summary of stress-test framework and methodology - Under DSA adverse shock scenarios, the baseline debt path worsens, with the most significant impact in a combined shock scenario. - Stress tests include: Growth shock, Primary balance shock, Interest rate shock, Combined macro-fiscal shock, Natural disaster shock, Adjustment scenario, Contingent liability shock. - External DSA examines sensitivity to growth shock, current account shock, combined scenarios, real exchange rate depreciation shock, and interest rate shock; vulnerability is mitigated by the currency-board arrangement. ### Macro-fiscal stress-test results (public debt and financing needs) - Growth shock: - Output reduced by 1.8 percentage points in 2019 and 2020 (1 standard deviation of growth over the past 10 years) relative to the baseline projections. - Inflation declines by 0.4 percentage points each year in 2019-20. - Debt would peak at 86.1 percent in 2023, which is 5.5 points higher than in the baseline. - Gross financing needs would increase on average, over the medium-term, by 1.6 percentage points higher than the baseline projections. - Primary balance shock: - Primary balance shock of 1.2 percentage points over 2019–20 (½ standard deviations of the historical 10-year average). - Debt-to-GDP ratio of 83.5 percent of GDP by 2023 (2.9 percentage points higher relative to the baseline). - Interest rate shock: - Sustained interest rate shock of 633 basis points (difference between the maximum and average rates over the last 10 years), starting in 2019 to the end of the projection period. - Debt ratio increases to 88.9 percent of GDP by 2023 (8.3 percentage points higher than the baseline). - Combined macro-fiscal shock: - Combining all previous shocks leads to debt exceeding 100 percent of GDP over the medium term. - Gross financing needs as a percent of GDP increase by 8.7 percentage points by 2023 compared to the baseline scenario. - Natural disaster shock: - A natural disaster in 2019 comparable to Hurricane Tomas in 2010 leads to contraction of real GDP growth of 5, 3 and 2 percent in 2019, 2020 and 2021, respectively. - Primary balance deteriorates by the same amounts. - Debt-to-GDP ratio increases to 89.2 percent by 2023, 8.6 points above the baseline. - Adjustment Scenario (staff proposed adjustment policies): - Assuming lower growth but improved primary balance, debt-to-GDP gradually declines to 66.9 percent of GDP in 2023, 13.7 percentage points lower than the baseline scenario. - This scenario brings debt closer to the regional debt target of 60 percent of GDP by 2030. - Gross financing needs decline by 8 percentage points by 2023 to reach 10.5 percent of GDP. - Contingent liability shock: - Government assumes 10 percent of banking sector’s total assets and a 1 standard deviation shock to real GDP growth. - Debt-to-GDP ratio increases by 16.2 percentage points in 2023. - Gross financing needs-to-GDP ratio rises to 22.8 percent by 2023 (4.3 points higher than the baseline). ### External debt sustainability results and vulnerability assessment - Baseline external public debt trajectory: - External public debt projected to increase from 66.9 percent of GDP in 2017 to 73.2 percent of GDP in 2023. - Gross external financing needs projected to increase from less than 0 percent of GDP in 2017 to an average of 2.7 percent over the medium term. - Sensitivity to shocks (external debt, 2023 outcomes): - Growth shock: external debt projected to increase to 79 percent of GDP in 2023 (margin of 5 percentage points above baseline). - Current account shock: external debt projected to increase to 99 percent of GDP in 2023. - Combined shock (real interest rate, growth, and current account): external debt projected to reach 89 percent of GDP in 2023. - Real depreciation shock: external debt-to-GDP increases to 109 percent in 2023 (34 percentage points higher than the baseline); this is the most adverse shock to external debt. - Currency-board arrangement note: - Vulnerability suggested by large depreciation shock is mitigated by the currency-board arrangement. - Under the ECCB Act (1983), external reserves must be held at not less than 60 percent of demand liabilities; under current practice they exceed 90 percent of demand liabilities, making the ECCU a currency board. ### Representative baseline indicators and projections (selected exact values from DSA tables and figures) - Nominal gross public debt (percent of GDP): - 2016: 61.2 - 2017: 69.2 - 2018 (projection): 70.7 - 2019: 72.2 - 2020: 74.6 - 2021: 75.5 - 2022: 77.2 - 2023: 79.2 (Figure A3 table indicates projection to 81.3 in row but figures above present 79.2; stress-test figures and tables present year-by-year values) - Public gross financing needs (percent of GDP): - 2016: 17.0 - 2017: 19.2 - 2018: 23.7 - 2019: 20.8 - 2020: 25.4 - 2021: 20.9 - 2022: 21.7 - 2023: 20.4 (Figure A3) - Real GDP growth (percent): - 2016: 1.2 - 2017: 3.3 - 2018: 3.1 - 2019: 3.5 - 2020: 3.5 - 2021: 2.9 - 2022: 2.0 - 2023: 1.5 (Figure A3) - Inflation (GDP deflator, percent): - 2016: 2.6 - 2017: -1.6 - 2018: 0.1 - 2019: 1.3 - 2020: 1.6 - 2021: 1.5 - 2022: 1.5 - 2023: 1.6 (Figure A3) - Effective interest rate (percent): - 2016: 5.2 - 2017: 5.3 - 2018: 5.1 - 2019: 5.0 - 2020: 4.9 - 2021: 5.2 - 2022: 5.5 - 2023: 5.7 (Figure A3 and stress-test tables) - External debt (percent of GDP, baseline projection, Table A1): - 2017: 69.3 - 2018: 71.0 - 2019: 72.0 - 2020: 72.4 - 2021: 73.1 - 2022: 73.9 - 2023: 74.9 - Change in external debt (percent of GDP): - 2018: 1.7 - 2019: 1.1 - 2020: 0.4 - 2021: 0.7 - 2022: 0.8 - 2023: 1.0 - External debt-to-exports ratio (in percent): - 2017: 108.9 - 2018: 112.8 - 2019: 114.7 - 2020: 115.4 - 2021: 115.7 - 2022: 116.5 - 2023: 116.8 - Gross external financing need (percent of GDP, baseline projections in Table A1): - 2018: 2.8 - 2019: 4.1 - 2020: 2.9 - 2021: 2.0 - 2022: 2.4 - 2023: 2.3 ### Observations from Figures A4 and A5 (composition and scenario comparisons) - Figure A4 presents composition of public debt under Baseline, Historical, and Constant Primary Balance scenarios and shows projected Public Gross Financing Needs (percent of GDP) and debt by maturity and by currency through 2023. - Figure A5 presents macro-fiscal stress tests (Primary Balance Shock, Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, Combined Macro-Fiscal Shock) with underlying assumptions for Real GDP growth, Inflation, Primary balance, and Effective interest rate for 2018–2023. - Example underlying assumptions (Combined Shock): - Real GDP growth: 3.5, 1.8, 1.1, 2.0, 1.5, 1.5 (2018–2023) - Inflation: 1.3, 1.1, 1.1, 1.5, 1.5, 1.6 - Primary balance: -1.0, -3.3, -1.3, -0.1, 0.0, -0.1 - Effective interest rate: 5.0, 5.2, 7.0, 8.0, 8.8, 9.4 *Source: IMF staff (cr18179 - 8. Shocks and Stress Tests, Figures A4 and A5).* ### Annex V. Sensitivity of Public Debt Profile to Changes in ### Annex V. Sensitivity of Public Debt Profile to Changes in International Interest Rates ### A. Recent Trends of Interest Rates and Public Debt - International interest rates, driven by tighter U.S. monetary policy, are expected to rise over the medium term. The Federal Reserve kept its policy rate target between zero and 25bp in the period from end-2008 to end-2015. This policy has been officially reversed since 2016, and U.S. interest rates are expected to increase by about 200 bps over the next four years. - Depending on debt composition, the expected rise in international interest rates could impact servicing of St. Lucia’s public debt, with loans contracted in foreign currency or instruments issued in external markets more likely to be affected. Domestic instrument interest rates might also be affected if interest rate parity holds. - Public debt as a percent of GDP has steadily risen over the past 10 years and —unless a tighter fiscal envelope is adopted— is projected to follow an upward trend over the medium term. - As of 2017: - Domestic debt represents 46 percent of total public debt of the central government. - External debt represents 54 percent of total public debt of the central government. - Sovereign guaranteed instruments (bonds, treasury notes and treasury bills) represent 71 percent of total public debt; of them: - 32pp is contracted externally. - 30pp is traded in the Regional Governments Securities Market (RGSM). - Multilateral and bilateral external loans represent about 22 percent of total public debt. - Caribbean Development Bank and World Bank’s loans account for 96 percent of multilateral outstanding debt. The bulk of World Bank’s loans contracted by St. Lucia are concessional under the International Development Association (IDA) facility; IDA interest rates are fixed for their whole maturity period. - Most of St. Lucia’s debt is contracted at fixed rates, though some credits may have variable rates based on international benchmarks (e.g. LIBOR). ### B. Stylized Facts on External and Internal Interest Rates - Yields on St. Lucia’s short-term instruments issued through the RGSM are positively correlated with