## 27. The global financial crisis worsened the already high debt burdens in the Caribbean.

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### Stylized facts and country groupings
- Country groups:
  - Commodity exporters: Belize, Guyana, Suriname, Trinidad and Tobago.
  - Service-based economies (mainly tourism and financial services): The Bahamas, Barbados, ECCU countries.
  - Micro-states of the Eastern Caribbean Currency Union (ECCU).
- GDP per capita (PPP) range: US$32,000 (The Bahamas) to US$8,000 (Guyana).
- Credit ratings: The Bahamas and Trinidad and Tobago have investment grade credit ratings.
- Common characteristics:
  - Small, very open economies; high exposure to natural disasters and economic shocks.
  - Exchange rate regimes effectively fixed in most countries (key policy anchor).
  - Extensive emigration and large private remittances (in some countries exceeding exports).
  - In several service-based economies and ECCU: very high debt levels and low growth.
  - Some indigenous banks with significant capital shortfalls.

### Crisis impact and recent growth outcomes
- Growth and shock transmission:
  - Growth stagnated over the last two decades for most Caribbean countries except commodity exporters.
  - Non-commodity-exporters were hit hard by the 2008–09 global crisis via lower tourism arrivals, remittances, and exports.
  - The reduction of international financial flows following the collapse of Lehman weakened balance sheets of financial institutions and tourism-exposed firms.
- Quantified crisis impact:
  - Public debt to GDP ratio increased by about 15 percentage points between 2008 and 2010.
  - In 2012, overall public sector debt was estimated at about 79 percent of regional GDP.
  - Between 1997 and 2004, average debt to GDP rose from 54 percent to 84 percent (driven mainly by deteriorating primary balances).
  - Interest payments on existing debt in the most highly indebted countries are in the range of 16 percent to 41 percent of total revenues.
  - Actual Fund disbursements (to assisted countries) equivalent to about 4½ percent of those countries’ GDP (simple average).

### Natural disasters: exposure and macro effects
- Disaster frequency and impacts:
  - Caribbean suffered 187 natural disasters over the last 60 years; most were tropical cyclones and floods.
  - For most countries the probability of a hurricane is high, above 10 percent per year; Jamaica and the Bahamas have the highest probability.
  - Historical weighted averages for the Caribbean since the early 1960s:
    - Losses equivalent to almost 1 percent of GDP on average in damages each year.
    - 1.5 percent of the population affected each year.
    - 1,345 people killed over the past 60 years.
  - Economic costs rising: losses increased from 0.9 percent of GDP per year in the 1980s and 1990s to 1.3 percent of GDP in the 2000s.
- Estimated macro impacts:
  - Strobl (2012): average hurricane reduces output by nearly 1 percent.
  - Acevedo (2013): moderate storms reduce growth by half a percentage point; severe storms have an impact close to 1 percentage point.
  - In the ECCU, the debt to GDP ratio grows faster, by almost 5 percentage points the year a storm strikes, with a cumulative debt increase of 5 percent of GDP a few years later.

### Financial sector structure and vulnerabilities
- System size and composition:
  - Total assets of financial systems averaged 320 percent of GDP; banks account for 149 percent of GDP.
  - Over 340 credit unions; credit-union assets around 8 percent of regional GDP at end-2010; membership over one third of the region’s population and nearly two thirds in ECCU countries.
  - Very large credit-union asset shares in selected countries: Montserrat (66 percent of GDP), Dominica (39 percent of GDP).
- Bank sector features:
  - Strong presence of Canadian banks operating as subsidiaries; regional financial conglomerates headquartered in Barbados and Trinidad and Tobago.
  - Large credit union sectors (Montserrat, Dominica); very large offshore banking sectors (Montserrat, Barbados, Antigua, St. Lucia).
- ECCU-specific weaknesses:
  - Severe long-standing weaknesses across all sub-sectors, mostly rooted in poor supervision.
  - Failure of indigenous banks in the ECCU is the main risk; indigenous banks are structurally weak with poor risk management, inadequate supervision, capital shortfalls, exposures to large borrowers, and in one case fraudulent activity.
- Non-ECCU banking sector and nonbank institutions:
  - Dominance of foreign banks (mostly branches of Canadian banks) provided stability during the global financial crisis due to conservative banking and sound supervision.
  - Insurance sector vulnerabilities highlighted by the 2009 collapse of CL Financial Group (CLICO/BAICO).

