## _cr05304 — Executive Summary and Staff Report Highlights

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### Executive summary — background and macro context
- Living standards and social indicators:
  - Adult literacy rates average more than 90 percent.
  - Average life expectancy is more than 70 years.
- Political environment:
  - Democracy is deep-rooted with elections typically held every 4–5 years.
  - Political mandates are tilted heavily toward social objectives.
- Economic growth:
  - Declined from nearly 6 percent per annum in 1980–89 to less than 3 percent per annum in 1990–2004.
  - ECCU: Average 1980-89 = 5.7 percent; Average 1990-2004 = 2.7 percent (3-year moving average series shown).
- Structural change in output composition:
  - Agriculture declined from 15 percent of GDP in the mid-1980s to about 6½ percent at end-2004.
  - Sector shares (2004): Manufacturing 12.0 percent; Agriculture 6.5 percent; Construction 4.9 percent; Services 76.6 percent.
- Public finances and debt:
  - Fiscal stances relaxed in the second half of the 1990s; public investments rose and governments used as employer of last resort.
  - Public sector debt stocks averaged over 100 percent of GDP at end-2004.
  - Debt levels can be expected to decline in 2005–06 if ongoing debt restructurings in Antigua and Barbuda, Dominica, and Grenada are successfully completed.
- Regional monetary arrangement:
  - The ECCB operates a quasi-currency board arrangement (CBA).
  - Foreign exchange reserve coverage is substantially in excess of the legal floor of 60 percent of demand liabilities.
  - No obvious periods of pressure on the EC dollar; inflation remains in the low single digits.
- Vulnerability to natural disasters:
  - Measured in natural disasters per square mile, all ECCU member countries rank in the top ten in the world.
  - 2004 shocks included Hurricane Ivan—damage estimated at 200 percent of GDP in Grenada—and an earthquake in Dominica.

### Policy discussions — key findings and required actions
- Political economy and reform momentum:
  - Economic issues featured prominently in recent elections (examples: Antigua and Barbuda, Dominica, St. Kitts and Nevis).
  - Authorities are stepping up outreach to build consensus for reforms.
- Fiscal consolidation:
  - Key steps underway in the most indebted countries (Dominica, Grenada, Antigua and Barbuda); pace should be accelerated.
  - In St. Kitts and Nevis the closure of the loss-making sugar industry has been announced; planning and funding of a transition strategy is needed.
  - Fiscal consolidation underway in Dominica, Grenada, and Antigua and Barbuda, but measures are not sufficient to reduce high debt stocks.
- Consistency with the CBA and fiscal governance:
  - Ensuring fiscal consistency with the CBA is key to preserving macroeconomic stability.
  - Absent an enforceable fiscal-discipline mechanism, the regional CBA has induced a free-rider problem exacerbated by election-linked spending spikes.
  - Fiscal benchmarks introduced in 1998 (to be observed by 2007) have not been met: in 2004 two countries met one of the four benchmarks, and the other four countries met none.
  - Recommendation: enhance effectiveness of fiscal benchmarks through greater public dissemination and setting interim annual or quarterly targets.
- Structural adjustment to changing external environment:
  - Erosion of preferential trade arrangements and declining ODA increase transition costs for bananas and sugar.
  - Policy needs: safety nets for displaced workers; sustain production where viable; diversification support.
- Growth, competitiveness, and regional cooperation:
  - Remove distortions from tax concession regimes; increase labor market flexibility; improve efficiency of public utilities.
  - Greater integration of product and labor markets and collective provision of government services could yield large-scale economies.
- Disaster preparedness and shock mitigation:
  - Strengthen disaster mitigation and preparedness; develop contingency plans.
- Financial sector and supervision:
  - Strengthen financial supervision; approve legal amendments to the Uniform Banking Act; increase recourse to on-site inspections.

### Recent developments and near-term prospects (selected)
- Growth and outlook:
  - Regional growth: just above 3 percent in 2004 (slightly below pre-Ivan projection of 4 percent); projected at 3–3½ percent in 2005.
- Selected economic indicators (2001–2005 series as shown):
  - Real GDP: -1.5, 0.7, 3.4, 3.2, 3.2
  - Consumer prices, end period: 1.5, 1.0, 2.1, 2.2, 2.1
  - Real effective exchange rate (end-of-period, 1990=100; depreciation -): 1.5, -5.5, -8.8, -3.6, ....
  - Overall central government balance: -7.8, -10.9, -5.6, -4.9, -7.1
  - Primary central government balance: -4.2, -6.7, -1.0, -0.4, -2.5
  - Total public debt (end-of-period): 89, 109, 109, 106, 108
  - External current account balance: -18.1, -20.4, -21.4, -17.3, -19.4
  - Stayover tourist visitors (annual percentage change): -5.0, 1.3, 9.9, 10.1, 8.8
  - Gross international reserves of the ECCB (U.S. dollar, millions): 446, 505, 540, 632, 679
  - External reserve coverage (percent of monetary demand liabilities): 92.9, 97.1, 95.3, 96.2, ....
- Sector contributions: construction, government services, and tourism principal contributors; many economies running at or close to potential.

### Grenada — Hurricane Ivan impact (Box 1)
- Event and damage:
  - Hurricane Ivan passed directly over Grenada on September 7, 2004.
  - Estimated damage: US$900 million, or more than 200 percent of GDP.
  - Nearly 90 percent of housing stock damaged or destroyed; all education facilities closed initially; significant electricity disruption.
  - Tourism facilities suffered considerable damage; nutmeg plantations largely destroyed.
- Macroeconomic impact:
  - GDP growth projection for 2004 (pre-Ivan) was over 4 percent; post-Ivan estimate: −3 percent.
  - Unemployment rate increased by at least 8 percentage points to more than 20 percent in the immediate aftermath.
- Reconstruction financing:
  - Pledges at two donors’ conferences: US$150 million (one-third of GDP), including over US$25 million in budgetary support.
  - Grenada purchased SDR 2.93 million (25 percent of quota) in November 2004 under the Fund’s emergency assistance policy for natural disasters.
- Ongoing needs: reconstruction of schools and housing, revitalizing agriculture; continued fiscal adjustment and further donor and creditor support needed over the medium term.

### External sector, tourism, and capital flows
- External current account:
  - Narrowed in 2004 but remained large at 17 percent of GDP, financed mostly by FDI.
  - Projected to widen marginally to 19 percent of GDP in 2005.
- Tourism rebound:
  - Tourist arrivals increased sharply due to easing global security concerns, world growth rebound, and depreciation of the U.S. dollar.
- Capital flows:
  - FDI financed investment especially construction.

### Fiscal outcomes, public debt, and restructuring
- Fiscal outcomes:
  - Central government primary balances improved modestly by ½ percent of GDP in 2004 but remained marginally in deficit.
  - Structural deficits widened in four countries despite modest fiscal improvements.
  - Approved 2005 budgets across the region could imply deterioration of about 2 percent of GDP in fiscal outcomes for the region as a whole, assuming historical capital expenditure implementation rates.
  - Potential to contain deterioration in primary balance to ½ percent of GDP if additional recommended measures are adopted.
- Public debt:
  - Regional average public debt at end-2004: 106 percent of GDP.
  - Debt expected to rise in 2005 in St. Lucia and St. Vincent and the Grenadines if fiscal policies are relaxed ahead of elections.
  - Ongoing debt restructuring in Antigua and Barbuda, Dominica, and Grenada expected to help reduce regional debt burden if successful.
  - St. Kitts and Nevis anticipate substantial privatization proceeds (including disposition of sugar lands) to help debt dynamics.
- Debt restructuring developments (Box 2 highlights):
  - Antigua and Barbuda: agreement with the Italian Government to clear US$196 million debt through a bullet payment of US$18.5 million; Debt Coordinating Committee formed in mid-2005.
  - Dominica: debt exchange launched April 2004; as of end-May 2005, creditors holding over 70 percent of eligible debt agreed to restructuring; authorities making payments into escrow for nonparticipating creditors.
  - Grenada: missed interest payments in December 2004 and downgrade to “selective default” by Standard and Poor’s; creditor committee formed; process complicated by severance of diplomatic ties with Taiwan Province of China.

### Monetary and financial sector developments
- Monetary aggregates and inflation:
  - Broad money growth: 9½ percent in 2003 and 13½ percent in 2004.
  - Inflation remained around 2 percent (up from about 1½ percent in early 2000s).
  - External reserve coverage of monetary demand liabilities at the ECCB rose to over 96 percent.
- Banking system liquidity and credit:
  - Brisk deposit growth and weak private sector credit growth left the banking system highly liquid.
  - Drivers of deposit growth: strengthening economy, large social security surpluses, ECCB floor on savings deposit rate set at 3 percent since September 2002, and limited alternative savings instruments.
  - Increased channeling of liquidity into government securities; substantial oversubscription in the RGSM.
  - Private sector credit growth slow; bulk of new loans related to real estate.
- Financial sector reform and capital markets:
  - ECCB prepared revised prudential guidelines on capital adequacy, risk-based supervision, and corporate governance consistent with FSAP recommendations.
  - Needed amendments to the Uniform Banking Act have not been enacted in any country (progress varied).
  - RGSM (end-May 2005): debt securities valued at US$134 million (4 percent of 2004 regional GDP) listed; half issued by St. Lucia; Antigua and Barbuda and Dominica yet to place issues.
  - Eastern Caribbean Securities Exchange: number of equities listed increased but trading activity remains low.

