## _cr08310 - Executive Summary ## Source details **Canonical URL:** [_cr08310 - Executive Summary](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08310.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08310.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08310.pdf.json) --- ### I. Introduction - Dominica ranked 12th on the Commonwealth Secretariat/World Bank composite vulnerability index (out of 111 countries). - Recent policy focus: create buffers against natural disasters and external shocks. - Past crises reflected both external shocks (post-September 11, 2001 global slowdown) and domestic policy weaknesses (lax fiscal policy, tax inefficiencies). - Current position: somewhat more fiscal room due to a lower debt burden and structural reforms, but further steps needed to increase resilience, reduce financial-sector vulnerabilities, and improve catastrophic risk insurance. ### II. Background and Recent Developments - Hurricane Dean (August 2007) caused damage estimated at almost 20 percent of GDP. - Sectoral and macro impacts: - Agricultural sector heavily affected. - Real GDP growth estimated to slow to around 1½ percent in 2007 (from a pre-hurricane forecast of 3 percent). - Loss in export earnings in 2007 estimated at 2½ percent of GDP. - Inflation reached 5½ percent in December 2007 (driven by food price increases and petroleum pass-through). - Donor response: disaster relief grants for humanitarian needs and infrastructure repair; reconstruction constrained by implementation capacity. - Fiscal performance FY 2007/08: - Robust VAT and import duty revenues (partly from reconstruction-related import surge). - Grants financed increased capital investment; overall achievement of a primary fiscal surplus of 3 percent of GDP (authorities’ target), though a preliminary outturn later estimated the primary surplus for 2007/08 at 1½ percent of GDP. - First phase of multiyear personal income tax reform implemented January 2008: projected revenue losses of about ½ percent of GDP in 2007/08 and 1½ percent of GDP annually over the medium term. - Debt and external accounts: - Public debt/GDP declined to below 95 percent of GDP in 2007 following 2005 restructuring; public sector debt at end-2007: 94 percent of GDP. - Current account deficit estimated to have widened by almost 6 percent of GDP in 2007 to 23½ percent of GDP. - Financial sector: - Private sector credit growth slowed in 2007 after rapid 2006 expansion. - Net foreign assets of the banking system increased by EC$50 million to over EC$300 million in 2007. - Banking system capital to risk-weighted assets over 16 percent (ECCU minimum requirement 8 percent). - Nonbank financial sector regulation uneven; credit unions and insurance companies lack comparable supervisory standards. - Structural agenda: - Growth and Social Protection Strategy (GSPS) being revised to emphasize cost of doing business, energy sector efficiency. - PetroCaribe fuel deliveries began in February; steps to explore geothermal potential. ### III. Outlook, Risks, and External Assessment - Short-term outlook: - Growth projected at 2½ percent in 2008, supported by reconstruction and agricultural recovery. - Inflation expected to reach 6½ percent at end-2008, then moderate in line with WEO projections. - External current account deficit projected to rise another 5 percent of GDP in 2008 (exports projected to fall by 2 percent of GDP; imports to continue rising for reconstruction). - Financing of large current account deficit expected mainly from FDI and public sector grants. - Medium-term baseline: - Growth sustained at around 3 percent from 2010 on. - Under maintenance of authorities’ fiscal targets, public debt projected to decline to the ECCB benchmark of 60 percent of GDP by 2014. - External and competitiveness assessment: - Real exchange rate does not appear out of line with fundamentals; has declined in recent years and remains below estimated equilibrium. - Medium-term external current account deficit projected to moderate to about 19 percent of GDP as reconstruction winds down and tourism diversification progresses. - Long-run equilibrium external current account deficit of 20 percent of GDP after accounting for FDI and grants. - Key downside risks: - Higher oil prices and further weakening of the U.S. economy. - Uncertainty in grant financing for public capital expenditure; decline could lead to additional borrowing and slower debt reduction. - Continued susceptibility to natural disasters. - Staff estimate: elasticity of Dominica’s growth to cyclical activity in the U.S. is slightly greater than one. ### IV. Fiscal Policy, Income Tax Reform, and Contingency Planning - Policy stance: - Staff supports authorities’ policy to reduce public debt gradually by maintaining a primary fiscal surplus. - Authorities committed to achieve a primary surplus of 3 percent of GDP in 2007/08 and over the medium term (ENDA request), while proceeding with income tax reform. - Income tax reform design and fiscal cost: - Three main features: increase in the personal allowance; reclassification of tax brackets; reduction in tax rates in each of the three income brackets. - Representative central government employee average tax rate trajectory: - Old schedule: 9.8 percent - FY 2007/08: 6.9 percent - Medium term: 4.8 percent - Income tax schedule (rates preserved exactly): - FY 2007/08 marginal rates: 18, 28, 38 (for taxable income bands 1–20000; 20001–50000; Over 50000 respectively) - Medium-Term marginal rates: 15, 25, 35 (for same bands) - Annualized tax revenue foregone due to the income tax reform: - About 0.9 percent of GDP for FY 2007/08 - Rising to the 1.4–1.7 percent range over the medium term - Authorities plan to implement the second phase of the reform in January 2009. - Baseline scenario: second-phase implementation together with other pressures "could generate fiscal pressures" (particularly if U.S. slowdown sharper-than-expected). - Staff recommendation: prepare contingency measures, including flexible implementation of the reform to protect fiscal targets. - Mission recommended revenue-strengthening measures: - Make accelerated depreciation the preferred method of granting tax incentives. - Broaden the income tax base by phasing out mortgage deductions and taxing interest on bank deposits (as recommended by FAD). - Authorities defended mortgage allowance as part of policy to provide affordable housing. - Note: "The preliminary outturn of the indirect tax reform introduced in March 2006 has surpassed the original estimates by an amount sufficient to cover the revenue forgone by the income tax reform." - Fiscal outcomes, wage bill, and public employment: - Government’s wage bill has declined by 5 percentage points of GDP to less than 12 percent of GDP since 2002. - Authorities committed to managing public sector employment to maintain the wage bill close to the indicative medium-term target of (12¼) percent of GDP established in the authorities’ program under the PRGF arrangement. - FY 2008/09 budget and medium-term framework: - 2008/09 budget proposes a primary surplus of the central government of 2 percent of GDP (about ½ percent of GDP below staff projection). - FY 2008/09 envisages a temporary decline in the primary surplus to about 2½ percent of GDP due to rising fuel and food prices, second phase of income tax reform, and winding down of reconstruction-related revenues. - Expenditure projected to fall by 3½ percent of GDP, mainly reflecting a decline in capital expenditure. - Official external grants projected to decline by 2 percent of GDP in FY 2008/09. - Implementation of second phase in January 2009 raises exempted threshold from EC$18,000 to EC$20,000 and marginal rates reduced by 2 percentage points; cost estimated at about 0.4 percent of GDP in 2008/09 and 0.9 percent of GDP in 2009/10. - Food price shocks, targeted assistance, and tax adjustments: - Authorities actions and revenue impacts: - Lowered the excise tax on fuel for electricity generation (revenue loss of 0.5 percent of GDP). - Reduced the common external tariff (CET) on a limited number of essential food items (0.2 percent of GDP). - Eliminated customs service charge on selected petroleum products. - Mission recommendation: strengthen existing mechanisms to deliver targeted transfers to the poor. - Authorities included a modest increase in such assistance in the FY 2007/08 budget (0.1 percent of GDP). ### V. Aid Inflows, MTEF, and PetroCaribe / ALBA Arrangements - Grant surge and composition: - Over the past three fiscal years, grant inflows more than doubled from pre-crisis levels. - Dominica now receives about 9½ percent of GDP in grants compared to an average of about 4 percent of GDP during the 1990s. - Donor composition: China, Venezuela, Trinidad and Tobago, European Union, and others. - Uses and volatility: - A significant proportion of the grants has been saved in commercial banks, reflecting limited implementation capacity. - Grant-financed capital expenditure (memo): 7.2, 7.6, 10.5, 8.5 (for listed fiscal years). - Total grants (percent of GDP) table entries: 7.5, 11.1, 10.1, 8.0 (for Est./Proj. 2005/06–2008/09 entries preserved). - Mission recommendations: - Move gradually to a medium-term expenditure framework (MTEF) to manage effects of recent aid inflows and reduce volatility. - Improve framework for executing and monitoring grant-financed projects; early approval of pending Finance Administration Act to enhance recording and accountability. - PetroCaribe specifics: - Authorities propose to save the bulk of concessional financing for fuel consumption under PetroCaribe by setting up an investment fund, possibly at the ECCB, and restrict spending on social projects from this source to the net return derived from the investment fund. - Footnote on PetroCaribe mechanics: state-owned petroleum trading company