## SCARRING EFFECTS OF THE PANDEMIC ON THE ECCU (content unit: 1eccea2022002)

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### Introduction
- Date: July 8, 2022.
- Prepared by Isabela Duarte, Roberto Garcia-Saltos, Salma Khalid, and Beatriz Nunes.
- Purpose:
  - Assess potential long-term (scarring) effects of COVID-19 on ECCU countries and fiscal implications.
  - Core questions:
    - How is the pandemic-related downturn different from previous downturns? How does the ECCU compare to other regions? Which economic features of ECCU countries relate to observed output losses?
    - What are the fiscal implications of the pandemic in terms of fiscal space and debt dynamics in ECCU countries?

### Output losses and economic structure — empirical findings
- Scarring concept:
  - Scarring (hysteresis) occurs when shocks generate economic damages that preclude recovery to pre-shock trend.
- Comparative context:
  - Comparison period: 2008–12 (global financial crisis) versus 2020–21 (pandemic).
  - For ECCU, forecast revisions were sizeable in both the GFC and the pandemic, with pandemic losses outstripping GFC losses in the first year and increasing in the subsequent year.
  - Using January 2022 WEO forecasts, real GDP for ECCU was estimated to reach the 2019 level only in 2024 and remain below its pre-pandemic projected path throughout the forecasting horizon.
- Cross-country regression on Annual Real GDP Losses (selected coefficients; standard errors in parentheses):
  - 2020 (Observations: 117; R-squared: 0.156):
    - Log (GDP Per Capita): -1.838 (1.443)
    - Rural Population: -0.134** (0.0573)
    - Lockdown Stringency Index: 0.209*** (0.0790)
    - Complexity Index: -0.874 (1.162)
    - Tourism Share of GDP: 0.530* (0.299)
  - 2021 (Observations: 116; R-squared: 0.218):
    - Log (GDP Per Capita): 0.311 (0.780)
    - Rural Population: 0.0429 (0.0312)
    - Lockdown Stringency Index: 0.0834* (0.0423)
    - Complexity Index: -1.536** (0.622)
    - Tourism Share of GDP: 0.423** (0.163)
  - 2022 (Observations: 114; R-squared: 0.274):
    - Log (GDP Per Capita): -0.0131 (0.844)
    - Rural Population: 0.0774** (0.0344)
    - Lockdown Stringency Index: 0.0609 (0.0458)
    - Complexity Index: -1.519** (0.667)
    - Tourism Share of GDP: 0.389** (0.175)
- Key interpretations:
  - Tourism share of GDP: significant and positive — higher tourism reliance associated with larger output losses during 2020–22.
  - Complexity Index: negative and significant in later years — countries producing more complex products were more resilient.
  - Lockdown stringency: positive and significant (notably 2020) — stricter containment measures associated with larger output losses.
  - Rural population: sign shifts from negative in 2020 to positive in 2022.

### Human capital channels — health and education regressions
- Health component (cumulative real GDP losses 2020–22; ECCU excluded in this regression; Observations: 67; 66; 65; R-squared: 0.138; 0.139; 0.218):
  - Young Deaths: 0.345* (0.177); 0.392* (0.211); 0.290 (0.209).
  - Lockdown Stringency Index: 0.142** (0.0586) in one specification.
  - Interpretation: Young deaths and lockdown stringency are positively associated with larger cumulative output losses.
- Education component (cumulative real GDP losses 2020–22; ECCU included; Observations: 171; 126; 120; 120; R-squared: 0.102; 0.183; 0.240; 0.280):
  - Weeks of full school closures: 0.116*** (0.0286); 0.143*** (0.0285); 0.0892*** (0.0324); 0.0799** (0.0319).
  - Weeks of full school closures_ECCU: 0.381** (0.152) in one specification.
  - Interpretation: Weeks of full school closures are highly significant and positively associated with cumulative output losses; ECCU shows a higher coefficient for school-closure impact in one specification.

### Pandemic impact and headline statistics for ECCU
- GDP estimated contraction: over 15 percent in 2020 due to the collapse of tourism and containment measures.
- Public debt increase: around 20 percentage points to 85 percent of GDP in 2020.
- Empirical summary:
  - High tourism exposure and low economic diversification correlated with output losses during 2020–22 (measured as downward revisions to growth forecasts, controlling for mobility restrictions and other variables).
  - Human capital risks: school closures and young deaths have potential to generate the largest negative long-term consequences for growth.

### Fiscal legacies from COVID — debt dynamics and fiscal space
- Overall deterioration:
  - Tax receipts eroded; spending needs rose for health and social assistance; tourism stoppages amplified shocks in tourism-dependent economies.
  - Result: accelerated debt accumulation and exacerbated debt-to-GDP ratios.
- Debt-stabilizing primary balance:
  - No significant difference between post-pandemic and pre-pandemic estimates of the long-run debt stabilizing primary balance, but near-term fiscal deterioration increased the gap between current primary balance and the debt-stabilizing primary balance.
  - Consequences: more fiscal effort required to return to debt-stabilizing trajectory; limited fiscal space; higher share of revenue allocated to interest payments; rollover costs expected to rise with tighter financial conditions.
- Tourism dependence and debt:
  - Cumulative output losses from COVID are a strong predictor of worsening debt as a percent of GDP.
  - Even after controlling for output losses, countries in the top quartile of tourism contribution to GDP have higher debt accumulation than less-tourism-dependent countries (Table 4).
  - Tourism-dependent economies experienced a dual shock: larger output losses and additional debt accumulation not fully explained by output losses alone.
- Credit access and pre-existing conditions:
  - Debt accumulation during the pandemic is positively correlated with credit access: higher initial debt pre-COVID correlates with higher debt accumulation; higher average nominal interest rate on debt pre-COVID correlates with lower debt accumulation during the pandemic (Table 4).
  - Only countries with pre-existing access to financing could exploit favorable global liquidity conditions during the pandemic.
  - Tourism-dependent countries entered the pandemic with already higher levels of debt.
- Fiscal support and debt accumulation:
  - Higher pandemic spending correlated with higher debt accumulation for all countries (Table 5).
  - Tourism-dependent economies had higher average levels of fiscal expenditures to combat the pandemic as a percent of GDP, resulting in greater overall debt accumulation.
  - Using alternate economic support indices, disparity in debt accumulation due to fiscal support between tourism-dependent and other economies was largest in 2020, persisted into 2021, and weakened in 2022 (Table 6).

### Short- and medium-term policy priorities and tradeoffs
- Short-term priorities:
  - Continue health spending to cope with the pandemic.
  - Use effective social transfers to cope with rising living costs.
- Medium-term priorities:
  - Move from income support and job retention measures to adopting active labor market policies to facilitate reallocation of workers and resources and foster productivity growth.
- Fiscal constraints:
  - Limited fiscal policy space and recent shocks imply difficult tradeoffs between supporting recovery and restoring fiscal sustainability.

### Natural disasters (NDs): incidence, economic effects, and implications
- Vulnerability and frequency:
  - ECCU experienced 1.6 natural disasters per year on average from 1980 to 2020.
  - Damages of 13 percent of GDP per disaster (average).
  - Controlling for land area, likelihood of a natural disaster for ECCU countries is twice that of disaster-prone Pacific islands and 5.6 times more than other Caribbean countries.
  - Around a quarter of the 50 most destructive country-specific natural disasters from 1980 to 2020 hit an ECCU country.
- Empirical and model-based impact estimates:
  - Severe storms: immediate negative impact of 1 percentage point on GDP growth.
  - Severe floods: immediate negative impact of 3 percentage points on GDP growth.
  - Rasmussen (2004): real GDP declined by about 2.2 percentage points in the year a natural disaster struck (12 events, 1970–2002).
  - Lian, Moran, and Vishvesh: a disaster with economic damage of 30 percent of GDP causes output to fall below its counter-factual trend by 8 percent five years after the shock.
- Sectoral vulnerabilities:
  - Tourism share of GDP ranged between 21.8 percent (Grenada) and 57.5 percent (Antigua and Barbuda) for 2010–2019.
  - Tourists decline by more than 50 percent during the hurricane season; visitors decline significantly following an ND even eight months after the event.
  - Tourism recovery examples: 12-month moving average of stayover visitors took almost 2 years to return after 9/11, 7 years after the Global Financial Crisis, and is still 74 percent lower than pre-crisis level following the COVID-19 shock.
  - Agriculture: primary sector accounts for more than 5 percent of GDP on average in Dominica, Grenada, and St. Vincent and the Grenadines; example — 95 percent of Grenada’s nutmeg trees destroyed after Hurricane Ivan; pre-disaster capacity estimated to return after 10 years.
  - Damages in Dominica’s agriculture sector: 31 percent of GDP following Hurricane Maria and 9.4 percent of GDP following Tropical Storm Erika.
- Fiscal effects of NDs:
  - Following NDs, the primary balance worsened by an average of 5.5 percentage points of GDP.
  - Public debt rose by 7 percentage points of GDP in ECCU economies since 1989, despite additional external grants of about 1 percent of GDP.

