## 2. External Sector ## Source details **Canonical URL:** [2. External Sector](https://www.imf.org/-/media/files/publications/cr/2018/cr18265-dominicaartiv.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18265-dominicaartiv.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18265-dominicaartiv.pdf.json) --- ### Background - Dominica was recovering from tropical storm Erika (August 27, 2015; damage estimated at 96 percent of GDP) when Category 5 Hurricane Maria made landfall on September 18, 2017 (more than thirty deaths; damage estimated at US$1.3 billion, 226 percent of GDP). - In October 2015, Dominica requested a disbursement under the Rapid Credit Facility (RCF) (75 percent of quota, or SDR 6.5 million) to support immediate financing needs. - Prior to Hurricane Maria, the government was making progress with fiscal consolidation committed to in the RCF. ### Recent developments — damage, economic impact, and fiscal response - Damage and sectoral distribution: - Hurricane Maria recovery cost estimate: US$1.3 billion. - Total damage: 226 percent of GDP (US$1.3 billion). - 58 percent of losses and damage fell on the private sector. - Private housing damage: 61 percent of GDP. - Tourism losses: about 16 percent of GDP (heavily concentrated in hotels). - Agriculture losses: about 31 percent of GDP. - Transport damage: about 17 percent of GDP. - Commerce (microbusiness) damage: about 13 percent of GDP. - Infrastructure damage in the public sector: about 43 percent of GDP. - Insurance and payouts: - Insurance coverage is low except for mortgage-backed housing—about 30 percent of the housing stock is insured. - Insurance payouts since Hurricane Maria: 20 percent of GDP. - Outstanding claims: 15 percent of GDP. - CCRIF insurance payout: US$20.6 million. - Economic output effects: - Estimated 4.7 percent output contraction in 2017 driven by destruction of roads, bridges, and public utility systems. - Agriculture output estimated at about ¼ of pre-hurricane levels. - Tourism room capacity halved. - Construction had a positive contribution to growth due to pre-hurricane investments and rehabilitation. - Fiscal effects and financing: - Excluding CBI revenue, the FY2016/17 deficit was 17.7 percent of GDP. - After the hurricane, tax revenue declined by 23 percent while expenditure increased by 18 percent. - As of December 2017, authorities had deposits in the banking system equivalent to 24 percent of GDP, largely from the Citizenship-By-Investment (CBI) program. - Grants received as of end-March 2018: US$10.9 million. - Pledges and donations received (text table): Total US$10.9 million (1.9 percent of GDP). ### Financial sector deterioration and vulnerabilities - Banks: - Banks’ NPLs end-2017: 17.4 percent of loans (pre-hurricane NPLs were 15 percent of total loans). - Provisioning nearly doubled to reach 80 percent of NPLs by end-2017. - Credit unions: - Credit unions account for over half of financial intermediation (assets of 51 percent of GDP). - Credit union capital: 7.4 percent of assets as of September 2017 (below the 10 percent minimum). - The smallest credit unions (30 percent of sector assets) had capital below 4 percent. - One credit union has assets of 36 percent of GDP. - Insurance sector: - One domestic insurer has a capital shortfall of 2 percent of GDP and is illiquid, pressuring for government support. - Outstanding claims and illiquidity increase contingent liability risk. - Policy and technical assistance: - Staff technical assistance provided in March 2018 to prepare a crisis management plan for credit unions and insurance. ### Outlook and risks — growth, fiscal, and external trajectories - Output and recovery projections: - Output projected to fall by over 14 percent in 2018, largely due to steep declines in agriculture and tourism services. - Projection assumes output recovers to pre-hurricane levels in 5 years, though recovery could take longer due to: need for significant restoration of electricity services; weak logistic capacity at the port; insufficient specialized labor; under-insurance and slow payouts; limited access to private financing. - Positive assumptions include large private investment projects financed under the CBI program (with hurricane-induced delay) and geothermal electricity plant construction to resume and become operational by end-2020. - Fiscal outlook: - Fiscal performance will deteriorate significantly; deficit expected to peak at 8.4 percent of GDP in 2020 and improve gradually thereafter. - Staff expect average deficits of 5.9 percent of GDP through 2018–21, or 10.9 percent excluding CBI revenues. - Revenue declines expected due to lower output and temporary import tax exemptions on construction materials. - Expenditure increases expected for rehabilitation and reconstruction, social relief transfers, and purchases of goods and services. - External sector projections: - External current account deficit projected to deteriorate to 31.7 percent of GDP in 2018, then improve with recovery. - Exports of goods and services expected to decline by approximately 32 percent. - Imports expected to increase by 7.5 percent due to reconstruction materials and restocking of durables. - Near-term current account deficits financed mainly with official and bilateral loans, grants, and use of government deposits. - Outlook includes net official capital inflows averaging 6 percent of GDP annually in the next five years. - World Bank financing package approved: US$115 million over 3 years (US$75 million IDA credits; remainder IDA grants). - CDB considering topping up an undisbursed US$50 million loan with US$40 million from its Special Development Fund and US$0.2 million in grants. - Other sources (bilateral grants and loans) expected to total US$111 million. ### Private sector recovery constraints - Insurance and household finance: - Progress with insurance payments: total payments of about 20 percent of GDP; remaining outstanding claims 15 percent of GDP. - The sole domestic insurer has become illiquid with a capital shortfall of 2 percent of GDP. - Financial intermediation constraints: - Banks and credit unions unlikely to provide significant financing due to asset quality deterioration and lower household incomes. - Credit unions’ portfolio deterioration could constrain lending capacity and raise liquidity pressures. - Public financial institutions face funding constraints given a financially constrained government. ### Key statistics and figures (as reported) - Hurricane Maria damage estimate: US$1.3 billion (226 percent of GDP). - Hurricane Erika damage estimate: 96 percent of GDP. - RCF disbursement requested October 2015: 75 percent of quota, or SDR 6.5 million. - Recovery cost estimate: US$1.3 billion. - Private housing damage: 61 percent of GDP. - Agriculture damage: 31 percent of GDP. - Transport damage: 17 percent of GDP. - Commerce (microbusiness) damage: 13 percent of GDP. - Infrastructure damage (public sector): 43 percent of GDP. - Insurance coverage for housing with mortgages: about 30 percent of housing stock. - 2017 estimated output contraction: 4.7 percent. - Tax revenue decline after hurricane: 23 percent. - Expenditure increase after hurricane: 18 percent. - Government deposits in banking system as of December 2017: 24 percent of GDP. - CCRIF insurance payout: US$20.6 million. - Grants received as of end-March 2018: US$10.9 million. - Banks’ NPLs end-2017: 17.4 percent of loans; provisioning: 80 percent of NPLs. - Credit union assets: 51 percent of GDP; capital: 7.4 percent of assets as of September 2017. - One credit union assets: 36 percent of GDP. - Insurance payouts since Hurricane Maria: 20 percent of GDP; outstanding claims: 15 percent of GDP; domestic insurer capital shortfall: 2 percent of GDP. - Output projected fall in 2018: over 14 percent. - Fiscal deficit peak: 8.4 percent of GDP in 2020. - Average deficits through 2018–21: 5.9 percent of GDP; excluding CBI: 10.9 percent. - CBI revenue: 13.9 percent of GDP in 2017 projected to decline to near 2.5 percent of GDP over the medium term. - Grants peak: 9.1 percent of GDP (current fiscal year). - External current account deficit projected 2018: 31.7 percent of GDP. - Exports decline projection: approximately 32 percent. - Imports expected increase: 7.5 percent. - Net official capital inflows assumed: averaging 6 percent of GDP annually (next five years). - World Bank financing: US$115 million over 3 years (US$75 million IDA credits; remainder IDA grants). - CDB potential top-up: US$40 million (plus US$0.2 million grants) to an undisbursed US$50 million loan. - Other bilateral grants and loans expected: US$111 million. - CBI program investor amounts: cash contribution US$100,000 or investment US$200,000. --- ### Medium-term fiscal constraints and debt outlook (from Section 14 and Annex I) - Fiscal constraint timeline and debt trajectory: - The government is projected to become financially constrained by FY2022/23 considering eventual depletion of deposits and normalization of official financing and donor grants down to historical norms. - Public debt increases to near 90 percent of GDP with identified official and bilateral loans. - SOE debt: around 12 percent of GDP. - Public sector debt (percent of GDP) trajectory reported: 72.4 (2012), 80.1 (2013), 78.7 (2017), 83.3 (2018 est.), 86.1 (2019 proj.), 87.8 (2020 proj.), 85.2 (2023 proj.). - Fiscal space and public investment: - Fiscal space would become insufficient to sustain the post-hurricane increase in spending; assuming recurrent spending is downwardly rigid, the space for public investment would decline to near 3 percent of GDP, insufficient for capital replacement. - Debt distress assessment: - Dominica continues to be rated as under high risk of debt distress based on projected increase in public debt and fiscal sustainability challenges augmented with the hurricane. - Debt sustainability analysis (Annex I) findings: - Risk of external debt distress: High. - Total estimated losses and damage after Hurricane Maria: 226.3 percent of GDP. - Total public sector debt (end-FY2016/17): around 72 percent of GDP (about ¾ external). - Baseline shows PV of debt-to-GDP ratio breached over the entire projection period. - Alternative and customized scenarios (including sudden stop in CBI inflows and one-time 30 percent depreciation) produce worse debt dynamics. ### Policy implication from DSA - Dominica would need a fiscal consolidation of about 4 percent of GDP in order to create fiscal space for public investment required for capital replacement and to sustain reconstruction (under the macroeconomic projection and downward-rigid recurrent spending assumption). ### Main risks to the outlook and selected Risk Assessment Matrix entries - Key risk drivers: - Public financing uncertainties (including possible discontinuation of Petrocaribe financing flows of near 1 percent of GDP per year). - Possible financial sector instability: significant increases in NPLs, liquidity pressures and capital shortfalls (especially in the credit unions), and potential