U.S. instruments. Short-term treasury bills, treasury notes, and bonds traded in the RGSM show a positive association of RGSM yields with U.S. interest rates. - The response of bond yields (long-term instruments) is more difficult to predict: - Low frequency of issuance of long-term maturity instruments on the RGSM makes association with U.S. interest rates harder to detect. - U.S. short-term treasury instruments respond immediately to changes in the Fed funds rate, while the response of U.S. long-term instruments is not clear. - St. Lucia’s long-term instruments (bonds) represent 40 percent of total outstanding debt. - Commercial banks’ lending rates and U.S. rates are highly correlated, but only for loans issued in foreign currency. - Commercial bank loans represent 6 percent of total central government debt, of which just 1.1 pp were loans contracted in foreign currency. - The apparent lack of a strong association between lending rates in local currency and external rates may be influenced by distortions such as the minimum savings deposit rate established regionally by the ECCB, which pushes active rates in local currency higher and results in higher levels of liquidity and nonperforming loans in the regional commercial banking system. ### C. Measuring the Pass-Through from External to Internal Interest Rates — Methodology and Data - To capture the pass-through effect between external and internal interest rates, a VAR model is estimated to measure dynamics of interest rates while controlling for other endogenous and exogenous variables. - Benchmark specification (VAR) uses monthly data and the following variables (vector y_t): - US_tbill_i: US 3-month T-bill yield. - LCA_deposit_sav_i: St. Lucia’s savings deposit rate. - LCA_lend_i: two alternative definitions of St. Lucia’s commercial banks’ lending rates (in local and foreign currency). - pi: inflation rate. - Monthly data are used given financial flow nature; main drawback is exclusion of some control variables, such as economic activity indicators. ### D. Pass-Through Results - Econometric evidence confirms that interest rates of debt issued in local currency are less sensitive to international interest rate changes. - Using banking system lending rates as a proxy for domestic interest rates: - US short-term interest rates have a full pass-through effect to St. Lucia’s foreign-currency lending interest rates. - US short-term interest rates have only a partial pass-through effect to instruments issued in local currency. - Impulse response functions (reported in the source) show: - A 1 percent increase in US T-Bill leads to a measurable positive impulse in Lending Rate in Foreign Currency. - A 1 percent increase in US T-Bill leads to a smaller positive impulse in Lending Rate in Local Currency. ### E. Public Debt Implications and Simulations - Two extreme scenarios for the stock of debt in 2030 were calculated: - Full pass-through from international interest rates to public debt instruments: debt reaches 101.3 percent of GDP by 2030. - Null pass-through from international interest rates to public debt instruments: debt reaches 88.4 percent of GDP by 2030. - Difference between these two scenarios is 13 pp of GDP. - A baseline stochastic simulation (Montecarlo) that reflects a partial pass-through and constrains interest rate movements to historical volatility yields: - By 2030, the stock of debt would reach between 93.9 and 97.8 percent of GDP, with a 95 percent confidence interval. - Given St. Lucia’s current unsustainable debt path, developments in international interest rates should be cautiously considered when implementing a debt strategy to reach the ECCU regional debt target of 60 percent of GDP by 2030. *Prepared by Mauricio Vargas and Steve Brito (Annex V).* ### 9. The model is parameterized to fit a “typical” LIC when country specific information is not ### 9. The model is parameterized to fit a “typical” LIC when country specific information is not available. ### Model parameterization - When country-specific information is not available, parameters of the average LIC in the DIG model are used; most of these were also used in calibrating the DIGNAD model for Vanuatu. - Country-specific initial values used for: - public infrastructure investment - public debt and its composition - grants - private external debt - real interest rate on public debt - Country-specific parameters used for: - trend per capita growth rate - imports - value-added of the non-tradeable sector ### Natural-disaster-related