### Nonbank financial sector: credit unions and insurance
- Credit unions:
  - Over 340 credit unions; assets ~8 percent of regional GDP at end-2010.
  - Large presence in ECCU: membership nearly two thirds.
  - Country asset shares: Montserrat 66 percent of GDP; Dominica 39 percent of GDP; Belize, Barbados, Grenada, St. Vincent and St. Lucia range from 13–19 percent of GDP.
- Insurance:
  - Largest insurance sectors in Barbados, Jamaica, and Trinidad and Tobago.
  - ECCU: 61 insurance companies, or 10 per 100,000 inhabitants (10 times the ratio of Canada, Jamaica or Panama).
  - Concerns about soundness and profitability and ability to supervise the industry.
- CL Financial collapse (January 2009):
  - Collapse of CL Financial Group left a hole of about 3½ percent of GDP on average across Caribbean countries; as high as 12 percent in Trinidad and Tobago and 10 percent of GDP in ECCU countries.
  - Resolution approaches varied: liquidation/sales in small-exposure jurisdictions; government-issued long-term bonds in CLICO Trinidad and Tobago; stalled resolution in CLICO Barbados; sale of BAICO Trinidad and Tobago’s traditional insurance portfolio with annuity obligations expected to be repaid with government assistance.

### Supervisory and regulatory gaps
- Common weaknesses:
  - Poor capitalization, weak supervision, rudimentary risk management practices.
  - Weaknesses exacerbated by poorly trained staff, enforcement gaps, and political interference.
  - Small scale of supervisory authorities leads to severe human resource constraints and likely prevents consolidated supervision for cross-border institutions.
- Recent reforms (with donor technical assistance, including CARTAC):
  - Strengthened regulatory framework for credit unions (ECCU).
  - Strengthened insurance legislation (ECCU, Trinidad and Tobago).
  - Strengthened supervisory framework for all nonbanks and set up Financial Services Authorities (ECCU, Barbados).

### Debt dynamics, composition, and sustainability
- Debt-growth empirical thresholds:
  - Debt increases associated with faster growth at debt < 30 percent of GDP.
  - Effect on growth diminishes rapidly beyond 30 percent of GDP.
  - Beyond 55 percent of GDP, debt becomes a drag on growth.
- Debt composition (2010):
  - External debt: 41%
  - Domestic debt: 59%
  - Note: "Domestic debt accounts for over three-fifths of the Caribbean's total public debt..."
- Composition of domestic debt (percent):
  - Central Bank: 7%
  - Commercial Banks: 36%
  - Non-bank financial institutions: 27%
  - Social security schemes: 20%
  - Others: 10%
- Composition of external debt (percent):
  - Multilateral: 34%
  - Bilateral: 14%
  - Commercial: 46%
  - Others: 6%
- Implications:
  - Large domestic debt held by financial institutions means restructuring must consider impacts on already-weak financial systems.
  - Large share of external debt held by commercial creditors reduces scope for traditional restructuring in some countries.
- Historical drivers of debt accumulation:
  - Cost of natural disasters, successive years of fiscal deficit, public enterprise borrowing, off-balance-sheet spending (including financial sector bailouts).

### Sovereign restructurings: case studies and lessons
- Case studies: Antigua and Barbuda, Jamaica, St. Kitts and Nevis.
  - Pre-restructuring conditions: debt ratios exceeded 100 percent of GDP; debt service was 16 percent of GDP.
  - Outcomes:
    - Jamaica: 21 percent NPV reduction; cut in face value: 0.0 percent; restructuring provided significant debt service relief but policy slippages reversed some gains.
    - St. Kitts and Nevis: NPV haircut estimate 65 to 73 percent; cut in face value expected 21 percent; restructuring expected to reduce debt service on average by 8 percent of GDP.
    - Antigua and Barbuda: Final exchanged value US$1.02 billion; cut in face value estimate 6 percent; reduction in face value about ⅓ of the eligible debt.
  - All three restructurings were supported by IMF programs, with financing of over 300 percent of quota.
- Innovations used:
  - Financial sector support fund to provide liquidity support in event of negative spillovers (Jamaica; also adopted in St. Kitts and Nevis).
  - Use of a CDB guarantee (US$12 million) for new debt instrument’s interest and principal (St. Kitts and Nevis).
- Key lessons:
  - A credible economic program is required to frame restructuring and gain creditor confidence.
  - Ownership of economic policies is critical to sustain gains.
  - Multilateral support (including IMF programs) is key—providing financing, policy advice, sustainability assessment, and clarity on financing gaps.
  - Effective communication to bondholders is crucial.
  - Avoid contagion and banking system spillovers, especially in currency unions (e.g., ECCU).
  - Partial restructurings that are too small can be costly and may eliminate future renegotiation possibilities.