### Fiscal responsibility frameworks (FRFs), rule design, and operational details
- Regional guidance and changes:
  - 1998 guidance: public debt ceiling of 60 percent of GDP and an overall deficit target of 3 percent of GDP to be reached by 2020 (deficit target abandoned in 2006; debt target deadline delayed to 2030 in 2015).
  - Pandemic response: temporary suspension of fiscal rules; ECCB Monetary Council in February 2021 decided to extend the debt target by five years (current regional debt-to-GDP ceiling stands at 60 percent to be achieved by 2035).
  - Grenada and St. Vincent and the Grenadines triggered escape clauses under their fiscal rules in 2020-22.
- Country-level FRFs:
  - Only three ECCU member states had legislated FRFs/Acts prior to the pandemic: Grenada (2015), St. Vincent and the Grenadines (2020), and Anguilla (2013).
  - Examples of anchors and targets:
    - Antigua and Barbuda: public gross debt ceiling of 70 percent of GDP by 2030.
    - St. Vincent and the Grenadines: public gross debt ceiling of 60 percent of GDP by 2030.
    - Grenada: public gross debt ceiling of 55 percent of GDP by 2025.
    - Dominica: public gross debt ceiling of 60 percent of GDP by 2035.
    - Anguilla: ceiling on net debt of 80 percent of recurrent revenues; operational targets on debt service relative to recurrent revenue and liquid assets relative to recurrent spending.
  - Operational rules often center on primary balance targets, supported by spending rules (including public wages); Anguilla is an exception with different operational metrics.
  - Escape clauses for extraordinary events typically require certification by competent authorities and remedial plans to return to targets.
- Oversight committees:
  - FRFs in all countries require establishment of an oversight committee.
  - In most cases committees lack independence as they are appointed by Cabinet (Antigua and Barbuda, Dominica, St. Vincent and the Grenadines).
  - Operationalization pending in Antigua and Barbuda, and Dominica.
- Design principles and adjustments for ND exposure:
  - Fiscal rules should be simple, flexible (well-defined escape clauses and clear return plans), and enforceable (inscribed in law; designate independent fiscal council).
  - NDs call for setting fiscal policy more conservatively: debt ceilings should be set lower to internalize ND impact unless disaster-mitigating buffers are available.
  - Trade-offs:
    - Expenditure rules typically achieve lower GDP volatility but slower debt convergence.
    - Primary balance rules may be preferable for small economies with high ND exposure and elevated initial debt.
    - Within primary balance rules, instruments with the smallest multiplier tend to offer better trade-offs between counter-cyclicality and speed of debt convergence.

### Simulation framework, fiscal-rule performance, and calibration
- Methodology:
  - Performance examined via stochastic simulations following Andrle and Hunt (2020) using historical distributions of annual demand, inflation and natural disaster shocks and the IMF’s Global Integrated Monetary and Fiscal Model (GIMF).
- Fiscal rule types and formal specifications:
  - Primary balance (PB) rule: Def_t = Def* − α Y_t − β (Debt_{t−1} − Debt*)
    - Three PB variants: Strict PB (α = β = 0); PB with output stabilization (α ≠ 0, β = 0); PB with output and debt stabilization (α ≠ 0, β ≠ 0).
    - Two fiscal adjusters: government consumption (GC) and general transfers (GT).
  - Nominal expenditure (EXP) rule with a debt break: 100 log(EXP_t) = 100 log(EXP*) + δ Y_t − γ (Debt_{t−1} − Debt*)
    - Rule sustains government consumption at trend/target and includes debt target consistency; δ and γ calibrated so public debt-to-GDP returns to target within 10 years after a shock.
- Simulation findings and trade-offs:
  - Rules trade off counter-cyclicality (GDP stabilization) and speed of debt convergence to targets.
  - Presence of NDs associated with greater and more protracted departures of public debt from its target and greater GDP volatility.
  - Within PB rules:
    - PB rules with some weight on output stabilization produce lower GDP volatility but slower debt convergence.
    - PB rules that allow both output and debt stabilization do worse on output stabilization but achieve faster debt convergence.
    - Strict PB rules lie in between.
  - Instrument choice:
    - Using general transfers (GT) typically yields better outcomes (GDP volatility and debt convergence) because government consumption (GC) has a larger multiplier.
  - Expenditure (EXP) rules:
    - Tend to deliver lower GDP volatility but slower debt convergence compared with PB rules using government consumption as instrument due to one-period response delay.
  - Country heterogeneity matters: differences in ND prevalence explain why certain rules perform differently across Grenada and St. Vincent and the Grenadines.
- Fiscal rule parameterizations presented (examples):
  - CG Primary balance rule α=0 β=0
  - CG Primary balance rule w/ output stabilization α=0.25 β=0
  - CG Primary balance rule w/ output stabilization and debt correction α=0.25 β=0.5
  - CT Primary balance rule α=0 β=0
  - CT Primary balance rule w/ output stabilization α=0.25 β=0
  - CT Primary balance rule w/ output stabilization and debt correction α=0.25 β=0.5
  - CG expenditure rule with small debt correction δ=0 γ=0.5
  - CG expenditure rule with larger debt correction δ=0 γ=1

### Case studies, calibration inputs, and steady-state ratios (Grenada and St. Vincent and the Grenadines)
- Calibration and steady-state shares (in percent of GDP):
  - Private consumption: 63.3 (GRD), 60.8 (VCT)
  - Investment: 23.4 (GRD), 19.8 (VCT)
  - Public Spending: 16.6 (GRD), 21.9 (VCT)
    - Consumption: 12.9 (GRD), 17.1 (VCT)
    - Investment: 3.7 (GRD), 4.8 (VCT)
  - Exports: 52.6 (GRD), 44 (VCT)
  - Imports: 55.9 (GRD), 46.5 (VCT)
  - Total Revenues: 24.8 (GRD), 34.4 (VCT)
  - Consumption tax: 8.5 (GRD), 8.5 (VCT)
  - Labor tax: 2.1 (GRD), 4 (VCT)
  - Corporate tax: 1.8 (GRD), 3 (VCT)
  - Tariffs: 7.8 (GRD), 16.2 (VCT)
  - Government Spending: 24.5 (GRD), 34 (VCT)
    - Public consumption: 12.9 (GRD), 17.1 (VCT)
    - Public investment: 3.7 (GRD), 4.8 (VCT)
    - Transfers: 7.9 (GRD), 12.1 (VCT)
- Notes:
  - Grenada is more open than St. Vincent and the Grenadines but has a smaller public sector with lower expenditures on consumption goods, investment and transfers and lower revenues.
  - Calibration based on average ratios prior to the pandemic.
  - Openness affects fiscal multipliers; assumed labor share is 60 percent for both countries.