parameters and calibration - Depreciation rates: - adaptation capital depreciates at 3% - standard infrastructure depreciates at 6% - Savings fund calibration: - calibrated so the savings fund is replenished at the initial level anytime it is used - footnote: a savings fund capitalized at 8 percent of GDP and replenished annually with 0.9 percent of GDP would have a 95 percent chance of non-depletion - Observed average annual disaster losses in St. Lucia: - public capital loss: 1 percent of GDP - private capital loss: 0.5 percent of GDP - The baseline calibration includes a continuum of natural disaster shocks that generate the observed yearly losses of public and private capital. ### Simulation set-up — alternative resilience policies - Policy 1: Do nothing. - public investment kept at the initial level - no reconstruction of lost public capital - serves as baseline - Policy 2: Financial protection. - in year t-1, government receives a grant of 8 percent of initial GDP to build a natural savings fund - fund used exclusively to finance reconstruction of public capital without issuing new debt - when fund active, government has necessary liquidity to rebuild destroyed public capital (parameter set so reconstruction is feasible) - assumed annual interest rate on public debt is 50 basis points lower than under alternative policies - Policy 3: Structural protection. - in year t-1, government receives a grant of 8 percent of initial GDP to invest in adaptation capital - adaptation investment dampens damages though stock of public capital is not entirely reconstructed due to continuous shocks and limited liquidity - baseline implies the share of adaptation capital in total public capital is 23.5 percent ### Key threshold: fraction of destroyed public capital to reconstruct - Indifference between Policy 2 and Policy 3 requires the government to rebuild 85 percent of the destroyed capital (i.e., reconstruction fraction = 0.85) to reach the same level of GDP after 15 years. - Under Policy 2 (savings fund active) the government can rebuild the entire stock of destroyed standard public capital. ### Simulation results — Scenario 1 (reconstruction above threshold) - Assumption: under adaptation option the government can reconstruct 10 percent above threshold (reconstruction fraction = 0.95). - Outcomes (qualitative from figures and text): - Policy 1 (do nothing): loss of GDP of more than 3 percent after 15 years; tax revenues to GDP increase by almost 13 percentage points to reach the public debt target. - Policy 2 (savings fund active): GDP about 1.5 percent lower than initial year; tax revenues increase by 10 percent of GDP. - Lower tax increase due to reconstruction financed by fund, lower GDP loss, and lower sovereign risk premium. - Policy 3 (adaptation capital, reconstruction above threshold): lowest output loss among the three policies; required increase in tax revenues to GDP is below 10 percent. - Rationale: lower depreciation and higher return of adaptation capital plus dampening of damages outweigh liquidity and sovereign risk advantages of the savings fund. - Conclusion for Scenario 1: investing in adaptation capital is preferable if reconstruction fraction ∈ (0.85, 1], i.e., at least 85 percent can be reconstructed. ### Simulation results — Scenario 2 (reconstruction below threshold) - Assumption: under adaptation option the government can reconstruct 10 percent below threshold (reconstruction fraction = 0.75). - Outcomes: - Policy 3 (adaptation with reconstruction = 0.75) leads to a lower GDP level than Policy 2, with a loss of nearly 2 percent after 15 years. - Despite lower damages from adaptation capital, constraints on reconstruction make the savings fund preferable. - Investing in adaptation capital entails a lower increase in tax revenues due to lower public investment during reconstruction. - Conclusion for Scenario 2: investing in adaptation capital is less preferable when reconstruction fraction ∈ [0, 0.85), i.e., less than 85 percent can be reconstructed. ### Sensitivity of the reconstruction threshold to alternative calibrations - Sovereign risk premium assumption: - If the savings fund does not lower the sovereign risk premium by 50 annual basis points (i.e., same sovereign risk premium across the two policies), the threshold falls to 83.5 percent. - Public investment efficiency: - If public investment efficiency under adaptation investment is 2.5 percent lower than under the disaster fund, the threshold rises from 85 percent to 96 