### Financial soundness indicators and stress tests (Box 5 highlights)
- Indigenous banks — selected indicators (percent, Box 5 table order):
  - Capital adequacy: 13.0, 23.0, 14.9, 36.5, 18.0, 8.9
  - NPLs/Total loans: 2.4, 41.6, 7.1, 11.2, 22.2, 14.3
  - Gross government exposure/Total assets: 12.0, 11.4, 11.3, 27.6, 13.0, 20.7
  - Loans to households/Total loans: 41.8, 52.1, 59.4, 38.1, 47.8, 55.1
  - (Pre-tax) return on average assets: 1.6, 1.2, 0.5, 2.8, 2.4, 1.2
  - Liquid assets/Total assets: 32.5, 45.5, 38.4, 38.9, 22.7, 36.0
  - Total loans/Total deposits: 75.0, 57.5, 57.6, 75.6, 80.7, 71.2
- Aggregated ECCU indicators (end-2004, percent):
  - Capital Adequacy 1/: 12.0 (aggregated banking system), 7.9 (foreign branches), 17.3 (locally incorporated)
  - NPLs/Total Loans 2/: 34.3 (aggregated), 41.2 (foreign branches), 15.6 (locally incorporated)
  - Provisioning/NPLs 2/: 4.1 (aggregated), 3.2 (foreign branches), 1.3 (locally incorporated)
  - Provisioning/Total Loans 2/: 1.8 (aggregated), 2.2 (foreign branches), 4.9 (locally incorporated)
  - Return on Assets: 1.5 (locally incorporated)
  - Return on Equity: 13.9 (locally incorporated)
  - Notes: 1/ Foreign branches have consolidated capital positions with parent banks in Canada and Barbados. 2/ Non-performing loans.
- Stress-test example:
  - An adverse shock adding 5 percent of total loans in loan losses and a 10 percent nonrepayment on government obligations could lead to undercapitalization of about half of the local banks; the undercapitalized banks account on average for one-third of total deposits.
- Concentration of vulnerabilities:
  - Local banks’ exposure to the government amounted to 21 percent of total assets in 2004, about three times the level at foreign banks.
  - Capital adequacy of locally incorporated banks was more than double the 8 percent prudential requirement.

### Investment incentives, tax concessions, and revenue losses
- Staff findings:
  - ECCU has relied primarily on costly fiscal incentives (tax concessions) to attract FDI.
  - Discretionary granting of concessions was widespread.
  - FDI benefits from concessions appear limited; a World Bank firm survey ranked fiscal incentives 16th of 40 determinants of the investment climate.
- Revenue loss estimates (chapter figures):
  - Effective corporate income tax revenue losses: 3–6 percent of GDP per year.
  - Effective import-related tax revenue losses: 4–12 percent of GDP per year.
  - Forgone customs revenue alone: 4–12 percent of GDP.
- Table — Actual and Predicted Annual Per Capita Growth Rates (1990-2003):
  - Antigua: 2.8; Barro 3.8; Levine-Renelt 5.8
  - Dominica: 1.4; Barro 2.7; Levine-Renelt 5.9
  - Grenada: 2.1; Barro 2.2; Levine-Renelt 6.4
  - St. Kitts and Nevis: 2.7; Barro 4.6; Levine-Renelt 9.5
  - St. Lucia: 0.9; Barro 3.5; Levine-Renelt 4.2
  - St. Vincent and the Grenadines: 3.1; Barro 2.0; Levine-Renelt 5.8
  - ECCU: 2.2; Barro 3.1; Levine-Renelt 6.3

### Structural reforms, labor markets, and growth strategy
- Key constraints identified:
  - Labor market rigidities, skill shortages, distortionary tax regime, weak regulatory environment, limited regional integration.
  - Wage rates significantly higher than in other Caribbean countries and upper middle income countries; evidence of skill mismatches and high unemployment.
  - Emigration: during 1970–2000, between 40 and 70 percent of the skilled labor force had emigrated.
- Staff recommendations:
  - Raise quality of education; reorient education and training to regional needs.
  - Undertake civil service reform; introduce performance- and productivity-based wage increases.
  - Allow freer movement of labor among islands.
  - Reform tax concessions: eliminate discretionary concessions; publish cost of concessions in a tax expenditure annex to the budget; limit size, duration, and scope of statutory concessions.
  - Consider tax credits for investment, accelerated depreciation, and loss carry forward as alternatives.
- Growth paradigm shift:
  - Realize growth potential by redefining public sector role toward creating a conducive investment climate and facilitating private-sector-led growth.
  - Reprioritize public investment to projects complementary to private sector development and strengthen project evaluation, contracting, and disclosure.

### Regional cooperation and policy coordination
- Achievements and scope:
  - Stability from the CBA; broadening of regional capital markets; common judiciary; centralized procurement of pharmaceuticals; common diplomatic missions at the WTO; progress in telecommunications and civil aviation.
  - Scope to expand collective provision of services: tax administration, debt management, public investment appraisal, procurement, security, transport and energy regulation.
- Challenges:
  - Important initiatives (free movement of labor, free trade in services) yet to be implemented; CARICOM CET average tariff rate around 10 percent but effective protection higher due to exemptions and nontariff barriers.
  - Risk of a “race to the bottom” in concessions; harmonization efforts exist but enforcement is difficult.
- Staff urged speedy implementation of OECS and CARICOM integration initiatives and vigorous pursuit of CSME, FTAA, and WTO opportunities.

### Disaster preparedness, financing, and risk management
- Natural disasters:
  - Region in Atlantic Basin hurricane belt: 9 hurricanes and 14 tropical storms during 2004; similar number expected this year.
  - Region located on a geological fault line; Dominica earthquake magnitude: 6.0 on the Richter scale (November 2004).
  - Damage estimates: Grenada over 200 percent of 2003 GDP; St. Vincent and the Grenadines about 5 percent of 2003 GDP; Dominica about 7 percent of 2004 GDP.
- Findings and recommendations:
  - National and regional disaster contingency funds are inadequate; traditional insurance markets have concentrated coverage, high prices, and low-risk transfer.
  - Enhance disaster risk mitigation and enforcement (e.g., building codes).
  - Work with multilateral agencies to develop new schemes such as regional insurance pools.
  - Recommended graduated financing approach from vulnerability assessments to ex ante funding, regional insurance pools/reinsurance/catastrophe bonds, contingent lines of credit, and concessional loans/grants for post-disaster reconstruction.

### Crisis management, contingency planning, and supervision
- Recommendation: develop contingency plans delineating responsibilities of the ECCB and national governments.
- Supervision recommendations:
  - Increase frequency of on-site banking inspections (on-site inspections averaged four institutions per year during 2000–04; staff recommended raising this number).
  - Approve amendments to the Uniform Banking Act, the ECCB Act, and prudential guidelines.
  - Strengthen regulatory and supervisory frameworks for nonbank and insurance sectors.
  - Diversify social security schemes’ portfolios away from concentrated government exposures.

### Statistics, outreach, and capacity building
- Finding: further strengthening of statistics and outreach warranted, especially labor markets, poverty, and other social indicators.
- Proposed follow-up: next regional discussions with the ECCU in 12 months, with an update in about six months.
- CARTAC activity highlights:
  - More than 200 missions to ECCU countries in a little over three years.
  - Support in tax policy and administration, public finance management, SATAP macro projections, financial sector supervision preparatory work, and economic and financial statistics improvements.

### Key numeric aggregates and indicators (selected exact figures from chapter)
- ECCU GDP at market prices, 2004 (in US$ million) = 3,105
- ECCU GDP per capita (US$) in 2004, estimate = 5,473
- Selected time-series snapshots (series as presented):
  - Real GDP (2000–2005): 2.9, -1.5, 0.7, 3.4, 3.2, 3.2
  - Consumer prices, end of year (annual % change): 1.5, 1.5, 1.0, 2.1, 2.2, 2.1
  - Liabilities to the private sector (M2) (annual % change): 10.6, 5.9, 6.6, 9.5, 13.3, 9.1
  - ECCB end-year gross foreign reserves (U.S. dollar million): 383.7, 446.0, 504.8, 539.9, 632.4, 678.7
  - Total public debt (end-of-period, percent of GDP): 83.2, 89.4, 108.7, 108.7, 105.5, 107.5
- Country-level total public sector debt (percent of GDP, end-2004):
  - Antigua and Barbuda 99.4; Dominica 124.1; Grenada 129.4; St. Kitts and Nevis 178.7; St. Lucia 70.5; St. Vincent and the Grenadines 78.9
- RGSM yields and auction context (selected):
  - 91 day treasury bill: 5.21
  - 365 days treasury bill: 6.04
  - 5 year bond: 5.82
  - 10 year bond: 7.06
- Gross external financing requirement (US$ billion): 0.509, 0.556, 0.672, 0.730, 0.828, 0.774

### Staff appraisal — macro outlook and priority policy package
- External shocks, erosion of preferences, decline in official assistance, and frequent natural disasters contributed to deceleration of growth since early 1990s and rapid accumulation of public debt.
- Positive country actions welcomed: determined actions in Antigua and Barbuda, Dominica, and Grenada; St. Kitts and Nevis closure of sugar industry.
- Urgent priorities:
  - Stronger and more rapid fiscal adjustment to place debt on a clearly downward path.
  - Debt restructuring and privatization cannot substitute for fiscal consolidation.
  - Strengthen fiscal institutions, tax systems, budget processes, expenditure management, public debt management, and public sector investment programs.
  - Preserve the CBA by ensuring fiscal policies consistent with currency board arrangement; set interim annual targets and broaden dissemination of fiscal performance.
  - Raise productivity through labor market flexibility and better alignment of wages with productivity growth.
- Operational follow-up:
  - Strengthen outreach and public debate on economic issues; improve statistics (labor, poverty, social indicators); continue capacity building via CARTAC and ECCB cooperation.