sizable contingent liabilities. - Capacity constraints affecting reconstruction: availability of grants, administrative capacity to meet disbursement requirements for official loans, CBI program performance, bottlenecks in construction materials and specialized labor, and success of CREAD. - Natural disasters remain a recurrent threat. - Selected Risk Assessment Matrix entries (likelihood, impact, policy response): - Slow pace of recovery - Likelihood: High; Impact: High - Policy response: Identify and address supply bottlenecks (ports, skilled labor). Ensure CREAD becomes operational as soon as possible. - Natural disasters - Likelihood: High; Impact: High - Policy response: Build resilient infrastructure. Strengthen PFM, procurement and reporting to facilitate access to grants from green funds. - Petrocaribe financing - Likelihood: High; Impact: High - Policy response: Identify alternative sources of financing, especially grants. Monitor and gradually improve the underlying primary fiscal balance. - Reduced financial services by correspondent banks - Likelihood: High; Impact: Medium - Policy response: Strengthen AML/CFT framework in line with the 2012 FATF standard; communicate efforts to address perceived risks. - Financial sector instability - Likelihood: Medium; Impact: High - Policy response: Implement regional strategy to strengthen indigenous banks in the ECCU; strengthen regulation and supervision of credit unions; adopt crisis management TA recommendations for credit unions and insurance sectors. - Citizenship program demand (↑/↓) - Likelihood: Medium; Impact: Medium to High - Policy response: Create a government fund for debt reduction, resilient infrastructure investment, and post-disaster reconstruction; maintain strict governance standards and strengthen program integrity. ### Fiscal policy discussion — objectives, sequencing, and simulations - Objective: - Provide social support and facilitate recovery while minimizing long-term fiscal burden and safeguarding financial stability. - Sequencing and anchor: - Need for cost-effective fiscal policies and careful sequencing given rising debt and financing constraints; a fiscal consolidation plan mindful of recovery will likely be necessary at a later stage after output recovers closer to pre-hurricane levels. - Anchor: The plan should be anchored on the underlying primary balance excluding CBI revenues, hurricane-related grants, and the transitory increase in reconstruction expenditure; this balance should be monitored regularly. - Illustrative fiscal simulation: - A gradual consolidation after FY2022/23 of 4 percent of GDP, plus the unwinding of hurricane-related expenditures, would lead to a primary balance surplus of 2.2 percent of GDP by 2025, sufficient to set public debt on a downward trajectory and to provide fiscal space to maintain public investment for reconstruction. - The projections include a fiscal cushion of 1.5 percent of GDP per year as an additional annual cost of future natural disasters. - Scenario definitions used in staff charts: - Financially constrained: includes identified financing sources and then normalization of debt financing to pre-hurricane Maria levels. Grants and CBI revenues as projected. Financing constraints assumed to crowd-out public investment. - Financially unconstrained: assumes public investment is not crowded out; public investment remains elevated to cover total public sector damages and loss of US$ 800 million. - Financially unconstrained with fiscal consolidation: assumes gradual fiscal consolidation begins in FY2022/23, providing fiscal space to accommodate public damages and losses of US$ 800 million. ### Revenue-side recommendations - Support gradual recovery of tax revenues and restore compliance. - The three-month import tariff exemption on construction materials should not be extended; it could be compensated with temporary and well-targeted transfers. - Deploy additional tax auditors and postpone the planned increase in the income tax threshold included in the FY2017/18 budget to contain revenue losses. - Given the importance of CBI revenue, strengthen program integrity with enhanced due diligence while improving transparency and on-budget recording of full program revenues. - Reform tax exemptions to minimize revenue loss, including an annual ceiling on discretionary concessions. - To bolster Social Security Fund sustainability, continue contribution increases as envisaged. ### Expenditure-side recommendations - Protect fiscal space for social relief and investment; resist pressures for public wage increases that have intensified after the hurricane. - Target social transfers and import tariff concessions efficiently with attention to poverty and income distribution; increase transfer allocations to the most vulnerable sectors in the FY2018/19 budget while limiting untargeted support and discretionary transfers. - Monitor post-hurricane social transfers (including a new unemployment program) to ensure efficient allocation and plan to unwind them gradually as household incomes recover. - Examine expenditures on goods and services for efficiency gains. ### Public investment, sequencing, and grants access - Prioritize and sequence public investment according to contribution to recovery and employment; give precedence to critical investment for recovery of output and private income to facilitate withdrawal of hurricane-related social transfers, especially in labor‑intensive sectors such as agriculture and fisheries. - Ensure public investment execution is consistent with supply constraints (specialized labor and construction materials) to limit inflation and erosion of external competitiveness. - Improve capacity to access grants by reviewing PFM and procurement systems to minimize debt issuance. - Establishment of CREAD: - A Climate Resiliency Executing Agency of Dominica (CREAD) will be established to boost execution of large resilient public investment projects; CREAD will be independent, report to Parliament, be funded by DFID grants, and be managed by non-government technical experts; it will be temporary and eventually merge into the Ministry of Public Works. ### Resilient infrastructure and insurance - Government decision to invest in resilient infrastructure is appropriate despite higher upfront cost; staff analysis indicates resilient infrastructure can have positive effects on output, private wages, and employment. - Assumption: a natural disaster with damage in line with historical averages occurs every five years; resilient infrastructure increases tax revenues and more-than-offsets additional cost by a factor of 3 when accounting for reduced expected loss and improved long-term output. - The average additional cost of resilience is approximately 50 percent above replacement (Post-Disaster Needs Assessment). - Government commitment to create a saving fund for natural disasters is commendable and should be advanced legislatively and operationalized as soon as feasible. - Complement savings with higher coverage under the Caribbean Catastrophe Risk Insurance Facility (CCRIF); Dominica remains significantly below the maximum eligible. ### Financial stability and sectoral measures - Systemic risk drivers: - Large increases in NPLs, liquidity pressures, capital shortfalls (especially in credit unions), contagion via credit union links with banks, and potential loss of correspondent banking relations (CBRs). - Policy responses and measures: - Strengthen regulation and supervision of credit unions. - Promptly implement remaining elements of the regional strategy to strengthen indigenous banks in the ECCU. - Adopt crisis management technical assistance recommendations for credit unions and insurance sectors. - Continue strengthening AML/CFT framework and effectively communicate reforms to reduce risk of reduced correspondent banking services. - Intensify efforts to reduce bank NPLs; assess loan service forbearance (4–6 months granted) and develop a plan to unwind capital forbearance with clear guidelines and timeframes. - Valuation rules issued December 2017 and effective July 2018; provisioning guidance to be issued in October 2018; IFRS 9 will become binding in 2019. - Use extraordinary powers granted to the Eastern Caribbean Asset Management Corporation (per the 2017 Act) to resolve NPLs if it becomes fully operational. - Government should use representation powers on the Monetary Council to phase out the Minimum Saving Rate to strengthen bank profitability and reduce interest rates. ### Credit unions and insurance sector specific actions - Credit unions: - Prepare a crisis management plan guided by March 2018 staff technical assistance. - Strengthen regulation and supervision, including automatic, nondiscretionary, and effective responses to institutions in distress. - Strengthen resources and capacity of the Financial Services Unit (FSU), including legal powers to impose sanctions for non-compliance. - Insurance sector: - 33 percent of claims, mostly property, are still outstanding, much relating to the largest insurer, the sole domestic insurance company. - FSU actions and timelines: enforce regulations, redress the domestic insurer’s capital shortfall, and ensure payment of outstanding claims within the April 2019 timeline set by the FSU; lack of recovery within the agreed timeline should result in resolution. - Financing capital requirements with social security funds or loans from the national development agency (AID Bank) would compound fiscal sustainability challenges and should be avoided. - FSU should establish a contingency reserve for the insurance sector and promote harmonized regional regulation to reduce insurance costs via scale, risk diversification, and competition. ### Correspondent banking relationships, offshore banking, and AML/CFT - Government proactive stance will mitigate the risk of withdrawal of CBRs; withdrawals have not taken place though increased costs and administrative burdens reported. - AML/CFT legislation should continue to be strengthened in line with the FATF 2012 standard, with effective implementation ahead of the 2018 CFATF mutual evaluation. - Improve information sharing agreements between respondent and correspondent banks; explore bundling financial services to reduce costs. - Phase out of the offshore banking sector should continue (cessation of new license issuance since 2017); expedite revisions to the Offshore Banking Act with higher capital requirements, license application process reform, and enactment of regulations. ### Growth, competitiveness, and structural reforms - Key constraints to private-sector-led recovery: - Increase labor productivity. - Lower costs, especially in energy. - Address large infrastructure gaps. - Recommended policy actions: - Address structural factors limiting bank credit: improve information about borrower quality; review legislation affecting loan contract enforcement; advance regional plan to establish a credit bureau. - Remove rigidities in working hours and review severance payments. - Enhance