required to pay between 40–50 percent of the value oil imports (depending on the oil price) within 90 days and the rest is payable over 25 years at very concessional interest rates. ### VI. Debt Sustainability Analysis (DSA) — Baseline, Scenarios, and Stress Tests - Public sector debt at end-2007: 94 percent of GDP (external debt: 65 percent of GDP; domestic debt: 35 percent of GDP). - NPV of public sector debt: around 88.5 percent of GDP; external debt NPV: around 64 percent of GDP. - Baseline scenario assumptions: - Real growth: projected at 3 percent over the projection period after a two-year period of slightly lower growth. - Inflation: projected at 1.5 percent per year after shocks assimilated. - Primary balance (central government): remains at 3 percent of GDP from 2009. - FDI: assumed to remain at 8 percent of GDP. - Baseline outcome: - Public debt projected to reach 60 percent of GDP by 2014 under baseline. - Alternative and stress scenarios: - If growth is halved in 2009–11 and the primary surplus slips to 1½ percent of GDP, achievement of ECCB target would be delayed by two years. - Aid decline stress test (3 percent of GDP reduction from 2009) examined under partial adjustment and no adjustment scenarios: - Partial adjustment: government cuts public investment by 1½ percent of GDP; remainder financed with larger borrowing raising domestic interest rates by one percentage point; result: primary surplus declines to 1½ percent of GDP per year. - No adjustment: no cut in public investment; aid decline financed entirely via higher borrowing, assumed to increase domestic interest rates by two percentage points; new borrowing assumed to be funded in domestic market. - Debt dynamics and selected projections (exact figures preserved): - Public sector debt series: 103.6 (2005), 102.0 (2006), 94.3 (2007), 86.3 (2008), 81.2 (2009), 77.2 (2010), 73.3 (2011), 69.4 (2012), 65.6 (2013), 48.1 (2018), 18.3 (2028). - Foreig­n-currency denominated public debt: 71.1 (2005), 70.0 (2006), 65.0 (2007), 59.3 (2008), 55.3 (2009), 52.0 (2010), 48.2 (2011), 44.8 (2012), 42.0 (2013), 26.8 (2018), 10.0 (2028). - NPV of public sector debt: 101.3 (2005), 95.9 (2006), 88.6 (2007), 79.9 (2008), 73.6 (2009), 69.3 (2010), 65.5 (2011), 61.8 (2012), 58.2 (2013), 43.4 (2018), 17.2 (2028). - External debt (nominal) series: 71.1 (2005), 70.0 (2006), 65.0 (2007), 59.3 (2008), 55.3 (2009), 52.0 (2010), 48.2 (2011), 44.8 (2012), 42.0 (2013), 26.8 (2018), 10.0 (2028). - Debt service-to-revenue and grants ratio (percent): 10.1 (2005), 12.6 (2006), 12.6 (2007), 15.1 (2008), 17.5 (2009), 15.5 (2010), 15.3 (2011), 14.8 (2012), 13.3 (2013), 8.1 (2018), 5.5 (2028). - Conclusions from DSA: - Debt sustainability improved since restructuring, but public debt remains high at 94 percent of GDP. - Key vulnerabilities: bunching of payments in 2008–11; uncertain and volatile grant flows; exposure to external shocks and weather-related vulnerabilities. - Policy target: maintain primary surplus target of 3 percent of GDP to achieve a more comfortable debt ratio. ### VII. Enhancing Competitiveness, Energy, and Structural Reforms - Structural priorities: - (i) Maintaining prudent fiscal policies. - (ii) Enhancing investment climate for private sector development. - (iii) Strengthening oversight of, and resilience in, the financial sector. - Improving energy policies: - PetroCaribe Agreement expected to help reduce cost of fuel for electricity generation. - European Union funded multipartite agreement (€ 1½ million) to help develop geothermal energy resources. - Streamlining business processes: - Establishment of specialized one-stop agencies for investment and tourism promotion (with World Bank aid). - LEG assistance requested to draft legislative changes to facilitate foreclosures. - These efforts have improved Dominica’s ranking on the World Bank’s Doing Business index. - Expected outcomes: - Expansion of hotel capacity and improved infrastructure would shift tourist composition toward stayovers and boost tourism receipts, supporting export growth with higher value added. ### VIII. Financial Sector Resilience and Regulatory Priorities - Banking sector regulatory framework progressively strengthened by government and ECCB; passage of Financial Services Unit (FSU) Act and other enabling legislation urged before end-2008. - Nonbank financial institutions remain largely unregulated; credit unions total assets equivalent to 45 percent of GDP and amount to about a third of bank deposits. - Need to strengthen balance sheet of the AID bank and clarify responsibility for its supervision. - Staff urged enactment and implementation of pending FSU Act and strengthening FSU capacity in the Ministry of Finance. ### IX. Natural Disaster Mitigation and Insurance - Disaster preparedness reassessed after Hurricane Dean and November earthquake. - Government actions: reinforcing sea and river defenses; improving coordination among disaster relief agencies. - CCRIF developments: - CCRIF announced a 10 percent reduction in premiums for member states. - Minimum attachment point for hurricane policies decreased from coverage of 1 in 20 year events to 1 in 15 year events. - Caveat: several countries suffered significant damage due to hurricanes but wind speeds were insufficient to trigger payouts under the scheme. ### X. Staff Appraisal and Policy Recommendations (Selected) - Recovery: Dominica recovering rapidly from Hurricane Dean with international assistance; focus returning to medium-term challenges: restoring growth to pre-hurricane levels, maintaining fiscal stability to lower high public debt, and sustaining structural reform momentum. - Recommended policy mix and measures: - Maintain fiscal consolidation targeting primary fiscal surpluses of 3 percent of GDP over the medium term, with a temporary reduction in FY 2008/09. - Prepare contingency measures (including flexible implementation of income tax reform) if global slowdown is sharper or more prolonged. - Implement temporary, targeted food and energy subsidies for the poor while maintaining flexible fuel pricing regime. - Shift to accelerated depreciation as preferred mode for granting tax incentives; broaden the personal income tax base. - Enact and implement the Financial Services Act; build capacity in the Financial Services Unit to effectively regulate nonbanks. - Move gradually to a medium-term expenditure framework (MTEF) to manage volatile aid inflows and improve project execution and monitoring. - Preserve pass-through of changes in international oil prices in PetroCaribe arrangements; consider saving bulk of concessional financing from PetroCaribe in an investment fund. - Procedural note: next Article IV consultation proposed on the standard 12-month cycle. *Source: _cr08310 - Executive Summary* ### Executive Summary ...................................................................................................... ### _cr08310 - Executive Summary ### I. Introduction - Dominica is extremely vulnerable to exogenous shocks; ranked 12th on the Commonwealth Secretariat/World Bank composite vulnerability index (out of 111 countries). - Recent policy focus: create buffers against natural disasters and external shocks. - Past crises reflected both external shocks (post-September 11, 2001 global slowdown) and domestic policy weaknesses (lax fiscal policy, tax inefficiencies). - Current position: somewhat more fiscal room due to a lower debt burden and structural reforms, but further steps are needed to increase resilience, reduce financial-sector vulnerabilities, and improve catastrophic risk insurance. ### II. Background - Hurricane Dean (August 2007) caused damage estimated at almost 20 percent of GDP (Box 1). - Sectoral and macro impacts: - Agricultural sector heavily affected. - Real GDP growth estimated to slow to around 1½ percent in 2007 (from a pre-hurricane forecast of 3 percent). - Loss in export earnings in 2007 estimated at 2½ percent of GDP. - Inflation reached 5½ percent in December 2007 (driven by food price increases and petroleum pass-through). - Donor response: disaster relief grants for humanitarian needs and infrastructure repair; reconstruction constrained by implementation capacity. - Fiscal performance FY 2007/08: - Robust VAT and import duty revenues (partly from reconstruction-related import surge) helped offset revenue losses from income tax reform and reduction in excise tax on fuel for electricity generation. - Grants financed increased capital investment; overall achievement of a primary fiscal surplus of 3 percent of GDP. - First phase of multiyear personal income tax reform implemented January 2008: projected revenue losses of about ½ percent of GDP in 2007/08 and 1½ percent of GDP annually over the medium term. - Debt and external accounts: - Public debt/GDP declined to below 95 percent of GDP in 2007 following 2005 restructuring; authorities continuing to negotiate with hold-out creditors and making escrow payments. - Current account deficit estimated to have widened by almost 6 percent of GDP in 2007 to 23½ percent of GDP (exports down ~1 percent of GDP; imports up ~2½ percent of GDP). - Financial sector: - Private sector credit growth slowed in 2007 after rapid 2006 expansion. - Net foreign assets of the banking system increased by EC$50 million to over EC$300 million in 2007. - Banking system profitable and well-capitalized: capital to risk-weighted assets over 16 percent (ECCU minimum requirement 8 percent). - Nonbank financial sector regulation uneven; credit unions and insurance companies compete with banks but lack comparable supervisory standards. - Structural agenda: - Growth and Social Protection Strategy (GSPS) being revised to emphasize cost of doing business, energy sector efficiency. - Improvements in business climate reflected in World Bank Doing Business index. - Constraints: infrastructure, contract enforcement, land registration. - PetroCaribe fuel deliveries began in February; steps to explore geothermal potential. ### III. Policy Discussions #### A. Outlook and Risks - Short-term outlook: - Growth projected at 2½ percent in 2008, supported by reconstruction and agricultural recovery. - Inflation expected to reach 6½ percent at end-2008, then moderate in line with WEO projections. - External current account deficit projected to rise another 5 percent of GDP in 2008 (exports projected to fall by 2 percent of GDP; imports to continue rising for reconstruction). - Financing of large current account deficit expected mainly from FDI and public sector grants. - Domestic consumption and investment supported by remittances and abundant banking liquidity. - Medium-term baseline: - Growth sustained at around 3 percent from 2010 on, in line with pre-hurricane trends. - Under maintenance of authorities’ fiscal targets, public debt projected to decline to the ECCB benchmark of 60 percent of GDP by 2014 (well ahead of the 2020 target). - External and competitiveness assessment: - Real exchange rate does not appear out of line with fundamentals; has declined in recent years and remains below estimated equilibrium. - Large current account deficits reflect hurricane effects and rising food/energy prices; medium-term external current account deficit projected to moderate to about 19 percent of GDP as reconstruction winds down and tourism diversification progresses. - Long-run equilibrium external current account deficit of 20 percent of GDP after accounting for FDI and grants. - Key downside risks: - Higher oil prices and further weakening of the U.S. economy (affecting tourism and remittances) could widen the external current account deficit. - Uncertainty in grant financing for public capital expenditure; a decline in external aid could lead to additional borrowing and slow the decline in public debt. - Continued susceptibility to natural disasters. - Staff estimate: elasticity of Dominica’s growth to cyclical activity in the U.S. is slightly greater than one. #### B. Fiscal Policy - Policy stance: - Staff supports authorities’ policy to reduce public debt gradually by maintaining a primary fiscal surplus. - Authorities committed (at ENDA request) to achieve a primary surplus of 3 percent of GDP in 2007/08 and over the medium term, while proceeding with income tax reform. - FY 2007/08 performance: - On course to achieve the 3 percent primary surplus target, despite first-phase income tax reform (January 2008) and hurricane-related expenditures, owing to strong revenue performance. - FY 2008/09 outlook: - Budget envisages a temporary decline in the primary surplus to about 2½ percent of GDP due to: - Authorities’ response to hardships from rising fuel and food prices. - Implementation of the second phase of income tax reform. - Less robust revenue as post-hurricane reconstruction projects wind down. - Expenditure projected to fall by 3½ percent of GDP, mainly reflecting a decline in capital expenditure. - Official external grants projected to decline by 2 percent of GDP in FY 2008/09. #### C. Enhancing Competitiveness and Reducing Vulnerabilities - Structural priorities: - Continue reforms to reduce cost of doing business and improve infrastructure (air/sea access, tourism site access). - Improve energy sector efficiency and explore geothermal potential. - Further reform needed in nonbank financial sector regulation to align supervisory standards with commercial banks. - Expected outcomes: - Expansion of hotel capacity and improved infrastructure would shift tourist composition toward stayovers and boost tourism receipts. - Continued reforms and diversification into tourism expected to support export growth with higher value added and to moderate external vulnerabilities over time. ### IV. Staff Appraisal - Broad agreement between staff and authorities on policy recommendations: maintain fiscal consolidation to reduce debt, continue structural reforms to boost competitiveness and diversify the economy, and strengthen financial-sector oversight and disaster risk financing to increase resilience to shocks. *Source: _cr08310 - Executive Summary* ### 16. The authorities remain committed to carrying through the planned income ### 16. The authorities remain committed to carrying through the planned income tax reform given strong revenue growth from indirect tax reform ### Income tax reform, fiscal pressures, and contingency planning - Authorities plan to implement the second phase of the reform in January 2009. - Baseline scenario: second-phase implementation together with other pressures "could generate fiscal pressures," particularly if there is a sharper-than-expected slowdown in the U.S. - Staff recommendation: prepare contingency measures, including flexible implementation of the reform to protect the fiscal targets. - Mission recommended further revenue-strengthening measures: - Make accelerated depreciation the preferred method of granting tax incentives. - Broaden the income tax base by phasing out mortgage deductions and taxing interest on bank deposits (as recommended by FAD). - Authorities’ view: - Income tax reform seen as part of strategy to mitigate effects of food price shocks. - Government defended the mortgage allowance as part of policy to provide affordable housing. - Note in text: "The preliminary outturn of the indirect tax reform introduced in March 2006 has surpassed the original estimates by an amount sufficient to cover the revenue forgone by the income tax reform." ### Fiscal outcomes, wage bill, and public employment - Government’s wage bill has declined by 5 percentage points of GDP to less than 12 percent of GDP since 2002. - Multiyear wage negotiations concluded with two of three public sector labor unions; modest wage increases agreed; third union pending issues focus on nonsalary items. - Unions signaled they expect an improved offer in negotiations for 2009/10 given higher food prices. - Mission and authorities agreed on importance of limiting wage increases to affordable levels to: - Protect fiscal targets. - Prevent second-round increases in inflation when neither monetary nor exchange rate policy can be used. - Authorities committed to managing public sector employment to maintain the wage bill close to the indicative medium-term target of (12¼) percent of GDP established in the authorities’ program under the PRGF arrangement. ### Food price shocks, targeted assistance, and tax adjustments - Authorities actions and revenue impacts: - Lowered the excise tax on fuel for electricity generation (revenue loss of 0.5 percent of GDP). - State-owned export and import marketing company absorbed some price increases for basic foodstuffs by reducing other activities. - Reduced the common external tariff (CET) on a limited number of essential food items as part of CARICOM initiative (0.2 percent of GDP). - Eliminated the customs service charge on selected petroleum products. - Concerns: - Range of food items with lowered CET is small because benefit is difficult to target and price reduction might not reach intended population due to monopolistic distribution system. - Potential long-term revenue loss of these tax reductions may be difficult to reverse. - Mission recommendation: strengthen existing mechanisms to deliver targeted transfers to the poor. - Authorities noted: - A modest increase in such assistance was incorporated in the FY 2007/08 budget (0.1 percent of GDP). - Agreed to try to speed up World Bank-assisted efforts to improve targeting mechanisms. ### Aid inflows, MTEF, and PetroCaribe / ALBA arrangements - Mission recommended moving gradually to a medium-term expenditure framework (MTEF) to manage effects of recent aid inflows and reduce volatility. - Diversification of trade and cooperation (notably with China and Venezuela) has resulted in increased but uncertain aid flows, including PetroCaribe and ALBA assistance. - Benefits of MTEF: greater predictability of government expenditure; reduce economic volatility; help prevent REER appreciation associated with aid-financed spending beyond absorptive capacity. - Recommendation: improve framework for executing and monitoring grant-financed projects; early approval of pending Finance Administration Act to enhance recording and accountability. - On PetroCaribe and ALBA financing: - Staff and authorities agreed such financing should be consistent with overall public expenditure and debt strategy and preserve pass-through of changes in international oil prices. - Authorities propose to save the bulk of concessional financing for fuel consumption under PetroCaribe. - Plan to set up an investment fund, possibly at the ECCB, and restrict spending on social projects from this source to the net return derived from the investment fund. - Arrangements being made to incorporate the government-owned petroleum trading company and ensure its activities are clearly reflected in government accounts. - Footnote on PetroCaribe mechanics: state-owned petroleum trading company required to pay between 40–50 percent of the value oil imports (depending on the oil price) within 90 days and the rest is payable over 25 years at very concessional interest rates. ### Debt sustainability and scenarios - Achieving the primary surplus target is key to debt sustainability and consolidating the declining public debt path attained since the debt restructuring. - Debt sustainability analyses indicate public debt path is sensitive to changes in growth rate, primary surplus, aid flows, and interest rates. - Baseline scenario: - Annual growth assumed at 3 percent over the medium term and achievement of the authorities’ fiscal target; debt would reach the ECCB target of 60 percent of GDP by 2014. - Alternative scenario: - If growth is halved in 2009–11 and the