St. Kitts and Nevis: 2023 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for St. Kitts and Nevis
Author: International Monetary Fund. Western Hemisphere Dept.
Publication Date:
31 Mar 2023
eISBN:
9798400239748
Language:
English
Keywords:
CBI due diligence cost; due diligence; CBI upside; budgetary receipt; income support
Download PDF (3 MB)

1. St. Kitts and Nevis is a high income two-island economy. Its GDP per capita, about 18,000 USD in 2021 is the highest of the ECCU countries. The economy has been dominated by tourism representing about one-third of GDP in recent years. Construction and light manufacturing also emerged as the country transitioned away from traditional agricultural activities. The St. Kitts and Nevis’ economy is exposed to natural disasters (NDs). From 1970 to 2021, the country had an annual average negative impact from NDs of 4.2 percent of GDP.

Abstract

1. St. Kitts and Nevis is a high income two-island economy. Its GDP per capita, about 18,000 USD in 2021 is the highest of the ECCU countries. The economy has been dominated by tourism representing about one-third of GDP in recent years. Construction and light manufacturing also emerged as the country transitioned away from traditional agricultural activities. The St. Kitts and Nevis’ economy is exposed to natural disasters (NDs). From 1970 to 2021, the country had an annual average negative impact from NDs of 4.2 percent of GDP.

Context

1. St. Kitts and Nevis is a high income two-island economy. Its GDP per capita, about 18,000 USD in 2021 is the highest of the ECCU countries. The economy has been dominated by tourism representing about one-third of GDP in recent years. Construction and light manufacturing also emerged as the country transitioned away from traditional agricultural activities. The St. Kitts and Nevis’ economy is exposed to natural disasters (NDs). From 1970 to 2021, the country had an annual average negative impact from NDs of 4.2 percent of GDP.

2. Prudent fiscal management helped build large buffers ahead of the twin pandemic and cost-of-living crises. Recurrent CBI revenue (amouting to a cumulative 65 percent of GDP between 2017 and 2021) has resulted in fiscal surpluses in most years since 2017. Public debt, after peaking at 135 percent of GDP in 2010, fell to less than 70 percent in 2015 and remained below the ECCU target of 60 percent for most of the last 5 years. The fiscal stimulus undertaken in 2021–22 to mitigate the effect of the twin crises was supported by a surge in CBI revenue, leaving the public debt little affected.

3. Fiscal prudence remains a cornerstone of public policies. The general elections in August 2022 saw the victory of the St. Kitts Nevis Labor Party, whose ambitious social agenda and strong emphasis on improving governance are combined with a focus on fiscal caution. The new cabinet’s budget for 2023 envisages a small surplus, conservative projections for CBI revenue, well-contained current spending, and an increase in capital expenditure. The authorities’ medium-term forecast foresees a continuation of these trends, except for capital spending which sees a sharp decline. The authorities will need to continue exercizing fiscal prudence going forward to ensure current spending can indeed be contained, while achieving social inclusion objectives and boosting capital expenditure to build resilence to NDs. Concerns over the sustainability of CBI revenue and the increasing channelling of CBI revenue to current spending warrant an active policy to reverse tax revenue erosion and improve expenditure efficiency. An adequate prioritizing and sequencing of policies will be of essence to preserve the country’s legacy of fiscal prudence.

Recent Developments: from Pandemic to Cost-of-Living Crisis

4. A belated recovery. The economy was severely hit by the COVID-19 pandemic, with GDP contracting 14.5 percent in 2020 and 0.9 percent in 2021. Tourism recovery has been lagging the ECCU and other Caribbean peers because of stricter and longer-lasting COVID restrictions. At the onset of the pandemic, the authorities restricted inbound travel, completely halted cruise ships, introduced a month-long national lockdown. Unlike peer countries, they reopened borders with strict protocols.1

uA001fig01
Sources: ECCB authorities; and IMF staff calculations.

5. Global headwinds limited the rebound in 2022. The growth catch-up expected in 2022, while confirmed by coincident indicators, was moderated by an adverse global environment stemming from tighter global financing conditions and high global fuel and food prices. Staff projects growth to be 9 percent in 2022 and 4.5 percent in 2023, with real GDP returning to pre-pandemic levels by end-2024. By 2026, growth will be in line with potential, estimated at 2.7 percent.