### Debt-anchor calibration toolkit, debt fanchart, and operational templates
- Toolkit steps for debt anchor calibration:
  1. Construct paths for key macro variables with shocks drawn from historical distribution.
  2. Project medium-term debt trajectories consistent with each simulated path using the debt dynamic equation and a fiscal reaction function.
  3. Identify the debt anchor such that debt would not exceed a certain higher limit with high probability over the medium term.
- Natural disaster modeling in toolkit:
  - Model natural disaster shocks parametrically with Dt ~ Bernoulli(p) and Zt from a Pareto distribution calibrated to average marginal growth effects and skewness.
  - Two-step approach: differentiate small and large shocks; calibrate Pareto distribution using large natural disasters.
- Mitigating measures:
  - Toolkit integrates mitigating channels in reduced form: an amount in percent of GDP is disbursed in equal annual installments if at least one natural disaster occurs; debt accumulation impact reduced accordingly.
- Operational rule calibration:
  - Template based on debt dynamic equation determines deficit paths that allow convergence from current debt to anchor level, allowing for natural disaster shocks, escape clauses, and user-defined external resources.

### Country experiences and disaster risk financing
- Antigua and Barbuda:
  - Public debt rose to 102 percent of GDP in 2020.
  - Cabinet approved a rule-based FRF underpinned by a Medium-Term Fiscal Strategy (MTFS) and Fiscal Resilience Guidelines (FRG); framework not embedded in legislation and lacks independent oversight committee appointment procedures.
- Dominica:
  - Public debt increased from 70 percent of GDP in 2015 to 94 percent of GDP in 2019 post-tropical storm Erika and Hurricane Maria.
  - Parliament approved a rules-based FRF anchored on public debt-to-GDP ratio of 60 percent by 2035 (approved November 2021).
  - Measures estimated to improve fiscal stance over medium term by 5 percent of GDP through revenue mobilization and spending efficiency.
- Grenada:
  - Fiscal Responsibility Act (FRA) 2015; reduced public debt from 105 percent of GDP in 2013 to 84 percent in 2016; fell below 60 percent in 2019.
  - Suspended fiscal rules via escape clause during 2020-22; public debt rose to 71.4 percent of GDP in 2020 before projected 69 percent in 2022.
  - Observed design issue: overlapping operational rules constrained public investment.
- St. Vincent and the Grenadines:
  - Public debt rose to 89.2 percent of GDP in 2021 from 68.1 percent in 2019.
  - Fiscal Responsibility Resolution approved January 2020; escape clauses and the 2021 eruption of La Soufrière Volcano delayed FRF implementation.
- Disaster risk financing layers and instruments:
  - Dominica: three-layer strategy targeting coverage of 99 percent of estimated fiscal costs; Layer 1 savings fund financed by CBI revenues and budget contributions; Layer 2 CCRIF; Layer 3 CAT bonds considered.
  - Grenada: National Disaster Risk Financing Strategy with risk retention (contingency fund), risk transfer (CCRIF, CAT-DDO, hurricane clause), and private insurance.
  - St. Vincent and the Grenadines: Contingent Fund, CCRIF enrollment, CAT-DDO contingent credit lines.

### Policy implications and recommendations
- Scarring risks:
  - High tourism dependence, human capital impacts (young deaths and prolonged school closures), and limited fiscal space raise sizable scarring potential for ECCU countries.
- Fiscal-rule design:
  - Rules should be simple, flexible, and enforceable; include well-defined escape clauses and clear return plans; be calibrated conservatively for ND exposure.
  - For small economies with high ND exposure and elevated initial debt, primary balance rules could be preferable to expenditure rules.
- Operational choices:
  - Prefer instruments with smaller fiscal multipliers (e.g., general transfers rather than government consumption) when debt convergence is a priority and to reduce GDP volatility.
  - Set debt ceilings lower the greater the exposure to NDs unless sufficient buffers (insurance, contingency funds, disaster clauses, grants) exist.
- Resilience financing:
  - Consider risk layering: self-insurance (contingency funds), regional risk-sharing (CCRIF), contingent credit lines (CAT-DDO), and market instruments (CAT bonds) as part of medium-term strategies.
  - IMF staff simulations: Caribbean countries would need insurance coverage of 15–30 percent of GDP to cover 99 percent of the fiscal costs related to natural disasters, at an annual cost in the range of 0.5–2 percent of GDP.
- Revenue mobilization:
  - Strengthen incentives and measures for domestic revenue mobilization; expenditure rules alone may not incentivize revenue mobilization and can encourage tax expenditures.

### Data and indicator definitions used in the analysis (selected)
- GDP Losses: Comparison between real GDP projections from January 2022 WEO and October 2019. Source: IMF staff estimations.
- Rural Population: Share of total population residing in rural areas. Source: World Bank staff estimates based on the United Nations Population Division's World Urbanization Prospects.
- Lockdown Stringency Index: Average of the Lockdown Stringency Index in 2020 and 2021. Source: University of Oxford and IMF staff calculations.
- Complexity Index: Measures complexity of products the country successfully exports; normalized between 0 and 4.5. Source: Harvard’s Growth Lab.
- Tourism Share of GDP: Travel and tourism total contribution to GDP. Source: World Travel & Tourism Council.
- Young Deaths: People between 0 and 40 years old who died from COVID-19 until March 2022 (percent of total deaths from COVID-19). Source: Max Planck Institute for Demographic Research and IMF staff calculations.
- Weeks of Full School Closures: Number of weeks schools were closed nationally between March 2020 and October 2021. Source: UNESCO global dataset.
- Debt to GDP: Comparison between debt-to-GDP projections from January 2022 WEO and October 2019. Source: IMF staff estimates.
- Average Nominal Interest Rate on Debt: Ratio of gross interest expenditures in year t to stock of debt in year t-1. Source: IMF staff estimates.
- Fiscal Spending on COVID: Includes above-the-line and below-the-line measures and contingent liabilities. Source: IMF’s Fiscal Monitor Database of Country Fiscal Measures in Response to the COVID-19 Pandemic.
- Economic Support Index 2021 and 2022: Index for economic support measures including income support, debt/contract relief, other economic stimulus spending and COVID-19 related foreign aid. Source: University of Oxford, COVID-19 Government Response Tracker.

*Source: 1eccea2022002 - SCARRING EFFECTS OF THE PANDEMIC ON THE ECCU*

### References _______________________________________________________________________________________ 11

### SCARRING EFFECTS OF THE PANDEMIC ON THE ECCU

### Introduction
- Date: July 8, 2022.
- Prepared by Isabela Duarte, Roberto Garcia-Saltos, Salma Khalid, and Beatriz Nunes.
- Purpose: Assess potential long-term (scarring) effects of COVID-19 on ECCU countries and fiscal implications; focus questions:
  - How is the pandemic-related downturn different from previous downturns? How does the ECCU compare to other regions? Which economic features of ECCU countries relate to observed output losses?
  - What are the fiscal implications of the pandemic in terms of fiscal space and debt dynamics in ECCU countries?