### Policy recommendations and reform priorities
- Fiscal strategy:
  - Fiscal adjustment is unavoidable given fiscal and external imbalances and the debt overhang.
  - For large adjustment needs, combine spending cuts and revenue increases; survey evidence favors expenditure-based consolidation for effectiveness.
  - Specific fiscal measures:
    - Better control of the public wage bill.
    - Improvements in public sector efficiency and rationalization of transfer spending.
    - Extending controls to proliferating off-budget agencies.
    - Reducing tax expenditure, eliminating distortions, and broadening the tax base.
  - Complement fiscal consolidation with:
    - Tax policy reforms.
    - Higher efficiency of spending.
    - Containment of contingent liabilities.
    - Public sector rationalization and restoration of a unified budget.
    - Active debt management and debt restructuring.
    - Growth-enhancing structural reforms.
- Structural and financial sector reforms:
  - Strengthen anticipation and provisioning for financial system vulnerabilities and reinforce supervisory and regulatory frameworks.
  - Consolidated supervision of financial conglomerates and stronger asset classification and provisioning norms.
  - Address human resource constraints and reduce political interference in supervisors.
- Growth and competitiveness:
  - Implement comprehensive growth strategies to replace public sector demand with self-financing private sector demand.
  - Assess appropriateness of exchange rate instruments to jump-start growth; authorities generally prefer fiscal adjustment and structural reform.
  - Address competitiveness issues: high electricity costs, high labor costs relative to productivity, trade protectionism, and high cost of credit.
- Disaster risk management and climate funding:
  - Small states should be frontline candidates for climate-change funding given high disaster costs.
- Regional and multilateral collaboration:
  - Debt restructuring is likely to be part of strategies for sustainability but must be carefully designed; avoid overreliance on restructuring as a permanent solution.
  - Implementation requires collaboration beyond IMF expertise, including World Bank’s Comprehensive Debt Framework and other IFIs.
  - Recommend regional approaches and technical assistance platforms (e.g., CARTAC), a Caribbean-wide regional surveillance exercise, and consideration of a regional resident representative to coordinate strategy.

*Prepared by Western Hemisphere Department; February 20, 2013. Source: _022013b - 27. The global financial crisis worsened the already high debt burdens in the Caribbean.*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Stylized facts and country groupings
- Caribbean small states can be grouped as:
  - commodity exporters (Belize, Guyana, Suriname, Trinidad and Tobago),
  - service-based economies (mainly tourism and financial services; e.g., The Bahamas, Barbados, ECCU countries),
  - micro-states of the Eastern Caribbean Currency Union (ECCU).
- GDP per capita (PPP) in the region varies from US$32,000 (The Bahamas) to US$8,000 (Guyana).
- The Bahamas and Trinidad and Tobago have investment grade credit ratings.
- Common characteristics shared across many countries:
  - small economies, very open to international trade,
  - high exposure to natural disasters and economic shocks,
  - exchange rate regimes effectively fixed in most countries (serving as a key policy anchor),
  - extensive emigration and large private remittances (in some countries exceeding exports),
  - in several service-based economies and ECCU, very high debt levels and low growth,
  - some indigenous banks with significant capital shortfalls.

### Recent growth and macroeconomic outcomes
- Growth has stagnated in the last two decades for most Caribbean countries, except commodity exporters.
- The last rapid growth spurt in the 1980s was fueled mainly by expansion of tourism, banana production, and public investments.
- Non-commodity-exporters were hit hard by the global crisis of 2008–09 through lower tourism arrivals, remittances, and exports.
- The reduction of international financial flows following the collapse of Lehman and the recession weakened balance sheets of financial institutions and corporate firms that are highly exposed to the tourism sector.