*Source: _cr05304 - Executive Summary and IMF staff report excerpts*

### Executive Summary ......................................................................................................

### Executive Summary

### Background: social outcomes and macro context
- Living standards are high: adult literacy rates average more than 90 percent and average life expectancy is more than 70 years.
- Political mandates are tilted heavily toward social objectives; democracy is deep-rooted with elections typically held every 4–5 years.
- Economic growth:
  - Declined from nearly 6 percent per annum in 1980–89 to less than 3 percent per annum in 1990–2004.
  - ECCU: Average 1980-89 = 5.7 percent; Average 1990-2004 = 2.7 percent (3-year moving average series shown).
- Structural change in output composition:
  - Agriculture declined from 15 percent of GDP in the mid-1980s to about 6½ percent at end-2004.
  - Sector shares (2004): Manufacturing 12.0 percent; Agriculture 6.5 percent; Construction 4.9 percent; Services 76.6 percent.
- Public finances and debt:
  - Fiscal stances relaxed in the second half of the 1990s; public investments rose and governments used as employer of last resort.
  - Public sector debt stocks averaged over 100 percent of GDP at end-2004.
  - Debt levels can be expected to decline in 2005–06 if ongoing debt restructurings in Antigua and Barbuda, Dominica, and Grenada are successfully completed.
- Regional monetary arrangement:
  - The ECCB operates a quasi-currency board arrangement (CBA).
  - Foreign exchange reserve coverage is substantially in excess of the legal floor of 60 percent of demand liabilities.
  - There have been no obvious periods of pressure on the EC dollar; inflation remains in the low single digits.
- Vulnerability to natural disasters:
  - The region is among the most vulnerable in the world to natural disasters; measured in natural disasters per square mile, all ECCU member countries rank in the top ten in the world.
  - 2004 shocks included Hurricane Ivan—causing damage estimated at 200 percent of GDP in Grenada—and an earthquake in Dominica.

### Policy discussions — key findings and required actions
- Political economy and reform momentum:
  - Economic issues have featured prominently in recent elections (examples cited: fiscal mismanagement in Antigua and Barbuda; the Fund-supported program in Dominica; very high public debt in St. Kitts and Nevis).
  - Authorities are stepping up outreach efforts to build consensus for reforms.
- Fiscal consolidation:
  - Key steps underway in the most indebted countries (Dominica, Grenada, Antigua and Barbuda) to address imbalances, but the pace of fiscal consolidation should be accelerated.
  - In St. Kitts and Nevis the closure of the loss-making sugar industry has been announced; planning and funding of a transition strategy is needed.
  - Fiscal consolidation is underway in Dominica, Grenada, and Antigua and Barbuda, but these measures are not sufficient to reduce high debt stocks.
- Consistency with the CBA and fiscal governance:
  - Ensuring the consistency of fiscal policies with the CBA is key to preserving macroeconomic stability.
  - Absent an enforceable fiscal-discipline mechanism, the regional CBA has induced a free-rider problem exacerbated by election-linked spending spikes.
  - A system of fiscal benchmarks introduced in 1998 (to be observed by 2007) has not been met: in 2004 two countries met one of the four benchmarks, and the other four countries met none.
  - Recommendation: enhance effectiveness of fiscal benchmarks through greater public dissemination and the setting of interim annual or quarterly targets.
- Structural adjustment to changing external environment:
  - Erosion of preferential trade arrangements and declining ODA increase the transition cost for traditional sectors (bananas and sugar).
  - Bananas and sugar remain important sources of rural employment and incomes despite smaller GDP shares.
  - Policy needs: safety nets for displaced workers; interventions to sustain production where viable; diversification support.
- Growth, competitiveness, and regional cooperation:
  - Realizing significant growth potential requires removing distortions from tax concession regimes, increasing labor market flexibility, and improving efficiency of public utilities.
  - Greater integration of product and labor markets and collective provision of government services could yield large-scale economies.
- Disaster preparedness and shock mitigation:
  - Given high vulnerability, strengthen disaster mitigation and preparedness, and develop contingency plans.
- Financial sector and supervision:
  - Financial supervision should be strengthened to contain potential risks.
  - Approval of legal amendments to the Uniform Banking Act would enhance prudential supervision.
  - Increased recourse to on-site inspections would enhance effectiveness of banking supervision.

### I. A brief perspective — structural features and risks
- Country heterogeneity:
  - ECCU countries are small middle-income states with strong social indicators, but cross-country divergence in per capita incomes has increased through time.
  - Example aggregate indicators (2004, as reported): ECCU GDP at market prices, 2004 (in US$ million) = 3,105; ECCU GDP per capita (US$) in 2004, estimate = 5,473.
- Sectoral and labor-market rigidities:
  - Longstanding structural rigidities, notably in the labor market, and disruptions from hurricanes and natural disasters constrain growth.
- Financial deepening and capital market access:
  - Confidence in the CBA and development of domestic financial markets enabled increased access to capital markets and use of fiscal policy to temper downturns (exception: Antigua and Barbuda faced restricted market access).
- Fiscal procyclicality and election-linked spending:
  - The CBA’s lack of enforceable fiscal discipline has led to procyclical fiscal behavior and election-related spending spikes.
  - Empirical indicators show fiscal procyclicality and correlations between primary balance and closeness to election across ECCU countries.
- Public debt burden:
  - Public debt-to-GDP ratios are among the highest in the world for the region; four of the six countries feature in the ten most indebted emerging market countries.
  - Public debt in the region has averaged more than 100 percent of GDP since end-2002.

*Source: _cr05304 - Executive Summary*

### 9.      While many of the challenges faced by the ECCU countries are similar to those

### 9–20. ECCU: Challenges, Recent Developments, and Policy Dialogues

### Major structural challenges and vulnerabilities
- Small size magnifies constraints on economic diversification, raises the cost of providing government services, and amplifies the effects of natural disasters.
- Erosion of trade preferences has impacted traditional producers of sugar and bananas throughout the region.
- Natural disasters cited: hurricanes, earthquakes, tropical storms, floods, and crop diseases.
- Recent public sector investment-driven stimulus in several countries has contributed to very high public debt to GDP ratios.

### IMF/Fund engagement and approach
- Three key elements:
  - Deepened analytical basis of staff's advice (Selected Issues papers for 2004 and 2005).
  - Increased policy coordination through common regional themes discussed with senior policymakers and key regional institutions; strengthened by staff visits during budget preparations and annual Article IV consultations.
  - Outreach activities to build ownership of reforms (conference co-organized by the Central Bank of Trinidad and Tobago and the Fund).
- Example output: the paper “Stabilization, Debt, and Fiscal Policy in the Caribbean” presented at the conference and later issued as IMF Working Paper (WP/05/26).

### Recent economic developments and near-term prospects (2001–2005)
- Growth and outlook:
  - Economic activity accelerated since mid-2003 despite an active 2004 hurricane season.
  - Growth drivers: construction and rapid expansion in tourism.
  - Regional growth: just above 3 percent in 2004 (slightly below pre-Ivan projection of 4 percent); projected at 3–3½ percent in 2005.
- Selected economic indicators (2001–2005):
  - Real GDP: -1.5, 0.7, 3.4, 3.2, 3.2
  - Consumer prices, end period: 1.5, 1.0, 2.1, 2.2, 2.1
  - Real effective exchange rate (end-of-period, 1990=100; depreciation -): 1.5, -5.5, -8.8, -3.6, ....
  - Overall central government balance: -7.8, -10.9, -5.6, -4.9, -7.1
  - Primary central government balance: -4.2, -6.7, -1.0, -0.4, -2.5
  - Total public debt (end-of-period): 89, 109, 109, 106, 108
  - External current account balance: -18.1, -20.4, -21.4, -17.3, -19.4
  - Stayover tourist visitors (annual percentage change): -5.0, 1.3, 9.9, 10.1, 8.8
  - Gross international reserves of the ECCB (U.S. dollar, millions): 446, 505, 540, 632, 679
  - External reserve coverage (percent of monetary demand liabilities): 92.9, 97.1, 95.3, 96.2, ....
- Sector contributions to real GDP growth: construction, government services, and tourism are principal contributors; many economies running at or close to potential.