education targeting and shorter training programs aligned with employer needs. - Reduce the cost of dealing with government (insolvency, property registration, taxes, construction permits). - Enforce construction and zoning regulations strictly given vulnerability to natural disasters. - Progress development of geothermal electricity generation to lower electricity costs and reduce dependence on imported fossil fuels. ### Data and statistical capacity - Data provision has shortcomings due to capacity constraints in the statistical agency: weaknesses in coverage, accuracy, frequency, and timeliness of data. - Data are broadly adequate for surveillance but constrain economic analysis and policy formulation; more timely and improved data on national and fiscal accounts, labor market, balance of payments, and non-bank financial institutions would benefit surveillance. ### Staff appraisal and macroeconomic outlook (summary points) - The economy is recovering from Hurricane Maria; estimated output decline of 4.7 percent in 2017. - Economic activity picking up from a low base, led by construction. - Significant capacity and financing constraints slow recovery; returning to pre-Maria output levels could take 5 or more years. - Identified government financing (official loans, donor grants, use of deposits from the CBI program) will support domestic demand while output rebounds. - Collapse of tax revenues and increase in reconstruction expenditures will raise fiscal deficits to 5.9 percent of GDP on average during 2018–22, with public debt increasing to near 90 percent. - Private sector recovery constrained by insufficient financing and inadequate insurance payouts and savings. - External outlook: government financing will support imports, but export collapse will lead to significant current account deficits, projected to average 20 percent of GDP during 2018–23; these deficits will gradually narrow as output and exports recover. - Outlook is subject to significant uncertainty: if financing is lower than projected, fiscal and external deficits would be lower, and output recovery would take more time. *Source: IMF staff report content (cr18265-dominicaartiv - 2. External Sector and related sections provided).* ### 2. External Sector ________________________________________________________________________________ 26 ### 2. External Sector ### Background - Dominica was recovering from tropical storm Erika (August 27, 2015; damage estimated at 96 percent of GDP) when Category 5 Hurricane Maria made landfall on September 18, 2017 (more than thirty deaths; damage estimated at US$1.3 billion, 226 percent of GDP). - In October 2015, Dominica requested a disbursement under the Rapid Credit Facility (RCF) (75 percent of quota, or SDR 6.5 million) to support immediate financing needs. - Prior to Hurricane Maria, the government was making progress with fiscal consolidation committed to in the RCF. ### Recent developments — damage, economic impact, and fiscal response - Hurricane Maria recovery cost estimate: US$1.3 billion. - Distribution of losses and damage: - 58 percent of losses and damage fell on the private sector. - Private housing damage equivalent to 61 percent of GDP. - Tourism losses about 16 percent of GDP (heavily concentrated in hotels). - Agriculture losses about 31 percent of GDP. - Transport about 17 percent of GDP. - Commerce (microbusiness) about 13 percent of GDP. - Infrastructure damage in the public sector about 43 percent of GDP. - Insurance coverage is low except for mortgage-backed housing—about 30 percent of the housing stock is insured. - The destruction of roads, bridges, and public utility systems in late 2017 underpinned an estimated 4.7 percent output contraction in 2017. - Agriculture output estimated at about ¼ of pre-hurricane levels. - Tourism room capacity was halved. - Construction had a positive contribution to growth due to pre-hurricane investments and rehabilitation. - Fiscal effects and financing: - Excluding CBI revenue, the FY2016/17 deficit was 17.7 percent of GDP. - After the hurricane, tax revenue declined by 23 percent while expenditure increased by 18 percent. - As of December 2017, authorities had deposits in the banking system equivalent to 24 percent of GDP, largely from the Citizenship-By-Investment (CBI) program. - Insurance payout from CCRIF: US$20.6 million. - Grants received as of end-March 2018: US$10.9 million. - Pledges and donations received (text table): Total US$10.9 million (1.9 percent of GDP). - Financial sector deterioration and vulnerabilities: - Banks: NPLs increased to 17.4 percent of loans; provisioning nearly doubled to reach 80 percent of NPLs by end-2017. - Pre-hurricane NPLs were 15 percent of total loans. - Credit unions account for over half of financial intermediation (assets of 51 percent of GDP); credit union capital was 7.4 percent of assets as of September 2017 (below the 10 percent minimum); the smallest credit unions (30 percent of sector assets) had capital below 4 percent. - One credit union has assets of 36 percent of GDP. - Insurance sector: insurance payouts since Hurricane Maria amount to 20 percent of GDP; outstanding claims are 15 percent of GDP; one domestic insurer has a capital shortfall of 2 percent of GDP and is illiquid, pressuring for government support. - Staff technical assistance provided in March 2018 to prepare a crisis management plan for credit unions and insurance. ### Outlook and risks — growth, fiscal, and external trajectories - Output and recovery: - Output projected to fall by over 14 percent in 2018, largely due to steep declines in agriculture and tourism services. - Projection assumes output recovers to pre-hurricane levels in 5 years, though recovery could take longer due to: - Need for significant restoration of electricity services. - Weak logistic capacity at the port delaying importation of construction materials. - Insufficient labor for reconstruction, particularly specialized skills. - Under-insurance in the private sector and slow payouts. - Limited access to private financing due to fall in household and investor income. - Positive assumptions: large private investment projects financed under the CBI program (with hurricane-induced delay); geothermal electricity plant construction to resume and become operational by end-2020. - Fiscal outlook: - Fiscal performance will deteriorate significantly; deficit expected to peak at 8.4 percent of GDP in 2020 and improve gradually thereafter. - Staff expect average deficits of 5.9 percent of GDP through 2018–21, or 10.9 percent excluding CBI revenues. - Revenue declines expected due to lower output and temporary import tax exemptions on construction materials. - Expenditure increases expected for rehabilitation and reconstruction, social relief transfers, and purchases of goods and services. - Institutional response: - A Climate Resiliency Executing Agency of Dominica (CREAD) will be established to boost execution of large resilient public investment projects; CREAD will be independent, report to Parliament, be funded by DFID grants, and be managed by non-government technical experts; it will be temporary and eventually merge into the Ministry of Public Works. - Key fiscal and financing assumptions and risks: - Forecast assumes: - CBI revenue follows a conservative path and declines gradually from 13.9 percent of GDP in 2017 to near 2.5 percent of GDP over the medium term. - Grants peak at 9.1 percent of GDP in the current fiscal year. - Largely concessional loan disbursements from international financial institutions materialize in the near term. - If financing flows are lower than projected, government spending and thus growth and fiscal and current account deficits would be smaller. - External sector projections: - External current account deficit projected to deteriorate to 31.7 percent of GDP in 2018, then improve with recovery. - Exports of goods and services expected to decline by approximately 32 percent. - Imports expected to increase by 7.5 percent due to reconstruction materials and restocking of durables. - Near-term current account deficits financed mainly with official and bilateral loans, grants, and use of government deposits. - Outlook includes net official capital inflows averaging 6 percent of GDP annually in the next five years. - World Bank financing package approved: US$115 million over 3 years (US$75 million IDA credits; remainder IDA grants). - Caribbean Development Bank (CDB) considering topping up an undisbursed US$50 million loan with US$40 million from its Special Development Fund and US$0.2 million in grants. - Other sources (bilateral grants and loans) expected to total US$111 million. - Private sector recovery constraints: - Progress with insurance payments: total payments of about 20 percent of GDP; remaining outstanding claims 15 percent of GDP. - The sole domestic insurer has become illiquid with a capital shortfall of 2 percent of GDP. - Banks and credit unions unlikely to provide significant financing due to asset quality deterioration and lower household incomes. - Credit unions’ portfolio deterioration could constrain lending capacity and raise liquidity pressures. - Public financial institutions face funding constraints given a financially constrained government. ### Key statistics and figures (as reported) - Hurricane Maria damage estimate: US$1.3 billion (226 percent of GDP). - Hurricane Erika damage estimate: 96 percent of GDP. - RCF disbursement requested October 2015: 75 percent of quota, or SDR 6.5 million. - Recovery cost estimate: US$1.3 billion. - Private housing damage: 61 percent of GDP. - Agriculture damage: 31 percent of GDP. - Transport damage: 17 percent of GDP. - Commerce (microbusiness) damage: 13 percent of GDP. - Infrastructure damage (public sector): 43 percent of GDP. - Insurance coverage for housing with mortgages: about 30 percent of housing stock. - 2017 estimated output contraction: 4.7 percent. - Tax revenue decline after hurricane: 23 percent. - Expenditure increase after hurricane: 18 percent. - Government deposits in banking system as of December 2017: 24 percent of GDP. - CCRIF insurance payout: US$20.6 million. - Grants received as of end-March 2018: US$10.9 million. - Banks’ NPLs end-2017: 17.4 percent of loans; provisioning: 80 percent of NPLs. - Credit union assets: 51 percent of GDP; capital: 7.4 percent of assets as of September 2017. - One credit union assets: 36 percent of GDP. - Insurance payouts since Hurricane Maria: 20 percent of GDP; outstanding claims: 15 percent of GDP; domestic insurer capital shortfall: 2 percent of GDP. - Output projected fall in 2018: over 14 percent. - Fiscal deficit peak: 8.4 percent of GDP in 2020. - Average deficits through 2018–21: 5.9 percent of GDP; excluding CBI: 10.9 percent. - CBI revenue: 13.9 percent of GDP in 2017 projected to decline to near 2.5 percent of GDP over the medium term. - Grants peak: 9.1 percent of GDP (current fiscal year). - External current account deficit projected 2018: 31.7 percent of GDP. - Exports decline projection: approximately 32 percent. - Imports expected increase: 7.5 percent. - Net official capital inflows assumed: averaging 6 percent of GDP annually (next five years). - World Bank financing: US$115 million over 3 years (US$75 million IDA credits; remainder IDA grants). - CDB potential top-up: US$40 million (plus US$0.2 million grants) to an undisbursed US$50 million loan. - Other bilateral grants and loans expected: US$111 million. - CBI program investor amounts: cash contribution US$100,000 or investment US$200,000. *Source: IMF staff report content (cr18265-dominicaartiv - 2. External Sector).