6. Proactive policies have kept inflation under control. Higher food prices and shipping costs pushed inflation to 3.8 percent y/y in December, the highest since 2011 although still low compared to regional peers. Core inflation remained relatively low and multiple government measures (see Annex V) contributed to softening the price impact on food and energy.

7. Measures to fight the twin crises have weighed on public finances. The policy response during the pandemic, at 5 percent of GDP, was one of the strongest in the ECCU (Figures 1 and 2). But thanks to strong CBI flows, the debt-to-GDP ratio increased only modestly and remains the lowest of the region. As concerns shifted from the pandemic to the cost-of-living crisis, the government extended support measures. H1 2022 measures included a 10 percent increase in public wages and pensions, income support to the vulnerable, and a reduction of excise taxes—totaling 4 percent of GDP. The new government proposed additional measures with a focus on healthcare, affordable housing, and access to education. But overall current expenditure in the 2023 budget is well contained.2

8. Reliance on CBI revenue has increased. Tax revenue continued to fall, due to a decline in income taxes, on the heels of a two-decade long fall in tax revenue and persistent underperformance relative to regional peers. The previous government made a substantial repurchase of land (8 percent of GDP) in 2022 from the debt-for-land swap arrangement3, hereby reducing both its deposits and contingent liability (which now remains at 12 percent of GDP; see Annex VIII). This, as well as increasing CBI due diligence fees and income support, materially raised expenditures. In addition, public wages rose rapidly last year, despite a high wage bill relative to regional peers, and are now 3 percentage points of GDP above pre-pandemic levels. In contrast, capital spending edged lower in 2022 with some planned projects delayed. The government recorded a deficit of 3 percent of GDP in 2022.

9. In 2022, the external position was moderately weaker than the level consistent with fundamentals and desirable policies (see ESA Annex). Before the pandemic, the external position was broadly in line with the level consistent with medium-term fundamentals and desirable policy settings. Large tourism loss led to a sizable current account deterioration in 2020. But the deficit narrowed during 2021–2022 supported by tourism recovery and is expected to continue to improve in the medium term as the economy recovers.

EBA-lite Model Results, 2022

article image

Based on the EBA-lite 3.0 methodology

Additional cyclical adjustment to account for the temporary impact impact of the pandemic on tourism (-0.12 percent of GDP).

Cyclically adjusted, including multilateral consistency adjustments.

10. Financial sector buffers remain adequate, but profits are volatile, NPLs are high, and capital ratios edged lower. Loans under COVID-19 moratoria declined steadily from the high level in 2020, and the expected post-moratoria increase in NPLs has not yet materialized. NPLs are some of the highest in the region because of legacy loans but have not increased during the pandemic, as banks made efforts to write off some bad loans, Provisions relative to NPLs rose substantially and were near target of 60 percent end-2022. Profitability dropped sharply in 2022, driven by losses on the overseas investment portfolio amid tightened global financial conditions. Regulatory capital ratios declined in 2021–22 but remain well above the 8 percent minimum. Banks continue to have ample liquidity buffers. Despite structural challenges, credit growth was stronger than in other ECCU countries (figure) amid heightened competition and some relaxation of lending standards.

uA001fig02

Credit to the Private Sector

(In percent, year on year)

Citation: IMF Staff Country Reports 2023, 130; 10.5089/9798400239748.002.A001

Sources: ECCB MFS; and IMF staff calculations.

Figure 1.
Figure 1.

St. Kitts and Nevis: Macroeconomic Performance vs. Regional Peers

Citation: IMF Staff Country Reports 2023, 130; 10.5089/9798400239748.002.A001

Sources: ECCB authorities; and IMF staff calculations.

