Public Information Notice No. 07/105

Public Information Notice: IMF Executive Board Concludes 2007 Article IV Consultation with Dominica

August 16, 2007

On July 16, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the 2007 Article IV consultation with Dominica.¹

Background

Dominica has fully recovered from the 2001-02 economic and financial crisis. Output growth has rebounded, reaching 4 percent in 2006—the highest in two decades—and it is expected to remain above trend in 2007. The rebound is driven by a pickup in tourism, recovery in banana production, and buoyant construction and offshore school activity. Inflation has remained subdued, reflecting stabilizing oil prices, and is projected to remain low. The external current account deficit narrowed sharply in 2006 and is likely to remain large at around 20 percent of GDP this year, financed mainly by foreign direct investment and large capital grants. External competitiveness remains broadly adequate due to fiscal adjustment and to a lesser extent the depreciation of the U.S. dollar against major currencies.

Fiscal balances have improved significantly. The central government primary surplus, before grants, is projected to reach 5.9 percent of GDP in 2006/07, a significant turnaround from the primary deficit in 2001/02. Tax buoyancy (partly due to the newly-introduced VAT and excise taxes), sustained expenditure restraint and continued output growth have contributed to the strong fiscal performance. Grants received have more than doubled the average pre-crisis level, reaching almost 13 percent of GDP for the first nine months of 2006/07.

Monetary aggregates have continued to increase rapidly, underpinned by expansion in deposits and private credit. Continued fiscal consolidation in recent years has helped expand private credit by 11 percent in 2006. Banking prudential indicators have improved, reflecting in part stricter enforcement of prudential guidelines by the Eastern Caribbean Central Bank and strong macroeconomic performance. Nevertheless, nonperforming loans remain high and loan loss provisioning is low by international standards.

Further progress has been made in structural reforms. The contribution rate for the Dominica Social Security was raised by 1 percentage point in March 2007 as part of an ongoing comprehensive reform strategy. The authorities have recently started to merge the port and airport authorities and to breakup the National Development Corporation into a tourism board and an investment promotion agency to raise efficiency. A draft law on the Financial Sector Unit has recently been submitted to parliament, albeit after much delay. The authorities have maintained good-faith efforts in pursuing debt restructuring agreements with the remaining creditors.

Executive Board Assessment

Executive Directors commended the authorities for continuing to implement sound economic policies, which have been pivotal in Dominica's remarkable recovery from the economic crisis in 2001−02. They noted that, under the authorities' comprehensive program, supported by the Fund, Dominica had successfully restored macroeconomic stability and reversed the debt build-up, while sustaining above-trend growth. They agreed that, with the implementation of the authorities' reform strategy reflected in the Growth and Social Protection Strategy, real GDP growth could remain above the historical average in coming years.

Directors commended the authorities for their strong commitment and efforts to address long-standing policy challenges. They agreed that the government's medium-term primary surplus target of 3 percent of GDP was consistent with the government's strategy of reducing vulnerabilities. Directors applauded the authorities for the progress made in reforming Dominica's Social Security System, which had been identified as a major risk to the public finances in the last Article IV consultation. Directors noted the authorities' good-faith efforts in pursuing debt restructuring agreements with non-participating creditors.

Directors welcomed the recent surge in budgetary aid to Dominica, but highlighted the associated policy challenges. Given the still high public debt ratio and the volatility of aid, Directors were encouraged by the authorities' commitment to continue with the strategy of smoothing the spending of the scaled-up aid over time and to use some of these resources to substitute expensive borrowing and reduce debt. A few Directors also called on donors to establish streamlined and more predictable procedures for the disbursement of aid. Directors also welcomed the authorities' intention to improve budget management, in particular regarding capital expenditure, in order to use aid in an efficient and transparent manner and consistent with macroeconomic objectives.

Directors stressed the importance of ensuring that modifications of the indirect taxes lead to an improvement in the efficiency of the tax system and be consistent with sustaining fiscal consolidation. While recognizing the regional dimension of tax competition, they noted that tax cuts need to be modest and accompanied by the revamping of the tax incentive system to try to make it more efficient, while safeguarding the integrity of the recently introduced value-added tax. They reaffirmed the willingness of the Fund to continue to provide technical assistance as needed, specifically to reform tax incentives.

Directors supported the authorities' commitment to achieving greater progress in financial sector supervision. The recent improvements in banking prudential indicators are a welcome development, but the rapid credit expansion, low provisioning, and strong competition from loosely-regulated nonbank financial institutions warrant enhanced supervision over the financial sector. Given extensive regional financial linkages and the lack of supervisory expertise, Directors agreed that the authorities consider delegating part of supervisory functions over the nonbanks, including to other regulatory bodies in the region.

Directors agreed that the overall level of Dominica's external competitiveness is adequate. They viewed that the real exchange rate level is broadly competitive, in part reflecting fiscal consolidation and the EC dollar depreciation against the currencies of trading partners. They also observed that the exchange regime, if supported by sound fiscal policy, continues to serve Dominica well.

Directors called for further progress in the implementation of structural reforms as envisaged in Dominica's Growth and Social Protection Strategy. They observed that priority be given to efforts to reduce the cost of doing business in Dominica and to foster private sector-led growth, including by streamlining public sector entities, improving contract enforcement and foreclosure arrangements and reforming the utilities and customs administration. They welcomed the authorities' commitment to undertake a poverty assessment this year, which will help design efficient and well-targeted social safety nets.

Directors encouraged the authorities to continue to improve the quality of economic and social statistics that are key for effective surveillance.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.