Public Information Notice No. 08/01

Public Information Notice: IMF Executive Board Concludes 2007 Article IV Consultation with St. Lucia

January 4, 2008

On September 26, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with St. Lucia.¹

Background

Macroeconomic outcomes have strengthened significantly in recent years. Real GDP growth averaged 3¾ percent during 2003-05, and reached about 5 percent in 2006. Activity was sustained by construction and government services, both related to tourism and preparations for the Cricket World Cup (CWC). In 2007, growth is expected to slow to 3¼ percent, due

largely to weakening construction, lackluster performance of the tourism sector, and hurricane-induced damage to banana production. Inflation remains low under the regional currency board arrangement.

Fiscal imbalances remained high in 2006. Total tax revenues were strong, buoyed by reforms at customs. However, petroleum tax collection was poor (given the limited pass-through of world oil prices), and significant increases occurred in capital expenditures and wages and salaries. As a result, the overall deficit fell only slightly to 6½ percent of GDP in 2006, and gross public debt rose to 67 percent of GDP.

Following a sharp increase in 2006, the external current account deficit is expected to narrow in 2007. The deterioration (to over 32 percent of GDP) was driven by a rapid fall in both the terms of trade and tourism arrivals, and an increase in imports related to hotel construction and public

capital expenditure for the CWC. Foreign direct investment surged in 2006 (to over 23 percent of GDP), reflecting tourism-related construction. In 2007 the current account deficit is projected to narrow on account of a slowdown in tourism-related imports and a moderate rebound in exports of goods and services.

While St. Lucia's real exchange rate does not appear to be overvalued, competitiveness remains a challenge. At end-2006 the real effective exchange rate (REER) was at its lowest level in nearly 20 years, reflecting the depreciation of the U.S. dollar against major currencies, and staff analysis indicates that the REER is close to its estimated equilibrium level. However, there are challenges in maintaining external competitiveness, as real wages have increased, the terms of trade have deteriorated significantly since 2002, and in recent years St. Lucia has experienced a decline in its share of stayover visitors to the Eastern Caribbean Currency Union (ECCU).

Broad money growth remained strong in 2006, and prudential indicators point to a strengthening of the financial system. Credit to the private sector expanded by 25 percent, attributable to CWC-related activities and hotel construction. In 2007, growth in private credit is expected to slow, in line with anticipated real GDP and construction sector growth. While bank provisioning has been stable and nonperforming loans continue to decline, the credit boom has the potential to erode the quality of banking system assets, raising the importance of effective financial supervision.

There has been some progress toward strengthening the financial supervisory and regulatory framework since the 2004 ECCU regional FSAP. Amendments to the uniform Banking Act were passed in December 2006, enhancing ECCB regulatory powers and requiring banks to provision for nonperforming government loans. The authorities have bolstered supervision of nonbanks through the strengthening of the Financial Services Supervision Unit, and legislation governing cooperatives, money services institutions and domestic insurance is expected to be passed by end-2007. However, progress has been slow in developing a broad supervisory framework to regulate all nonbank financial intermediaries, and while a Single Regulatory Unit for nonbanks was approved by Cabinet in 2006, it has yet to be fully implemented.

There has also been progress in implementing broad structural reforms. On fiscal issues, the authorities intend to enhance revenue-raising by the introduction of a more flexible mechanism for retail fuel pricing and a market valuation-based property tax (both in 2008), and a value-added tax (in 2009). The erosion of trade preferences for bananas has reduced incomes and employment prospects for poor rural households, and the authorities have attempted to bolster the country's social safety net to alleviate poverty. St. Lucia is one of the world's most disaster-prone countries, and has made good strides in bolstering national disaster mitigation and preparedness, including by the enhancement of the National Emergency Management Organization, improvements to the national disaster response plan, and participation in regional risk pooling.

Executive Board Assessment

Directors welcomed St. Lucia's recent strong economic performance, marked by robust growth and low inflation. At the same time, Directors noted that the country faces important challenges, including the need to diversify the economy, lower unemployment, and reduce the vulnerability to economic shocks. They encouraged the authorities to build on the country's strong foundations, and to continue to work toward the sustained implementation of prudent fiscal policies and structural reforms.

Directors stressed that fiscal consolidation and reforms are needed to maintain a sustainable public debt/GDP ratio and enhance fiscal flexibility to respond to exogenous shocks, while permitting effective public investment and social spending. They welcomed the authorities' plans to boost revenue through the introduction of a value-added tax, more flexible retail fuel pricing to achieve greater pass through of oil price increases, property tax assessments based on market values, and the improvement of tax administration. Directors recommended that tax incentives be rationalized to reduce revenue losses and promote investment more effectively. Directors also called for greater expenditure restraint, and welcomed the authorities' intentions to reform the civil service, introduce a formal mechanism for evaluating public investments, and strengthen debt management. While they acknowledged the need for investment in tourism-related infrastructure to help diversify the economy away from banana production, Directors advised the authorities to carefully evaluate and prioritize investment projects and to seek mostly grant and highly concessional financing.

Directors considered that the fixed-exchange rate has served St. Lucia well, and that the real effective exchange rate appears in line with fundamentals. They emphasized the importance of prudent macroeconomic policies and structural reforms to maintain competitiveness and underpin the exchange rate.

Directors noted that declining non-performing loan ratios and rising profitability point to a relatively healthy financial sector. They welcomed the measures being taken to further strengthen the sector, including the planned consolidation of nonbank regulation and supervision and the improvement of the legal and institutional framework for preventing money laundering. Given the rapid growth in private sector credit and net foreign liabilities of commercial banks, Directors recommended that banks' credit quality and risk management practices be closely monitored.

Directors recognized that the erosion of trade preferences for bananas is placing a considerable burden on rural households. They supported the authorities' plans to provide well-targeted assistance to the most affected while seeking to restructure the economy away from banana production. They were encouraged by the relatively low cost of doing business in St. Lucia, and underlined the importance of labor retraining and increasing labor market flexibility. Directors stressed the importance of the timely disbursement by donors of the substantial aid committed to St. Lucia in support of the economic restructuring.

Directors welcomed the authorities' commitment to regional cooperation and integration. In this regard, they commended St. Lucia's progress in implementing the requirements of the Caribbean Single Market and Economy, and in removing non-tariff barriers.

Directors supported the authorities' ongoing efforts to mitigate the economic impact of natural disasters, including through the regional pooling of catastrophe risk.

Directors encouraged the authorities to continue to improve the quality and timeliness of economic and social statistics, especially the national accounts, the public sector fiscal accounts, and the balance of payments. They supported Fund technical assistance for this purpose.

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.