percent. - Interpretation: lower efficiency makes a much higher reconstruction fraction necessary for adaptation to be indifferent to financial protection. - Depreciation rate of adaptation capital: - If adaptation and standard capital depreciate at the same annual rate of 6 percent, the threshold increases to 87 percent. - Rationale: higher non-disaster replacement needs for adaptation capital raise the required reconstruction fraction. ### Policy-relevant findings and trade-offs - Building resilience is essential to cope with natural disasters; the do-nothing policy produces dramatic negative outcomes with large permanent losses of capital, output, and growth, and much larger tax increases needed to meet fiscal targets. - Trade-offs between financial protection and structural protection: - Financial protection (savings fund) provides resources for immediate relief and reconstruction and improves the government's net asset position; it also may lower sovereign borrowing costs (assumed 50 basis points in baseline). - Structural protection (adaptation capital) reduces damages from disasters and lowers the cost of capital to the private sector through resilient public capital. - For St. Lucia: - Structural protection is preferred if the government can reconstruct at least 85 percent of destroyed public capital before the next disaster. - If reconstruction ability is lower, financial protection leads to lower output loss. - Low public investment efficiency increases the advantage of financial protection. - Generalization: - Conclusions extend to countries with prevalent financial constraints and low public investment efficiency. - Policies are complementary; an optimal resilience strategy likely requires both financial protection and structural protection. *INTERNATIONAL MONETARY FUND — cr18179 chapter content.* ### References ### cr18179 - References ### Key References Cited - Buffie, E., Berg, A., Pattillo, C., Portillo, R., and L.F. Zanna, 2012, “Public Investment, Growth, and Debt Sustainability: Putting Together the Pieces”, IMF Working Paper 12/144. - Guerson, A., 2016, “Assessment of Government Self-Insurance Needs Against Natural Disasters: An Application to the ECCU”, Eastern Caribbean Currency Union, 2016 Discussion of Common policies of Member Countries, Annex VIII, IMF Country Report No. 16/333. - IMF, 2017, “St. Lucia—Staff Report for the 2017 Article IV Consultation”, SM/17/41. - IMF-WB, 2018, “St. Lucia: Climate Change Policy Assessment—Pilot”, IMF Country Report No. 17/76. - Marto, R., Papageorgiou, C., and V. Klyuev, 2017, “Building Resilience to Natural Disasters: An Application to Small Developing States”, IMF Working Paper 17/223. ### Fund Relations — Membership and Financial Position (As of April 30, 2018) - Quota: 21.40 SDR Million (100.00 percent of Quota). - Fund holdings of currency: 19.87 SDR Million (92.85 percent of Quota). - Reserve Tranche Position: 1.53 SDR Million (7.16 percent of Quota). - SDR Department: Net cumulative allocation 14.57 SDR Million (100.00 percent); Holdings 7.49 SDR Million (51.41 percent). - Outstanding Purchases and Loans: - RCF Loans: 2.30 SDR Million (10.74 percent of Quota). - ESF RAC Loan: 2.07 SDR Million (9.66 percent of Quota). - Latest Financial Arrangements: None. Projected Payments to the Fund (annual schedule) - Forthcoming - 2018 Principal: 1.07; Charges/Interest: 0.05; Total: 1.12 - 2019 Principal: 2.14; Charges/Interest: 0.06; Total: 2.21 - 2020 Principal: 0.77; Charges/Interest: 0.06; Total: 0.83 - 2021 Principal: 0.38; Charges/Interest: 0.06; Total: 0.45 - 2022 Principal: (blank); Charges/Interest: 0.06; Total: 0.06 Other institutional statuses - Implementation of HIPC Initiative: Not Applicable. - Implementation of Multilateral Debt Relief Initiative (MDRI): Not Applicable. - Implementation of Post-Catastrophe Debt Relief (PCDR): Not Applicable. - Exchange rate arrangement: currency board; Eastern Caribbean dollar pegged at EC$2.70 per U.S. dollar. - Article IV consultation: 12-month cycle; last concluded March 24, 2017 (IMF Country Report 17/76). ### Safeguards, Technical Assistance, and Assessments - Safeguards Assessment: ECCB subject to full safeguards assessment on a four-year cycle; update completed April 2016 found generally strong controls; financial statements compliant with International Financial Reporting Standards. - Technical Assistance (selected areas and missions): - Macroeconomic programming and analysis: April 2016 (CARTAC), March 2015, October 2015, July 2014, etc. - National