### Output Losses and Economic Structure
- Concept: Scarring (hysteresis) occurs when shocks generate economic damages that preclude recovery to pre-shock trend.
- Comparative context:
  - Comparison period: 2008–12 (global financial crisis) versus 2020–21 (pandemic).
  - For ECCU, forecast revisions were sizeable in both the GFC and the pandemic, with pandemic losses outstripping GFC losses in the first year and increasing in the subsequent year.
  - Using January 2022 WEO forecasts, real GDP for ECCU was estimated to reach the 2019 level only in 2024 and remain below its pre-pandemic projected path throughout the forecasting horizon.
- Cross-country regression findings (sample sizes noted in table footnotes and rows):
  - Regression on Annual Real GDP Losses (Table 1) — coefficients (standard errors in parentheses), Observations, and R-squared:
    - 2020 column:
      - Log (GDP Per Capita): -1.838 (1.443)
      - Rural Population: -0.134** (0.0573)
      - Lockdown Stringency Index: 0.209*** (0.0790)
      - Complexity Index: -0.874 (1.162)
      - Tourism Share of GDP: 0.530* (0.299)
      - Constant: 18.57 (14.20)
      - Observations: 117
      - R-squared: 0.156
    - 2021 column:
      - Log (GDP Per Capita): 0.311 (0.780)
      - Rural Population: 0.0429 (0.0312)
      - Lockdown Stringency Index: 0.0834* (0.0423)
      - Complexity Index: -1.536** (0.622)
      - Tourism Share of GDP: 0.423** (0.163)
      - Constant: -1.417 (7.665)
      - Observations: 116
      - R-squared: 0.218
    - 2022 column:
      - Log (GDP Per Capita): -0.0131 (0.844)
      - Rural Population: 0.0774** (0.0344)
      - Lockdown Stringency Index: 0.0609 (0.0458)
      - Complexity Index: -1.519** (0.667)
      - Tourism Share of GDP: 0.389** (0.175)
      - Constant: 1.088 (8.284)
      - Observations: 114
      - R-squared: 0.274
  - Key interpretations from regressions:
    - Tourism share of GDP is significant and positive: countries more reliant on tourism suffered larger output losses during 2020–22.
    - Complexity Index has negative sign and is significant in later years: countries producing more complex products were more resilient.
    - Lockdown stringency is positive and significant (notably 2020), indicating stricter containment measures associated with larger output losses.
    - Rural population variable switches sign from negative in 2020 to positive in 2022.
- Human capital channels (Tables 2 and 3):
  - Health component (Table 2) — cumulative real GDP losses 2020–22 (ECCU excluded from this regression):
    - Log (GDP Per Capita): -0.323 (0.678); -0.458 (0.845); -0.961 (0.852) across three specifications.
    - Young Deaths: 0.345* (0.177); 0.392* (0.211); 0.290 (0.209).
    - Share of Expenditure in Health: -0.0185 (0.127); -0.0446 (0.123).
    - Population Median Age: 0.0455 (0.0999); 0.0843 (0.0986).
    - Lockdown Stringency Index: 0.142** (0.0586) in one specification.
    - Observations: 67; 66; 65.
    - R-squared: 0.138; 0.139; 0.218.
    - Interpretation: Young deaths and lockdown stringency are positively associated with larger cumulative output losses.
  - Education component (Table 3) — cumulative real GDP losses 2020–22 (ECCU included in regression):
    - Log (GDP Per Capita): -0.451 (0.353); -0.349 (0.388); -0.709* (0.375); -0.738** (0.367) across four specifications.
    - Weeks of full school closures: 0.116*** (0.0286); 0.143*** (0.0285); 0.0892*** (0.0324); 0.0799** (0.0319).
    - Share of Expenditure in Education: -0.0387 (0.0907); 0.0108 (0.0828); 0.0352 (0.0815).
    - Lockdown Stringency Index: 0.105** (0.0430); 0.120*** (0.0425) in some specifications.
    - Weeks of full school closures_ECCU: 0.381** (0.152) in one specification.
    - Constant: 9.652*** (3.448); 8.348* (4.232); 5.926 (3.930); 5.125 (3.856).
    - Observations: 171; 126; 120; 120.
    - R-squared: 0.102; 0.183; 0.240; 0.280.
    - Interpretation: Weeks of full school closures are highly significant and positively associated with cumulative output losses; ECCU shows a higher coefficient for school-closure impact in one specification.

### Fiscal Legacies from COVID
- Overall deterioration:
  - Sharp curtailment of economic activity eroded public sector tax receipts; spending needs rose for health and social assistance; tourism stoppages amplified the shock in tourism-dependent economies.
  - Result: accelerated debt accumulation and exacerbated debt-to-GDP ratios.
- Debt dynamics and fiscal space:
  - No significant difference found between post-pandemic and pre-pandemic estimates of the long-run debt stabilizing primary balance, but near-term fiscal deterioration increased the gap between current primary balance and the debt-stabilizing primary balance.
  - Consequences: more fiscal effort required to return to debt-stabilizing trajectory; limited fiscal space to absorb additional shocks; higher share of revenue allocated to interest payments; rollover costs expected to rise with tighter financial conditions.
- Tourism dependence and debt:
  - Cumulative output losses from COVID are a strong predictor of worsening debt as a percent of GDP.
  - Even after controlling for output losses, countries in the top quartile of tourism contribution to GDP have higher debt accumulation than less-tourism-dependent countries (Table 4).
  - Tourism-dependent economies experienced a dual shock: larger output losses and additional debt accumulation not fully explained by output losses alone.
- Credit access and pre-existing conditions:
  - Debt accumulation during the pandemic is positively correlated with credit access: higher initial debt pre-COVID correlates with higher debt accumulation; higher average nominal interest rate on debt pre-COVID correlates with lower debt accumulation during the pandemic (Table 4).
  - Only countries with pre-existing access to financing could exploit favorable global liquidity conditions during the pandemic.
  - Tourism-dependent countries entered the pandemic with already higher levels of debt, contributing to deteriorating debt dynamics.
- Fiscal support and debt accumulation:
  - Higher pandemic spending is correlated with higher debt accumulation for all countries (Table 5).
  - Tourism-dependent economies had higher average levels of fiscal expenditures to combat the pandemic as a percent of GDP, resulting in greater overall debt accumulation.
  - Using alternate economic support indices, disparity in debt accumulation due to fiscal support between tourism-dependent and other economies was largest in 2020, persisted into 2021, and weakened in 2022 (Table 6).
  - Interpretation: Link between economic support and debt accumulation is stronger in tourism-dependent economies because they provided larger support and are small open economies with higher import dependence, smaller fiscal multipliers, and greater leakages to imports.

### Conclusions (section heading appears next in source)
- The chapter emphasizes the sizable scarring potential of COVID-19 for ECCU countries driven by:
  - High tourism dependence (positive association with output losses and debt accumulation).
  - Human capital impacts from young deaths and prolonged school closures (significant coefficients in health and education regressions).
  - Limited fiscal space due to near-term fiscal deterioration and increased debt-service burdens.
- Policy implications (drawn from analysis sections):
  - Need to consider the interplay of pandemic path, sectoral composition (notably tourism exposure), adaptation capacity (ability to shift to lower-contact activities), and effectiveness of policy responses in shaping long-term outcomes.
  - Recognize that tourism-dependent small open economies face compounded risks: larger output losses, greater fiscal support needs, higher debt accumulation, and constrained fiscal buffers for future shocks.

*Source: 1eccea2022002 - References*

### 14. The pandemic has inflicted large output losses in the ECCU that would generate

### 14. The pandemic has inflicted large output losses in the ECCU that would generate

### Pandemic impact and scarring in the ECCU
- GDP estimated to have contracted over 15 percent in 2020 due to the collapse of tourism and containment measures.
- Public debt estimated to have risen by around 20 percentage points to 85 percent of GDP in 2020.
- Empirical results: high tourism exposure and low economic diversification are correlated with output losses during 2020–22 in the ECCU, measured as downward revisions to growth forecasts (controlling for restrictions on mobility and other variables).
- The pandemic reduced fiscal space and increased interest payment burdens, weakening governments’ ability to invest in projects with higher fiscal multipliers (for example, infrastructure) and creating another potential source of hysteresis in the region.
- Human capital risks: school closures and young deaths have the potential to generate the largest negative long-term consequences for growth.

### Short- and medium-term policy priorities and tradeoffs
- Short-term priorities:
  - Continue health spending to cope with the pandemic.
  - Use effective social transfers to cope with rising living costs.
- Medium-term priorities:
  - Move from income support and job retention measures to adopting active labor market policies to facilitate reallocation of workers and resources and foster productivity growth.
- Fiscal constraints imply difficult tradeoffs given limited fiscal policy space and recent shocks.