Outlook And Risks

11. After a strong rebound in 2022, growth should gradually go back to trend. With headwinds in key tourism source markets, staff project growth to be 4.5 percent of GDP in 2023 and 3.8 percent in 2024, with GDP returning to the pre-pandemic level by end-2024. By 2026, growth is expected to be in line with potential, estimated at 2.7 percent of GDP. Inflation is projected to be on average 2.3 percent in 2023 and 2 percent in 2024.4 In the fiscal sector, the broadly balanced budgets projected in 2023–25 are expected to turn into growing deficits of up to 3 percent of GDP in the outer years, as CBI revenue declines from 25 percent of GDP in 2022 to 10 percent towards the end of the forecast horizon.5 After the positive fiscal impulses6 in 2017–22, the fiscal impulse is projected to be negative in 2023–25, as revenues recover and crisis-era support measures are gradually withdrawn. Gross public debt will remain below 60 percent of GDP, though on an upward trajectory in 2025–28. The current account deficit is projected to be 3.6 percent of GDP in 2023 and 2.8 percent of GDP in 2024 as tourism gradually recovers. In the financial sector, credit growth is projected to follow nominal GDP (figure).

uA001fig03

Credit and Nominal GDP Growth

(YoY percentage change)

Citation: IMF Staff Country Reports 2023, 130; 10.5089/9798400239748.002.A001

Sources: ECCB authorities; and IMF staff calculations.

12. Risks to the outlook are tilted to the downside in the short term but with an upside potential in the medium term. Risks primarily stem from global factors: a global slowdown, particularly in the United States, a de-anchoring of inflation expectations and stagflation, and commodity price shocks (see Risk Assessment Matrix). In the fiscal sector, the key risk is growing dependence on CBI revenue. In the financial sector, fuller NPLs recognition could dampen credit growth and the recovery. Further tightening in global financial conditions could hit bank capital, through its exposure to the U.S. stock market. St. Kitts and Nevis is highly exposed to the risks of NDs, whose frequency and intensity will likely intensify with climate change. Upside risks include a faster-than-expected rebound in tourism, strong CBI revenue, and the development of renewable energy resources which would lower energy costs and boost potential growth.

Authorities’ Views

13. The authorities broadly agreed with the staff’s macroeconomic outlook. They expected a slightly stronger GDP growth in 2022 than staff’s projection, supported by a robust recovery in tourism, trade, and related sectors. They anticipated that a strong performance of the tourism and construction sectors will drive robust growth in 2023. They had slightly more ambitious medium-term growth than staff’s projections. They noted that their efforts to diversify the economy, develop renewable energy, and invest in infrastructure will support medium-term growth, but expected private sector investment to be the main driver. The authorities broadly shared staff’s assessment of risks, stressing their efforts in climate resilience investment and CBI reform.

Policy Discussions

St. Kitts and Nevis face important challenges. Its large fiscal buffers and low debt have played a key role in cushioning the shock from the twin pandemic and cost-of-living crises, but its concerning dependency on CBI revenue has increased, concealing a hollowing out of tax revenue that undermines its fiscal framework. Fiscal prudence calls for a well-sequenced set of policies: (i) in the short run, tighten the fiscal stance through a phasing out of crisis-related measures; (ii) in the medium term, rationalize and strictly control current spending, including the wage bill; (iii) make social transfers better targeted; and (iv) streamline tax policy to reduce dependance on CBI. The additional fiscal space should support investment in climate change resilience, accelerate economic diversification, and help restore waning competitiveness. On the financial sector front, the systemic risk represented by the state-owned systemic bank is an important source of concern calling for a business model change, including de-risking its investment portfolio, addressing legacy asset quality issues, and safeguarding government deposits, while supporting credit growth and financial stability.

A. Entrenching Fiscal and Debt Sustainability

14. In the short term, the fiscal stance should be tightened. The continuing recovery presents an opportunity to phase out pandemic-era measures. On the revenue side (table), taxes on income and international trade have remained below the pre-pandemic averages, creating room to raise the effective tax rate. On the expenditure side, current expenditure in 2022 was 16 percentage points of GDP above the average pre-pandemic level, driven by wages, goods and services, and transfers. The composition of public spending should be improved, including through the rationalization and strict control of the wage bill. In addition, expenditure policy should be recalibrated to properly address medium-term policy priorities (see below). Otherwise, a negative fiscal impulse is expected in 2023.