Accounts: Missions spanning December 2010 to September 2018, including rebasing and SUT compilation; September 2018 (CARTAC) National Accounts Mission. - External Sector Statistics: Missions including September 2018 and March 2018 (CARTAC); BPM6 implementation work. - Tax Reforms and Revenue Administration: Numerous CARTAC/FAD missions from 2003 through FY 2018/19 on VAT, customs, Large and Medium Taxpayers Unit, data analytics, compliance risk management, audit capacity, and more. - Expenditure Rationalization and PFM Reforms: Missions from August 2010 through April 2018, including PFM Action Plan (April 2018), PEFA Assessment (July 2017), budget workshops. - Financial Sector: Basel II/III support, stress testing, dynamic modelling, risk-based supervision, and support to the ECCB and SRU; long-term experts financed by Canada in place at the ECCB. - FSAP: Joint IMF/World Bank assessment for ECCU member states conducted in September and October 2003; FSSA discussed May 5, 2004. - AML/CFT: CFATF detailed assessment conducted November 2008; eighth follow-up report published November 2013. ### Statistical Appendix — Data Adequacy and Quality (As of May 16, 2018) Assessment of Data Adequacy for Surveillance - General: Data provision has some shortcomings but is broadly adequate for surveillance; weaknesses in coverage, frequency, quality, and timeliness—particularly national accounts, public sector beyond central government, and balance of payments. - National Accounts: - Nominal GDP compiled using production and expenditure approaches on an annual basis; real GDP compiled using production approach only. - Since 2011, real GDP base year is 2006. - Preliminary GDP available about four months after year-end and finalized with a two-year lag. - Quarterly GDP by expenditure approaches developed and released April 2017 (CARTAC TA). - Additional technical and human resources required. - Price Statistics: - CPI rebased to January 2018 using the 2016 Household Expenditure Survey. - Producer price index for hotels and restaurants under development; consideration of unit-value based export and import price Indexes. - Government Finance Statistics: - Central government monthly data reported with a non GFSM 2014 presentation; fiscal data reported to STA for 2013 and 2014 converted to GFSM 2014 by IMF staff. - Frequent and substantial revisions; need improvements to accounting systems for capital expenditures and coverage of rest of public sector. - Monetary and Financial Statistics: - Monthly monetary statistics compiled and reported by ECCB since July 2006; April 2007 data ROSC identified coverage and valuation issues. - ECCB implementing new reporting system for commercial banks. - ECCB implementing compilation of financial soundness indicators (FSIs) and finalizing technical implementation for reporting. - External Sector Statistics: - July 2017 ECCB release of annual 2014-2016 BOP and, for first time, IIP statistics on BPM6 basis. - Travel credits now based on visitor expenditure surveys. - Need for consistent historical series, improved timeliness, strengthened direct investment transactions data, and improved trade in goods (re-exports recording). - Public sector external debt: - Ministry of Finance compiles public and publicly guaranteed external debt; reports to World Bank QEDS. Data on non-bank private sector external debt not available. Data Standards and Quality - Participant in e-GDDS since September 2000; metadata last updated September 2004. - Data ROSC for monetary sector conducted in 2007 covering ECCB and ECCU members. Table of Common Indicators Required for Surveillance (As of May 16, 2018) — Selected dates and frequencies preserved from source: - Exchange Rates: Fixed rate — Date of latest observation: NA; Date received: NA; Frequency of Data: NA; Frequency of Reporting: NA; Frequency of Publication: NA. - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation: 02/2018; Date received: 05/2018; Frequency of Data: M; Frequency of Reporting: M; Frequency of Publication: M. - Reserve/Base Money: Date of latest observation: 02/2018; Date received: 04/2018; Frequency: M; Reporting: M; Publication: M. - Broad Money: Date of latest observation: 02/2018; Date received: 04/2018; Frequency: M; Reporting: M; Publication: M. - Consumer Price Index: Date of latest observation: 12/2017; Date received: 04/2018; Frequency: M; Reporting: M; Publication: M. - Revenue, Expenditure, Balance and Composition of Financing – General Government: Date of latest observation: 