### Grenada — impact of Hurricane Ivan (Box 1)
- Event and damage:
  - Hurricane Ivan passed directly over Grenada on September 7, 2004.
  - Estimated damage: US$900 million, or more than 200 percent of GDP.
  - Nearly 90 percent of housing stock damaged or destroyed; all education facilities closed initially; significant disruption to electricity supply.
  - Tourism facilities suffered considerable damage; nutmeg plantations largely destroyed.
- Macroeconomic impact:
  - GDP growth projection for 2004 (pre-Ivan) was over 4 percent; post-Ivan estimate: −3 percent.
  - Unemployment rate increased by at least 8 percentage points to more than 20 percent in the immediate aftermath.
- Financial sector and response:
  - Banking system resilience: deposits rose due to insurance payments and transfers from abroad, but profitability fell as loan loss provisioning rose sharply.
  - Reconstruction and stabilization: security and utilities restored early; schools reopened gradually; emergency relief and reconstruction support from regional/international community and NGOs.
  - Reconstruction financing:
    - Pledges at two donors’ conferences: US$150 million (one-third of GDP), including over US$25 million in budgetary support.
    - Grenada purchased SDR 2.93 million (25 percent of quota) in November 2004 under the Fund’s emergency assistance policy for natural disasters.
  - Ongoing needs: reconstruction of schools and housing, revitalizing agriculture; continued fiscal adjustment and further donor and creditor support needed over the medium term to close large projected financing gaps.

### External sector and tourism
- External current account:
  - Narrowed in 2004 but remained large at 17 percent of GDP, financed mostly by foreign direct investment (FDI).
  - External current account deficit projected to widen marginally to 19 percent of GDP in 2005.
- Tourism rebound:
  - Tourist arrivals increased sharply due to easing global security concerns, world growth rebound, and depreciation of the U.S. dollar improving competitiveness in European markets.
- Capital flows:
  - Capital inflows, notably FDI, financed investment especially construction.

### Fiscal outcomes, public debt, and restructuring
- Fiscal performance:
  - Central government primary balances improved modestly by ½ percent of GDP in 2004 but remained marginally in deficit.
  - Structural deficits widened in four countries despite modest fiscal improvements.
  - Approved 2005 budgets across the region could imply a deterioration of about 2 percent of GDP in fiscal outcomes for the region as a whole, assuming historical capital expenditure implementation rates.
  - Potential to contain deterioration in primary balance to ½ percent of GDP if additional recommended measures are adopted.
- Public debt:
  - Regional average public debt at end-2004: 106 percent of GDP.
  - Debt trajectories:
    - Expected to rise in 2005 in St. Lucia and St. Vincent and the Grenadines if fiscal policies are relaxed ahead of elections.
    - Ongoing debt restructuring in Antigua and Barbuda, Dominica, and Grenada expected to help reduce the regional debt burden if successful.
    - St. Kitts and Nevis anticipate substantial privatization proceeds (including disposition of sugar lands) to help debt dynamics.
- Debt restructuring developments (Box 2 highlights):
  - Antigua and Barbuda: agreement with the Italian Government to clear US$196 million debt through a bullet payment of US$18.5 million; Debt Coordinating Committee formed in mid-2005.
  - Dominica: debt exchange launched April 2004; as of end-May 2005, creditors holding over 70 percent of eligible debt agreed to restructuring; authorities making payments into escrow for nonparticipating creditors.
  - Grenada: following missed interest payments in December 2004 and downgrade to “selective default” by Standard and Poor’s, government engaging creditors; creditor committee formed; process complicated by severance of diplomatic ties with Taiwan Province of China.

### Monetary and financial sector developments
- Inflation and monetary aggregates:
  - Broad money growth: 9½ percent in 2003 and 13½ percent in 2004.
  - Inflation remained around 2 percent (up from about 1½ percent in early 2000s), partly due to rising global energy prices.
  - External reserve coverage of monetary demand liabilities at the ECCB rose to over 96 percent.
- Banking system liquidity and credit:
  - Brisk deposit growth and weak private sector credit growth have left the banking system highly liquid.
  - Drivers of deposit growth: strengthening economy, large social security surpluses, ECCB floor on savings deposit rate set at 3 percent since September 2002, and limited alternative savings instruments.
  - Increased channeling of liquidity into government securities; substantial oversubscription in the Regional Government Securities Market (RGSM).
  - Private sector credit growth slow; bulk of new loans related to real estate.
- Financial sector reform and capital markets:
  - ECCB prepared revised prudential guidelines on capital adequacy, risk-based supervision, and corporate governance consistent with ECCU regional FSAP recommendations.
  - Needed amendments to the Uniform Banking Act have not been enacted in any country (progress varied across countries).
  - RGSM development: at end-May 2005, debt securities valued at US$134 million (4 percent of 2004 regional GDP) listed on the RGSM, half issued by St. Lucia; Antigua and Barbuda and Dominica yet to place issues.
  - Eastern Caribbean Securities Exchange: number of equities listed increased but trading activity remains low.
  - ECCB support for institutional development: Eastern Caribbean Home Mortgage Bank, Eastern Caribbean Unit Trust, and Eastern Caribbean Enterprise Fund.

### Policy dialogue and priorities
- Regional recognition of severity of economic situation heightened by 2004 shocks (Hurricane Ivan and Dominica earthquake).
  - Dominica earthquake magnitude: 6.0 on the Richter scale.
  - Damage estimates: Grenada over 200 percent of 2003 GDP; St. Vincent and the Grenadines about 5 percent of 2003 GDP; Dominica about 7 percent of 2004 GDP.
  - Oil prices noted as having risen sharply and expected to rise further.
- Authorities’ actions and Fund engagement:
  - Reducing debt levels identified as top regional priority.
  - Progress noted:
    - Dominica under PRGF arrangement.
    - Grenada designing reconstruction and macro stabilization strategy.
    - Antigua and Barbuda addressing deep fiscal and macro imbalances.
    - St. Kitts and Nevis announcing closure of sugar industry.
  - Challenge: longstanding macroeconomic stability under the Currency Union has made it difficult to instill urgency for substantial policy adjustments; complacency risks continuation of stability without corrective policies.

*Source: IMF staff report (excerpt covering paragraphs 9–20 and Boxes 1–2).*

### 21.      The Fund is increasingly viewed as a valued advisor and a catalyst for donor

### 21.      The Fund is increasingly viewed as a valued advisor and a catalyst for donor support in the region, but the appetite for formal Fund-supported programs remains limited

### Fund role, public perception, and political constraints
- The Fund is increasingly valued as an advisor and catalyst for donor support across the region, with authorities appreciating emphasis on regional issues and focus on growth and vulnerabilities (high public debt levels, natural disasters, and declining official assistance).
- Long-term Fund engagements in Guyana and Jamaica were perceived negatively by their populations, making it politically difficult for countries to request formal Fund arrangements.
- Implementing and sustaining good policies with public support is key to success, with or without a Fund-supported program.

### Outreach, public debate, and civil-society engagement
- Ensuring sustainability of ongoing reforms and initiating new ones requires further strengthening of outreach efforts with civil society.
- Staff noted active media discussions on political and social topics but a relative paucity of informed debates on economic issues.
- Many countries are increasing outreach via town hall meetings, public policy debates, regional conferences, and press conferences (including by the ECCB and at the conclusion of Fund missions).
- Authorities observed Fund outreach initiatives but indicated the Fund remained behind the World Bank in resources devoted to such activity.

### Policy challenges discussed (three broad themes)
- Adjusting to a changing world environment and reinvigorating growth:
  - Confront continued erosion of trade preferences and declining official development assistance flows.
  - Raise competitiveness, change the role of the public sector, remove labor market rigidities, adapt the investment climate, maximize benefits of migration, and pursue regional cooperation and integration.
- Address fiscal imbalances and the large stock of public debt:
  - Fiscal consolidation, active debt management, and divestment of public assets.
- Manage high vulnerability to shocks:
  - Key vulnerabilities include natural disasters, a narrow export base, and potential contagion through the financial system.

### Adjusting to a changing world environment and reinvigorating growth
- Preferential trading arrangements supporting bananas and sugar have been steadily eroding since the 1990s; these sectors remain vital for rural employment in Dominica, St. Lucia, St. Vincent and the Grenadines, and St. Kitts and Nevis.
- Staff supported temporary measures to facilitate transition from these sectors, such as income transfers to farmers and retraining programs.
- Following closure of the loss-making sugar industry, St. Kitts and Nevis established a committee, with donor support, to design a transition strategy including a land use management plan, land sales, and retraining programs.
- Foreign aid flows to ECCU countries have fallen sharply in recent years; overall official assistance has remained roughly constant in U.S. dollar terms since the mid-1970s, implying a significant decline in real terms and relative to GDP.
- Staff noted that reduced availability of grants and, in some cases, loss of access to concessional financing have contributed directly to rising public debt burdens in the region.