### Debt and fiscal stance
- Many Caribbean economies face high and rising debt to GDP ratios jeopardizing medium-term debt sustainability and growth.
- In 2012, overall public sector debt was estimated at about 79 percent of regional GDP.
- Weak fiscal positions deteriorated further as policymakers tried to offset lower external demand after the crisis.

### Caribbean-specific vulnerabilities — Natural disasters
- The Caribbean is one of the most disaster-prone regions in the world.
- Over the last 60 years, the Caribbean suffered from 187 natural disasters, most of them tropical cyclones and floods.
- For most countries the probability of a hurricane is high, above 10 percent per year; Jamaica and the Bahamas have the highest probability.
- Historical disaster impacts (weighted averages for the Caribbean):
  - losses equivalent to almost 1 percent of GDP on average in damages each year since the early 1960s,
  - 1.5 percent of the population affected each year,
  - 1,345 people killed over the past 60 years.
- Economic costs of disasters rising: losses increased from 0.9 percent of GDP per year in the 1980s and 1990s to 1.3 percent of GDP in the 2000s.
- Disaster impacts on growth and debt:
  - Strobl (2012): average hurricane reduces output by nearly 1 percent.
  - Acevedo (2013): moderate storms reduce growth by half a percentage point; severe ones have an impact close to 1 percentage point.
  - In the ECCU, the debt to GDP ratio grows faster, by almost 5 percentage points the year a storm strikes, with a cumulative debt increase of 5 percent of GDP a few years later.

### Caribbean-specific vulnerabilities — Financial sector issues
- The financial sector is large relative to economic size and dominated by banks:
  - total assets of the financial systems in the region averaged 320 percent of GDP,
  - 149 percent of GDP held by banks.
- Structural features:
  - strong presence of Canadian banks operating as subsidiaries,
  - regional financial conglomerates headquartered in Barbados and Trinidad and Tobago,
  - large credit union sectors in some countries (Montserrat, Dominica),
  - very large offshore banking sectors in some countries (Montserrat, Barbados, Antigua, St. Lucia).
- ECCU-specific issues:
  - severe long-standing weaknesses across all sub-sectors of the financial system, mostly rooted in poor supervision,
  - failure of indigenous banks in the ECCU is the main risk and a major source of stress to the currency union,
  - indigenous banks are structurally weak with poor risk management, inadequate supervision, capital shortfalls, exposures to large borrowers, and in one case fraudulent activity; the largest indigenous bank (in Antigua) was recently intervened.
- Non-ECCU banking sector:
  - dominance of foreign banks (mostly branches of Canadian banks) provided stability during the global financial crisis due to conservative banking and sound supervision,
  - in the rest of the Caribbean banks have generally weathered the crisis and remain well capitalized, although increasing non-performing loans continue to erode capital bases.
- Nonbank financial sector weaknesses:
  - insurance sector vulnerabilities highlighted by the 2009 collapse of a large financial conglomerate, CL Financial.
- Supervisory and regulatory gaps across the region:
  - need for consolidated supervision of financial conglomerates,
  - need to strengthen asset classification and provisioning norms to reflect true capitalization,
  - supervisory practices hampered in some cases by insufficient numbers of skilled supervisors, frequent turnover, and lack of independence from political leaders.

### Policy engagement and responses
- Support from the Fund and other IFIs expanded significantly in response to the region’s difficult financial position.
- Fund engagement centers on surveillance, programs, and technical assistance from headquarters and CARTAC.
- Fiscal technical assistance has sharply increased (much externally financed) to strengthen institutions for fiscal consolidation.
- Regional discussions and high-level conferences (e.g., High Level Caribbean Forum, Port of Spain, September 4–5, 2012) inform policy dialogue on common issues in ECCU and the region.
- ECCU-specific reform efforts:
  - a joint financial task force (set up November 2011) assessed soundness of the financial sector and recommended reforms to the regulatory and supervisory framework, bank resolution, and crisis management; recommendations were issued in 2012 and the Fund urged decisive implementation by ECCB authorities.

### Main challenges looking ahead
- Low growth, high debt, high exposure to natural disasters, and financial sector weaknesses.
- Addressing these challenges will likely demand innovative approaches to economic policy-making and strengthened institutional capacity.