Key Revenue and Expenditure Items

(In percent of GDP)

article image

15. Social transfers should be more targeted to protect the most vulnerable. As the cost-of-living crisis continues, emphasis should be on targeted transfers rather than price controls or blanket energy subsidies. Current crisis-related measures—the electricity and fuel subsidies—are untargeted and disproportionally benefit wealthier consumers. These measures distort price signals and will lead to fiscal pressures as consumers have little incentive to adjust their consumption. Options to phase out energy subsidies include (i) electricity block pricing, (ii) lump sum bonus, or (iii) budgeted transfers to low-income households (Annex VI). The phasing out of crisis-related measures should be complemented by a reform of the social assistance program (PAP) to better target the most vulnerable, which is consistent with the authorities’ plan.

16. The efficiency of the tax system should be improved to create fiscal space. The main objective of any good tax system is to raise appropriate revenue to deliver public services, address distributional issues, and provide incentives for sustainable investment. A comprehensive review of tax policy is thus overdue. Furthermore, increased public investment will require generating extra fiscal space at a time when reliance on CBI revenue to finance current expenditure (figure) puts public finance at risk, as the overall deficit ex-CBI revenue and land buybacks stood at 18 percent of GDP in 2022. Annex VII discusses how to effectively and efficiently tax tourism, as well as the appropriate approach to investment tax incentives. In the context of St. Kitts and Nevis:

  • Items with zero- or low-rated VAT (e.g., sugar and hydrocarbon fuels) should be reduced and temporary exemptions be avoided. In general, VAT should be as broad as possible and applied at all stages of production to minimize leakages through CIT and unregistered businesses.

  • Import taxes should be low and flat on all imports, and exemptions on certain products (zero duty on food, duty-free items available to residents) be avoided. Excise taxes on alcohol and tobacco should be raised, with no exemptions.

  • Property tax is generally both efficient and progressive if based on actual residential property and commercial land values. The current property tax rates in KNA are extremely low, and there is scope to raise them. On the other hand, property transaction taxes inhibit the housing market and home ownership and should be reduced.

  • CIT holidays and exemptions should be avoided and replaced with expenses for capital expenditures or forward loss carryovers.

  • A non-zero PIT should be introduced to broaden the tax base. A PIT system should be designed to be progressive to improve redistribution.

uA001fig04a

Dependence of CBI Revenue

(In percent of GDP, unless otherwise specified)

Citation: IMF Staff Country Reports 2023, 130; 10.5089/9798400239748.002.A001

Source: ECCB authorities; and IMF staff calculations.

17. The risk of sovereign stress is assessed as moderate, but financing policy should be strengthened, and long-term risks tackled. If fiscal restraint is exercised, as in the past, St. Kitts and Nevis’s gross public debt is projected to remain below the regional target of 60 percent of GDP with stable deposits. Hence, the wedge between the regional target and the current debt level could be viewed as a buffer. However, to operationally use the low debt as a buffer, the country should consider using its access to the regional government securities market (RGSM). The authorities should also strive to lengthen debt maturities and use state contingent debt instruments when possible. The debt sustainability analysis (see DSA, Annex VIII) shows that net debt breaches the regional ceiling over the medium term only in the 95th percentile scenarios with joint GDP, primary deficit, and interest rate shocks. However, the long-term risk is high due to a very large funding gap of the SSB.

uA001fig04b

Public Debt, by Instrument

(Percent of GDP)

Citation: IMF Staff Country Reports 2023, 130; 10.5089/9798400239748.002.A001

Sources: National authorities; and IMF Staff calculations

Authorities’ Views

18. The authorities concurred with staff on the need to maintain a prudent fiscal stance going forward. They flagged risks to their current expenditure projections stemming from the wage bill, the streamlining of social support, and the planned phasing out of energy subsidy. Authorities agreed in principle with the need to rebalance current and capital expenditures but noted that their lower capital expenditure forecasts (after 2024) were based on actual projects in the pipeline and reflected the need to maintain balanced budgets. In addition, some investment in housing and infrastructure would come from statutory bodies. However, this is not fully accounted for in the fiscal reporting framework despite being part of the broader public sector.7 The authorities requested TA in this regard. Referring to the prior experience, they noted that the execution rate of the budgeted projects should be improved.