### Competitiveness and tourism dynamics
- With depreciation of the U.S. dollar since 2002, real effective exchange rates (REER) have fallen sharply since end-2001 and are currently below early 1990s levels; both customer-based and competitor-based REER measures have declined recently.
- Tourist arrivals (absolute and as a share of CARICOM) increased sharply since 2002.
- Authorities expressed confidence in the exchange rate peg as a contributor to macroeconomic stability; staff concurred that changing the peg would be unlikely to yield significant benefits because of:
  - High pass-through of imported prices to domestic ones.
  - Significant foreign currency component of public debt.
  - Potential weakening of the financial sector.
  - Low price elasticity of demand for tourism services.
- Maintaining the peg requires determined efforts to bring fiscal and debt positions to more sustainable levels and to increase labor and product market flexibility.

### Constraints to growth and public investment
- Growth rates in the past decade have been disappointing relative to high spending on physical and human capital.
- Robust growth in the 1980s was driven by high public investment financed by official assistance, preferential export access, and emerging tourism; by the 1990s official assistance dried up and growth slowed.
- Public investments rose while growth declined (particularly visible in the 2000s); since the mid-1990s, public expenditure shifted from economic infrastructure toward social sectors and general public services.
- Much recent public investment was to replace capital or protect populations after natural disasters or to install infrastructure (e.g., international airports) needed for tourism expansion.
- Staff recommended cutting back or reprioritizing large public investment programs toward those complementary to private sector development.
- Staff recommended an overhaul of legislation and systems governing contracting, management, and disclosure of public investment and debt, including contingent liabilities.
- Strengthening public sector investment programs has begun with CARTAC assistance and ECCB-initiated debt management workshops held at the Fund and in St. Kitts and Nevis.

### Are growth rates in the ECCU too low? (Box 3: simulation results)
- Simulation analyses using Barro (1991) and Levine-Renelt (1992) models show realized per capita real GDP growth rates (1990-2003) are lower than predicted for all ECCU countries (one exception excluded in text).
- Table 1. Actual and Predicted Annual Per Capita Growth Rates (1990-2003) — Realized / Barro / Levine-Renelt:
  - Antigua: 2.8 3.8 5.8
  - Dominica: 1.4 2.7 5.9
  - Grenada: 2.1 2.2 6.4
  - St. Kitts and Nevis: 2.7 4.6 9.5
  - St. Lucia: 0.9 3.5 4.2
  - St. Vincent and the Grenadines: 3.1 2.0 5.8
  - ECCU: 2.2 3.1 6.3
- Levine-Renelt forecasts are much higher than Barro’s, highlighting that investment (very high in the ECCU) has not been productive.

### Shifting the growth paradigm: private sector and investment climate
- Growth potential requires shifting from the public sector as the main engine toward strengthening the investment climate and private-sector-led growth.
- Authorities were disappointed by perceived lack of local entrepreneurial initiative; staff identified hindrances faced by the private sector:
  - Labor market rigidities, skill shortages, distortionary tax regime, weak regulatory environment, limited regional integration.
- Staff emphasized the public sector’s role in addressing these hindrances.

### Labor market rigidities and skills shortages
- Labor market rigidities are high and reflected in relatively high wages amid high unemployment.
- Wage rates in the ECCU are significantly higher than in other Caribbean countries and upper middle income countries.
- Evidence points to skill mismatches, low access to tertiary education and job training, high unemployment, predominance of the public sector, strong labor unions, significant hiring/firing costs, and relatively low intra-regional labor mobility.
- Staff recommended:
  - Raising quality of education.
  - Reorienting education and training to regional needs.
  - Undertaking civil service reform.
  - Introducing performance- and productivity-based wage increases.
  - Allowing freer movement of labor among islands.
- Authorities generally agreed but noted legal constraints in some countries (labor codes) and data limitations for measuring productivity.
- Several countries are establishing new hospitality training centers for tourism sector needs.

### FDI, tax concessions, and revenue losses
- ECCU has relied primarily on costly fiscal incentives (tax concessions) to attract FDI.
- Staff noted FDI remained significant but came at the expense of large fiscal losses; foregone customs revenue alone was estimated equivalent to 4–12 percent of GDP.
- Box 4 (Tax Concessions in the ECCU) key points:
  - Investment concessions typically provided via tax holidays and import duty exemptions; agriculture and fisheries often exempt from taxes on investment and inputs; concessions also benefited government bodies and NGOs.
  - Discretionary granting of concessions was widespread; data from Dominica and St. Vincent and the Grenadines show investment-related concessions account for nearly 50 percent of total customs duty concessions and discretionary Cabinet decisions about 20 percent.
  - Revenue losses from concessions are large and have increased significantly in two countries; estimated effective corporate income tax rates are about 40 percent of statutory rates, accounting for revenue losses of 3–6 percent of GDP per year.
  - Estimated effective import-related tax rates are about 60 percent of statutory rates, accounting for revenue losses of 4–12 percent of GDP per year.
  - In Antigua and Barbuda and St. Kitts and Nevis, concessions rose sharply over the past decade.
  - FDI benefits from concessions appear limited; a World Bank firm survey ranked fiscal incentives 16th of 40 determinants of the investment climate.
  - A preliminary empirical analysis suggests tax concessions played a very limited role in attracting FDI; key factors attracting FDI are good governance, a generally low and broad-based corporate tax regime, and the absence of FDI restrictions.

### Key statistics and exact figures from the chapter
- Public revenue loss estimates from concessions:
  - Effective corporate income tax revenue losses: 3–6 percent of GDP per year.
  - Effective import-related tax revenue losses: 4–12 percent of GDP per year.
- Forgone customs revenue alone: 4–12 percent of GDP.
- Weighted realized and predicted per capita growth rates (1990-2003):
  - Antigua: 2.8; Barro 3.8; Levine-Renelt 5.8
  - Dominica: 1.4; Barro 2.7; Levine-Renelt 5.9
  - Grenada: 2.1; Barro 2.2; Levine-Renelt 6.4
  - St. Kitts and Nevis: 2.7; Barro 4.6; Levine-Renelt 9.5
  - St. Lucia: 0.9; Barro 3.5; Levine-Renelt 4.2
  - St. Vincent and the Grenadines: 3.1; Barro 2.0; Levine-Renelt 5.8
  - ECCU aggregate: 2.2; Barro 3.1; Levine-Renelt 6.3

*IMF staff analysis as presented in the source chapter.*

### 35.      While all country authorities voiced their concerns regarding the pressures they

### _cr05304 - 35.      While all country authorities voiced their concerns regarding the pressures they

### Investment incentives and investment climate
- Authorities differed on tax concessions: some argued tax concessions should be reined in to protect tax bases and reduce distortions facing domestic investors; others considered the existing system of tax incentives to be broadly appropriate and argued that without them investment—and, therefore, employment and tax revenues—would be significantly lower.
- Staff recommended transparency and limits on concessions:
  - Eliminate the granting of discretionary concessions.
  - Publish the cost of all concessions granted in a tax expenditure annex to the budget.
  - Limit the size, duration, and scope of statutory concessions.
- To encourage investment, staff noted tax credits for investment, accelerated depreciation, and loss carrying forward provisions could be considered.
- Footnote: In Dominica, the Cabinet has decided to publish tax concesssions granted from July 2005 onwards.

### Regulatory, infrastructure, and private sector capacity reforms (staff recommendations)
- Revamp the regulatory framework:
  - Address complex and cumbersome laws and amendments in tax and custom administration that preclude effective monitoring and collecting of taxes.
  - Step up e-government, reduce trade barriers, and allow greater competition in domestic markets, including eliminating remaining state monopolies for distribution of imported goods.
  - Strengthen regulatory framework for utilities, energy, and transport services to attract private investment and promote competition and efficiency.
- Improve infrastructure:
  - While access to basic infrastructure to the general population is high, reliability, quality, and costs to the productive sector need further improvement.
  - Maritime transportation is irregular, vessels are in poor condition, and freight and port costs are high.
- Build private sector capacity:
  - Encourage donor financing of feasibility studies, provide information on best practices, support business incubators, and create incentives for firms to train and innovate.
  - Governments could pool resources for seminars and roundtable discussions with foreign and local businesses for exchanging ideas, information, hearing concerns and attracting investments.

### Growth opportunities and diaspora
- Staff identified considerable growth potential in niche products leveraging geographical location, natural beauty, rich culture, and English-speaking population, including:
  - Diversification of tourism activities.
  - Increasing interlinkages between tourism and the agriculture and other sectors.
  - Offshore education, information and communications technology (ICT) enabled products and services, health and wellness activities, and offshore financial services.
- Migration and diaspora:
  - High emigration from the region has created a large diaspora that represents a potential source for investment and entrepreneurial skills.
  - Emigration rates: during 1970–2000, between 40 and 70 percent of the skilled labor force had emigrated.
  - Staff noted it is unclear if emigration has been a net benefit given the drastic lowering of domestic stocks of human capital and entrepreneurial skills.
  - Recommendation: enhance contacts with the diaspora to build networks for trade, investment promotion, and tourism.
  - Example: Dominica is trying to formulate an explicit diaspora strategy based on input from Dominicans living abroad.