*Prepared by Western Hemisphere Department; February 20, 2013.*

### 14. Credit unions are important players in the financial sector due to their high

### _022013b - 14. Credit unions are important players in the financial sector due to their high

### Nonbank financial sector: credit unions and insurance
- Credit unions
  - Over 340 credit unions in the region.
  - Overall assets of around 8 percent of regional GDP at end-2010.
  - Membership: over one third of the region’s population, and nearly two thirds in ECCU countries.
  - Very large credit-union asset shares in selected countries: Montserrat (66 percent of GDP), Dominica (39 percent of GDP).
  - Credit-union assets in Belize, Barbados, Grenada, St. Vincent and St. Lucia range from 13–19 percent of GDP.
- Insurance sector
  - The largest insurance sectors are in Barbados, Jamaica, and Trinidad and Tobago.
  - Insurance firms are widespread in the ECCU: 61 insurance companies, or 10 per 100,000 inhabitants, 10 times the ratio of Canada, Jamaica or Panama.
  - Concerns about soundness and profitability of insurance companies in the ECCU and about whether the industry can be properly supervised.

### Supervisory and regulatory weaknesses in nonbank institutions
- Common weaknesses
  - Poor capitalization, weak supervision, rudimentary risk management practices in many small Caribbean states.
  - Weaknesses exposed by the 2009 failure of a large regional insurance conglomerate (CL Financial Group and subsidiaries).
  - Causes: poor regulation and supervision by country authorities, poorly trained staff, and poor enforcement.
- Recent reform efforts (with donor technical assistance, including CARTAC)
  - Strengthened the regulatory framework for credit unions (ECCU).
  - Strengthened insurance legislation to address weaknesses that led to the collapse of CLICO and BAICO (ECCU, Trinidad and Tobago).
  - Strengthened supervisory framework for all nonbanks and set up Financial Services Authorities to regulate nonbanking institutions (ECCU, Barbados).
- Remaining constraints
  - Small scale of supervisory authorities leads to severe human resource constraints and continued exposure to political interference.
  - Likely prevention of consolidated supervision for institutions with cross-border presence.

### Box 1 — Failure of Regional Insurance Companies (summary of CL Financial/CLICO/BAICO)
- Event and mechanism
  - January 2009 collapse of CL Financial Group (Trinidad and Tobago) was a major regional financial shock.
  - Insurance subsidiaries Colonial Life Insurance Company (CLICO) and British American Insurance Company (BAICO) were active in all 15 CARICOM states except Jamaica and Haiti.
  - These subsidiaries offered deposit-like annuity products with very high returns while evading stricter banking regulation and supervision, and invested resources in real estate and other assets adversely affected by the 2008 global economic deterioration.
- Impact
  - The collapse left a hole of about 3½ percent of GDP on average across Caribbean countries.
  - The hole was as high as 12 percent in Trinidad and Tobago and 10 percent of GDP in ECCU countries.
- Resolution status and approaches
  - Jurisdictions with small exposures (Bahamas, Belize, Guyana, Suriname): failed companies were either liquidated or sold.
  - In larger-exposure countries:
    - CLICO Trinidad and Tobago has recently been resolved, with long-term bonds issued by the government of Trinidad and Tobago to holders of its deposit-like obligations (“annuities”).
    - Resolution of CLICO Barbados has stalled after several options proved infeasible; authorities are discussing alternative resolution options.
    - Traditional insurance portfolio of BAICO Trinidad and Tobago is being sold to a large regional insurance company and its annuity obligations are expected to be fully repaid—both with financial assistance from the government of Trinidad and Tobago.

### Growth and competitiveness: diagnosis and indicators
- Growth patterns
  - Growth in the Caribbean has stagnated in the last two decades, except in commodity exporters.
  - The last rapid growth spurt was in the 1980s; slowdown from the 1990s triggered by loss of trade preferences to European markets, deterioration of terms of trade, reduced fiscal space, demographic trends (including emigration of skilled labor), and recurring natural disasters.
- External imbalances and current accounts
  - External current accounts of tourism-based countries deteriorated from a peak of 7 percent of GDP in 1993 to some 18 percent in 2010.
  - Most deterioration is due to the private sector and financed largely by FDI inflows; about a third is due to weak public finances.
  - Currently, the public sector accounts for about a third of the external imbalance in the Caribbean, and is the largest contributor to the deficit in a few countries.
  - At these levels, current account deficits have led to persistent deterioration in the external position in most countries except commodity exporters.
- Other competitiveness indicators and costs
  - Decline in Caribbean world shares of goods exports; anecdotal evidence of manufacturing lines closing due to high input costs, especially electricity.
  - Decline in the share of tourism arrivals and receipts.
  - Decline in total factor productivity.
  - Labor costs high and have grown faster than productivity, in part reflecting high unionization.
  - Electricity costs among the highest in the world, reflecting sector inefficiencies, lack of investments, and/or monopoly powers.
  - Trade protectionism high (tariffs and non-price restrictions).
  - High cost of credit driven by poor transmission of easy U.S. monetary policy, deposit rate floors in selected countries, absence of credit bureaus, and lengthy credit recovery processes.
  - CGER-based estimates indicate REER overvaluation: 14 percent on average for the Caribbean and 23 percent for the ECCU economies.