primary surplus slips to 1½ percent of GDP, achievement of the ECCB target would be delayed by two years. ### Enhancing competitiveness: priorities and reforms - Revised and updated Growth and Social Protection Strategy (GSPS); main priorities: - (i) Maintaining prudent fiscal policies. - (ii) Enhancing the investment climate for private sector development. - (iii) Strengthening oversight of, and resilience in, the financial sector. - Efforts to reduce Dominica’s vulnerability to exogenous shocks. - Improving energy policies: - PetroCaribe Agreement with Venezuela expected to help reduce cost of fuel for electricity generation. - European Union funded multipartite agreement (€ 1½ million) to help develop geothermal energy resources for domestic demand and neighboring French territories; project could reduce dependence on imported oil, lower cost of energy, and increase exports. - Streamlining business processes: - Establishment of specialized one-stop agencies for investment and tourism promotion (with World Bank aid). - Requested LEG technical assistance to draft legislative changes to facilitate foreclosures. - These efforts have resulted in steady improvements in Dominica’s ranking on the World Bank’s index of doing business. ### Financial sector resilience and regulatory priorities - Authorities and staff concurred on necessity to increase financial sector resilience; pressing to pass associated legislation before end-2008. - Banking sector regulatory framework progressively strengthened by government and ECCB. - Nonbank financial institutions remain largely unregulated; authorities moving to strengthen supervisory capabilities but constrained by shortage of human capital. - Staff urged enactment and implementation of pending Financial Services Unit (FSU) Act and other enabling legislation to create a unified regulatory framework for nonbanks. - Importance of strengthening the FSU in the Ministry of Finance by providing adequate resources to staff the institution effectively. - Credit union sector: total assets equivalent to 45 percent of GDP and amount to about a third of bank deposits; stepped-up oversight is a high priority. - Need to strengthen balance sheet of the AID bank and clarify responsibility for its supervision. ### Natural disaster mitigation - Disaster preparedness reassessed after Hurricane Dean and November earthquake. - Government actions: reinforcing sea and river defenses; improving coordination among disaster relief agencies. - Reduction in Dominica’s premium for disaster insurance charged by CCRIF is welcome. - Note: In January, CCRIF announced a 10 percent reduction in premiums for member states, and the minimum attachment point for hurricane policies was decreased from coverage of 1 in 20 year events to 1 in 15 year events. - Caveat: several countries suffered significant damage due to hurricanes but wind speeds were insufficient to trigger payouts under the scheme. ### Staff appraisal: outlook, policy stance, and recommendations - Recovery: Dominica recovering rapidly from Hurricane Dean with international assistance; focus returning to medium-term challenges: restoring growth to pre-hurricane levels, maintaining fiscal stability to lower high public debt, and sustaining structural reform momentum. - Growth risks: prospects conditioned on global developments (close relationship with U.S.) and implementation of GSPS; further diversification into tourism and structural reforms needed to achieve above-trend output growth. - Commodity price pressures: higher fuel and food prices create hardship for vulnerable groups; recommended policy mix: - Implement temporary, targeted food and energy subsidies for the poor while maintaining flexible fuel pricing regime. - Fiscal policy: - Staff supports authorities’ intention to continue targeting primary fiscal surpluses of 3 percent of GDP over the medium term, with a temporary reduction in FY 2008/09. - Determined implementation of such fiscal policy would help achieve ECCB public debt targets well ahead of 2020. - To secure fiscal target if global slowdown is sharper or more prolonged, authorities may need to consider more extended phasing-in of planned income tax reform. - To enhance tax system: shift to accelerated depreciation as preferred mode for granting tax incentives, and broaden the base of the personal income tax. - External and currency assessment: - Dominica’s real exchange rate appears consistent with macroeconomic fundamentals. - Hurricane-related run up in external current account deficit expected to be reversed over medium term but remain elevated. - Existing policies yield projected external debt profile consistent with the common currency arrangement. - Financial regulation: - Passage of the Financial Services Act would strengthen regulation and supervision of nonbank financial institutions. - Critical to build capacity in the Financial Services Unit to effectively regulate and supervise nonbanks, particularly credit unions and insurance companies. - Structural reform agenda: - Fiscal consolidation and productivity-enhancing reforms are essential to improving competitiveness and ensuring stability of the currency union arrangement. - Procedural note: It is proposed that the next Article IV consultation be held on the standard 12-month cycle. *Source: IMF staff report text excerpt.* ### introduction of the VAT and excise duty regime in March 2006.The three main features of ### Introduction of the VAT and excise duty regime in March 2006. The three main features of ### Income tax reform: design and distributional impact - Three main features of the income tax reform are: an increase in the personal allowance; a reclassification of tax brackets; and a reduction in tax rates in each of the three income brackets. - The average tax rate paid by a representative taxpayer will decline substantially with the reform, providing proportionally the greatest benefit to lower income taxpayers. - Representative central government employee average tax rate trajectory: - Old schedule: 9.8 percent - FY 2007/08: 6.9 percent - Medium term: 4.8 percent ### Income tax schedule (Eastern Caribbean dollars and percentages) - Old Regime / FY 2007/08 / Medium-Term - Taxable Income 1-15000 — Tax Rate Old: 20 / FY 2007/08 Taxable Income 1-20000 — Tax Rate 18 / Medium-Term Tax Rate 15 - Taxable Income 15001-48000 — Tax Rate Old: 30 / FY 2007/08 Taxable Income 20001-50000 — Tax Rate 28 / Medium-Term Tax Rate 25 - Taxable Income Over 48000 — Tax Rate Old: 40 / FY 2007/08 Taxable Income Over 50000 — Tax Rate 38 / Medium-Term Tax Rate 35 - Source: Ministry of Finance. ### Regional comparison - On completion, the maximum personal income tax rate will be 35 percent, equal to that in Trinidad and Tobago, but still above most of the rates in other Caribbean countries. - The ratio of the exempted threshold to GDP per capita will rise to 1.7—above most countries in the region. ### Fiscal stance, implementation timing, and fiscal cost - Income tax cuts need to be undertaken gradually and consistent with the primary surplus of 3 percent of GDP that guides the authorities’ growth and debt sustainability strategy. - The income tax reform is being introduced in stages starting in January 2008. - The pace of implementation remains flexible to protect the primary surplus target of 3 percent of GDP. - Annualized tax revenue foregone due to the income tax reform: - About 0.9 percent of GDP for FY 2007/08 - Rising to the 1.4–1.7 percent range over the medium term - The bulk of the fiscal cost comes from increasing the exempted threshold. ### Assessment of external stability (Box 3) - The 2007 underlying current account deficit, which excludes temporary effects from Hurricane Dean, is estimated at around 21 percent of GDP. - The equilibrium current account deficit (current account ‘norm’) is estimated at around 20 percent of GDP for samples of tourism-based economies. - The projected medium-term current account balance for Dominica is close to the estimated equilibrium current account when using coefficients regressed on either: - (i) a CARICOM-only sample, or - (ii) an extended sample of tourism-dependent countries. - These two approaches indicate there is no evidence of misalignment of the real exchange rate. - Staff estimates show a large equilibrium current account deficit is observed across ECCU countries. The deficit in Dominica is mostly driven by imports, which represent nearly 50 percent of GDP, a large portion related to FDI and grant-financed projects. - Assuming an import content of 90 percent, FDI and grants together explain a significant part of the current account deficit. Excluding FDI- and grant-related imports, the current account deficit declines to: - 6 percent of GDP in 2007 - 4½ percent of GDP over the medium term ### Dominica: Current account and related figures (As percent of GDP) - Observed Current Account (a): - 2007: -23.6 - 2013: -18.8 - Temporary Effects (b): - Increased imports related to hurricane reconstruction: 1.9 (2007) - Loss of banana exports due to Hurricane Dean: 0.2 (2007) - Loss of non-banana exports due to Hurricane Dean: 0.5 (2007) - Underlying Current Account (a-b): - 2007: -21.0 - 2013: -18.8 - FDI: - 2007: 8.0 - 2013: 8.0 - Grants 1/: - 2007: 8.4 - 2013: 7.8 - Import content of FDI and Grants 2/: - 2007: 14.7 - 2013: 14.2 - Current Account Excluding Import content of FDI and Grants: - 2007: -6.2 - 2013: -4.6 - Memo: - Fuel imports 2007: 7.6 - Fuel imports 2013: 10.9 - Notes: - 1/ Grants actually used during the year. - 2/ Assumes that 90% of FDI and used grants are spent on imports. ### Inflation developments and policy response (Box 4) - Inflation acceleration: - Twelve-month inflation reached 5½ percent at end 2007 from 1.6 percent a year earlier. - Food inflation rose to 8.4 percent and fuel to 24.1 percent. - The joint contribution of food