### Natural disasters (NDs): incidence, economic effects, and implications
- Vulnerability and frequency:
  - ECCU experienced 1.6 natural disasters per year on average from 1980 to 2020.
  - Damages of 13 percent of GDP per disaster (average).
  - Controlling for land area, likelihood of a natural disaster for ECCU countries is twice that of disaster-prone Pacific islands and 5.6 times more than other Caribbean countries.
  - Around a quarter of the 50 most destructive country-specific natural disasters from 1980 to 2020 hit an ECCU country.
- Empirical and model-based impact estimates:
  - Severe storms: immediate negative impact of 1 percentage point on GDP growth.
  - Severe floods: immediate negative impact of 3 percentage points on GDP growth.
  - Rasmussen (2004): real GDP declined by about 2.2 percentage points in the year a natural disaster struck (12 events, 1970–2002).
  - Lian, Moran, and Vishvesh: a disaster with economic damage of 30 percent of GDP causes output to fall below its counter-factual trend by 8 percent five years after the shock.
- Sectoral vulnerabilities:
  - Tourism share of GDP between 21.8 percent (Grenada) and 57.5 percent (Antigua and Barbuda) for 2010–2019.
  - Tourism declines: risk of NDs and worse weather reduce number of tourists by more than 50 percent during the hurricane season; visitors decline significantly following an ND even eight months after the event.
  - Tourism recovery example: the 12-month moving average of stayover visitors took almost 2 years to return to pre-crisis level after 9/11, 7 years after the Global Financial Crisis, and is still 74 percent lower than pre-crisis level following the COVID-19 shock.
  - Agriculture: primary sector accounts for more than 5 percent of GDP on average in Dominica, Grenada, and St. Vincent and the Grenadines; large disasters can cause long gestation scarring (example: 95 percent of Grenada’s nutmeg trees destroyed after Hurricane Ivan; pre-disaster capacity estimated to return after 10 years).
  - Damages in Dominica’s agriculture sector: 31 percent of GDP following Hurricane Maria and 9.4 percent of GDP following Tropical Storm Erika.
- Fiscal effects of NDs:
  - Following NDs, the primary balance worsened by an average of 5.5 percentage points of GDP.
  - Public debt rose by 7 percentage points of GDP in ECCU economies since 1989, despite additional external grants of about 1 percent of GDP.

### Fiscal frameworks, FRFs, and rule design implications
- Regional debt guidance and recent changes:
  - 1998 guidance: public debt ceiling of 60 percent of GDP and an overall deficit target of 3 percent of GDP to be reached by 2020 (deficit target abandoned in 2006; debt target deadline delayed to 2030 in 2015).
  - Pandemic response: temporary suspension of fiscal rules; ECCB Monetary Council in February 2021 decided to extend the debt target by five years (current regional debt-to-GDP ceiling stands at 60 percent to be achieved by 2035).
  - Grenada and St. Vincent and the Grenadines triggered the escape clause under their fiscal rules in 2020-22.
- Country-level FRFs and operational targets:
  - Only three ECCU member states had legislated FRFs/Acts prior to the pandemic: Grenada (2015), St. Vincent and the Grenadines (2020), and Anguilla (2013).
  - Anguilla, Grenada, and Dominica enacted FRFs in parliament; St. Vincent and the Grenadines and Antigua and Barbuda set FRFs under a parliament resolution and Cabinet approval, respectively.
  - Anchors and targets (examples):
    - Antigua and Barbuda: public gross debt ceiling of 70 percent of GDP by 2030.
    - St. Vincent and the Grenadines: public gross debt ceiling of 60 percent of GDP by 2030.
    - Grenada: public gross debt ceiling of 55 percent of GDP by 2025.
    - Dominica: public gross debt ceiling of 60 percent of GDP by 2035.
    - Anguilla: ceiling on net debt of 80 percent of recurrent revenues; operational targets on debt service relative to recurrent revenue and liquid assets relative to recurrent spending.
  - In most FRFs, a primary balance rule is the main operational target, supported by spending rules (including public wages); Anguilla is an exception with different operational metrics.
  - Extraordinary events (natural disaster, health crisis, recession, financial crisis) can trigger suspension of targets in most ECCU countries; certification by competent authorities required and remedial plans must be developed to return to targets.
- Design principles and adjustments for ND exposure:
  - General principles: fiscal rules should be simple, flexible (well-defined escape clauses and clear return plans), and enforceable (inscribed in law; designate independent fiscal council).
  - NDs call for setting fiscal policy more conservatively: debt ceilings should be set lower to internalize the impact of NDs unless disaster-mitigating buffers are available.
  - Trade-offs between rule types: expenditure rules typically achieve lower GDP volatility but slower debt convergence; primary balance rules may be preferable for small economies with high ND exposure and elevated initial debt.
  - Within primary balance rules, instruments with the smallest multiplier tend to offer better trade-offs between counter-cyclicality and speed of debt convergence.

### Data and indicator definitions used in the analysis
- GDP Losses: Comparison between real GDP projections from January 2022 WEO and October 2019. Source: IMF staff estimations.
- Rural Population: Share of total population residing in rural areas. Source: World Bank staff estimates based on the United Nations Population Division's World Urbanization Prospects.
- Lockdown Stringency Index: Average of the Lockdown Stringency Index in 2020 and 2021. Source: University of Oxford and IMF staff calculations.
- Complexity Index: Measures complexity of products the country successfully exports; normalized between 0 and 4.5. Source: Harvard’s Growth Lab.
- Tourism Share of GDP: Travel and tourism total contribution to GDP. Source: World Travel & Tourism Council.
- Young Deaths: People between 0 and 40 years old who died from COVID-19 until March 2022 (percent of total deaths from COVID-19). Source: Max Planck Institute for Demographic Research and IMF staff calculations.
- Share of Expenditure in Health: 2018 health expenditures including healthcare goods and services as a share of GDP. Source: World Health Organization Global Health Expenditure database.
- Population Median Age: Estimate for 2019. Source: Our World in Data.
- Weeks of Full School Closures: Number of weeks schools were closed nationally between March 2020 and October 2021. Source: UNESCO global dataset.
- Share of Expenditure in Education: 2018 general government expenditure on education as percent of GDP. Source: UNESCO Institute for Statistics and World Bank.
- Debt to GDP: Comparison between debt-to-GDP projections from January 2022 WEO and October 2019. Source: IMF staff estimates.
- Average Nominal Interest Rate on Debt: Ratio of gross interest expenditures in year t to stock of debt in year t-1. Source: IMF staff estimates.
- Fiscal Spending on COVID: Includes above-the-line and below-the-line measures and contingent liabilities. Source: IMF’s Fiscal Monitor Database of Country Fiscal Measures in Response to the COVID-19 Pandemic.
- Economic Support Index 2021 and 2022: Index for economic support measures including income support, debt/contract relief, other economic stimulus spending and COVID-19 related foreign aid. Source: University of Oxford, COVID-19 Government Response Tracker.

*Source: 1eccea2022002 - 14. The pandemic has inflicted large output losses in the ECCU that would generate*

### 13.      The FRFs in all countries require the establishment of an oversight committee. In most

### 1eccea2022002 - 13.      The FRFs in all countries require the establishment of an oversight committee. In most

### Oversight committees: status and independence
- The FRFs in all countries require the establishment of an oversight committee.
- In most cases, the committees lack independence as they are appointed by Cabinet (Antigua and Barbuda, Dominica, and St. Vincent and the Grenadines).
- Operationalization of the oversight committee is pending in Antigua and Barbuda, and Dominica.
- Examples from Table 1:
  - FRC, appointed by the Minister and approved by the Cabinet.
  - Nominated by the parliament in consultation with the Director of Audit, and appointed by the Governor General.
  - Members appointed by Cabinet.
  - Fiscal Responsibility Committee (FRC), to be established by March 31, 2025.
  - To-be-established Fiscal Resilience Oversight Committee (FROC).
  - FROC still to be appointed by Cabinet.
  - Fiscal Responsibility Oversight Committee (FROC), operational since August 2017.

### Selected fiscal rule anchors, operational targets, and triggers (preserved text excerpts)
- Medium-term debt anchor: 60 percent of GDP by 2035.
- Examples of rule parameters and operational targets:
  - Net debt below 80 percent of recurrent revenue;
  - Debt service below 10 percent of recurrent revenue;
  - Liquid assets at a minimum of 25 percent of recurrent expenditure (90 days).
  - Net debt below 90 percent of recurrent revenue by 2015.
  - Primary surplus between 0.5 and 1 percent of GDP by 2023.
  - Overall deficit of less than 1.5 percent of GDP by 2024.
  - Tax-to-GDP ratio of at least 18 percent by 2023 and 20 percent over the medium-term.
  - Wage bill not exceeding 9 percent of GDP by 2025.
  - Primary balance has to reach a surplus of 2 percent of GDP by 2026 and to remain above that level thereafter, when the debt to GDP ratio is above 60 percent.
  - Primary balance exceeding 3.5 percent of GDP.
  - Public expenditure growth lower than 2 percent in real term (excl. grant-financed capital expenditure).
  - Wages lower than 9 percent of GDP.
  - Parameters to be recalibrated when the public debt falls below 55 percent of GDP.
  - Primary balance rule: primary deficit on average of 1.2 percent of GDP annually for 2021-2023; and primary surplus of 2.7 percent of GDP from 2024 onwards.
- Escape clause triggers (examples preserved):
  - Natural disaster is declared.
  - A public health epidemic or pandemic is declared.
  - Real GDP contracts by 2 percent or more in a fiscal year or cumulatively by 3 percent or greater over two consecutive years.
  - A financial crisis with fiscal costs has occurred or is imminent.
  - The ECCB has certified that a financial crisis has occurred.
  - The prime Minister determines that implementation of the fiscal rules, targets or corrective measures would be unduly harmful to public finances or macroeconomic or financial stability.
  - Financial crisis certified by the ECCB, or fiscal cost related to capital injection exceeding 4 percent of GDP.
  - To be activated by Parliament in some cases.

