IMF Executive Board Concludes 2008 Article IV Consultation with St. LuciaPublic Information Notice (PIN) No. 08/118
September 16, 2008
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On July 30, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with St. Lucia.1
Macroeconomic performance has been mixed in recent years. While real GDP growth averaged 4 percent during 2003-06, growth slowed to about 1¾ percent in 2007, reflecting contraction in hurricane-affected agriculture (mainly banana exports), and slowdowns in construction activity and stayover tourist arrivals. Inflation increased sharply to almost 7 percent at end-December 2007, due to higher imported fuel and food prices and the ongoing depreciation of the U.S. dollar. With deteriorating global prospects and slow recovery in agriculture, growth is expected to be modest in 2008 (at 2⅓ percent) and to rise further in 2009. Additional hotel capacity, combined with vigorous marketing and more frequent airlift, is expected to boost growth. Despite this broadly positive outlook, vulnerabilities remain, including the country's dependence on imported oil, high food prices, declining European Union (EU) banana preferences, volatile tourism receipts, and exposure to natural disasters.
The fiscal position has strengthened in 2007, yet public debt and debt servicing payments continue to rise. The primary balance improved in FY 2007/08 (April 1-March 31), reflecting an increase in current revenue and a marked reduction in capital expenditure. While the total revenue-to-GDP ratio increased from about 27 percent in FY 2006/07 to 28¼ percent in FY 2007/08, total spending (excluding interest payments) declined sharply from 29½ percent to about 27½ percent, contributing to a 3½ percent of GDP improvement in the primary balance. However, public debt increased to 70½ percent of GDP.
The external current account deficit remained elevated in 2007. The large deficit (29 percent of GDP) was driven primarily by a continued deterioration of the terms of trade and decline in tourist arrivals, and higher imports related to hotel construction and energy demand. The deficit continues to be almost entirely financed by foreign direct investment, mainly in the tourism sector. Nonetheless, St. Lucia remains vulnerable to external shocks, given its dependence on imported oil, volatile tourism receipts, exposure to natural disasters, and rising food and energy prices.
Indicators present a mixed picture of St. Lucia's external competitiveness. St. Lucia's real effective exchange rate (REER) is at its lowest level in 20 years, reflecting the depreciation of the U.S. dollar against major currencies. However, real wages have increased, the terms of trade has deteriorated since 2000, and in recent years St. Lucia experienced a decline in its share of stayover visitors to the Caribbean. Analysis undertaken by Fund staff finds that the REER was close to its estimated equilibrium level, suggesting that the exchange rate, if supported by fiscal and wage policies, will remain competitive.
Broad money growth remained strong in 2007, and prudential indicators point to a strengthening of the financial system. Despite a softening in economic activity, demand for credit by firms and households has continued to rise. As a result, commercial banks have accelerated their drawdown of net foreign assets to expand their loan portfolio. Meanwhile, the health of the financial sector continues to strengthen. Provisioning, asset quality and capital adequacy all improved in 2007. Nonperforming loans (NPLs) of local banks continue to decline. However, the decline in the NPL ratio reflects in part the continued growth in bank lending, which could engender future problem loans, especially in the event of any large macroeconomic shock.
There has been some progress toward strengthening the financial supervisory and regulatory framework. The authorities have enhanced supervision of nonbanks by strengthening the Financial Services Supervision Unit, and expect to pass in 2008 the OECS-wide uniform Cooperatives Society Act, uniform Insurance Act, and uniform Money Services Act. However, progress has been slow in developing a broad supervisory framework to regulate all nonbank financial intermediaries. While a Single Regulatory Unit for nonbanks (including the offshore financial sector, domestic insurance sector, credit unions, money transfer institutions, and the soon-to-be-established National Development Bank) was approved by Cabinet in 2006, it has not yet been fully implemented.
There has also been progress in implementing broad structural reforms. On fiscal issues, the authorities intend to enhance the tax base by the introduction of a more flexible mechanism for retail fuel pricing in 2008, a market valuation-based property tax in FY 2009/10, and a revenue-positive VAT in FY 2009/10. Regarding the real sector, the erosion of trade preferences for bananas has negatively affected employment creation, income levels, and the general standard of living in the island's rural communities; the authorities have announced their intention to develop a five-year strategic management plan, with a view to promote diversification in the agriculture sector. They have also attempted to bolster the country's social safety nets to alleviate poverty. St. Lucia is one of the world's most disaster-prone countries, and has made good progress 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
Executive Directors observed that although economic activity was flat in 2007, growth is likely to accelerate in 2008 and 2009, due to a rebound in agriculture, a recovery of tourism receipts, and related support activities. Medium-term growth prospects are favorable, but risks are tilted to the downside given the uncertainties in the external environment, in particular with regard to the effect of energy price increases on tourist arrivals. Directors considered that the reforms envisaged by the authorities aimed at strengthening the tourism infrastructure, improving the investment climate, and diversifying exports would broaden the bases of economic growth and reduce exposure to external shocks.
Directors welcomed the recent improvement in fiscal performance. They stressed the need to maintain a primary surplus to ensure debt sustainability, and to help dampen inflationary pressures. Directors called for a broadening of the tax base, along with stepped up preparations for the introduction of the VAT. They encouraged the authorities to follow through on commitments to introduce a more flexible retail fuel pricing mechanism to achieve greater pass-through of world oil price increases, as well as market valuation-based property taxation. Directors noted that achieving fiscal and debt sustainability will also require greater prioritization of capital spending, limiting the civil service wage bill, and enhancing debt management.
Directors noted that the acceleration in inflation appears to be due largely to the high prices of imported food and fuel and the ongoing depreciation of the U.S. dollar. Given the negative impact of inflation and the erosion of trade preferences on the purchasing power of the poorest segment of society, Directors welcomed the government's plan to sharpen its poverty reduction programs, and commended the authorities' efforts to strengthen social safety nets.
Recognizing that St. Lucia's currency, the Eastern Caribbean dollar, is pegged to the U.S. dollar, Directors took note of the staff's assessment that the country's real effective exchange rate is in line with fundamentals. Directors saw the recent rise in the current account deficit as reflecting adverse terms of trade shocks and a decline in tourism arrivals. They noted further that the deficit remains almost fully financed by non-debt creating private capital inflows, and that the current account imbalances are expected to decline over the medium term to sustainable levels. Given the high level of public debt, Directors emphasized the importance of sustained fiscal consolidation and structural reforms to maintain competitiveness and support the stability of the region's currency board arrangement.
Executive Directors noted that continued rapid growth in private sector credit could erode the quality of banks' loan portfolios, and looked to effective supervision by the Eastern Caribbean Central Bank to monitor closely banks' credit quality and risk management practices. Directors emphasized the need for the St. Lucian authorities to consolidate regulation and supervision of nonbank financial intermediaries under an independent Single Regulatory Unit, enhance supervision of international financial services, improve the Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) regime, and terminate unregulated investment schemes.
Directors called on the authorities to improve further the coverage and timeliness of economic and social statistics, in particular on the national accounts, tourism, the balance of payments, and public sector debt, and to devote adequate resources to this area. They supported the authorities' request for Fund technical assistance to strengthen the statistical data base.