and fuel price increases amounted to about three quarters of overall end-year inflation in 2007. - In March 2008, inflation accelerated further to 7.7 percent driven by the recent run-up in commodity prices. - CPI composition: - “Food and beverages” weight in the CPI basket: 33 percent - Fuel weight in the CPI basket: 6 percent - Poverty and exposure to food price increases: - Almost 40 percent of the population falls in the category of poor or very poor. - Half of total expenditure in the lowest two quintiles of the population is devoted to food. - Energy pricing regime: - Dominica moved to flexible fuel pricing in 2003. - Prices remain administered in the rest of the ECCU except for Grenada and St. Kitts and Nevis, which adopted flexible pricing regimes in late 2006. - Drivers of price pressures: - Largely developments in the external environment, including depreciation of the EC dollar against other currencies. - Domestic demand has a lesser role as the economy grew below trend in 2007 due to Hurricane Dean, though supply disruptions after the hurricane contributed to temporarily higher prices. - Policy responses implemented by the Dominican authorities: - Reduced import tariff on a limited number of food items under the CARICOM initiative. - Cut in half the excise on fuel used in electricity (at a fiscal cost of about ½ of 1 percent of GDP). - Exempted pensioners from the income tax at a modest fiscal cost. - Mission proposals: - Strengthen existing social protection programs, in the context of work with the World Bank to improve efficiency of social safety nets. - Social protection spending: - Central government current spending on social protection programs amounted to about 2½ percent of GDP in FY 2006/07, of which broadly ½ of 1 percent of GDP was devoted to addressing basic needs. *IMF staff report excerpt.* ### Box 5. Dominica: Sources of Grants ### Box 5. Dominica: Sources of Grants ### Recent grant inflows and macroeconomic effects - Over the past three fiscal years, grant inflows to Dominica have more than doubled from pre-crisis levels. - Dominica now receives about 9½ percent of GDP in grants compared to an average of about 4 percent of GDP during the 1990s. - A significant proportion of the grants has been saved in commercial banks, reflecting limited implementation capacity and the authorities’ commitment to sound spending policies. - Prudent fiscal policy and careful management of the increase in grants helped to keep inflation low, prior to the recent increases in food and fuel prices. ### Donor composition and uses of grant resources - The surge in grants comes largely from new donors including China, Venezuela, and Trinidad and Tobago. - These grants are part of economic and cultural cooperation agreements and financial assistance following Hurricane Dean. - Uses by donor: - China: used to finance sports facilities, road improvement, river control, and schools. - Venezuela: used to develop the airport, sea defenses and government buildings infrastructure, low-income housing, and disaster relief. - Trinidad and Tobago: mainly contributed to the rehabilitation of infrastructure after Hurricane Dean. ### Volatility, fiscal management, and the role of an MTEF - Most of the government capital expenditure is financed by grants, which had a standard deviation of 2.2 percent of GDP over the 1990–2006 period, due in part to one-off aid disbursements. - Such volatility poses challenges for Dominica’s fiscal and liquidity management. - A medium-term expenditure framework (MTEF) can help better manage increasing aid inflows by: - assuring greater predictability of government expenditure; - contributing to internalizing the recurrent cost implications of grant-financed capital investment; - helping reduce pressures for real effective exchange rate appreciation. ### Dominica: Sources of grants (In percent of GDP) - Fiscal Year columns: Est. Proj. 2005/06 2006/07 2007/08 2008/09 - Trinidad and Tobago: 2.8 2.2 - Venezuela: 0.1 3.9 2.9 0.8 - China: 3.8 1.4 0.4 0.4 - European Union: 1.6 1.5 0.6 2.3 - Others: 2.0 1.5 3.9 4.5 - Total: 7.5 11.1 10.1 8.0 Memo: - Grant financed capital expenditure 1/: 7.2 7.6 10.5 8.5 - Average grants 1990-1999: 4.0 *Sources: Ministry of Finance; and Fund staff estimates and projections.* ### Appendix I. Dominica: Fund Relations ### Appendix I. Dominica: Fund Relations (As of May 31, 2008) ### I. Membership Status - Joined 12/12/78; Article VIII ### II. General Resources Account - Quota: 8.20 SDR Million — 100.00 percent of Quota - Fund holdings of currency: 10.24 SDR Million — 124.90 percent of Quota - Reserve position in Fund: 0.01 SDR Million — 0.11 percent of Quota ### III. SDR Department - Net cumulative allocation: 0.59 SDR Million — 100.00 percent of Allocation - Holdings: 0.03 SDR Million — 5.30 percent of Allocation ### IV. Outstanding Purchases and Loans - Emergency Assistance: 2.05 SDR Million — 25.00 percent of Quota - PRGF Arrangements: 7.69 SDR Million — 93.76 percent of Quota ### V. Latest Financial Arrangements - PRGF: Approval Date 12/29/03; Expiration Date 12/28/06; Amount Approved 7.69 SDR Million; Amount Drawn 7.69 SDR Million - Stand-by: Approval Date 08/28/02; Expiration Date 01/02/04; Amount Approved 2.97 SDR Million; Amount Drawn 2.97 SDR Million - SAF: Approval Date 11/26/86; Expiration Date 11/25/89; Amount Approved 2.80 SDR Million; Amount Drawn 2.80 SDR Million - Stand-by: Approval Date 07/18/84; Expiration Date 07/17/85; Amount Approved 1.40 SDR Million; Amount Drawn 0.97 SDR Million - EFF: Approval Date 02/06/81; Expiration Date 02/05/84; Amount Approved 8.55 SDR Million; Amount Drawn 8.55 SDR Million - Projected Payments to the Fund on an Obligation Basis (SDR Million)1: - Forthcoming 2008 2009 2010 2011 2012 (columns) - Principal: 0.50 0.72 1.84 2.56 - Charges/Interest: 0.11 0.13 0.13 0.12 0.07 - Total: 0.11 0.64 0.85 1.96 2.64 1 Based on existing use of resources and present holdings of SDRs. ### VI. Exchange rate arrangement and Safeguards Assessment - Exchange rate arrangement: - Dominica is a member of the Eastern Caribbean Currency Union, with a common central bank (the Eastern Caribbean Central Bank) and currency (the Eastern Caribbean dollar). - Since July 1976, the Eastern Caribbean dollar has been pegged to the U.S. dollar at the rate of EC$2.70 per U.S. dollar. - Dominica has accepted the obligations of Article VIII, Sections 2, 3 and 4 and maintains an exchange system free of restrictions on the making of payments and transfers for current international transactions. - Safeguards Assessment (ECCB): - Under the Fund's safeguards assessment policy, the Eastern Caribbean Central Bank (ECCB), of which Dominica is a member, is subject to a full safeguards assessment under a four year cycle. - The most recent assessment was completed in July 2007 and concluded that the ECCB continues to have appropriate control mechanisms in place, which have strengthened since the first safeguards assessment completed in 2003. - ECCB management places emphasis on good governance and sound controls, and has enhanced the bank's transparency and accountability since the last assessment, including the publications of financial statements that comply with International Financial Reporting Standards. - The assessment made some recommendations to sustain the ECCB's safeguards framework going forward. ### VII. Article IV consultation - Last Article IV consultation concluded by the Executive Board on July 16, 2007. - Relevant documents: IMF Country Report No. 07/322 and IMF Country Report No. 05/324. - Dominica is on a 12-month cycle. ### IX. Technical assistance - January 2007: FAD and Caribbean Regional Technical Assistance Center (CARTAC) mission — technical assistance on revenue administration and tax policy. - 2006: MCM mission — technical assistance in drafting an action plan for AID Bank. - 2005: MCM mission — technical assistance in strengthening the supervisory framework for AML/CFT in the nonbank sector. - FAD missions provided technical assistance on tax policy and administration, and social security reform. - Most recent missions listed: - Pension reform options (2005) - TA on fiscal responsibility laws (2004) - VAT implementation (1999) - Urban property taxation (1997) - Tax policy and administration, and expenditure control (1995) - Technical assistance from MFD and FAD has complemented CARTAC assistance in Barbados. - LEG assistance: drafting and interpretation of the VAT legislation. ### X. FSAP - A joint IMF/World Bank team performed an assessment of the financial sector of the member states of the ECCB in two missions—September 1–19 and October 20−31, 2003. - Principal objective: assist authorities in assessing development needs and opportunities for the financial sector; identify potential vulnerabilities of financial institutions and markets to macroeconomic shocks; and identify risks to macroeconomic stability from weaknesses in the financial sector. - A detailed assessment of the AML/CFT regimes of Dominica was conducted in September 2003 by the Caribbean Financial Action Task Force (CFATF). - The Financial System Stability Assessment (FSSA) was discussed by the Executive Board on May 5, 2004, and subsequently published on the IMF’s external website, including the Report on the Observance of Standards and Codes (ROSC) on Banking Supervision. *Appendix I. Dominica: Fund Relations (As of May 31, 2008).