* ### 14. In the medium term, constraints to continued debt accumulation could limit the fiscal ### 14. In the medium term, constraints to continued debt accumulation could limit the fiscal ### Medium-term fiscal constraints and debt outlook - The government is projected to become financially constrained by FY2022/23 considering the eventual depletion of deposits and the normalization of official financing and donor grants down to historical norms. - Public debt increases to near 90 percent of GDP with identified official and bilateral loans. - Fiscal space would become insufficient to sustain the post-hurricane increase in spending; assuming recurrent spending is downwardly rigid, the space for public investment would decline to near 3 percent of GDP, insufficient for capital replacement. - Dominica continues to be rated as under high risk of debt distress based on projected increase in public debt and fiscal sustainability challenges augmented with the hurricane. ### Main risks to the outlook - Key risk drivers: - Public financing uncertainties (including possible discontinuation of Petrocaribe financing flows of near 1 percent of GDP per year). - Possible financial sector instability, including significant increases in NPLs, intensifying liquidity pressures and capital shortfalls (especially in the credit unions), and potential sizable contingent liabilities. - Capacity constraints affecting reconstruction: availability of grants, administrative capacity to meet disbursement requirements for official loans, CBI program performance, bottlenecks in construction materials and specialized labor, and success of CREAD. - Natural disasters remain a recurrent threat. - Private sector projects introduce upside and downside risks: large construction projects in tourism, the geothermal power plant (significant upside if it results in lower electricity tariffs), resumption of a new hospital project, and return/expansion of two medical schools. ### Risk Assessment Matrix — selected entries (likelihood, impact, policy response) - Slow pace of recovery (↓) - Likelihood: High; Impact: High - Policy response: Identify and address supply bottlenecks (ports, skilled labor). Ensure CREAD becomes operational as soon as possible. - Natural disasters (↓) - Likelihood: High; Impact: High - Policy response: Build resilient infrastructure. Strengthen PFM, procurement and reporting to facilitate access to grants from green funds. - Petrocaribe financing (↓) - Likelihood: High; Impact: High - Policy response: Identify alternative sources of financing, especially grants. Monitor and gradually improve the underlying primary fiscal balance. - Reduced financial services by correspondent banks (↓) - Likelihood: High; Impact: Medium - Policy response: Strengthen AML/CFT framework in line with the 2012 FATF standard; communicate efforts to address perceived risks. - Tighter global financial conditions (↓) - Likelihood: High; Impact: Medium - Policy response: Implement structural reforms to boost competitiveness. Ensure reconstruction debt issuance is not indexed to global interest rates when possible. - Financial sector instability (↓) - Likelihood: Medium; Impact: High - Policy response: Implement regional strategy to strengthen indigenous banks in the ECCU; strengthen regulation and supervision of credit unions; adopt crisis management TA recommendations for credit unions and insurance sectors. - Large-scale investment projects (↑) - Likelihood: Medium; Impact: Medium to High - Policy response: Continue improving the business environment. - Citizenship program demand (↑/↓) - Likelihood: Medium; Impact: Medium to High - Policy response: Create a government fund for debt reduction, resilient infrastructure investment, and post-disaster reconstruction; maintain strict governance standards and strengthen program integrity. ### Fiscal policy discussion — objectives and sequencing - Objective: Provide social support and facilitate recovery while minimizing long-term fiscal burden and safeguarding financial stability. - Need for cost-effective fiscal policies and careful sequencing given rising debt and financing constraints; a fiscal consolidation plan mindful of recovery will likely be necessary at a later stage after output recovers closer to pre-hurricane levels. - Anchor: The plan should be anchored on the underlying primary balance excluding CBI revenues, hurricane-related grants, and the transitory increase in reconstruction expenditure; this balance should be monitored regularly. ### Fiscal simulations and consolidation scenario - Illustrative simulation: A gradual consolidation after FY2022/23 of 4 percent of GDP, plus the unwinding of hurricane-related expenditures, would lead to a primary balance surplus of 2.2 percent of GDP by 2025, sufficient to set public debt on a downward trajectory and to provide fiscal space to maintain public investment for reconstruction. - The projections include a fiscal cushion of 1.5 percent of GDP per year as an additional annual cost of future natural disasters. - Scenario descriptions used in staff charts: - Financially constrained: includes identified financing sources and then normalization of debt financing to pre-hurricane Maria levels. Grants and CBI revenues are as projected in the macroeconomic framework. Financing constraints are assumed to crowd-out public investment. - Financially unconstrained: assumes that public investment is not crowded out as a result of financing constraints. Public investment remains elevated to cover total public sector damages and loss of US$ 800 million. - Financially unconstrained with fiscal consolidation: assumes that a gradual fiscal consolidation begins in FY2022/23, which provides fiscal space to accommodate public damages and losses of US$ 800 million. ### Revenue-side recommendations - Support gradual recovery of tax revenues and restore compliance. - The three-month import tariff exemption on construction materials should not be extended; it could be compensated with temporary and well-targeted transfers. - Deploy additional tax auditors and postpone the planned increase in the income tax threshold included in the FY2017/18 budget to contain revenue losses. - Given the importance of CBI revenue, strengthen program integrity with enhanced due diligence while improving transparency and on-budget recording of full program revenues. - Reform tax exemptions to minimize revenue loss, including an annual ceiling on discretionary concessions. - To bolster Social Security Fund sustainability, continue contribution increases as envisaged. ### Expenditure-side recommendations - Protect fiscal space for social relief and investment; resist pressures for public wage increases that have intensified after the hurricane. - Target social transfers and import tariff concessions efficiently with attention to poverty and income distribution; increase transfer allocations to the most vulnerable sectors in the FY2018/19 budget while limiting untargeted support and discretionary transfers. - Monitor post-hurricane social transfers (including a new unemployment program) to ensure efficient allocation and plan to unwind them gradually as household incomes recover. - Examine expenditures on goods and services for efficiency gains. ### Public investment, sequencing, and grants access - Prioritize and sequence public investment according to contribution to recovery and employment; give precedence to critical investment for recovery of output and private income to facilitate withdrawal of hurricane-related social transfers, especially in labor‑intensive sectors such as agriculture and fisheries. - Ensure public investment execution is consistent with supply constraints (specialized labor and construction materials) to limit inflation and erosion of external competitiveness. - Improve capacity to access grants by reviewing PFM and procurement systems to minimize debt issuance. ### Resilient infrastructure and insurance - Government decision to invest in resilient infrastructure is appropriate despite higher upfront cost; staff analysis indicates resilient infrastructure can have positive effects on output, private wages, and employment. - Assumption: a natural disaster with damage in line with historical averages occurs every five years; resilient infrastructure increases tax revenues and more-than-offsets additional cost by a factor of 3 when accounting for reduced expected loss and improved long-term output. - The average additional cost of resilience is approximately 50 percent above replacement (Post-Disaster Needs Assessment). - Government commitment to create a saving fund for natural disasters is commendable and should be advanced legislatively and operationalized as soon as feasible. - Complement savings with higher coverage under the Caribbean Catastrophe Risk Insurance Facility (CCRIF); Dominica remains significantly below the maximum eligible. ### Financial stability and sectoral measures - Risks to financial stability are significant and could be systemic: large increases in NPLs, liquidity pressures, capital shortfalls (especially in credit unions), contagion via credit union links with banks, and potential loss of correspondent banking relations (CBRs). - Policy responses: - Strengthen regulation and supervision of credit unions. - Promptly implement remaining elements of the regional strategy to strengthen indigenous banks in the ECCU. - Adopt crisis management technical assistance recommendations for credit unions and insurance sectors. - Continue strengthening AML/CFT framework and effectively communicate reforms to reduce risk of reduced correspondent banking services. *Source: Fund staff calculations based on Dominica government data.