### Structural bottlenecks and business climate
- Weaknesses identified in business climate assessments
  - Limited access to finance.
  - Weaknesses in property registration, contract enforcement, and resolving insolvency.
  - Security concerns in some countries.
- High effective business tax rates and firms identifying tax burden as a bottleneck.
- High real interest rates in many cases reflecting mandated floors on deposit interest.

### Fund engagement, IFI support, and reform options
- Fund engagement
  - Fund engagement with country authorities on improving long-term growth and competitiveness is intensifying, including collaboration with other IFIs.
  - Staff advice focuses on robust structural reforms and policy options to reduce relative costs.
  - Analytical work on growth and competitiveness discussed during Article IV consultations and a high-level Caribbean forum in Trinidad and Tobago.
- Policy options discussed with authorities
  - Internal devaluation via fiscal adjustment.
  - Fiscal devaluation (limited scope because payroll taxes are relatively minor).
  - Exchange rate adjustment.
  - Authorities generally prefer recovering competitiveness via fiscal adjustment and structural reform rather than exchange rate tools.
- Program design considerations
  - To alleviate growth impact of fiscal adjustment, Fund programs give priority to protecting fiscal space for public investment wherever possible.
- Participation in initiatives
  - Staff participation in IMF/ECCB Growth and Debt Task Force, World Bank’s Caribbean Growth Forum, and Fund’s Group on Small Island States.

### IFI financing during the global financial crisis
- Fund financial assistance
  - Fund financial assistance to the Caribbean during the global financial crisis increased substantially.
  - Countries receiving assistance include Jamaica, Haiti, the Dominican Republic, and all six ECCU Fund members.
  - Actual disbursements equivalent to about 4½ percent of those countries’ GDP (simple average).
  - Scale of Fund financing to Antigua and Barbuda, Jamaica, and St. Kitts and Nevis was larger as a share of GDP than to any other countries in the rest of the hemisphere including Mexico and Haiti.
- MDB activity
  - The World Bank, Inter-American Development Bank (IDB), and Caribbean Development Bank (CDB) are key MDBs active in the region.
  - WB and IDB have concentrated activity in larger countries; CDB lends or provides grants to all economies excluding Dominican Republic and Suriname.
  - MDBs often co-finance and collaborate to diversify credit risk.

### Challenges of public debt and fiscal sustainability
- Debt levels and vulnerabilities
  - Non-commodity-exporter Caribbean economies face high and rising debt to GDP ratios that jeopardize medium-term debt sustainability and growth.
  - In 2012, overall public sector debt was estimated at about 79 percent of regional GDP.
  - Interest payments on the existing debt stock in the most highly indebted countries with rising debt ratios are already in the range of 16 percent to 41 percent of total revenues.
  - High amortization exposes some countries to considerable rollover risk that could trigger a fiscal crisis.
- Historical debt accumulation
  - Between 1997 and 2004, the average debt to GDP ratio in the region increased from 54 percent to 84 percent, driven mainly by deteriorating primary balances.
  - Contributing factors: cost of natural disasters, successive years of fiscal deficit, public enterprise borrowing, off-balance-sheet spending (including financial sector bailouts).
  - Prior to the global crisis, moderate growth helped some countries broadly stabilize and reduce debt ratios, albeit at high levels.