* ### Appendix IV. Dominica: Statistical Issues ### Appendix IV. Dominica: Statistical Issues ### Data provision — overview - Data provision is "broadly adequate for surveillance" but has shortcomings in coverage, accuracy, frequency, and timeliness that hamper effective economic analysis and policy formulation. - Priority should be given to compilation and dissemination of national accounts, in particular tourism, agriculture and labor statistics. - Significant weaknesses remain in the compilation of fiscal accounts and the balance of payments. - Dominica participates in the General Data Dissemination System. Metadata for external sector and government finance statistics have not been updated since December 2002. ### Real sector - Annual nominal GDP data: compiled using the production and the expenditure approaches; estimates by economic activity compiled using production approach at 1990 prices. - Availability and revisions: - GDP estimates available about four months after the end of the year. - Data are revised frequently and usually finalized with a two-year lag following completion of the National Accounts Survey. - Ongoing improvements: - Program to develop supply and use table. - Late 2007: comprehensive assessment of GDP methodology and data with assistance of the Eastern Caribbean Central Bank (ECCB). Revised national accounts data are not yet public. - Prerequisite: revision and/or update of the base year, currently 1990. - Price indices and inflation: - CPI data compiled with a two-month lag, weights based on the 1997/1998 Household Expenditure Survey. - Program to develop export and import price indices (XMPIs), but shortage of staff limits CPI methodology development and likelihood of XMPIs in near term. - IMF (via Caribbean Regional Technical Assistance Center) providing technical advice on XMPI methodology. - Other data gaps: - Employment data are limited. - No official data on producer prices or wages in the private sector. - Results of the 2001 population census have not yet been published. ### Government finance statistics - Timeliness and quality problems affect government finance statistics; data are subject to frequent revisions from omissions and misclassifications. - Central government operations data are incomplete and must be supplemented from external sources because some operations occur outside the consolidated fund (including certain investment spending, loan and grant receipts, and on-lending and transfers to public enterprises). - Capital expenditure recorded by the Treasury must be supplemented with donor financing information; public sector investment program (PSIP) data are not timely due to reporting delays from line ministries. - Ongoing initiatives: - Effort to automate expenditure execution process. - New automation technology installed in all line ministries in 2005 to electronically generate and track local purchase orders (LPOs). Commitments are charged once LPOs are generated; all ministries and suppliers compelled to use the system. - Debt measurement: - Progress made in measuring government's debt, but concerns remain about under-recording of government commitments. - Public sector coverage: - Authorities do not provide consolidated nonfinancial public sector data. Data for the rest of public sector—Dominica Social Security and public enterprises—must be obtained directly from each entity during Fund Article IV missions. - Reporting to STA: - No government finance data are reported to STA for publication in the International Financial Statistics (IFS) or the Government Finance Statistics (GFS) Yearbook. ### Monetary and financial statistics - Monetary statistics compiled and reported to the Fund by the ECCB on a monthly basis based on a standardized report form since July 2006. - April 2007 data ROSC assessed monetary statistics with reference to the GDDS and the DQAF (July 2003): - Institutional coverage of other depository corporations is incomplete: mortgage companies, finance companies, building societies, and credit unions (all accept deposits) are excluded. - Accrued interest is not incorporated in the value of interest-bearing assets and liabilities. - Valuation adjustments are included in other liabilities. - Source data for commercial banks do not provide the disaggregation recommended in the Monetary and Financial Statistics Manual. - Recommendation: - Close coordination between the ECCB and the single regulatory unit (which supervises financial corporations other than those licensed under the Banking Act) is crucial. ### Balance of payments statistics - Balance of payments data compiled by the ECCB on an annual basis but lack sufficient detail for publication using the full BPM5 classification. - Data reported to STA are improving in timeliness but still suffer from relatively numerous and large errors and omissions. - Recommendations: - Enhanced data resources and better compilation procedures to improve accuracy and timeliness. - Authorities should strive to compile quarterly balance of payments statistics and the annual international investment position statement. ### External debt - Ministry of Finance maintains a database on public and publicly-guaranteed external loans with detailed information on disbursements, debt service, and debt stocks. - Treasury maintains data on bonds placed abroad. - These two databases are not consolidated, requiring further adjustments to measure total debt stock. - Recommendation: - Payments by creditor (actual and scheduled) should be available to compilation agencies at least on a monthly basis to allow production of timely debt stock data. ### Table of Common Indicators (selected entries; as of June 24, 2008) - Exchange Rates: Fixed Rate (member of Eastern Caribbean Currency Union; peg US$1=EC$2.70). - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: April 2008; Date received 6/17/08; Frequency of Data M; Frequency of Reporting M; Frequency of Publication Q. - Reserve/Base Money; Broad Money; Central Bank Balance Sheet; Consolidated Balance Sheet of the Banking System: April 2008; Date received 6/17/08; Frequency of Data M; Frequency of Reporting M; Frequency of Publication Q. - Interest Rates: April 2008; Date received 6/17/08; Frequency of Data Q; Frequency of Reporting Q; Frequency of Publication Q. - Consumer Price Index: April 2008; Date received 5/22/08; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M. - Revenue, Expenditure, Balance and Composition of Financing – General Government: 2007; Date received 5/22/08; Frequency of Data A; Frequency of Reporting A; Frequency of Publication A. - Revenue, Expenditure, Balance and Composition of Financing – Central Government: April 2008; Date received 5/22/08; Frequency of Data M; Frequency of Reporting M; Frequency of Publication A. - Stocks of Central Government and Central Government-Guaranteed Debt: April 200; Date received 5/22/08; Frequency of Data M; Frequency of Reporting M; Frequency of Publication A. - External Current Account Balance: 2007; Date received 2/19/08; Frequency of Data A; Frequency of Reporting A; Frequency of Publication A. - Exports and Imports of Goods and Services: March 2008; Date received 5/22/08; Frequency of Data M; Frequency of Reporting Q; Frequency of Publication A. - GDP/GNP: 2007; Date received 5/22/08; Frequency of Data A; Frequency of Reporting A; Frequency of Publication A. - Gross External Debt: March 2008; Date received 5/22/08; Frequency of Data M; Frequency of Reporting M; Frequency of Publication A. - Notes on data quality assessments: - Footnote 9 and 10 reference assessments from the data ROSC published on August 21, 2007, based on an April 10–18, 2007 mission. Assessment codes: O (fully observed), LO (largely observed), LNO (largely not observed), NO (not observed). ### Debt Sustainability Analysis — overview - Summary: Despite Hurricane Dean (August 2007), Dominica has steadily improved its debt sustainability outlook due to authorities’ firm commitment to sound fiscal policies. Large risks remain from possible further weakening of global outlook, dependence on aid flows to finance capital expenditure, and vulnerability to natural disasters. ### I. Underlying DSA assumptions - Staff prepared a baseline scenario consistent with authorities’ updated Growth and Social Protection Strategy (GSPS). Main assumptions summarized in Box 1. - Dominica has a CPIA rating of 3.85 in 2007 and is classified as a strong performer. Corresponding indicative policy thresholds for external public debt (Strong Policy): - NPV of debt in percent of Exports: 200 - NPV of debt in percent of GDP: 50 - NPV of debt in percent of Revenue: 300 - Debt Service in percent of Exports: 25 - Debt Service in percent of Revenue: 35 Box 1. Baseline Macroeconomic Assumptions (2008–2028) - Real growth: projected at 3 percent of GDP over projection period after a two-year period of slightly lower growth related to current global slowdown. Growth supported by policy reform and strong FDI to expand tourism capacity. - Inflation: projected to remain low (1.5 percent per year) after international food and fuel price shocks are assimilated. - Primary balance (central government): remains at 3 percent of GDP from 2009 in line with GSPS and previous DSA. - Public enterprises: overall deficit of 0.5 percent of GDP (average 1999–2006). - External grants: decline to 7 percent of GDP after aid surge in FY 2006/07–07/08. - External concessional debt disbursements: assumed 1.5 percent of GDP through 2013, decline to 0.5 percent of GDP thereafter. Financing terms similar to existing external debt. - New domestic debt: projected interest rate of 7 percent. - PetroCaribe financing: excluded from DSA due to lack of information; omission not expected to significantly distort debt outlook. - Current account deficit: assumed to remain high during 2008–13, then gradually fall; exports of goods projected to grow with GDP; tourism receipts projected to grow vigorously. - FDI: assumed to remain at 8 percent of GDP (2006–07 level). - Note: A revision in national accounts for 2000–2006 led to nominal GDP higher by about 3 percent compared with figures in the 2007 Article IV consultation. - Previous DSA assumptions on concessional disbursements adjusted due to improved debt sustainability. ### II. Evaluation of public sector debt sustainability