* ### 24. A framework for oversight and monitoring fiscal risks arising from state-owned ### 24. A framework for oversight and monitoring fiscal risks arising from state-owned enterprises (SOEs) ### SOE fiscal risks and fiscal management - Most SOEs are operationally balanced but depend on central government grants to finance investments of significant magnitude. - This has allowed SOEs to maintain debt at around 12 percent of GDP in recent years. - Compliance improvements needed: - Submit audited annual financial statements. - Prepare an annual risk statement to improve fiscal management. - Hurricane-related impacts: - Hurricane imposed additional financial sustainability challenges on SOEs, including the need to access additional financing to repair damage and the decision to build with resilience. - Resilient reconstruction will increase interest expenditure but is expected to result in long-term cost savings given recurrence of natural disasters and support overall economy performance (Annex III). ### Authorities’ views on SOE and fiscal policy - Authorities broadly agreed with policy recommendations and welcomed staff advisory support. - Commitments and intentions expressed by the authorities: - Prepare a fiscal plan with technical support from official development partners. - Recurrent spending restraint. - Non-extension of hurricane-related import tariffs exemptions. - Increase in the income tax threshold. - Contain discretionary tax concessions. - Allocate CBI resources to public investment. - Resume progress to establish a fund for natural disasters, in line with staff technical assistance recommendations. - Continue improving governance and accept staff’s conservative CBI program revenue projections. - Consider fiscal rules but retain fiscal policy discretion in the near term given extreme uncertainty after hurricane Maria. ### Key statistics and projections related to SOEs and fiscal outlook - SOE debt: around 12 percent of GDP. - Fiscal deficits projected to average 5.9 percent of GDP during 2018-22. - Public debt projected to increase to near 90 percent. - Output decline in 2017: 4.7 percent (estimate). - Recovery to pre-Maria output levels could take 5 or more years. --- ### Financial sector—overall assessment - Hurricane Maria increased the risk of financial instability, given high NPLs and undercapitalization of most financial institutions. - Stronger financial oversight and crisis management frameworks for non-bank institutions and decisive actions to resolve NPLs are key to financial stability and to support private sector recovery. ### Bank nonperforming loans (NPLs) and forbearance - Ongoing efforts to reduce bank NPLs should be intensified; reducing NPLs could increase space for private sector financing to support reconstruction. - Loan service relief granted for 4-6 months after the hurricane should be assessed; a plan to unwind capital forbearance is needed. - Insurance payouts and early signs of output recovery imply expiration of debt service relief is unlikely to lead to significant portfolio underperformance. - A plan should assess the impact of forbearance on banks and normalize compliance with regulatory requirements. - Clear guidelines to acquire required capital should be adopted, including close institutional monitoring and specific timeframes. - New regulations and accounting changes: - Valuation rules issued December 2017 and effective July 2018. - Provisioning guidance to be issued in October 2018. - IFRS 9 will become binding in 2019. ### Foreclosure, resolution, and structural measures - Enhanced foreclosure procedures aligned with incentives for timely loan repayment are needed. - Extraordinary powers granted to the Eastern Caribbean Asset Management Corporation (per the 2017 Act) should be used to resolve NPLs if it becomes fully operational. - Government should use representation powers on the Monetary Council to phase out the Minimum Saving Rate to strengthen bank profitability and reduce interest rates. ### Publicly-financed lending programs - Public financing to support private recovery could be considered but should be efficiently targeted and limited in scope. - The government provided financing to increase credit lines through the Agricultural and Industrial Development (AID) Bank. - The amount of these credit lines is limited at 0.3 percent of GDP. - Funded with CDB loans and CBI resources. - Target sectors: agriculture, tourism, manufacturing, and housing. - Given NPLs of 29 percent and the need to preserve fiscal space, lending programs should remain limited in scope and be well targeted to ensure good repayment prospects. - Lending programs should focus on addressing supply constraints and rebuilding capital stock rather than consumer lending. --- ### Credit unions and crisis management - A crisis management plan and identification of capital shortfalls in the credit union sector is urgently needed. - Pre-hurricane conditions: credit unions already had high NPLs and weak capital. - Illustrative simulation: a 50 percent increase in NPLs would result in capital shortfalls in most credit unions and could lead to possible liquidity pressures. - Recommended measures: - Prepare a crisis management plan guided by March 2018 staff technical assistance. - Strengthen regulation and supervision of credit unions, including automatic, nondiscretionary, and effective responses to institutions in distress. - Strengthen resources and capacity of the Financial Services Unit (FSU), including legal powers to impose sanctions for non-compliance. - Pass reforms prior to a regional agreement for regulatory harmonization if necessary. ### Insurance sector - Stronger regulation and supervision in the insurance sector is key. - 33 percent of claims, mostly property, are still outstanding, much relating to the largest insurer, the sole domestic insurance company. - FSU actions and timelines: - Enforce regulations, redress the domestic insurer’s capital shortfall, and ensure payment of outstanding claims within the April 2019 timeline set by the FSU. - Lack of recovery within the agreed timeline should result in resolution. - Financing capital requirements with social security funds or loans from the national development agency (AID Bank) would compound fiscal sustainability challenges and should be avoided. - Given hurricane risk, the FSU should establish a contingency reserve for the insurance sector. - Government should use representation powers to advance harmonized regional regulation for the insurance sector to reduce insurance costs via scale, risk diversification, and competition. - The insurance sector should play a key role in risk sharing for natural disasters. ### Correspondent banking relationships (CBRs) and offshore banking - Government proactive stance will mitigate the risk of withdrawal of CBRs; withdrawals have not taken place. - Banks and money transfer companies report increased costs and administrative burdens to maintain CBRs. - AML/CFT legislation should continue to be strengthened in line with the FATF 2012 standard, with effective implementation. - Improve information sharing agreements between respondent and correspondent banks; explore bundling financial services (e.g., credit card clearing, remittances). - Phase out of the off-shore banking sector should continue (cessation of new license issuance since 2017). - Strengthening the regulatory framework would support phasing out and address perceived reputational and CBRs risk. ### Authorities’ views on financial sector - Authorities committed to strengthening the financial sector, increasing capital buffers, and reducing NPLs. - Plans to intensify efforts to obtain additional capital for the indigenous bank with capital calls and continued engagement with regional banks for new capital. - For the credit union sector, authorities agreed on enhanced monitoring and sought technical support for on-site supervisions to assess capitalization. - Expectation that stronger capital in the largest credit union would allow mergers with undercapitalized institutions over time. - Supportive of regional harmonization and will continue unwinding the offshore banking sector. - Commit to continue monitoring CBRs and reach full compliance with AML/CFT international standards. --- ### Growth, competitiveness, and structural reforms - A more prominent role for the private sector is crucial for recovery and requires removal of costs and barriers affecting investment and profitability. - Key constraints to address: - Increase labor productivity. - Lower costs, especially in energy. - Address large infrastructure gaps. ### Policies to support recovery and longer-term growth - Financing private investment: - Address structural factors that limit bank credit, including insufficient information about borrower quality and costly, protracted legal processes for loan contract enforcement and seizing collateral. - Review legislation affecting loan contract enforcement. - Advance regional plan to establish a credit bureau. - Employment and labor market: - Remove rigidities in working hours and review severance payments for redundancy. - Address educational gaps undermining labor force adaptability to facilitate mobility across sectors (seasonal demand in tourism and agriculture). - Enhance education targeting, including shorter training programs to align labor skills with promising sectors in consultation with employers. - Public sector compensation decisions should consider their impact on private wages and competitiveness. - Public services and infrastructure: - Reduce the cost of dealing with government, especially resolving insolvency, registering property, paying taxes, and obtaining construction permits. - Enforce construction and zoning regulations strictly given vulnerability to natural disasters. - Progress development of geothermal electricity generation; competitiveness benefits depend on lowering electricity costs (noted as now among the highest in the world). - Geothermal power could reduce dependence on imported fossil fuels and improve external sustainability. ### Authorities’ views on growth and competitiveness - Authorities support private entrepreneurship and highlighted: - Introduction of an online payment system to pay taxes, including tutorials to boost utilization. - Intent to explore options to reduce electricity prices in light of low geothermal generation costs. - Need to gather support from private sector and social organizations to address labor market rigidities. - Need to better align education and training incentives with productive sector demands and national development goals. - Commitment to build a resilient state, to be specified in the National Resilient Development Strategy 2018-2030. - Welcome staff analysis to assess output and tax revenue returns of costly resilient investment. --- ### Statistics and data capacity - Dominica continues to strengthen data provision but has shortcomings due to capacity constraints in the statistical agency. - Limitations include weaknesses in coverage, accuracy, frequency, and timeliness of data. - Data are broadly adequate for surveillance but constrain economic analysis and policy formulation. ### Staff appraisal and macroeconomic outlook - The economy is recovering from hurricane Maria; estimated output decline of 4.7 percent in 2017. - Economic activity picking up from a low base, led by construction. - Significant capacity and financing constraints slow recovery; returning to pre-Maria output levels could take 5 or more years. - Identified government financing (official loans, donor grants, use of deposits from the CBI program) will support domestic demand while output rebounds. - Collapse of tax revenues and increase in reconstruction expenditures will raise fiscal deficits to 5.9 percent of GDP on average during 2018-22, with public debt increasing to near 90 percent. - Private sector recovery constrained by insufficient financing and inadequate insurance payouts and savings. - Scope for financial sector lending limited given undercapitalization and high NPLs, both expected to deteriorate after the hurricane. - External outlook: - Government financing will support imports, but export collapse will lead to significant current account deficits, projected to average 20 percent of GDP during 2018–23. - These deficits will gradually narrow as output and exports recover. - Outlook is subject to significant uncertainty: if financing is lower than projected, fiscal and external deficits would be lower, and output recovery would take more time. *Source: IMF staff report content provided in the supplied material.