*Source: IMF.*

### 27. The global financial crisis worsened the already high debt burdens in the Caribbean.

### 27. The global financial crisis worsened the already high debt burdens in the Caribbean.

### Crisis impact and recent debt dynamics
- The crisis and subsequent slow recovery in advanced economies had a significant adverse effect on the more tourism-dependent countries of the Caribbean, undermining growth and exposing balance sheet vulnerabilities built up over many years.
- These vulnerabilities originated from increasing public spending to counteract declining trade performance (partly due to the erosion of trade preferences), and from rebuilding costs after frequent natural disasters.
- As a result, the ratio of public debt to GDP increased by about 15 percentage points between 2008 and 2010.
- Caribbean commodity exporters rebounded rapidly after the crisis, buoyed by high commodity prices, and their debt ratios have stabilized at relatively low levels.

### Past attempts at debt reduction and persistent challenges
- Several countries have attempted reducing debt mainly through ad hoc restructuring or fiscal consolidation, but without comprehensive economic reforms, initial gains were too small or not sustained.
- Because of middle income status, the majority of the region has not benefited from international debt relief; only a few Caribbean countries still qualify for concessional borrowing at the World Bank.
- Caribbean economies have been in a high debt-low growth trap for the past two decades—a silent debt crisis.

### Debt-growth relationship and thresholds
- Empirical evidence points to a non-linear relationship between public debt and growth:
  - At debt levels lower than 30 percent of GDP, increases in the debt to GDP ratio are associated with faster economic growth.
  - The effect on growth diminishes rapidly as debt rises beyond 30 percent of GDP.
  - Beyond 55 percent of GDP debt becomes a drag on growth.
- Given virtually nonexistent growth in the current environment, significant fiscal consolidation is inevitable but may not be sufficient to bring down high debt levels.

### Fiscal consolidation approaches
- Survey evidence: fiscal consolidation based on expenditure reductions tends to be more effective than tax-based consolidations.
- For countries with large adjustment needs, fiscal consolidation may need to be a balanced combination of spending cuts and revenue increases (Baldacci, Gupta, Mulas-Granados, 2010), along with debt restructuring.
- Given the already sizable public sector, most consolidation would have to come from restraining spending while taking measures to boost revenues. Specific targets include:
  - Better control of the public wage bill.
  - Improvements in public sector efficiency and rationalization of transfer spending.
  - Extending controls to proliferation of off-budget agencies.
  - Reducing tax expenditure, eliminating distortions and broadening the tax base.
- Fiscal consolidation should be complemented by a comprehensive strategy to reduce public debt, including:
  - Tax policy reforms.
  - Higher efficiency of spending.
  - Containment of contingent liabilities.
  - Public sector rationalization and restoration of a unified budget.
  - Active debt management and debt restructuring.
  - Growth-enhancing structural reforms.

### Debt composition and restructuring constraints
- Public debt composition (2010):
  - External debt: 41%
  - Domestic debt: 59%
- The report notes: "Domestic debt accounts for over three-fifths of the Caribbean's total public debt..."
- Composition of domestic debt (percent):
  - Central Bank: 7%
  - Commercial Banks: 36%
  - Non-bank financial institutions: 27%
  - Social security schemes: 20%
  - Others: 10%
- Composition of external debt (percent):
  - Multilateral: 34%
  - Bilateral: 14%
  - Commercial: 46%
  - Others: 6%
- Because a large share of debt is domestic and mainly held by financial institutions, debt restructuring would need to be mindful of impacts on financial systems which are in some cases already weak.
- The larger share of external debt to commercial creditors in some countries reduces the scope for traditional debt restructuring in high-debt cases.

### Recent sovereign debt restructurings: case studies and outcomes
- Antigua and Barbuda, Jamaica, and St. Kitts and Nevis are recent case-studies of sovereign debt restructuring.
  - Before restructuring, these countries’ debt ratios exceeded 100 percent of GDP, and debt service was 16 percent of GDP.
  - Restructuring provided significant debt service relief for Jamaica, and is expected to do so in St. Kitts and Nevis, reducing debt service on average by 8 percent of GDP.
  - Despite the debt relief, these three countries remain vulnerable to debt distress, with still high debt ratios between 90 percent of GDP (Antigua and Barbuda) and 140 percent of GDP (Jamaica).
  - All three restructurings were supported by IMF programs, with financing of over 300 percent of quota.
  - Extent of debt relief varied widely:
    - Jamaica: 21 percent NPV reduction; cut in face value: 0.0 percent.
    - St. Kitts and Nevis: NPV haircut estimate 65 to 73 percent; cut in face value expected 21 percent.
    - Antigua and Barbuda: Final exchanged value US$1.02 billion; cut in face value estimate 6 percent; reduction in face value about ⅓ of the eligible debt.
  - Jamaica’s and St. Kitts and Nevis’ restructurings were preemptive; Antigua and Barbuda’s was post-default.
  - Jamaica restructured only domestic debt; Antigua and Barbuda restructured both domestic and external debt; St. Kitts and Nevis is restructuring domestic public debt including through a debt/land swap.