### Case study: Grenada (Box 1)
- Grenada’s Fiscal Responsibility Act (FRA) 2015 established enforceable fiscal rules and a Fiscal Responsibility Oversight Committee.
- Outcomes and timeline:
  - Public debt reduced from 105 percent of GDP in 2013 to 84 percent in 2016.
  - Public debt fell to below 60 percent of GDP in 2019.
  - During 2020-22, Grenada suspended its fiscal rules consistent with the FRA’s escape clause to enable counter-cyclical measures.
  - Public debt rose to 71.4 percent of GDP in 2020, before falling back to a projected 69 percent in 2022.
- Observed design issue:
  - Overlapping operational rules: ceiling on growth rate of real expenditure and floor on primary balance led to restricting public investment to meet the expenditure rule, resulting in the primary balance being well above its floor.
- Recalibration provision:
  - FRA allows core parameters to be recalibrated once public debt falls below 55 percent of GDP.

### Principles and considerations for FRF design (preserved guidance)
- General objective: strike a balance between being simple, flexible, and enforceable.
- Key potential costs to avoid:
  - Procyclicality;
  - Shift toward short-term visible but unproductive spending at expense of high-quality long-term spending;
  - Creative accounting or off-budget operations to achieve targets.
- Design principles to minimize costs:
  - Enshrine FRFs into law to support transparency and enforceability; define principles of fiscal sustainability, procedural and accountability requirements, and increase costs of non-compliance.
  - Create independent institutions to monitor, report on, and recalibrate the fiscal rule; ensure operational independence, technical capacity, and budget resources; provide public accountability via peer reviews, public hearings, uncensored and timely public release of reports, and ex-post assessments by a supreme auditing institution.
  - Strengthen public financial management (PFM) and credible medium-term fiscal plans; have a medium-term debt anchor and simple operational rules closely tied to the anchor; produce detailed multi-year fiscal statements; link macro-fiscal projections and fiscal risk evaluation to budget preparation.
  - Follow good practices in operational rule design: broad coverage where possible, specify instruments the government controls, consider one-offs and contingency buffers, avoid compositional shifts away from high-quality spending, ensure instruments are easily measurable and timely; exclude revenue windfalls, including CBI, and/or one-off expenditures from targets and instruments.
  - Define detailed escape clauses: describe circumstances for suspension, authority to activate and monitor, and mechanisms and timing for returning to the fiscal rule.

### Fiscal rules in small states (Box 2 highlights)
- Rising adoption: number of countries with fiscal rules doubled to over 105 over past two decades; small states adopted rules more slowly but adoption has increased.
- Effectiveness: greater benefits when (i) debt and operational targets are combined; and (ii) rules are enforceable.
- Among peers: Anguilla and Grenada have fiscal rules supported by formal enforcement mechanisms and approved by legislation; some peers have legally backed rules but lack enforcement mechanisms (The Bahamas, Cabo Verde, Maldives) or a strong legal basis (Antigua and Barbuda and St. Vincent and the Grenadines).
- Enforceability definition: rules are deemed enforceable if there are (i) a monitoring mechanism outside of the government (“fiscal council”); (ii) formal enforcement procedure; and (iii) strong legal basis, above statutory level.

### Interplay between fiscal rules and resilience to natural disasters
- Long-run benefits of resilient public investment:
  - Resilient public investment can boost the level of GDP in the long run by 3– 11 percent through increased employment and wages and a decline in outward migration.
- Insurance coverage needs (IMF staff simulations):
  - Caribbean countries would need insurance coverage of 15–30 percent of GDP to cover 99 percent of the fiscal costs related to natural disasters, at an annual cost in the range of 0.5–2 percent of GDP.
- Current constraints on ex-ante resilience:
  - Upgrading infrastructure competes with other development needs due to limited fiscal space and capacity constraints; insurance coverage remains low due to relatively low-income populations, high administrative costs, non-insurability of many assets, high insurance premiums, and regulatory obstacles.
- Role of rule-based FRFs:
  - FRFs can help create fiscal space for resilience building by containing current expenditure and enabling resilient public investment.
  - FRFs can build credibility, lower interest rate costs, and attract international financing and grants for resilience.
  - Examples: Dominica and Grenada developed Disaster Resilience Strategies (DRS) with IMF support; Grenada and St. Vincent and the Grenadines enrolled in the World Bank’s CAT DDO in 2020; St. Vincent and the Grenadines received a disbursement in 2021.

### Implications of natural disasters for debt ceilings and fiscal anchors
- Natural disasters (NDs) are large and asymmetric supply shocks that:
  - Lower output;
  - Increase inflation;
  - Deteriorate fiscal and current account balances due to relief and reconstruction needs.
- Policy implication:
  - The prudent ceiling on public debt should be set lower, all else equal, the greater the exposure to NDs.
- Determinants of how much lower the debt ceiling should be:
  - Extent of scarring or persistence of subdued growth due to NDs;
  - Prevalence of NDs;
  - Size of financial buffers: government self-insurance, insurance policies, disaster clauses in debt securities, access to grants conditional on disasters, and private self-insurance.
- Analytical approach:
  - IMF’s fiscal rule calibration toolkit (Eyraud and others 2018), extended to incorporate NDs and climate-related considerations, was used to analyze the debt ceiling.

*Source: Excerpts from the provided IMF chapter content.*

### 19.      Natural disasters also suggest a conservative approach to setting operational targets,

### 1eccea2022002 - 19. Natural disasters also suggest a conservative approach to setting operational targets

### Natural disasters and the need for conservative operational targets
- Countries exposed to NDs have a greater need to create and preserve fiscal space, especially if debt is already elevated and exceeds the debt ceiling.
- ECCU countries have sought to establish operational targets calibrated to returning to their debt ceiling by a certain date or within a certain number of years.
- A ND is highly likely to occur within typical policy windows; setting operational targets conservatively accounts for:
  - debt rises following a ND due to both growth and tax revenues falling, and
  - fiscal support typically needed in the recovery phase.
- Setting operational targets more conservatively than a mechanical approach would suggest is therefore recommended.

### Fiscal-rule performance assessment: methodology
- Performance examined by assessing ability to mitigate output fluctuations and stabilize public debt using stochastic simulations.
- Methodology:
  - Follows Andrle and Hunt (2020).
  - Uses historical distributions of annual demand, inflation and natural disaster shocks.
  - Employs the IMF’s Global Integrated Monetary and Fiscal Model (GIMF) that incorporates ND-induced demand and inflation shocks.
  - See Annex III for model details (as referenced in source).