Dominica’s public debt at end-2007 - Public sector debt at end-2007: 94 percent of GDP. - External debt: 65 percent of GDP. - Domestic debt: 35 percent of GDP. - External debt composition (percent of GDP figures cited): - Multilateral creditors: about 70 percent of GDP (Caribbean Development Bank holds more than half of that). - Bilateral creditors: about 14½ percent of GDP. - Commercial creditors: about 12 percent of GDP. - Domestic creditor composition: - Dominica Social Security System: about 11½ percent of GDP. - NPV terms: - Public sector debt NPV: around 88.5 percent of GDP. - External debt NPV: around 64 percent of GDP (reflecting concessionality). - Note on restructuring assumptions: - Simulations assume hold-out creditors take the intermediate bond with a hair-cut of 20 percent. Discount rate for NPV calculations is 5 percent. The baseline scenario - Under the baseline (Table 1a): indicators show progressive improvement in debt sustainability. - Debt service to revenue (and grant) ratio increases in 2008 and 2009 and remains high until 2015, underscoring need to maintain fiscal discipline to avoid liquidity constraints. - Under the baseline, public debt to GDP ratio would reach 60 percent (the ECCB benchmark) by 2014. Alternative scenarios and stress tests - Key drivers of debt path: economic growth and the primary surplus target; both are subject to large exogenous shocks (volatility of grants, foreign growth—especially U.S. growth). Staff estimate elasticity of Dominica’s growth to U.S. economic cycles is slightly greater than one. - Sensitivity analysis highlights: - If primary balance and growth return to ten-year averages (primary balance 0.4 percent, growth 1 percent) — scenario A1 — public debt starts rising again. - If Dominica maintains fiscal effort projected for 2008 (primary balance 2.4 percent, slightly below 3 percent target) — scenario A2 — public debt stays on a declining path. - Scenario A3 (growth declines to 2.3 percent per year): debt initially declines but later reverts to increasing path because fiscal expenditure drives the debt trajectory; slower growth leads to rising primary expenditure relative to baseline while tax revenues remain roughly constant, deteriorating the primary balance. - Figure 2 (referenced) shows debt-to-GDP ratio declines even with slower growth if a steady fiscal policy committed to 3 percent primary surplus is maintained. - Decline in aid flows: - External grants averaged 8.1 percent of GDP during past three fiscal years, about 4 percentage points higher than 1990s average. - Stress test: 3 percent of GDP reduction in aid flows from 2009 examined under two scenarios: - Partial adjustment scenario: - Government cuts public investment by 1½ percent of GDP. - Remainder of aid decline financed with larger borrowing, assumed to raise domestic interest rates by one percentage point. - Result: primary surplus declines to 1½ percent of GDP per year. - No adjustment scenario: - No cut in public investment. - Aid decline financed entirely via higher borrowing, assumed to increase domestic interest rates by two percentage points. - New borrowing assumed to be funded in domestic market. *Source: Appendix IV. Dominica: Statistical Issues; Debt Sustainability Analysis (as provided).* ### 9. As the figure illustrates, in the no adjustment scenario where the aid decline is ### _cr08310 - 9. As the figure illustrates, in the no adjustment scenario where the aid decline is ### Other shocks - Shocks considered: possible natural disasters, shocks to interest rates, and balance sheet effects of further depreciation of the U.S. dollar against other major international currencies. - Hurricane risk: - Another hurricane of similar magnitude as Hurricane Dean: sensitivity exercise (not shown) indicated that after an initial increase, the debt ratio returns to a downward trajectory after growth is restored and reconstruction projects are completed. - Dominica participates in the Caribbean Catastrophe Risk Insurance Facility (CCRIF). - Interest rate shocks: - Have little impact on Dominica’s public debt because most debt, including domestic debt, is contracted at fixed interest rates. - Exchange-rate shocks: - A further depreciation of the U.S. dollar against other major currencies would have a modest balance sheet effect given Dominica’s debt currency composition. - Debt currency composition: About 69 percent of the external debt is denominated in U.S. dollars, 21 percent in SDRs (where the weight of the U.S. dollar is about 44 percent), and 3.2 percent is denominated in Euro. ### Evaluation of external debt sustainability - Public vs. external debt: - The majority of Dominica’s external debt is owed by the public sector; private sector borrowing largely takes place with domestic commercial banks. - Therefore, the external DSA shares similar properties as the public sector DSA. - Baseline path: - Since the debt restructuring, external debt continues to decline in the baseline scenario (Table 1c). - Indicators that do not decline continuously: share of external debt service as a percent of exports and public sector revenues — both increase until 2009 reflecting initial consequences of the debt restructuring, then start to decline. - Adverse shocks contributing to temporary hikes: Hurricane Dean’s impact on exports and the closure of a large foreign manufacturing toothpaste factory in late 2007. - Large residuals over the medium term reflect absence of an independent estimate of private sector debt (private sector debt excluded from analysis). - Sensitivity tests (Table 1d): - If key variables stay at their historical averages, external debt would remain on a declining path as higher grants and FDI would result in less external debt. - Higher interest rates (Scenario A2) have little impact on external debt paths because Dominica faces low financing needs in the baseline. ### Conclusions and policy implications - Achievements: - Continuing the process of debt restructuring has improved Dominica’s debt sustainability based on economic growth and implementation of the strong fiscal policy outlined in the GSPS. - Fiscal policy remained strong following Hurricane Dean as reflected in the authorities’ request for emergency assistance from the Fund. - Public debt projections show a declining trend similar to previous DSAs. - The current projection will achieve the ECCB target of 60 percent for the debt-to-GDP ratio in 2014, two years earlier than projected in the 2007 Article IV consultation DSA. - Dominica reduced debt-related vulnerabilities by joining the Caribbean Catastrophe Risk Insurance Facility and introducing a pension reform. - Remaining vulnerabilities: - (i) Public debt is still high at 94 percent of GDP. - (ii) There is a bunching of payments in 2008–11 (notes: Debt with Government of Bahamas (US$4 million) and with Government of Trinidad and Tobago (US$10 million) are scheduled to be repaid in 2008 but are highly likely to be rolled over into 2009 in line with past practice). - (iii) New grant flows are uncertain and volatile. - (iv) Dominica is exposed to external shocks and weather-related vulnerabilities. - Policy target: - The updated GSPS maintains the primary surplus target of 3 percent of GDP to achieve a more comfortable debt ratio, create room to deal with natural disasters, and eventually adopt some countercyclical policies. ### Key projections and indicators (selected exact figures from tables and text) - Public debt and related projections: - Public sector debt: 103.6 (2005), 102.0 (2006), 94.3 (2007), 86.3 (2008), 81.2 (2009), 77.2 (2010), 73.3 (2011), 69.4 (2012), 65.6 (2013), 48.1 (2018), 18.3 (2028). - Foreig­n-currency denominated public debt: 71.1 (2005), 70.0 (2006), 65.0 (2007), 59.3 (2008), 55.3 (2009), 52.0 (2010), 48.2 (2011), 44.8 (2012), 42.0 (2013), 26.8 (2018), 10.0 (2028). - Change in public sector debt: -6.9 (2005), -1.6 (2006), -7.7 (2007), -8.1 (2008), -5.1 (2009), -4.0 (2010), -4.0 (2011), -3.9 (2012), -3.8 (2013), -3.3 (2018), -2.8 (2028). - Primary deficit (series): -4.2, -6.9, -5.0, -0.4, 5.5, -2.7, -3.2, -3.2, -3.2, -3.1, -3.1, -3.0, -3.1, -3.1 (table entries preserved exactly as shown). - Debt dynamics contributors (selected): - Automatic debt dynamics: -2.0 (2005), -1.4 (2006), -1.6 (2007), -5.0 (2008), -1.8 (2009), -0.8 (2010), -0.8 (2011), -0.8 (2012), -0.7 (2013), -0.3 (2018), 0.3 (2028). - Contribution from interest rate/growth differential: -4.1 (2005), -3.1 (2006), -1.5 (2007), -2.4 (2008), -1.2 (2009), -1.0 (2010), -1.1 (2011), -1.0 (2012), -0.9 (2013), -0.5 (2018), 0.2 (2028). - Contribution from real GDP growth: -3.6 (2005), -4.0 (2006), -1.5 (2007), -2.4 (2008), -2.4 (2009), -2.4 (2010), -2.2 (2011), -2.1 (2012), -2.0 (2013), -1.5 (2018), -0.6 (2028). - NPV and ratios: - NPV of public sector debt: 101.3 (2005), 95.9 (2006), 88.6 (2007), 79.9 (2008), 73.6 (2009), 69.3 (2010), 65.5 (2011), 61.8 (2012), 58.2 (2013), 43.4 (2018), 17.2 (2028). - NPV of public sector debt-to-revenue and grants ratio (in percent): 216.1 (2005), 197.2 (2006), 178.3 (2007), 166.5 (2008), 158.2 (2009), 151.3 (2010), 145.1 (average 2008–13), 137.5 (2018), 129.4 (2028), 96.4 (average 2014–28), 38.3 (table entries preserved). - Debt service-to-revenue and grants ratio (in percent): 10.1 (2005), 12.6 (2006), 12.6 (2007), 15.1 (2008), 17.5 (2009), 15.5 (2010), 15.3 (2011), 14.8 (2012), 13.3 (2013), 8.1 (2018), 5.5 (2028). - Key macroeconomic and fiscal assumptions (selected): - Real GDP growth (in percent): 3.3 (2005), 4.0 (2006), 1.5 (2007), 1.0 (2008), 3.2 (2009), 2.6 (2010), 2.8 (2011), 3.0 (2012), 3.0 (2013), 3.0 (2018), 2.9 (2028), 3.0 (average 2014–28), 3.0 (other listed entries). - Average nominal interest rate on forex debt (in percent): 2.0 (2005), 2.4 (2006), 2.2 (2007), 3.5 (2008), 1.2 (2009), 2.6 (2010), 2.8 (2011), 2.7 (2012), 2.6 (2013), 2.5 (2018), 