* ### 39. Looming fiscal pressures require cost-efficient policies to protect fiscal space for social ### 39. Looming fiscal pressures require cost-efficient policies to protect fiscal support and reconstruction investment. ### Fiscal pressures, reconstruction financing, and public investment - Identified financing is insufficient to complete reconstruction, critical for full recovery. - The government should address inefficiencies in policies to support recovery, which include untargeted tax concessions and discretionary transfers, and allocate resources according to needs. - Public investment should be prioritized based on contribution to employment and output, thereby restoring household incomes. - Resilient investments to natural disasters is justified despite its relatively high cost, in light of disaster frequency and intensity. - CREAD, the new investment execution agency, will help address administrative and execution capacity constraints affecting public investment, while ensuring resilience to natural disasters and with the potential to attract additional grant financing. - Recurrent spending not related to supporting the recovery should be contained. - With identified financing, fiscal consolidation will be required at a later stage to create space for reconstruction, after output recovers. - Indicative simulations point at a fiscal consolidation of 4 percent of GDP to sustain reconstruction investment, with a primary surplus of over two percent of GDP, as needed to set public debt on a downward trajectory. ### Structural fiscal reforms to support recovery and resilience - Continued strengthening of CBI program integrity to reduce revenue uncertainty. - A saving fund for natural disasters. - Enhancement of public financial management and procurement systems to meet donor and green funds’ requirements and increase access to grants. - Fiscal rules in line with regional commitments. ### Banking sector stability, NPLs, and crisis frameworks - Stronger financial oversight, crisis management frameworks, and decisive action to resolve NPLs are key for financial stability and to support the recovery. - Ongoing efforts to reduce bank NPLs have gained importance after the hurricane and should be intensified. - The impact of loan service forbearance should be assessed and a plan developed to normalize compliance with regulatory requirements. - Appropriate loan classification and provisioning should be strictly enforced, and foreclosure procedures aligned with incentives for timely loan repayment. - Progress on NPL reduction could increase space for private sector financing needed to support reconstruction and rebuild productive capital. - Recommendations in the ECCB Asset Quality Reviews should be implemented. - The extraordinary powers granted to the Eastern Caribbean Asset Management Corporation should be used to resolve NPLs once it becomes fully operational. - The government should use its representation powers at the Monetary Council to phase out the Minimum Saving Rate to strengthen bank profitability and reduce interest rates, ultimately supporting capitalization and NPL reduction. ### Credit unions, insurance sector, and regulatory capacity - A crisis management plan and the identification of capital shortfalls in the credit union and insurance sector is needed. - Credit union portfolio performance will inevitably deteriorate with the hurricane and, given pre-hurricane NPLs and undercapitalization, the risk of financial instability in this sector increased. - A crisis management plan should be prepared, guided by staff recommendations from March 2018 technical assistance. - Stronger regulation with appropriate regulation enforcing powers and stricter supervision of credit unions is needed to protect membership savings, support financial inclusion, and safeguard financial stability. - Financial and human resources of the FSU need to be strengthened. - The FSU should use its powers to assess the solvency position of insurance companies with on-site supervision, and implement a plan to enforce capital and liquidity requirements if necessary. - Lack of recovery within the agreed timeline should result in resolution, and possible financing of capital requirements with government funds should be avoided. - Given the risk of natural disasters, strong regulation and enforcement would enhance competition in the insurance market by facilitating participation of internationally-diversified institutions and risk transfer, while consider establishing a contingency reserve for the sector. - The government should use its representation powers to advance harmonized regional regulation for the insurance sector, thereby reducing costs with the increase in scale, risk diversification, and competition. ### AML/CFT, offshore banking, and legislative reforms - The government should maintain its proactive stance to mitigate the risk of withdrawal of CBRs. - The authorities should continue strengthening the AML/CFT framework and ensure effective implementation on time for the 2018 CFATF mutual evaluation. - The phase out of the off-shore banking sector should continue, following cessation of new license issuance in 2017. - Approval of revisions to the Offshore Banking Act with higher capital requirements, license application process reform, and enactment of regulations should be expedited. ### Private sector role, labor, and business environment reforms - A more prominent role for the private sector is crucial, which requires identification and removal of costs and barriers that affect investment and profitability. - While prospects for early recovery of lending are difficult, to mobilize credit, information about borrower quality needs improvement, and legal processes for loan contract enforcement and seizing collateral should be revised for faster resolution and in protection of property rights. The regional plan to establish a credit bureau should be advanced. - To increase employment, legal constraints on working hours should be removed and severance payments for redundancy should be reviewed. - Addressing educational gaps, in consultation with private employers, will help address labor force adaptability and will facilitate mobility across sectors. - Public sector compensation decisions should consider their impact on private wages and competitiveness, mindful of the need to retain and attract qualified professionals to enhance capacity. - To improve the business environment, the government should maintain efforts to reduce the cost of dealing with government. This includes resolving insolvency and registering property, paying taxes, and obtaining construction permits. - Ongoing efforts to review construction and zoning regulations should be enforced strictly given vulnerability to natural disasters. - Progress with development of geothermal electricity generation is welcome; competitiveness benefits will depend on lowering electricity prices. Geothermal power will reduce dependence on imported fossil fuels, improving external sustainability. ### Data and statistical capacity - Data provision has shortcomings due to capacity constraints in the statistical agency, including weaknesses in coverage, accuracy, frequency, and timeliness of data. - Although it is broadly adequate for surveillance, these limitations constrain economic analysis and policy formulation. - Surveillance would benefit from more timely and improved data pertaining to the national and fiscal accounts, labor market, the balance of payments, and non-bank financial institutions. *DOMINICA — INTERNATIONAL MONETARY FUND* ### 47. It is recommended that the next Article IV Consultation with Dominica be held on the ### It is recommended that the next Article IV Consultation with Dominica be held on the standard 12-month cycle. ### Economic performance - Hurricane Maria caused sharp decline in output; 2017 Real GDP growth outturn: -4.7 percent. - Key sector contributions to 2017 real GDP: notable negative contributions from Construction and Public administration and public services; tourism-related industries had mixed performance (tourism was doing well prior to the hurricane). - Banking sector credit to the private sector has been flat, which is not supportive of growth. - Inflation remains subdued. - Credit and deposit indexes: Credit to the private sector and Deposits (Indexes, Jan 2014 = 100) tracked through 2017. - CPI inflation components (Percent change, y-o-y) show All items, Food, Core CPI, and Fuel series through 2017. ### External sector - A weakening U.S. dollar is boosting competitiveness. - Current account deficit is growing due to the hurricane-related fall in exports and increase in reconstruction-related imports. - Goods exports are on a downward trend; goods imports were also trending downward pre-hurricane but reconstruction raised imports thereafter. - Trade cargo volumes indicate preempt sharp deteriorations in the trade balance after the hurricane. - External debt and imputed reserves pressure debt and external sustainability. - Real and nominal effective exchange rates indexed to January 2005 = 100 shown through 2018. - Current account balance (percent of GDP) historical and projected: notable deterioration in 2017 (calendar‑year basis shows Current account balance: -31.7 percent of GDP in 2017 est.; table also reports -69.7 in millions USD for 2017). - Exports of goods and services (percent of GDP): 2017 est. 43.7 percent. - Imports of goods and services (percent of GDP): 2017 est. 85.5 percent. - Net imputed international reserves end-year (millions of U.S. dollars): 210.9 (2017 est.). - Months of imports of goods and services: 6.8 (2017 est.). - External debt (gross) 2017 est.: 99.8 percent of GDP. ### Fiscal sector - Primary fiscal balance will deteriorate sharply; capital spending remains high after the 2015 tropical storm. - Citizenship-by-Investment (CBI) revenue has been high but fell in 2017. - Reconstruction will depend on grants and concessional financing. - Public debt rises: Central government and broader public sector debt increase in projections. - Public debt (incl. guaranteed), percent of GDP series: 2017 est. 82.7 percent (Table 1: Central government debt (incl. guaranteed) 82.7). - Revenues