### Types of fiscal rules considered (formal representations)
- Primary balance (PB) rule:
  - Seeks to achieve primary deficit targets each period, consistent with PB rules in the ECCU.
  - Formal specification (primary balance as percent of GDP):
    Def_t = Def* − α Y_t − β (Debt_{t−1} − Debt*)
  - Definitions:
    - Def is the primary balance as a percent of GDP.
    - Def* is the associated primary deficit target consistent with the debt-to-GDP target (Debt*).
    - Y is the output gap.
    - Debt is the debt-to-GDP ratio.
  - Three PB variants:
    - Strict PB: α = β = 0 (primary deficit targets met each period).
    - PB with output stabilization: α ≠ 0, β = 0.
    - PB with output and debt stabilization: α ≠ 0, β ≠ 0.
  - Two fiscal adjusters (in operationalization): government consumption (GC) and general transfers (GT).
- Nominal expenditure (EXP) rule with a debt break:
  - Formal specification:
    100 log(EXP_t) = 100 log(EXP*) + δ Y_t − γ (Debt_{t−1} − Debt*)
  - Definitions:
    - EXP denotes government consumption of goods and services; EXP* is trend GC.
  - Rule sustains government consumption at trend/target and includes a debt target to ensure consistency with debt stabilization.
  - Calibration of δ and γ is such that public debt-to-GDP returns to its target level within 10 years following a shock.

### Simulation findings and trade-offs
- General result:
  - Rules trade off counter-cyclicality (GDP stabilization) and speed of debt convergence to targets.
- Natural-disaster effects:
  - Presence of NDs (compared to their absence) is associated with greater and more protracted departures of public debt from its target and greater GDP volatility.
- Within PB rules:
  - PB rules that place some weight on output stabilization tend to have lower volatility of GDP at the expense of slower debt convergence.
  - PB rules that allow for both output and debt stabilization tend to do worse in terms of output stabilization but achieve faster debt convergence to target.
  - Strict primary deficit rules without a role for output or debt stabilization lie in between.
- Instrument choice within PB rules (GC vs GT):
  - Using general transfers (GT) typically results in better outcomes, both in terms of GDP and speed of debt convergence.
  - Rationale: government consumption (GC) has a larger multiplier than GT, so cutting GT is less damaging to GDP while aiding debt convergence.
- Expenditure rules (EXP):
  - Face a similar trade-off: associated with lower GDP volatility at the expense of slower debt convergence relative to PB rules that employ government consumption as the instrument.
  - Intuition: the expenditure rule responds to shocks with a one period (year) delay and thus “sees through” the first-period shock, preventing amplification of fiscal policy on GDP but leading to higher debt and slower convergence.
- Country heterogeneity:
  - Lower prevalence and impact of ND shocks in St. Vincent and the Grenadines compared to Grenada explains why the PB rule with transfers outperforms the expenditure rule in some cases, even with natural disasters.
- Metric note:
  - Public debt deviations proxied by the standard deviation of five-year average deviations of public debt from its target level.

### Policy implications and recommendations
- Choice of fiscal rule depends on tolerance for output volatility versus desired speed of debt convergence:
  - Lower GDP volatility is welfare-enhancing, but rapid debt convergence is crucial when debt is initially elevated and debt sustainability concerns are pronounced.
- Model assumptions relevant for policy interpretation:
  - Simulations assume governments follow the fiscal rule and ensure long-term sustainability of public debt.
  - Households, firms and market participants believe the government is intertemporally solvent in every period; insolvency and default are not possible in the model.
  - In reality, the possibility of debt default would likely have negative impacts on domestic yields, capital inflows and GDP.
  - Where debt is high, deploying a rule that mitigates debt deviations from target may be highly desirable.
- Non-model considerations:
  - Incentives for revenue mobilization matter. Expenditure rules may incentivize the extension of tax expenditures and typically do not create appropriate incentives for mobilizing domestic revenue.
  - Domestic revenue mobilization is critical for several ECCU countries.
- Specific guidance for ND-prone countries:
  - Countries exposed to ND shocks should set fiscal policy more conservatively than countries not exposed to NDs, both for medium-term debt ceilings and operational targets.
  - Presence of NDs warrants setting a lower debt ceiling, unless buffers and other mitigating mechanisms are in place.
  - The extent by which the debt ceiling should be set lower depends on:
    - the extent of scarring or persistence of subdued growth due to NDs,
    - the prevalence of NDs, and
    - the size of financial buffers in place.
  - Choice of operational target depends on country characteristics, including exposure to NDs, because those characteristics modulate ability of different rules to trade off counter-cyclicality and speed of debt convergence.
  - For small economies with high exposure to natural disasters and elevated initial level of debt, primary balance rules could be preferable to expenditure rules.

### Country experiences (selected ECCU examples relevant to fiscal rules and disaster resilience)
- Antigua and Barbuda:
  - Prior to the pandemic, declining domestic revenues led to cash flow pressures, arrears, wider fiscal deficits, and rising public debt.
  - Public debt rose to 102 percent of GDP in 2020.
  - In January 2021, Cabinet approved a rule-based fiscal framework underpinned by a Medium-Term Fiscal Strategy (MTFS) and Fiscal Resilience Guidelines (FRG).
  - MTFS and FRG set quantitative fiscal targets for the primary balance, spending growth, tax collections, and public debt (Table 1 referenced).
  - Framework is not embedded in legislation; lacks independent appointment of an oversight committee and timing for selection and operationalization is yet to be defined.
- Dominica:
  - Public debt increased from 70 percent of GDP in 2015 to 94 percent of GDP in 2019 post-tropical storm Erika and Hurricane Maria.
  - In 2020, authorities requested a Rapid Credit Facility (RCF) and committed to a fiscal consolidation plan.
  - Fiscal measures to increase revenue mobilization and improve spending efficiency were estimated to improve the fiscal stance over the medium term by 5 percent of GDP.
  - On November 2021, Dominica’s parliament approved a rules-based Fiscal Responsibility Framework (FRF) anchored on a public debt-to-GDP ratio of 60 percent by 2035 to be met by operational targets on the primary fiscal balance.
  - Fiscal rules and targets exclude grant-financed capital expenditures and include escape clauses for natural disasters and pandemics.
  - Ongoing institutional reforms: Public Procurement and Disposal of Public Property Act and a framework to monitor state-owned enterprises.
- Grenada:
  - First sovereign country in the ECCU to adopt a rule-based FRF via the Fiscal Responsibility Act of 2015 (FRA).
  - Public debt rose from below 42 percent of GDP in 2000 to over 100 percent of GDP by 2010 after severe external shocks (e.g., Hurricanes Ivan and Emily).
  - FRA initially calibrated to lower debt-to-GDP ratio to 55 percent by 2025.
  - Supported by an IMF Extended Credit Facility (ECF 2014–16); fiscal discipline, structural reforms, concessional financing, and debt restructuring helped restore macroeconomic stability.
  - Public debt fell to 84 percent of GDP by 2016 and below 60 percent of GDP by 2019.
  - Prior to the pandemic, Grenada was estimated to reach the FRA’s debt target by 2021—four years ahead of the target—reflecting adherence to the FRF.

*Source: IMF staff calculations and chapter text.*

### 8.      The COVID-19 pandemic and weak recovery led to the suspension of the fiscal rule,

### 8.      The COVID-19 pandemic and weak recovery led to the suspension of the fiscal rule,

### Overview
- The escape clause was triggered in 2020–22 to support the economic recovery and protect the vulnerable population.
- The authorities plan to return to the FRA in 2023.
- Key areas for future review include:
  - enhancing the communication strategy about medium-term fiscal targets;
  - making fiscal rules more flexible and compatible with recovery from the pandemic while making progress towards resilience building.

### St. Vincent and the Grenadines — Fiscal Responsibility Framework (FRF)
- The authorities adopted a Fiscal Responsibility Framework (FRF) at the onset of the pandemic.
- Complementary measures before and during the pandemic included fiscal consolidation measures and the setup of a Contingencies Fund.
- The Fiscal Responsibility Resolution was approved by parliament in January 2020.
- The FRF (not yet entrenched in primary legislation) includes primary balance and spending operational targets to achieve the public debt-to-GDP ratio of 60 percent by 2030.
- A fiscal council (Fiscal Responsibility Mechanism) was established to oversee compliance with the FRF.
- Implementation delays and triggers:
  - The escape clauses in the FRF led to delayed implementation in 2020 due to the COVID-19 pandemic.
  - The 2021 eruption of La Soufrière Volcano led the government to release fiscal policy measures and further delayed FRF implementation and worsened the fiscal position.
- Debt evolution and implementation planning:
  - Public debt rose to 89.2 percent of GDP in 2021 from 68.1 percent in 2019.
  - A revision and update of the FRF’s fiscal rule target and its implementation timeframe and modalities is deemed necessary.
  - No detailed plan announced yet; Cabinet appointed five Fiscal Council members in September 2021.