19. The authorities agreed with the need to undertake an overhaul of their tax policy framework, which could be supported by IMF TA. This would help ramp up tax revenue mobilization and reduce dependence on CBI revenue. The authorities stressed the importance of taking a holistic approach to tax reform to improve equity, efficiency, and effectiveness, but also to maintain competitiveness and increase traction with private sector stakeholders. Authorities agreed to examine the merits of the proposed abolishment of various tax exemptions, broadening the tax base, and lowering harmful tariffs but noted the need to remain in compliance with CARICOM tariffs agreement. The authorities consider the RGSM as a viable option for raising government financing, however, there are no immediate plans to tap the RGSM. They also noted their robust debt management strategy which guides the funding options by the government. Given their strong fiscal position, they did not anticipate any difficulties in accessing the RGSM, if needed.

B. Achieving Natural Disaster Resilience and Climate Change Adaptation

20. ND risks call for resolute preparedness policy implementation. In St. Kitts and Nevis, the risks of NDs are high. From 1970 to 2021, the country had an annual average impact from ND of 4.2 percent of GDP compared to the average of 2.0 percent for small developing states and had about three times more NDs than other developing states. With climate change accelerating, the intensity and frequency of NDs could worsen.

uA001fig04

Frequency of Natural Disasters

(Disasters per billion population)

Citation: IMF Staff Country Reports 2023, 130; 10.5089/9798400239748.002.A001

Sources: EM-DAT(Emergency Events Database) by Centre for Research on the Epidemiology of Disasters, IMF World Economic Outlook database; and IMF staff calculations.

21. Decisive action on ND and climate change preparedness can raise growth and save fiscal costs. Investment in resilient investment and additional insurance coverage would result in economic and fiscal savings after each ND (see SIP).

  • Required investment in resilience would need to be substantial and span over the long term (20 years or longer). While upfront fiscal costs will need to be budgeted, resulting gains for growth and fiscal savings could be significant. Front-loaded investment in resilience would also reduce insurance costs.

  • A multi-layered insurance framework would protect government finances from NDs and accelerate subsequent economic recovery. While the government has sufficient deposits for the first, self-insurance layer, a legal framework should be established to earmark deposits for NDs insurance. The government should boost CCRIF coverage for immediate financing and consider state-contingent debt instruments such as a catastrophe bond for extreme events.

  • The country would benefit from the development of a comprehensive fiscal policy framework for climate mitigation and adaptation. The framework would include the two key elements discussed above: (1) an enhanced multi-layered insurance framework and (2) substantial investment in resilience, to be supplemented by a strategy to increase public investment, enhance growth, build up buffers and maintain debt below the regional ceiling.

uA001fig05
Sources: National authorities; and IMF staff calculations.

22. The benefits of ND preparedness through long-term fiscal planning are illustrated in an alternative scenario. The scenario assumes a shift of investment towards resilience8 up to 5.8 percent of GDP—which brings it in line with the long-term average—to remain below the regional debt ceiling over the medium term (text table and Figure 5). Fiscal costs also increase because of a larger CCRIF insurance coverage. As the share of resilient investment accumulates, the need for insurance via both deposits and CCRIF falls, resulting in smaller insurance costs. Deposits are allowed to decline gradually towards about 12 percent of GDP by 2040. The reduction in deposits alone is not sufficient to absorb upfront fiscal costs; hence gross debt rises through 2040. Gains are considerable under this scenario: a 4 percent increase in the level of GDP relative to baseline by 2028 and a 14 percent increase by 2040 (figure).

23. The scenario highlights that:

  • Fiscal restraint should be exercised as debt would be on an upward trajectory. Tax revenues and expenditures should be optimized to create more fiscal space for ND preparedness and make debt sustainable. Additional fiscal relaxation would lead to breaching the regional ceiling by 2028.