2.5 (2028), 5.5, 3.4 (table entries preserved). - Inflation rate (GDP deflator, in percent): 1.5 (2005), 0.6 (2006), 2.9 (2007), 1.6 (2008), 1.0 (2009), 6.3 (2010), 2.8 (2011), 1.5 (2012), 1.5 (2013), 1.5 (2018), 1.5 (2028). - External debt (nominal) and indicators (selected): - External debt (nominal): 71.1 (2005), 70.0 (2006), 65.0 (2007), 59.3 (2008), 55.3 (2009), 52.0 (2010), 48.2 (2011), 44.8 (2012), 42.0 (2013), 26.8 (2018), 10.0 (2028). - Change in external debt: -5.7 (2005), -1.1 (2006), -5.0 (2007), -5.7 (2008), -3.9 (2009), -3.4 (2010), -3.8 (2011), -3.4 (2012), -2.9 (2013), -2.4 (2018), -0.9 (2028). - NPV of external debt (table): 64.0, 57.5, 52.5, 48.6, 44.5, 40.7, 37.6, 24.1, 8.9 (selected entries preserved). - NPV of external debt in percent of exports: 152.8, 146.0, 129.3, 118.8, 107.9, 97.7, 89.5, 54.9, 18.4 (selected entries preserved). - Debt service-to-exports ratio (in percent): 12.6 (2005), 9.6 (2006), 11.6 (2007), 14.6 (2008), 14.7 (2009), 12.5 (2010), 11.9 (2011), 10.9 (2012), 9.6 (2013), 5.4 (2018), 3.2 (2028). - Aid and grant-related figures: - Aid flows (in millions of U.S. dollars): 63.4, 108.4, 117.8, 87.9, 86.6, 85.6, 83.2, 85.2, 90.1, 114.2, 179.8 (table entries preserved across years where listed). - Grants (component): 17.8, 39.7, 43.1, 30.8, 29.8, 31.5, 30.3, 30.3, 30.8, 32.2, 40.7, 63.5 (selected table entries preserved). - Grant-equivalent financing (in percent of GDP): 8.7, 8.0, 8.1, 7.5, 7.3, 7.3, 7.2, 7.2 (entries preserved where shown). - Grant element of new external borrowing (in percent): 17.9 (repeated across projection years where shown). - Projections and scenario outcomes (figures and table summaries preserved): - Figure summaries show baseline, no reform, most extreme stress test, and various sensitivities to primary balance, GDP growth, and aid flows; specific series values are given in tables and preserved above. *Statement by the IMF Staff Representative on Dominica, July 30, 2008 (information on the 2008/09 budget presented July 10, 2008).* ### 1. The preliminary primary surplus for 2007/08 is now estimated at 1½ percent of ### _cr08310 - 1. The preliminary primary surplus for 2007/08 is now estimated at 1½ percent of ### Fiscal outcomes: 2007/08 preliminary outturn - Preliminary primary surplus for 2007/08 is now estimated at 1½ percent of GDP compared with the staff’s projection of 3 percent. - Divergence driven by capital outlays in advance of forthcoming grant funding and expenditure on post-hurricane reconstruction projects that have exceeded initial cost estimates. - Higher overall deficit was domestically financed mainly by reducing government deposits. - Delay in receipt of external assistance is unlikely to affect the baseline projection for foreign grants. - Public debt/GDP is estimated to have declined to 95 percent of GDP at the end of the fiscal year. ### 2008/09 budget and medium-term fiscal framework - 2008/09 budget proposes a primary surplus of the central government of 2 percent of GDP, about ½ percent of GDP below the projection in the staff report. - Medium-term primary surplus target remains 3 percent of GDP; deviation does not alter conclusions of the debt sustainability analysis, although the public debt/GDP ratio would be about 1½ percent of GDP higher by 2013. - Key budget components: - Removal of the excise tax on LPG (at a cost 0.1 percent of GDP). - Guarantee of a minimum pension of EC$200 per month for government pensioners. - An ambitious, largely grant-financed public sector investment program (about 14 percent of GDP), which could challenge implementation capacity. - Implementation of the second phase of the income tax reform in January 2009: - Exempted income threshold raised from EC$18,000 to EC$20,000. - Marginal rates reduced by 2 percentage points. - Cost of this phase estimated at about 0.4 percent of GDP in 2008/09 and 0.9 percent of GDP in 2009/10. ### Structural and institutional measures - Financial Services Unit (FSU) Act introduced in parliament to provide a unified regulatory and supervisory framework for nonbank financial institutions. - Authorities encouraged to quickly build capacity in the Financial Services Unit to regulate effectively nonbanks, particularly credit unions and insurance companies. - Authorities’ structural reform focus: implementation of Dominica’s Growth and Social Protection Strategy and measures to reduce the cost of doing business, including improving energy sector efficiency. - Authorities creating one-stop agencies for tourism and investment promotion and simplifying business procedures. ### Macroeconomic developments and outlook - Hurricane Dean (August previous year) caused damage estimated at about 20 percent of GDP. - Real output growth slowed to 1½ percent in 2007 after reaching 4 percent in 2006. - Economy expected to grow by 2½ percent in 2008 supported by recovery in agriculture and reconstruction efforts. - Inflation accelerated to 5½ percent in 2007 and projected to rise to about 6½ percent in 2008. - Primary fiscal surplus of 1½ percent of GDP achieved in FY 2007/08 despite a 50 percent reduction of the excise tax on fuel for electricity generation and implementation of the first phase of the income tax reform. - Revenue performance driven by VAT collection and import duties due to surge in imports related to reconstruction. - Scale up in capital expenditure to rehabilitate damaged infrastructure largely financed by external grants. ### External sector, competitiveness, and financing - Real effective exchange rate continued to decline, partly reflecting weakness in the U.S. dollar, and remains broadly in line with macroeconomic fundamentals despite widening external current account deficit to 24 percent of GDP. - Increase in external current account deficit reflects surge in imports for post-hurricane reconstruction and rising food and fuel import bill. - Financing of larger current account deficit facilitated by higher government grant inflows, foreign direct investment and private capital inflows. - Directors supported saving the bulk of concessional financing for fuel consumption under the PetroCaribe initiative, welcomed the setting up of an investment fund, and recommended restricting spending on social projects from this source to the net return derived from the investment fund. - Directors called on donors to make disbursements more predictable and encouraged authorities to develop a framework to smooth associated spending. ### Banking sector and financial stability - Banking sector experienced robust growth in deposits while credit growth slowed, resulting in an accumulation of net foreign assets by commercial banks. - Rapid growth in deposits, due in part to higher family remittances, boosted liquidity levels; banking system profitability and overall asset quality maintained. - Efforts under way to strengthen regulatory and prudential framework for nonbank financial institutions, which are unevenly regulated. ### Executive Board assessment and policy recommendations - Directors commended authorities for sound economic policies while addressing oil and food price shocks and for medium-term agenda focused on reducing vulnerabilities, including reduction of public debt ratios. - Recommended contingent measures in case of a deeper-than-expected global slowdown, such as more extended phasing-in of the planned income tax reform while maintaining the integrity of the VAT to facilitate return to the medium-term primary surplus target. - Recommended modification of the tax incentive regime and broadening the income tax base to strengthen the tax system. - Encouraged improving budget management and developing frameworks to smooth volatile scaled-up aid flows. - Agreed overall external competitiveness adequate; real exchange rate broadly in equilibrium but high external current account deficit poses risks to be carefully monitored and accompanied by fiscal efforts. ### Selected economic and social indicators (excerpted exact figures) - Real GDP (factor cost) growth: 2004: 3.0; 2005: 3.3; 2006: 4.1; 2007 (Prel.): 1.5; 2008 (Est./Proj.): 2.6 - GDP deflator (factor cost): 2004: 2.1; 2005: 1.5; 2006: 1.2; 2007 (Prel.): 2.9; 2008 (Est./Proj.): 6.3 - Consumer prices (end of period): 2004: 0.8; 2005: 2.7; 2006: 2.0; 2007 (Prel.): 1.6; 2008 (Est./Proj.): 5.7; 6.7 - Net foreign assets of the banking system: 2004: 8.1; 2005: -8.0; 2006: 5.1; 2007 (Prel.): 17.6; 2008 (Est./Proj.): 7.2; -3.7 - Credit to the private sector: 2004: 5.4; 2005: 4.6; 2006: 6.1; 2007 (Prel.): 8.5; 2008 (Est./Proj.): 4.0; 5.7 - Liabilities to the private sector (M2): 2004: 5.9; 2005: 6.7; 2006: 8.0; 2007 (Prel.): 9.6; 2008 (Est./Proj.): 9.0; 4.7 - Central government primary balance 4/: 2004: 3.5; 2005: 6.9; 2006: 4.0; 2007 (Prel.): 6.3; 2008 (Est./Proj.): 1.5; 2.4 - Central government overall balance 4/: 2004: -0.9; 2005: 1.2; 2006: 1.6; 2007 (Prel.): 3.7; 2008 (Est./Proj.): -0.9; 0.6 - Capital expenditure and net lending (central government): 2004: 8.8; 2005: 9.0; 2006: 10.1; 2007 (Prel.): 10.0; 2008 (Est./Proj.): 14.8; 10.5 - Nonfinancial public sector debt (gross) total: 2004: 110.5; 2005: 103.6; 2006: 101.4; 2007 (Prel.): 102.0; 2008 (Est./Proj.): 94.3; 86.3 - External current account balance (in percent of GDP): 2004: -16.5; 2005: -28.0; 2006: -21.3; 2007 (Prel.): -18.3; 2008 (Est./Proj.): -23.6; -28.4 - Nominal GDP at market prices (EC$ millions), calendar year: 2004: 770.1; 2005: 808.0; 2006: 809.5; 2007: 856.5; 2008: 906.4; 982.6 - Net international reserves (US$ millions; end-of-period): 2004: 33.6; 2005: 37.6; 2006: 44.2; 2007: 51.0; 2008: 50.4; 52.5 *Source: IMF Public Information Notice and staff report summarized in _cr08310 - 1. The preliminary primary surplus for 2007/08 is now estimated at 1½ percent of (canonical URL provided in source metadata).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08310.pdf_