### Regional cooperation and integration
- Successes and ongoing initiatives:
  - Stability provided by the common CBA.
  - Broadening and deepening of regional capital markets.
  - Common judiciary, centralized procurement of pharmaceuticals, common diplomatic missions at the WTO.
  - Greater competition and cost reduction in telecommunications under the Eastern Caribbean Telecommunications Authority.
  - Addressing security issues under the Directorate of Civil Aviation.
- Remaining scope for expansion of collective provision of government services: tax administration, debt management, evaluation of public investment projects, procurement, security, and regulatory environment for transport, energy and infrastructure.
- Limitations and challenges to regional integration:
  - Many regional initiatives (e.g., free movement of labor and a free trade regime in services) are yet to be implemented; important exceptions to free trade in goods remain.
  - CARICOM’s Common External Tariff (CET) average tariff rate is fairly low at around 10 percent, but effective protection for certain products is much higher due to exemptions and nontariff barriers; the CET serves to support larger CARICOM economies at the expense of consumers in the ECCU region.
  - Occupational barriers reduce the aggregate pool of labor supply and magnify skill mismatches.
- Staff urged speedy implementation of initiatives to foster closer economic integration within the OECS and CARICOM and encouraged vigorous pursuit of CSME, FTAA, and WTO opportunities.
- Regional coordination on concessions:
  - A cooperative approach could prevent a “race to the bottom,” but enforcement would be difficult.
  - Example: Harmonization of Fiscal Incentives to Industry Act establishes similar statutory concessions in each island, yet multinationals often negotiate for more generous packages.
  - Authorities noted stiff competition from neighboring islands and a disadvantage in negotiating with large multinational companies (example cited: cruise ship tourism).

### Fiscal consolidation and public debt
- Public debt levels in the region are very high; in two countries there appears to be a lack of urgency in addressing debt situations.
- St. Lucia and St. Vincent and the Grenadines (countries with lower public debts but with elections due during 2006) approved budgets that target a significant expansion in public sector investment.
  - Authorities in these countries view such investment as necessary to support growth and maintain that fiscal imbalances are not worrisome given relatively low debt levels.
- Staff cautioned against complacency: debt levels throughout the region—even in lower debt countries—are significantly above levels at which other countries had experienced financial or exchange rate crises.
- Authorities argued debt tolerance in small economies may differ from larger emerging market economies, citing their record of servicing debt and continued access to capital markets; they contended large public debts had not discouraged FDI flows.

### Financial market distortions, RGSM, and policy recommendations
- Continued access to capital markets despite high and rising debt levels reflects, in part, financial market distortions:
  - Demand for EC dollar assets—both bank deposits and government paper—appears buttressed by the ECCB mandated floor on savings deposit rates and implicit restrictions on the asset portfolios of social security schemes.
  - Resultant effects: lower debt service costs for some governments (example: in St. Vincent and the Grenadines the interest spread has declined to only 100 basis points over U.S. treasury bills), achieved at the expense of higher borrowing costs for the private sector.
  - Artificially high liquidity has mitigated the potential role of the RGSM as a fiscal disciplining device.
- Policy recommendations:
  - Floor on savings deposit rates:
    - The legislated floor, initially introduced to protect depositors, may no longer be needed.
    - The floor has limited responsiveness of lending rates to changing liquidity conditions, slowing private sector credit growth and discouraging locally-funded private sector investment.
    - Staff encouraged gradual removal of the floor to reflect the true cost of funds and eliminate distortionary effects; authorities agreed withdrawal could occur once financial markets were sufficiently well-developed.
  - Concentration of social security schemes’ portfolios in government securities:
    - Large exposures imply concentration of risk; staff recommended greater diversification into instruments held outside the region.
    - Authorities noted in some countries there were no formal restrictions on social security schemes’ asset portfolios and viewed RGSM development as providing opportunities for risk diversification.
- RGSM auction and yield context (selected indicators from the period covered):
  - 91 day treasury bill: 5.21 (oversubscription and EC$ amounts reported in source table).
  - 365 days treasury bill: 6.04.
  - 5 year bond: 5.82.
  - 10 year bond: 7.06.
  - Note: Data for 2005 are through end-April; the infrequent issuance of securities and lack of secondary market trading prevents analysis of individual country risk premia.

### Fiscal benchmarks and enforcement
- ECCB’s Monetary Council fiscal benchmarks:
  - Benchmarks are to be achieved by 2007.
  - Staff noted benchmarks have had little impact on fiscal policies and fiscal outcomes have increasingly diverged from targets since their introduction in 1998.
  - Authorities argued deviations were deliberate responses to shocks but acknowledged most benchmarks would not be achieved by the target date.
- Views on benchmarks:
  - Authorities unanimously opposed eliminating the fiscal benchmarks.
  - Opinions differed on whether targets needed modification: some saw moral hazard in changing targets; others favored revisiting specifications to ensure realism and correspondence to risks.
  - Several authorities supported setting annual benchmarks that could differ across countries, depending on starting conditions.
- Staff recommendations on benchmark metrics and transparency:
  - Clarify the definition of debt to include all public and publicly-guaranteed debt, rather than solely central government and government-guaranteed debt.
  - Encourage national authorities to publish and widely disseminate performance relative to established benchmarks on a quarterly or annual basis.
- Enforcement and supra-national authority:
  - Little appetite for creating a supra-national authority to enforce benchmarks; country authorities uniformly opposed any loss of sovereignty.
  - Authorities noted experience in the Euro Area showed compliance remained challenging even with a supra-national body.
  - Preferred enforcement mechanism: peer pressure at meetings of prime ministers.
  - Technical mechanisms have been established with assistance from CARTAC—the SATAP (Structural Adjustment and Technical Assistance Project) program—to enable policymakers to set, monitor, and achieve benchmarks, but effective feedback from SATAP units to policymakers needs substantial strengthening.

*Source: _cr05304 - 35.      While all country authorities voiced their concerns regarding the pressures they*

### 49.      In light of the large public debt positions, staff urged that substantial fiscal

### _cr05304 - 49.      In light of the large public debt positions, staff urged that substantial fiscal

### Fiscal consolidation: findings and recommended measures
- Finding: Large public debt positions require substantial fiscal consolidations based on broadening the tax base, streamlining expenditures, and strengthening fiscal institutions.
- Recommendation: Debt restructuring should not be viewed as a substitute for fiscal consolidation.
- Specific tax-base broadening measures:
  - Reduce tax concessions.
  - Enhance tax compliance.
  - Strengthen tax and customs administration.
  - Assess property at market value for tax purposes.
  - Introduce a broad-based consumption tax (or VAT).
- Fiscal sequencing: Consider lowering the high marginal tax rate in the medium term, concurrent with the phasing out of tax concessions.
- Expenditure-side measures:
  - Civil service reforms to reduce the wage bill and over-employment in the public sector.
  - Allow greater wage differentiation to reflect skills and performance.
  - Strengthen expenditure management systems.
  - Improve debt management.
  - Reprioritize and monitor overly ambitious public sector investment programs.
- Status: Many measures underway; civil service and tax concession reforms generally not yet prioritized except in Antigua and Barbuda and Dominica.

### Living with the region’s high vulnerability to shocks — principal sources
- Natural disasters:
  - Measured in terms of natural disasters per square mile, all ECCU countries rank in the top ten in the world.
  - The region is in the Atlantic Basin hurricane belt that experienced 9 hurricanes and 14 tropical storms during 2004, with a similar number expected this year.
  - The region is located on a geological fault line; most recent earthquake cited: Dominica in November 2004.
- Global economy:
  - High significance of tourism makes the region particularly vulnerable to the world business cycle and shocks to global security.
  - The region imports all its oil; very high debt levels increase susceptibility to global capital market conditions.
- Domestic or regional shocks:
  - Financial sectors have been resilient but evolving cross-border linkages raise contagion risk as regional capital markets develop.

### Natural disasters: mitigation and financing
- Finding: National and regional disaster contingency funds are inadequate; traditional insurance markets are characterized by relatively concentrated coverage, high prices, and low-risk transfer.
- Recommendation: Enhance disaster risk mitigation efforts and enforcement (e.g., strengthening building codes).
- Recommendation: Work with multilateral agencies—particularly the World Bank and the Commonwealth Secretariat—to develop new schemes, such as regional insurance pools.
- Observations:
  - Hurricane Ivan’s devastation in Grenada refocused authorities’ attention.
  - Some increases in coverage of publicly-insured infrastructure observed, but full coverage not possible given fiscal constraints.
  - Several countries urged international donors to provide an ex ante pool of disaster relief funds and grant financing for insurance of public infrastructure.

### Global economy: tourism and energy vulnerabilities
- Tourism dependence:
  - Growth in each country is highly correlated with world output; downturns (for example after September 11, 2001) can induce regional recessions.
  - Options for diversification away from tourism are limited; diversification of tourist source countries recommended (e.g., marketing campaigns).
- Oil and energy:
  - ECCU countries heavily dependent on oil and energy imports.
  - Retail prices usually linked by an explicit formula to imported price but adjusted infrequently; infrequent adjustments have shielded consumers at the budgetary cost of reduced tax revenues and loss of efficiency.
  - Staff urged increased flexibility in oil pricing (example: Dominica passes through oil price fluctuations fully to domestic prices).
  - Several countries exploring alternative energy sources such as geothermal energy.