  • The reliance on CBI—even assumed to follow the conservative baseline path—would remain significant and a source of concern. This is another argument to optimize fiscal policy. Part of this is earmarking the CBI revenue for ND preparedness. If the CBI upside materializes extra revenues should be used exclusively for ND preparedness and other capital expenditure, or saved.

  • On the timing of the action, adequate insurance coverage—through CCRIF—should be ensured in the early years. This would save growth and fiscal costs in the event of a large ND. Investment in resilience should be front loaded as much as feasible in the early years to boost growth and reduce insurance costs.

24. A sovereign wealth fund (SWF) with three objectives—standard wealth accumulation and expenditure smoothing, ND preparedness and investment in resilience—would be desirable.9 A SWF would help formalize and financially secure the country’s ND preparedness strategy by allocating public savings specifically for this purpose, help smooth government expenditures across the business cycle. Second, earmarking a portion of CBI revenue to the SWF would improve the transparency on the use of CBI revenue and help redistribution across generations. Finally, the transfer of public sector deposits from the systemic bank to an arm-length SWF with proper risk management would improve governance and diminish the sovereign-bank risk nexus.

Authorities’ Views

25. The authorities concurred with staff assessment that ND preparedness should be reinforced and be at the core of long-term fiscal planning. They welcomed the staff’s presentation of the SIP on ND preparedness including investment in resilience, insurance for ND, and the alternative scenario with these elements. The authorities noted that previous investments in resilience already paid off resulting in smaller adverse effects from flooding. On the need for more investment in resilience, they agreed in principle but pointed out that there is the need for stronger public and private partnerships with careful selection of projects and international participation to ensure transfer of critical knowledge and skills. Furthermore, authorities envision that state-owned entities (such as utility companies) and the private sector should take the lead to catalyze investments in resilience and renewable energy. On expanding the CCRIF, the authorities inquired about TA to establish the optimal insurance coverage. Consistent with staff advice, this administration continues to emphasize a plan for a SWF to lodge some CBI revenue, finance investment in resilience, and provide cushion against future shocks, including ND. The authorities requested a new TA in this area, given that fiscal parameters and goals of such a fund have evolved.

26. The transition to renewable energy could be a game changer over the medium term. The government actively explores various renewable energy options to attain its strategic goal of 100 percent renewable generation by 2030 and ensure energy security. The success of these projects could turn the country into a clean energy exporter10 and boost medium-term growth. The country would save on energy imports, and both commercial and residential consumers would pay considerably less for electricity, resulting in efficiency gains and profits. The use of locally produced renewable energy would drastically reduce the country’s vulnerability to ND and global shocks to fuel supply. However, the geothermal project is still in a testing phase with early results expected next year. Investment in wind and solar will require substantial investments, for which financing is yet to be secured and decided upon.

C. Enhancing Competitiveness to Achieve Sustainable Growth

27. The economy of St. Kitts and Nevis has been on the regional frontier but faces competitiveness challenges. The country has one of the highest GDP per capita and human development in the Caribbean (Figure 3). But the economy faces challenges with stagnant labor productivity, high energy and labor costs, and a large and growing public sector (Figure 4).

28. Continued structural policy efforts are needed to strengthen the labor market, encourage economic diversification, and promote sustainable growth. Ongoing efforts to improve the access and delivery of education and TVET are instrumental for unlocking growth potentials. These efforts should be complemented by Active Labor Market Policies (ALMPs) with an emphasis on better integrating training with the labor market to reduce skill mismatches and promote job opportunities. The hospitality sector is well positioned to become a stronger pillar of the labor market. Linkages between the hospitality sector and the rest of the economy can be leveraged to provide more diversified and higher-quality job opportunities (see SIP). The plan to diversify into agriculture, fishery, and manufacturing will benefit from the future rechanneling of CBI flows towards growth friendly sectors, hence supporting competitiveness. Reforms for labor market policies and institutions—including labor protection legislations, unemployment benefits, and statutory minimum wage—should be based on social dialogue, including through regular tripartite meetings of the government, employers, and employees.

uA001fig06

Electricity Generation Mix in 2020

(Percent)

Citation: IMF Staff Country Reports 2023, 130; 10.5089/9798400239748.002.A001

Source: U.S. Department of Enegy.