### Innovations and lessons from restructurings
- Innovations:
  - Creation of a financial sector support fund to provide liquidity support in the event of negative spillovers from the debt exchange (Jamaica; also adopted in St. Kitts and Nevis).
  - Use of a CDB guarantee (US$12 million) for the new debt instrument’s interest and principal payments (St. Kitts and Nevis).
- Key lessons:
  - A credible economic program is required to frame the debt restructuring and gain creditor confidence that debt sustainability will be restored.
  - Ownership of economic policies is critical: Antigua and Barbuda and St. Kitts and Nevis remained committed to fiscal adjustment; Jamaica experienced policy slippages that reversed some initial gains.
  - Multilateral support, including an IMF adjustment program, was key—providing financing, policy advice, sustainability assessment, and clarification of financing gaps. Other multilaterals provided guarantees and contingency funds.
  - Effective communication of government policy and strategy to bondholders is crucial.
  - Avoid spillovers and contagion effects, especially within currency unions or closely integrated arrangements (e.g., ECCU), where banking system spillovers could create systemic regional banking crises.
  - Case-specific menus of options must be identified to account for different policy constraints and vulnerabilities of various debt-holders.
  - It is costly for debt restructuring to be ‘too small’; partial restructurings that yield only minor gains while eliminating future renegotiation possibilities should be avoided where possible.

### Other forms of debt relief and operations since 2000
- Types of operations: debt write-offs, debt restructuring, debt swaps, and debt buy-backs.
- Examples:
  - Guyana received additional debt relief under the enhanced HIPC Initiative and the MDRI, including from the IMF (early 2000s).
  - In 2004, Jamaica received some debt relief from the UK under the Commonwealth Debt Initiative.
  - In 2007, Antigua and Barbuda and St. Vincent and the Grenadines (US$56 million) benefitted from an Italian debt write-off initiative.
  - Belize benefitted from a debt swap arrangement (US$8 million) with the USA government.
  - In 2005, Antigua and Barbuda engaged in a debt buy-back operation with private creditors, lowering its external debt by approximately US$500 million.

### Conclusions and policy recommendations
- Many Caribbean small states are at a critical juncture and bold strategies are essential to address high debt, low growth, vulnerability mitigation, and strengthening financial systems.
- Key conclusions and recommendations:
  - Fiscal adjustment is unavoidable given the extent of fiscal and external imbalances and the debt overhang, but smallness and vulnerabilities make adjustment exceptionally difficult.
  - Ideally, a comprehensive growth strategy would replace public sector demand with self-financing private sector demand.
  - Further work is needed to assess the appropriateness of the exchange rate instrument as an element in jump-starting growth.
  - Small states in the Caribbean should be frontline candidates for support from climate-change funding given exceptionally high natural disaster costs.
  - Strengthen anticipation and provisioning for financial system vulnerabilities associated with economic rebalancing and strengthen supervisory and regulatory frameworks to reduce long-run vulnerabilities.
  - Debt restructuring looks extremely likely to be part of countries’ strategies to return to sustainability, but past restructurings have been partial and inadequate in some cases; more work is needed to clarify when restructuring is worthwhile and to understand dangers of relying on restructuring as a permanent solution.
- Implementation considerations:
  - The agenda goes beyond IMF expertise and requires collaboration with all development partners and IFIs (including the World Bank’s Comprehensive Debt Framework).
  - Regional approaches (building on ECCU or Central American models) and technical assistance platforms like CARTAC are recommended to reduce stigma and marshal peer support.
  - Consideration should be given to a Caribbean-wide regional surveillance exercise and a regional resident representative to oversee and coordinate a regional strategy.

*Source: _022013b - 27. The global financial crisis worsened the already high debt burdens in the Caribbean.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_022013b.pdf_