### ECCU country approaches to disaster risk financing and resilience
- Dominica: comprehensive insurance strategy with a risk layering framework targeting coverage of 99 percent of estimated fiscal costs related to natural disasters. Layers:
  - Layer 1: Small and medium disasters — savings fund for self-insurance, financed by CBI revenues for start-up cost, plus annual budget contributions.
  - Layer 2: Large disasters — high access under the Caribbean Catastrophe Risk Insurance Facility (CCRIF).
  - Layer 3: Extreme disasters — consideration of Catastrophe (CAT) bonds; regional issuance pooling required; medium-term strategy due to high administration cost.
- Grenada: National Disaster Risk Financing Strategy (DRFS) with risk layering combining:
  - risk retention mechanisms (contingency fund/self-insurance),
  - risk transfer mechanisms (CCRIF, the World Bank’s CAT-DDO, hurricane clause for debt service),
  - private sector insurance mechanisms.
- St. Vincent and the Grenadines: three layers introduced to improve financial resilience:
  - Contingent Fund created in 2017 as self-insurance to cover emergency relief;
  - Enrollment in regional risk-sharing facility CCRIF;
  - Enrollment in contingent credit lines (World Bank’s CAT-DDO).
  - Structural resilience: National Climate Change Policy (2019); some GCF financing but limited funding for full adaptation responsibilities.
- Antigua and Barbuda:
  - Participation in CCRIF.
  - Sustainable Island Resource Framework (SIRF) Fund introduced in 2019 for environmental, climate mitigation and adaptation funding.
  - Planned Climate Resilience and Development Fund (CRDF) to be introduced in first half of 2020 delayed by the pandemic; financing for CRDF mainly from domestic sources including Tourism Guest Levy effective October 2021.

### Debt Fanchart and Operational Target Templates (toolkit overview)
- The toolkit (Gbohoui and Akanbi, forthcoming) builds on Eyraud and others (2018) and accounts for natural disaster shocks, mitigating mechanisms, and climate investment. Piloted for Grenada and St. Vincent and Grenadines.
- Debt anchor calibration (three-step procedure):
  1. Construct paths for key macro variables with shocks drawn from historical distribution.
  2. Project medium-term debt trajectories consistent with each simulated path using the debt dynamic equation and a fiscal reaction function.
  3. Identify the debt anchor such that debt would not exceed a certain higher limit with high probability over the medium term.
- Accounting for natural disaster risks:
  - Model natural disaster shocks parametrically: overall growth shock Yt = Yt* − 1{Dt=1} Zt, with Dt ~ Bernoulli(p) and Zt from a Pareto distribution calibrated to average marginal growth effects and skewness.
  - Two-step practical approach: differentiate small and large shocks; calibrate Pareto distribution using large natural disasters.
- Calibration differences:
  - Climate shocks calibrated to be larger and more frequent in Grenada than in St. Vincent and the Grenadines using EM-DAT dataset for damages > 2 percent of GDP during 1980-2019.
  - Map damages to GDP growth using the rule of thumb from Lian, Moran, and Vishvesh (forthcoming).
- Mitigating measures inclusion:
  - Toolkit integrates mitigating channels in reduced form: an amount in percent of GDP is disbursed in equal annual installments if at least one natural disaster occurs over the forecast horizon; debt accumulation impact is reduced accordingly.
- Calibrating operational (deficit) rules:
  - Template based on the debt dynamic equation to determine deficit paths that allow convergence from current debt to the anchor level.
  - Inputs required: growth, interest rates, current levels of deficit and debt.
  - Allows natural disaster shocks in the transition period, activating escape clauses and optionally extending the horizon to reach the debt anchor to accommodate gradual fiscal adjustment.
  - Allows user-defined external resources (mitigating measures) and incorporation of climate investment profiles, including front-loaded investment phases.

### Stochastic simulation methodology with GIMF
- GIMF model used to analyze stochastic properties of key macroeconomic variables; many alternative future paths drawn from statistical distribution of shocks.
- Estimation of shock distribution:
  - Model inversion: choose number of economic shocks equal to number of observed variables, estimate shocks using linear and non-linear models without specifying an a priori parametric distribution.
  - Estimated shocks cast into [N*K x T] matrix; kernel density estimated and used for sampling via block-bootstrap with jitter (multivariate Gaussian kernel used).
  - Block draws maintain cross-sectional and time dependence; jitter avoids sample impoverishment.
- Special events (climate shocks and natural disasters):
  - If observable and impulse-response functions well identified, shocks can be estimated jointly; however, rare events may require selecting fat-tailed distributions reflecting analysts’ knowledge rather than empirical distribution.
  - Climate shocks calibrated to match CCRIF and EM-DAT estimates of damages as percent of GDP; damages assumed to correspond to public and private capital damages; frequency extracted from EM-DAT.
  - Historically, climate events more frequent and intense in Grenada than in St. Vincent and the Grenadines.
- Advantages of sampling scheme:
  - Adaptive to the data, allows asymmetries, fat tails, and complex data interdependence; model misspecification reflected in estimated shocks.
- Fiscal rules modeled:
  - Primary balance rule (PB): Def_t = Def*_t − α Y_t − β (Debt_{t−1} − Debt*).
  - Nominal expenditure rule (EXP): 100 log(EXP_t) = 100 log(EXP*) + δ Y_t − γ (Debt_{t−1} − Debt*).
  - Calibration of δ and γ chosen so public debt-to-GDP ratio returns to target within 10 years following a shock.
- Fiscal rule parameterizations (as presented):
  - CG Primary balance rule α=0 β=0
  - CG Primary balance rule w/ output stabilization α=0.25 β=0
  - CG Primary balance rule w/ output stabilization and debt correction α=0.25 β=0.5
  - CT Primary balance rule α=0 β=0
  - CT Primary balance rule w/ output stabilization α=0.25 β=0
  - CT Primary balance rule w/ output stabilization and debt correction α=0.25 β=0.5
  - CG expenditure rule with small debt correction δ=0 γ=0.5
  - CG expenditure rule with larger debt correction δ=0 γ=1

### Calibration and key ratios (steady-state shares in percent of GDP)
- Country abbreviations used: GRD (Grenada) and VCT (St. Vincent and the Grenadines).
- Steady-State shares (in percent of GDP):
  - Private consumption: 63.3 (GRD), 60.8 (VCT)
  - Investment: 23.4 (GRD), 19.8 (VCT)
  - Public Spending: 16.6 (GRD), 21.9 (VCT)
    - Consumption: 12.9 (GRD), 17.1 (VCT)
    - Investment: 3.7 (GRD), 4.8 (VCT)
  - Exports: 52.6 (GRD), 44 (VCT)
  - Imports: 55.9 (GRD), 46.5 (VCT)
  - Total Revenues: 24.8 (GRD), 34.4 (VCT)
  - Consumption tax: 8.5 (GRD), 8.5 (VCT)
  - Labor tax: 2.1 (GRD), 4 (VCT)
  - Corporate tax: 1.8 (GRD), 3 (VCT)
  - Tariffs: 7.8 (GRD), 16.2 (VCT)
  - Government Spending: 24.5 (GRD), 34 (VCT)
    - Public consumption: 12.9 (GRD), 17.1 (VCT)
    - Public investment: 3.7 (GRD), 4.8 (VCT)
    - Transfers: 7.9 (GRD), 12.1 (VCT)
- Notes on calibration:
  - Grenada is more open than St. Vincent and the Grenadines but has a smaller public sector with lower expenditures on consumption goods, investment and transfers and lower revenues.
  - Despite being less open, St. Vincent and the Grenadines obtains more revenues from imports than Grenada.
  - Calibration is based on average ratios prior to the pandemic.
  - Openness affects fiscal multipliers; assumed labor share is 60 percent for both countries in absence of production-side data.

*Source: IMF staff estimates (content unit: 1eccea2022002 - 8.      The COVID-19 pandemic and weak recovery led to the suspension of the fiscal rule,)*

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1eccea2022002.pdf_