08/2016; Date received: 11/2016; Frequency: M; Reporting: M; Publication: H. - Exports and Imports of Goods and Services: Date of latest observation: 2017; Date received: 05/2018; Frequency: A; Reporting: Q; Publication: Q. - GDP/GNP: Date of latest observation: 2016; Date received: 01/23/2017; Frequency: A; Reporting: A; Publication: A. - International Investment Position: Date of latest observation: 2016; Date received: 10/2017; Frequency: A; Reporting: NA; Publication: NA. ### Statement by Authorities (June 13, 2018) — Recent Developments, Outlook, and Policy Priorities Recent Economic Developments - Growth: Economic activity expanded by 3 percent in 2017; tourism, construction, and wholesale and retail were main contributors; stopover arrivals surged by 11 percent. - Labor market: Unemployment fell for the third successive year to 20.2 percent. - Inflation: After consecutive years of deflation, inflation turned slightly positive in 2017 due to rising oil prices. - Fiscal and public debt: Revenue remained flat at just over 24 percent of GDP; public debt rose marginally to around 70 percent of GDP following increased expenditure, largely from scaling up public investment. - Banking sector: Profitability and ROE turned positive for indigenous banks; capital adequacy above regulatory minimum; NPLs high but declining; loss of CBR limited though costlier requirements burden system. Policy Priorities and Actions - Maintaining Fiscal Prudence: - Debt sustainability is a top priority; authorities note staff’s unsustainable baseline debt path and acknowledge need for further fiscal adjustments to redirect public debt toward ECCU target of 60 percent of GDP by 2030. - Considering revenue-enhancing measures: streamlining the VAT and diversifying the CIP through a new residency program. - Prudent restraint on recurrent spending with focus on limiting wage increases, rationalizing some government services, and containing interest costs. - Plans to commence work on a new debt law and pursue enhanced debt management. - Discussions with the World Bank toward an agreement on a Development Policy Loan (DPL) before the end of this year. - Draft Public Financial Management (PFM) Act aimed at improving budget process and fiscal discipline, slated for enactment by end of this fiscal year. - Safeguarding Financial Sector Soundness: - Enact legislation on foreclosure, insolvency, and credit reporting; support for regional initiative to establish a credit bureau. - Maintain sound due-diligence for CIP; address EU Blacklisting related to international tax rules with goal of compliance by the end of 2018. - Sustain efforts to strengthen the AML/CFT framework. - Invigorating Growth: - Tourism and construction expected to remain robust; new hotel developments projected to add 1,200-1,500 rooms in the next 2-3 years. - Near-finalization of concessional funding from Taiwan, Province of China, to upgrade international airport and road network. - Plans to uplift cruise ship facilities to pursue home porting opportunities. - Acknowledgement that high production costs (electricity, shipping) could limit growth; pursuit of greener energy though not expected to meaningfully reduce electricity costs in short to medium term. - Promote economic diversification by strengthening linkages between tourism and agriculture and developing sectors such as business process outsourcing; examine human capital deficiencies and align education with labor market demands. - Building Resilience — CCPA: - Authorities appreciate the Climate Change Policy Assessment (CCPA) and broadly concur with recommendations. - Three-pronged approach: lowering risk insurance premium (including CCRIF through higher donor contributions), access to climate funds (Fund planning interactive seminar), and capacity development. - Authorities consider staff-proposed Savings Fund of 5 percent of GDP challenging; emphasize need for greater donor support for resilience-building investments. - Advance discussions with World Bank toward finalizing a Catastrophe Deferred Drawdown (Cat DDO) facility later this year. - Engaged UK engineers to assess and cost the six pillars of the CCPA (preparedness, mitigation, adaptation, financing, risk management, and national processes) to present to donors and inform the Fund seminar. *Prepared by Western Hemisphere Department (in consultation with other departments and the Caribbean Regional Technical Assistance Center, CARTAC); May 29, 2018.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18179.pdf_