and expenditures (percent of GDP, Table 3b): - Revenue: 46.8 percent (2016), 37.0 percent (2017), projected 34.8 (2018) and 27.8 (2019). - Taxes: 22.0 percent (2016), 18.9 percent (2017), 20.1 percent (2018). - Grants: 2.7 percent (2012) through projections show 0.9 percent in multiple years. - Expenditure: 43.3 percent (2016), 46.1 percent (2017), 41.0 percent (2018), 38.9 percent (2019). - Capital expenditure high: 17.3 percent of GDP (2016), 14.1 percent (2017). - Central government overall balance (incl. ND cost buffers), in EC$ millions: 2017 reported -5.5 (Table 1 series reflects multiple years and projections). - Natural disaster (ND) annualised cost: 1.5 percent of GDP in projection years (Table 3b: Natural disaster (ND) annualised cost 1.5). - Primary balance (percent of GDP): 2.0 percent (2016), -2.1 percent (2017), projected -2.3 percent (2018). - Public sector debt (percent of GDP) trajectory: 72.4 (2012), 80.1 (2013), 78.7 (2017), 83.3 (2018 est.), 86.1 (2019 proj.), 87.8 (2020 proj.), 85.2 (2023 proj.) per Table 3b memorandum. ### Monetary and financial sector - Financial soundness indicators showed some improvement before the hurricane: provisioning ratio, NPL ratio net of provisioning, capital adequacy ratio, and return on assets series through 2017. - Bank deposits increased from government and private sector, especially demand deposits. - Commercial banks are holding more assets abroad; NFA of commercial banks (Millions ECD) and components tracked through 2017. - Weak credit dynamics and accumulation of liquid assets: real private sector credit growth has been weak or negative in several years. - Excess liquidity continues to drive down interest rates. - Selected indicators (Table 4 Summary Accounts of the Banking System, end of period in millions ECD): - Net foreign assets: 1,437 (2016), 1,420 (2017), 1,398 (2018 prelim.). - Net domestic assets: 177 (2016), 179 (2017). - Private sector credit: 785 (2016), 788 (2017), 806 (2018 prelim.). - Money and quasi‑money (M2): 1,614 (2016), 1,599 (2017), 1,592 (2018 prelim.). - Interest rates (end-period): ECCB policy rate 6.5 (2016–2017 series shows 6.5); U.S. policy rate 1.3 (2016), with historical lower values earlier. ### Key macroeconomic indicators and projections (selected, preserve reported values) - Area (sq. km.): 754 - Population (2016): Total 73,126; Annual rate of growth (percent) -0.1; Density 97.0 - Gross Domestic Product (2016): Millions of E.C. dollars 1,570; Millions of U.S. dollars 581; U.S. dollars per capita 7,952 - Life expectancy at birth (years, 2016): 76; Adult literacy rate (percent, 2016): 94; Infant mortality (per thousand live births, 2016): 12.3; Unemployment rate (2016): 23 - Real GDP (annual percent change, selected years): 2014 4.2; 2015 -3.7; 2016 2.6; 2017 -4.7; 2018 projected -14.1; 2019 projected 9.4; 2020 projected 6.8; 2021 projected 3.6 - Nominal GDP (annual percent change, selected years): 2016 8.7; 2017 -4.1; 2018 -12.9; 2019 11.2; projections thereafter provided through 2023 in tables. - Broad money (M2) annual percent change: 2016 17.4; 2017 -0.9; projections small positive in later years. - Real credit to the private sector (annual percent change): 2016 -3.0; 2017 -1.0; projections 0.5 in multiple years. - Current account balance (percent of GDP): 2016 -12.5; 2017 -31.7; projections -22.1 (2018), -20.4 (2019), -21.3 (2020). - Exports of goods and services (percent of GDP): 2016 42.6; 2017 33.2; 2018 41.4; 2019 44.2; 2020 43.4; 2021 43.7 - Imports of goods and services (percent of GDP): 2016 67.2; 2017 83.1; 2018 81.0; 2019 75.7; 2020 70.3; 2021 58.5 ### Policy implications and priorities implied by the data (from source analysis) - Hold next Article IV Consultation on the standard 12-month cycle. - Reconstruction financing: prioritize grants and concessional financing to limit debt burden increase. - Fiscal consolidation and revenue measures may be required to stabilize public debt given elevated post-hurricane spending and reduced CBI revenues. - Support private sector credit growth to underpin economic recovery, while monitoring bank asset quality and liquidity management. - Strengthen external buffers and reserve management given large current account deficits and elevated external debt. *DOMINICA — INTERNATIONAL MONETARY FUND (content as provided).* ### Annex I. Debt Sustainability Analysis ### Annex I. Debt Sustainability Analysis ### Risk assessment and executive summary - Risk of external debt distress: High. - Hurricane Maria (September 2017) caused estimated losses and damage of 226 percent of GDP. - The government becomes financially constrained by FY2022/23 under the baseline scenario. - Public debt increases to near 90 percent of GDP in the baseline. - Dominica’s three-year CPIA average declined to 2.63, shifting the performance category from “strong” to “medium” and tightening policy-dependent thresholds. - Annualized cost of reconstruction after natural disasters of 1.5 percent of GDP per year is included in all scenarios. ### Background and damage profile - Total estimated losses and damage after Hurricane Maria: 226.3 percent of GDP. - Distribution and notable sectoral figures (percent of GDP): - Private sector share of losses and damage: 58 percent of total losses and damage. - Private housing damage equivalent to 61 percent of GDP. - Infrastructure damage within the public sector: 43 percent of GDP. - Total public sector debt (end-FY2016/17): around 72 percent of GDP. - About ¾ of the stock is external debt. - Debt of the rest of the public sector (SOEs and Petrocaribe estimate) is about 20 percent of GDP (about ¼ of total debt). - Financing commitments and assumptions included in the DSA: - US$115 million in commitments approved by the World Bank. - US$90 million assumed financing option from the Caribbean Development Bank (CDB). - Conservative assumptions on donor grant disbursements and CBI revenues. ### Underlying macroeconomic and fiscal assumptions (2017–37) - Fiscal stance and reconstruction: - Increase in public investment for post-Maria reconstruction through 2018–22, widening the fiscal deficit. - Investment spending projected to decline to 3 percent of GDP over the medium term as the government becomes financially constrained. - CBI revenues: - Baseline assumes conservative CBI revenues projected to decline to 2.7 percent of GDP over the medium term. - Grants: - Near-term grants assume donor support for reconstruction, declining to 1 percent of GDP thereafter. - Real GDP and growth: - Real GDP growth peaks at over 9 percent in the near term as output rebounds, then gradually declines towards 1.5 percent growth by 2023. - Box A1 statement: Output growth declines gradually to 1.5 percent per year. - Inflation and balance of payments: - Inflation projected to remain near 2 percent. - Current account deteriorates substantially after the hurricane; financed by official debt flows, CBI revenues, grants, and FDI inflows; over medium-to long-term financed by FDI and to a lesser extent CBI revenues. - Primary balance: - Primary balance sharply deteriorates in the near term; starting in 2018, includes 1.5 percent of GDP per year of natural disaster costs (primary balance is central government measure). ### External DSA findings and scenarios - External PPG debt risk: Rated “high.” - Baseline scenario outcomes: - PV of the debt-to-GDP ratio is breached over the entire projection period. - Other debt stock and debt service measures remain at or below policy-dependent indicative thresholds during the entire forecast period in the baseline. - Historical and alternative scenarios: - Under the historical scenario (variables at 10-year historical averages), PV of debt-to-GDP and PV of debt-to-exports ratios breach thresholds; debt stock and debt service measures increase. - Under the alternative scenario with a shock to non-debt flows (net non-debt creating flows at historical average minus one standard deviation in 2018–2019), PV of debt-to-GDP remains above threshold for the entire forecast horizon; other measures breach thresholds for most of the period. - Customized scenarios (highlighting key vulnerabilities): - Financially unconstrained scenario: public sector assumed to continue accumulating debt to finance reconstruction (capital spending at historical levels); public debt increases. - Financially unconstrained with a sudden stop in CBI inflows in FY2019/20: illustrates downside risk of reliance on unpredictable CBI revenues; leads to permanent breach of the PV of debt-to-GDP threshold and unsustainable debt dynamics. - Conclusion on external risks: - Materialization of identified risks would render external debt dynamics unsustainable; customized scenarios receive significant weight in the risk assessment. ### Public DSA findings (PPG domestic and total public debt) - Total public-sector debt: - Under the baseline, the PV of total public-sector debt is expected to remain above the corresponding benchmark until 2032. - PV of the debt-to-revenue and debt service-to-revenue ratios increase in the near term; debt service-to-revenue ratio trajectory remains flat in the long term. - Alternative shocks: - A one-time real depreciation of 30 percent in 2018 produces an unsustainable and increasing PV of debt-to-GDP ratio. - “Fixed primary balance” scenario (primary balance-to-GDP remains at 2017 level) leads to PV of debt-to-GDP falling below the threshold by 2021. - Historical scenario yields similar debt dynamics to the “fixed primary balance” case. - Customized scenarios: - Under financially unconstrained and financially unconstrained with sudden stop in CBI revenues scenarios, PV of debt-to-GDP, debt-to-revenue, and debt service-to-revenue ratios continue to increase throughout the forecast period. ### Policy implications and recommended fiscal adjustment - Dominica is assessed at “high risk of debt distress” based on baseline and stress scenarios. - Key risks to the debt sustainability outlook: - Sudden stop in CBI program revenues. - Financial instability from weakened balance sheets. - Recurrent natural disasters. - Policy priorities and needs: - Prudent and efficient fiscal policies to set public and publicly guaranteed total and external debt on a declining path while safeguarding fiscal space for social relief and reconstruction investment. - A fiscal consolidation plan is needed after recovery takes hold to sustain reconstruction investment. - Donor grant mobilization is key to minimize the debt burden. - Quantified fiscal consolidation need: - Dominica would need a fiscal consolidation of about 4 percent of GDP in order to create fiscal space for public investment required for capital replacement and to sustain reconstruction (under the macroeconomic projection and downward-rigid recurrent spending assumption). *Source: Annex I. Debt Sustainability Analysis (Dominica), IMF staff report.