29. Competitiveness can be further strengthened by leveraging climate change and disaster preparedness efforts, and renewable energy transition efforts. High local electricity costs, due to heavy reliance on fossil fuels for electricity generation, hampers competitiveness and makes the country vulnerable to global price fluctuations. With progress underway to explore a renewable mix with geothermal, solar, and wind sources, further momentum could be generated by improving the resilience of energy and water infrastructure and initiating the geothermal energy exploration in Nevis. Multiple resources could be explored to finance this agenda, including by encouraging private investment, and channeling CBI revenue to renewable energy projects (Annex XI).

Authorities’ Views

30. The authorities agreed with the goal of strengthening competitiveness through renewable energy investment, economic diversification, and labor market development. Various policy initiatives unveiled with the 2023 budget aimed at this goal. The authorities plan to upgrade generators in SKELEC, address water shortage, and start exploring geothermal energy in Nevis with initial financing from the CDB. With the ongoing discussion on the optimal mix of renewable energies, they plan to explore all potential avenues with a focus on balancing reliability and cost savings considerations. They noted their efforts to diversify tourism products by developing agriculture tourism and community destination tourism. They recognized the need for developing skills in the local labor market and agreed that better integrating training and job opportunities would be of the essence, including through a better designed STEP with a graduation period to encourage private sector employment upon graduation. They concurred with staff on the merits of a tripartite engagement in the upcoming review on labor protection legislations and unemployment benefits.

D. Strengthening the Financial System

31. The systemically important bank is the largest financial institution in the ECCU, accounting for over a half of the country’s banking assets. The government owns 51 percent of the bank. The bank has sizeable exposure to the government because of the debt-for-land swaps in 2013–15. The government and the SSB keep their deposits at the bank, which fulfills the function of a SWF with a substantial share of its assets invested in U.S. equities. As a result, it recorded the largest losses in the ECCU in 2022, and currently appears to be vulnerable to a further tightening in global financial conditions. In addition, the systemic bank has some of the highest NPL ratios in the ECCU.

32. The business model of the systemic bank should be revisited with an emphasis on risk reduction. State ownership, large government deposits, market and credit risk exposures make the systemic bank a powerful conduit of financial risks to the fiscal sector and ultimately the economy. The bank’s overseas investments should be reviewed to mitigate risks of losses, with an emphasis on risk reduction, and a shift towards safer, less volatile instruments like bonds. Loan loss provisions should be increased to cover impaired loans.11 While the supervision is at the ECCB level, with the bank’s systemic importance, the national authorities could consider reducing the bank’s exposure to government and imposing limits on investments in volatile instruments such as equities and start establishing a contingency plan should risks materialize.

33. The financial system faces other challenges and pending reforms. Bank credit growth has been relatively upbeat recently, both through the recapitalization of interest on existing and new loans, amid high competition. This calls for a closer supervisory monitoring of restructured loans and additional data collection to ensure proper classification of these loans. Like other ECCU countries, insufficient credit growth may limit potential growth and economic diversification. Constraints to credit growth are related to structural (legislative gaps), legacy (high NPLs), regulatory (stricter provision requirements), and cyclical (tighter global financial conditions) factors. Credit unions are expanding quickly. But the regulation and oversight of the segment by the national regulator, the FSRC, is weaker than those from the ECCB for banks. Hence, the FSRC’s regulation and oversight need to be strengthened to ensure the credit union segment continues to thrive and play its important role in advancing financial inclusion. Annex X outlines measures to strengthen credit and advance the AML/CFT agenda. Since St Kitts and Nevis’ 2021 mutual evaluation, the authorities have started to undertake another national risk assessment (NRA) which will present the analysis of risk in greater detail than was done in the previous NRA. The FSRC increased its staff substantially between 2020 and 2022 and is in the process of developing a supervisory manual to be used by both of its branches. As recommended in its mutual evaluation report, it is important for the FSRC to ensure that its overall supervisory activities are sufficiently focused on AML/CFT supervision. The authorities should pass legislation to designate the ECCB as the supervisor in the AML/CFT area.