### Capital markets and debt management
- Finding: High debt ratios increase vulnerability to capital market conditions.
- Observed shift: Away from external financing toward increased reliance on domestic sources during the last year, partly reflecting low interest rates on the RGSM.
- Concern: Many placements at fairly short maturities, raising rollover risk.
- Recommendation: Prepare for likely rise in global interest rates through improved debt management and fiscal reforms to reduce debt levels.
- Note: The ECCB organized at end-April 2005 a seminar on debt management producing draft guidelines; a follow-up technical seminar to be hosted by CARTAC later this year.

### Domestic or regional shocks — financial sector vulnerabilities and linkages
- Banking system resilience: Systems remain highly liquid with reported capital positions above prudential norms, but exposures to the government are high and NPLs are rising.
- Cross-border linkages:
  - Holdings of other ECCU government securities are no more than 3½ percent of bank assets in any country.
  - Claims on other ECCU banks are higher as a share of assets but appear dominated by cross-border deposits between banks sharing the same parent.
  - Trade linkages are very low.
- Supervision and regulation:
  - Concern that enhanced prudential regulations were not fully effective.
  - On-site banking inspections averaged four institutions per year during 2000–04; staff recommended raising this number.
  - Authorities argue they conduct frequent off-site inspections and have detailed information on banks.
  - Recommendation from regional FSAP to transfer power to revoke bank licenses to the ECCB was opposed by country authorities on national sovereignty grounds.

### Banking system quantitative indicators and stress-test findings (as reported)
- Box 5 summary: Financial soundness indicators mixed — capital adequacy appears strong, but NPLs and government exposure very high in some countries; legal framework weaknesses contribute to persistently high NPLs (e.g., Dominica and St. Lucia).
- ECCU Banking System: Financial Soundness Indicators, December 2004 (In percent) — indigenous banks data presented in Box 5 table:
  - Capital adequacy: 13.0, 23.0, 14.9, 36.5, 18.0, 8.9
  - NPLs/Total loans: 2.4, 41.6, 7.1, 11.2, 22.2, 14.3
  - Gross government exposure/Total assets: 12.0, 11.4, 11.3, 27.6, 13.0, 20.7
  - Loans to households/Total loans: 41.8, 52.1, 59.4, 38.1, 47.8, 55.1
  - (Pre-tax) return on average assets: 1.6, 1.2, 0.5, 2.8, 2.4, 1.2
  - Liquid assets/Total assets: 32.5, 45.5, 38.4, 38.9, 22.7, 36.0
  - Total loans/Total deposits: 75.0, 57.5, 57.6, 75.6, 80.7, 71.2
- Concentration of vulnerabilities in local banks:
  - Local banks’ exposure to the government amounted to 21 percent of total assets in 2004, about three times the level at foreign banks.
  - Capital adequacy ratio of locally incorporated banks was more than double the 8 percent prudential requirement, but potential underprovisioning and sovereign risks could reduce that amount.
- Aggregated indicators (ECCU: Financial Soundness Indicators, end-2004, In percent):
  - Capital Adequacy 1/: 12.0 (aggregated banking system), 7.9 (foreign branches), 17.3 (locally incorporated)
  - NPLs/Total Loans 2/: 34.3 (aggregated), 41.2 (foreign branches), 15.6 (locally incorporated)
  - Provisioning/NPLs 2/: 4.1 (aggregated), 3.2 (foreign branches), 1.3 (locally incorporated)
  - Provisioning/Total Loans 2/: 1.8 (aggregated), 2.2 (foreign branches), 4.9 (locally incorporated)
  - Return on Assets: 1.5 (locally incorporated)
  - Return on Equity: 13.9 (locally incorporated)
  - Notes: 1/ Foreign branches have consolidated capital positions with parent banks in Canada and Barbados. 2/ Non-performing loans.
- Stress-test example:
  - An adverse shock adding 5 percent of total loans in loan losses and a 10 percent nonrepayment on government obligations could lead to undercapitalization of about half of the local banks. The undercapitalized banks account on average for one-third of total deposits.

### Crisis management and contingency planning
- Recommendation: Develop a contingency plan to deal with crisis scenarios, delineating responsibilities of the ECCB and national governments.
- Rationale: While prevention is critical, planning for a crisis is prudent given the region’s exposure to multiple shock sources.

### Statistics and data needs
- Finding: Efforts underway to improve quality, timeliness, and dissemination of statistical series.
- Concern: More comprehensive household-sector data needed; disappointing underuse of the 2001 census due to technological problems processing returns, leaving results not yet available in all countries.

### Staff appraisal: macroeconomic outlook and policy priorities
- External challenges: Erosion of preferential market access for bananas and sugar, decline in official development assistance, frequent natural disasters, tourism shocks (e.g., September 11), sharp increases in petroleum import prices.
- Result: Deceleration of growth since the early 1990s, relaxation in fiscal stances, rapid accumulation of public debt.
- Positive developments: Bold steps underway in several countries to address challenges; prominence of economic issues in recent electoral campaigns (Antigua and Barbuda, Dominica, St. Kitts and Nevis).
- Country actions welcomed:
  - Antigua and Barbuda, Dominica, and Grenada: determined actions to strengthen fiscal positions and reduce debt levels.
  - St. Kitts and Nevis: announced closure of the long-time loss-making sugar industry, expected to significantly enhance fiscal and growth prospects.
- Call for stronger fiscal adjustment:
  - Progress in 2003–04 positive but a more rapid adjustment needed to place debt on a clearly downward path.
  - Present global growth outlook and tourism prospects make it opportune for more forceful fiscal adjustment.
  - Debt reduction via creditor negotiations or privatization alone will not achieve debt sustainability.
  - Need to strengthen fiscal institutions, tax systems, budget processes, expenditure management, public debt management, and public sector investment programs in tandem.
- Consistency with the CBA (currency board arrangement):
  - CBA has delivered exchange rate and price stability despite shocks and fiscal indiscipline.
  - Preservation of the exchange rate peg requires governments to achieve fiscal benchmarks approved by the ECCB’s Monetary Council.
  - Staff urge setting interim annual targets and broader dissemination of performance relative to benchmarks to generate discipline and ownership of fiscal positions.
- Productivity and competitiveness:
  - Raising productivity is key for maintaining competitiveness and supporting the exchange rate peg.
  - Growth rates since the 1990s have been much lower compared to countries with similar levels of spending on human and physical capital, indicating low efficiency in investment.
  - Enhancing labor market flexibility is important so wages remain in line with productivity growth.

*Source: IMF staff report text provided in content unit _cr05304 - 49.*

### 65.      Several key steps can be taken to provide a supportive investment climate for the

### Several key steps can be taken to provide a supportive investment climate for the private sector to flourish.

### Investment climate, taxes, regulation, and skills
- "The distortionary, nontransparent, and costly tax concessions regime should be reformed."
- "The regulatory environment in utilities, energy, and transportation should be improved."
- "Importantly, the skill level in the region needs to be raised, and education and training programs reoriented to better serve the needs of the region."
- "In view of the high migration rates of skilled labor, the Caribbean diaspora should be tapped more aggressively to support private investment in home countries."

### Role of the public sector and public investment
- "Realizing the growth potential will require redefining the role of the public sector."
- "The public sector should focus on creating a conducive investment climate, rather than attempting to create employment and generate growth by further expansions."
- "Public sector investment programs that are critical for private sector development should be implemented only after careful project evaluation and prioritization, with continuous oversight and monitoring during the implementation phase."
- "More generally, the institutional capacity of the public sector should be enhanced in order to facilitate the needed fiscal reforms and assure higher quality of public services."

### Regional integration and cooperation
- "The potential benefits from regional integration and cooperation are extremely high and should be exploited."
- "Given the small size of the economies, and the high fixed costs of providing government services, there is tremendous scope to increase the collective provision of select government services both to cut costs and achieve efficiencies."
- "Steps need to be taken towards further integration of markets, particularly goods and labor, to benefit from economies of scale and to lower product and labor costs."

### Public debt, disaster preparedness, and diversification
- "High public debt levels limit the ability of the ECCU governments to use fiscal policy to respond to external shocks, underscoring the need for measures to reduce the region’s vulnerabilities."
- "Natural disasters occur regularly, so that disaster mitigation and preparedness efforts need to be stepped up, even as better insurance mechanisms are sought."
- "Given the increasing dependence of the countries on tourism and tourism-related products, diversification can be achieved by attracting tourists from a larger group of customer countries and increasing interlinkages between tourism and other sectors, particularly agriculture."

### Financial sector supervision
- "Further action to enhance the effectiveness of financial sector supervision is needed to contain potential risks."
- "As regional capital markets deepen, financial sector linkages are likely to rise and any adverse event in one country will likely affect neighboring ones, underscoring the need to constantly strengthen financial sector supervision."
- "An increase in the frequency of banks’ on-site inspections was needed, as recommended by the FSAP."
- "Amendments to the Uniform Banking Act, the ECCB Act, and the prudential guidelines, should be enacted soon."