* ### 14. The authorities concurred ### 14. The authorities concurred ### Authorities' assessment and policy stance - Dominica remains at a high risk of debt distress. - Importance of grants and CBI flows to finance post-Maria reconstruction. - Need to focus on cost-effective fiscal policies with a view to adopt a consolidation plan to restore sustainability when recovery takes hold. - The fiscal consolidation measures committed to after the October 2015 RCF disbursement remain eligible, with appropriate recalibration. - Petrocaribe debt remains a gross liability of the government. The authorities did not indicate the existence of a contingency plan in case Petrocaribe flows do not materialize. ### Scenario definitions and key assumptions - Financially unconstrained scenario (customized). - Financially unconstrained with sudden stop in CBI assumes a complete stop of CBI inflows starting in FY2019/20. - Grant-equivalent financing (in percent of GDP): ......10.89.77.82.72.51.91.71.81.7 - Grant-equivalent financing (in percent of external financing): ......58.858.651.519.823.225.427.327.727.4 - Nominal GDP (Billions of US dollars): 0.50.6 0.60.50.50.60.60.60.70.81.1 - PV of PPG external debt (in Billions of US dollars): 0.20.30.30.30.40.40.40.40.5 - Debt service-to-exports ratio (in percent): 12.214.014.211.924.322.316.416.717.719.917.9 - PPG debt service-to-exports ratio (in percent): 9.0 10.310.58.619.518.312.912.913.815.814.3 ### Selected historical and projection highlights (as presented) - External debt (nominal): 86.583.8 77.791.599.195.399.3102.1102.195.182.6 - PV of external debt: ......66.178.685.582.286.188.789.084.071.8 - PV of PPG external debt (percent of GDP): ...43.053.257.555.059.662.362.656.445.2 - PV of PPG external debt (in percent of exports): ......133.8172.5272.2207.4200.2208.9207.1195.6167.4 - Government revenues (excluding grants, in percent of GDP): 34.038.055.046.737.337.135.434.935.034.933.834.6 - Real GDP growth (in percent): 0.2-0.6-1.11.02.4-9.3-3.28.05.12.91.90.91.51.51.5 - Effective interest rate (percent) 6/: 3.63.6 3.84.40.92.93.43.73.73.83.93.64.14.14.1 ### Stress tests and sensitivity analyses (high-level) - The most extreme stress test corresponds to net non-debt creating flows at historical average minus one standard deviation in 2018-2019; shocks are applied to the baseline scenario. - Key bound tests include: - B1. Real GDP growth at historical average minus one standard deviation in 2018-2019. - B2. Export value growth at historical average minus one standard deviation in 2018-2019. - B3. US dollar GDP deflator at historical average minus one standard deviation in 2018-2019. - B4. Net non-debt creating flows at historical average minus one standard deviation in 2018-2019. - B6. One-time 30 percent nominal depreciation relative to the baseline in 2018. - Example sensitivity outcomes reported (selected indicators across scenarios and years include exact tabulations in the source tables and figures). ### Policy implications and recommendations (from authorities' concurrence) - Prioritize securing grants and CBI flows for post-Maria reconstruction financing. - Maintain focus on cost-effective fiscal policies now, with a plan to adopt fiscal consolidation once recovery takes hold. - Recalibrate previously committed fiscal consolidation measures (post-October 2015 RCF disbursement) as appropriate. - Develop contingency planning for Petrocaribe flows given that Petrocaribe debt remains a gross government liability and no contingency plan was indicated. *Source: International Monetary Fund.* ### Annex II. External Sector Assessment ### Annex II. External Sector Assessment ### Overall assessment - In 2017, Dominica’s external position was weaker than the level consistent with medium-term fundamentals and desirable policy settings. - Reserves decreased modestly in 2017, and remain adequate, but their shock-absorbing capacity is constrained given the regional quasi-currency board arrangement. - A solid and sustainable external sector requires policies and structural reforms geared toward improving competitiveness in the medium term. ### Current account developments and projections - The current account switched from a surplus of 0.8 percent of GDP in 2016 to an estimated deficit of 12.5 percent of GDP in 2017. - After Hurricane Maria on September 18, 2017, exports of goods and services collapsed due to severe damage, notably to agriculture and tourism infrastructure. - Imports and transfers increased due to post-hurricane reconstruction needs and higher external support, respectively. - Given projected increases in imports for reconstruction and decreased Citizenship-By-Investment (CBI) revenue, the current account deficit is expected to increase further to 31.7 percent of GDP in 2018, then decline from 2019. - Note on CBI: The CBI is a program whereby foreigners may obtain citizenship through either a cash contribution of US$100,000 or an investment of US$200,000 in a government pre-selected real estate project. ### A. Nominal and Real Effective Exchange Rate (REER) assessment - Dominica’s currency, the East Caribbean dollar, is pegged to the U.S. dollar. - The average nominal effective exchange rate (NEER) appreciated by 0.5 percent in 2017. - A weakening U.S. dollar contributed to a real effective exchange rate (REER) depreciation of 2.8 percent during 2017. - Measures of the REER in other Caribbean, tourism-based countries suggest a deterioration of about 2.1 percent in Dominica’s competitiveness in 2017. - Appreciation risks: - Appreciation could ensue if relatively stronger growth and higher interest rates in the United States lead to a strengthening of the U.S. dollar. - Inflation is expected to rise from 1.4 percent in 2017 (period-average) to around 2 percent (period-average) in the medium term, boosting the real exchange rate. ### B. External stability assessments (quantitative estimates) - Staff assessment: Dominica’s external position is moderately weaker than the level consistent with medium-term fundamentals and desirable policy settings. - EBA-Lite current account (CA) regression model (after accounting for Dominica-specific factors), 2017: - Cyclically-adjusted current account balance: - 25.9 percent of GDP. - Cyclically-adjusted current account norm: - 9.7 percent of GDP. - Resulting current account gap: -16.1 percent of GDP. - Assumed elasticity of the CA to the REER: -0.96. - Macroeconomic policies contributed - 8.1 percent of GDP to the gap, specifically: - Fiscal policy: -8.4 percent of GDP. - Private credit: 0.3 percent of GDP. - Change in reserves: -0.04 percent of GDP. - Remaining gap to be closed through structural policies: 6.6 percent of GDP. - Cyclically adjusted fiscal balance in steady state reflects: - A desired underlying primary balance of 1.5 percent of GDP after a 4 percent of GDP fiscal consolidation. - CBI revenues of 1 percent of GDP. - Interest payments of 2.2 percent of GDP — reflecting rising global interest rates and higher debt in Dominica. - Additional temporary adjustment of 14.6 percent of GDP included to reflect: - A difference of 19.3 percent of GDP from the extraordinary CBI revenue of 20.3 percent GDP in 2017 and the projected CBI revenue of 1 percent of GDP in the steady state. - 4.7 percent of GDP from public investment of 12.2 percent of GDP financed by high CBI in 2017 and the projected public investment of 7.5 percent of GDP with a fiscal consolidation of 4 percent of GDP. - The fiscal consolidation is required to continue reconstruction with fiscal sustainability and to align with tapering of hurricane-related official and bilateral financing. - External sustainability (ES) approach: - Sets a medium-term current account norm at the level that would bring the net foreign assets-to-GDP ratio to zero in ten years. - Estimated norm: a deficit of 6.6 percent of GDP. - Compared to a cyclically-adjusted current account deficit of 14.4 percent of GDP. ### REER gap estimates - EBA-Lite methodologies indicate the REER is overvalued; reported adjustment needs: - CA model: REER adjustment of 17.5 percent would be necessary to close the current account gap of -16.1 percent of GDP. - ES approach: REER needs to be adjusted by 15.2 percent. - Index REER model: REER needs to be adjusted by 9.5 percent. - Average REER gap from the three methodologies: 14 percent overvaluation. ### C. Reserve adequacy - Dominica is a member of the Eastern Caribbean Currency Union; under the quasi-currency board, foreign assets and liabilities of the Eastern Caribbean Central Bank (ECCB) cannot be directly assigned to an individual country. - The imputed reserves method is used as a proxy for net foreign assets held with the ECCB. - Estimated imputed reserves: - End-2016: US$220.9 million, which covered 8.4 months of imports and 43 percent of broad money (benchmarks: 3 months of imports and 20 percent of broad money). - End-2017: U$210.9 million (a fall of 4.5 percent from end-2016), which cover 6.8 months of imports and 35 percent of broad money. - Information on short term debt and other liabilities is unavailable; consequently, assessments against other reserve adequacy metrics such as the IMF’s composite Assessment Reserve Adequacy (ARA) metric cannot be computed. ### D. Conclusion and policy implications - Dominica’s external position is assessed to be weaker than the level consistent with medium-term fundamentals and desirable policy settings in 2017. - Considering the damage caused by Hurricane Maria, and the consequent revenue losses and reconstruction spending needs, the external position will weaken significantly in the medium term. - Policy priorities when recovery takes hold: - Implement a fiscal consolidation plan to restore sustainability by generating a primary surplus while providing space for infrastructure spending. - Supportive structural reforms to boost productivity, improve competitiveness, and raise prospects for export diversification, including: - Improving labor productivity. - Addressing emigration and brain drainage. - Reducing electricity costs. - Increasing access to finance. - Improving the business environment. *International Monetary Fund staff assessment as presented in Annex II. External Sector Assessment.* ### 11. The AID bank asset portfolio was severely affected by hurricane Maria. A ### 11. The AID bank asset portfolio was severely affected by hurricane Maria. A ### AID Bank portfolio damage and sector impacts - A preliminary assessment indicated that approximately 45 percent of properties in the AID Bank portfolio suffered physical damage. - Damage by sector: - Agriculture: about 80 percent - Manufacturing: about 60 percent - Housing: about 30 percent - Transportation: about 25 percent ### Bank response to help clients recover - The bank granted a payment moratorium of: - 6 months to the agricultural sector - 4 months to other sectors ### Non-performing loans (NPLs) - Reported NPLs increased from 25 percent before the hurricane to 29 percent as at end-April. - A further increase in NPLs is likely. *Source: DOMINICA — STAFF REPORT FOR THE 2018 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX (As of April 30, 2018)* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18265-dominicaartiv.pdf_