### Contingency planning
- "Contingency planning for an untoward event should be undertaken by both country and regional authorities."
- "While every possible attempt should be made to prevent a crisis, the possibility of a crisis cannot be ruled out."
- "Preparing in advance, irrespective of the likelihood of the event, could significantly reduce the financial and output costs associated with such events."

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05304.pdf*

### 71.      While the quality and depth of the dialogue between Fund staff and the

### While the quality and depth of the dialogue between Fund staff and the

### Dialogue, transparency, and statistics
- Finding: "While the quality and depth of the dialogue between Fund staff and the authorities has intensified in the past year, a further strengthening of statistics and outreach activities are warranted."
- Recommendation: "Greater debate on economic issues and outreach activities is recommended."
- Recommendation: "To facilitate better policymaking and permit regular monitoring of the impact of reforms on living standards, it is imperative that statistics in all areas be improved, but particularly on labor markets, poverty, and other social indicators."
- Proposed follow-up: "It is proposed that the next regional discussions with the ECCU take place in 12 months, with an update of regional developments in about six months time."

### Real sector and price developments
- Real GDP (annual percentage change): 2.9, -1.5, 0.7, 3.4, 3.2, 3.2 (2000–2005 series as shown)
- GDP deflator (annual percentage change): 1.2, 2.0, 1.3, 1.6, 2.2, 1.9
- Consumer prices, end of year (annual percentage change): 1.5, 1.5, 1.0, 2.1, 2.2, 2.1

### Monetary sector and reserves
- Liabilities to the private sector (M2) (annual percentage change): 10.6, 5.9, 6.6, 9.5, 13.3, 9.1
- Net foreign assets (annual percentage change): -7.2, 40.8, 25.8, 32.4, 20.0, 16.5
- Net domestic assets (annual percentage change): 15.2, -1.3, 0.9, 1.1, 10.1, 5.3
- Private sector credit (annual percentage change): 10.4, 2.3, 1.9, 2.2, 6.3, 6.3
- ECCB end-year gross foreign reserves (U.S. dollar million): 383.7, 446.0, 504.8, 539.9, 632.4, 678.7
- ECCB reserves in months of imports: 3.2, 4.1, 4.6, 4.4, 4.7, 4.8
- ECCB reserves in percent of broad money: 17.4, 19.1, 20.2, 19.8, 20.4, 20.1
- ECCB currency backing ratio (in percent): 88.3, 92.9, 97.1, 95.3, 96.2, ...

### Fiscal sector and public debt
- Primary central government balance (percent of GDP): -1.8, -4.2, -6.7, -1.0, -0.4, -2.5
- Overall central government balance (percent of GDP): -5.2, -7.8, -10.9, -5.6, -4.9, -7.1
- Total revenue and grants (percent of GDP): 27.7, 26.2, 28.1, 29.3, 28.8, 31.0
- Total expenditure and net lending (percent of GDP): 32.9, 34.0, 39.0, 34.9, 33.7, 38.1
- Foreign financing (percent of GDP): 2.8, 5.7, 8.1, 4.3, -6.0, 0.4
- Domestic financing including arrears (percent of GDP): 2.4, 2.1, 2.8, 1.3, 10.9, 6.6
- Central government current account balance (percent of GDP): -0.3, -2.0, -2.2, -0.2, -0.1, -1.9
- Total public debt (end-of-period, percent of GDP): 83.2, 89.4, 108.7, 108.7, 105.5, 107.5
- Country-level examples (total public sector debt as percent of GDP, end-2004, memorandum): Antigua and Barbuda 99.4, Dominica 124.1, Grenada 129.4, St. Kitts and Nevis 178.7, St. Lucia 70.5, St. Vincent and the Grenadines 78.9
- Instruction/Policy emphasis: "strengthening fiscal consolidation, lowering the debt ratios, and ensuring the consistency of fiscal policies with the currency board arrangement"; "strengthen fiscal institutions"; "expanded tax bases, better expenditure and public debt management, and well prioritized and effective public sector investment programs"; "setting of interim annual fiscal targets" and broader dissemination of fiscal performance.

### External sector and balance of payments
- External current account balance (percent of GDP): -16.1, -18.1, -20.4, -21.4, -17.3, -19.4
- Trade balance (percent of GDP): -37.7, -35.3, -34.8, -38.4, -39.2, -39.0
- Services, incomes and transfers (percent of GDP): 21.6, 17.2, 14.4, 17.0, 21.9, 19.5
- Travel (percent of GDP): 28.4, 26.3, 24.8, 27.9, 29.5, 30.9
- Exports, f.o.b. (annual percentage change): 8.6, -14.2, -1.1, 1.7, 4.4, 4.0
- Imports, f.o.b. (annual percentage change): 3.1, -8.1, 0.4, 12.7, 8.4, 5.0
- Net FDI inflows (percent of GDP): 10.9, 11.1, 10.7, 16.9, 14.6, 15.1
- External public debt (end-of-period, percent of GDP): 46.8, 52.9, 65.2, 68.2, 61.6, 63.1
- Gross external financing requirement (in US$ billion): 0.509, 0.556, 0.672, 0.730, 0.828, 0.774
- Memorandum: ECCU GDP at market prices, EC$ millions: 7,662.1, 7,687.7, 7,868.2, 8,273.1, 8,858.1, 9,384.8

### Financial sector vulnerabilities and supervision
- Capital adequacy ratio (indigenous banks, Tier I over risk weighted assets): 14.7, 15.8, 17.5, 16.4, 16.4, ...
- NPLs/total loans (percent): 11.5, 13.1, 13.7, 13.9, 12.0, ...
- Loan loss provision/NPLs (percent): 28.6, 28.9, 29.7, 30.0, 34.3, ...
- Private sector credit/GDP (percent): 76.3, 77.8, 77.4, 75.2, 74.7, 75.0
- Broad money/GDP (percent): 77.9, 82.2, 85.6, 89.1, 94.4, 97.2
- Policy advice: "continued efforts to strengthen financial sector supervision"; implement measures from the Financial Sector Assessment Program including increased frequency of on-site bank inspections and approval of amendments to the Uniform Banking Act; strengthen regulatory and supervisory frameworks for nonbank and insurance sectors; develop contingency plans in coordination with the ECCB.

### Structural reforms, competitiveness, and disaster risk
- Policy recommendations to boost competitiveness: "improving the investment climate and competitiveness through lowering labor costs, providing for greater flexibility and integration of the labor and product markets, and reducing the role of the public sector"; "deepening regional integration"; "removing labor market rigidities"; "revamping the regulatory framework"; "reform distortionary, nontransparent, and costly tax concessions"; "coordinated regional approach to avoid costly tax competition."
- Disaster risk and financing recommendations:
  - Risk identification and risk reduction (hazard data collection, vulnerability assessments, mitigation and preparedness; strengthen/relocate structures; enforce land use codes and building standards).
  - Self-insurance (precautionary saving fund; diversion of development expenditure; borrowing; remittance flows).
  - Risk transfer (external assistance; sovereign debt relief; market insurance and reinsurance; insurance risk pooling; capital-market instruments such as catastrophe bonds or options; contingent lines of credit; changes in public borrowing structure).
  - Graduated financing approach: (1) vulnerability assessments and mitigation; (2) ex ante funding for lower risk layers (national disaster contingency funds, remittances, traditional insurance); (3) regional insurance pools and reinsurance/catastrophe bonds for higher risk layers; (4) contingent lines of credit for extremely high risk layers; (5) concessional loans and grants by IFIs and bilateral donors for post-disaster mitigation and reconstruction, with partial contingency on ex ante risk mitigation activities to limit moral hazard.

### Capacity building and technical assistance
- CARTAC (established November 2001) activity highlights:
  - More than 200 missions to ECCU countries in a little over three years.
  - Tax policy and administration: support for VAT work in Antigua and Barbuda, Dominica, Grenada, St. Vincent and the Grenadines; customs valuation training; assistance to ECCB in VAT/excise yield estimation for Anguilla, Antigua and Barbuda, Grenada, St. Kitts and Nevis, and St. Lucia; assistance with inland revenue and audit training; reintroduction of personal income tax in Antigua and Barbuda.
  - Public finance management: diagnostic exercises under the Fiscal Machinery Project; assistance with cash management, budgeting, public sector investment, accounting; establishment support for Caribbean Public Finance Management Association (CaPFA).
  - SATAP: macro projections, identification of imbalances, active scenarios completed for all countries except Antigua and Barbuda; support for Coordinating and Monitoring Unit within the ECCB.
  - Financial sector supervision: preparatory work for single supervisory units, feasibility studies, draft legislation, international Banking Acts, Insurance Act, capital adequacy regulation, on-site/off-site procedures, training and attachments.
  - Economic and financial statistics: assistance with supply and use tables, rebasing national accounts, balance of payments gaps, services coverage, price statistics (household budget survey incorporation), import/export price indices pilot in St. Lucia and expansion to Dominica and St. Vincent and the Grenadines.

*Source: IMF staff report and Executive Board discussion summary on the Eastern Caribbean Currency Union (as presented in the supplied content).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05304.pdf_