Authorities’ Views

34. The authorities concurred that the business model of the systematically important bank should be strengthened with an emphasis on de-risking, while public sector deposits management should be ring-fenced. They noted that the management of the systemic bank had taken important steps to de-risk the overseas investment portfolio and to write off some legacy loans, but further progress was needed. The authorities agreed that public sector deposits should be ring-fenced from the risks inherent in any single bank, ideally through a separate arm-length structure. This goal could be achieved via the creation of a SWF, though its modalities and functions (including whether it will hold the entire stock of public deposits) were yet to be discussed. The authorities recognized that supervision of the credit union segment should be strengthened, including a close monitoring of restructured loans that exited the moratoria. They indicated that the ongoing National Risk Assessment (NRA) would demonstrate their sound and detailed understanding of ML/TF risks.12

E. Data Issues

35. The data framework should be improved to support evidence-based policymaking. Data provision has some shortcomings but is broadly adequate for surveillance. Key areas for improvement include reviewing National Accounts methodology to improve data accuracy, filling gaps in labor market statistics (e.g., unemployment rate and the size of the informal labor market) and surveys (e.g., labor market survey). These would require strengthening resources and training for the statistical office.

Staff Appraisal

36. Economic growth rebounded strongly in 2022 despite global headwinds. The lifting of all COVID-related travel restrictions in August sparked a strong rebound in the tourism sector and across the economy. Yet economic activity is not back to pre-pandemic levels. Inflation picked up, but the authorities’ policy response helped dampen inflation pressures. This came at a heavy cost to public finances, with a large primary deficit after years of surpluses and increased reliance on CBI revenue. The current account (excluding CBI) worsened modestly but was offset by large CBI flows. The financial sector remained stable, but adverse price movements of overseas asset prices and an increase in provisioning severely undermined profitability and weakened capital.

37. Beyond 2022, growth should converge towards its medium-term path. Return to the pre-pandemic activity level is expected by end-2024. Inflation is likely to moderate gradually in 2023 and 2024. The budget is expected to be balanced through 2025 and then turn into growing deficits—predicated on current policies. Yet public debt is expected to remain below the regional 60 percent of GDP target over the medium term.

38. Risks to the outlook are tilted to the downside in the short term, but there is considerable upside potential in the medium term. Global headwinds could adversely impact key tourism source markets, and lingering geopolitical uncertainty sustain commodity price volatility. The growing dependance on volatile and uncertain CBI revenue is a major source of vulnerability. Further tightening of global financial conditions could affect bank capital. In the medium term, more frequent and intense natural disasters represent a major source of downside risk. But prospects for an acceleration of the transition to renewable energy and increased investment in resilience by the public sector could represent material upside risks.

39. In the near term, phasing out crisis-related measures will be essential to safeguard fiscal prudence and entrench debt sustainability. The ongoing tightening of the fiscal stance, with the planned phasing-out of electricity price subsidies, the gradual streamlining of income support measures, and a restoration of the corporate income tax rate, is required to achieve the fiscal path outlined by the authorities’ medium-term fiscal plan.

40. In the medium term, a holistic overhaul of the taxation framework will be essential to reduce dependency on CBI and to maintain fiscal space. Evaluating thoroughly the current tax expenditure framework, with a view to eliminating those coming at a cost to public finance with little proven social and economic benefit, is a prerequisite to an effective tax reform. A streamlining of the VAT, a reform to the property tax to support the housing market and house ownership while increasing progressivity, an introduction of progressive personal income tax could help strengthen fiscal sustainability, improve fairness and progressivity, and achieve inclusive growth.

41. The use of budget resources should be geared in priority towards increasing sustainability. Better targeted social transfers can help address more efficiently the protection of the most vulnerable segment of the population. The ongoing reform of PAP is a commendable step in that direction (Annex I. Going forward a rebalancing between current expenditures, notably through a better control of the public sector wage bill, and higher capital expenditure will help catalyze private sector investment in natural disaster resilience, climate change adaptation and innovation to support the long-term growth potential of the federation.

42. Enhancing ND preparedness will require resolute policy implementation. Climate change mitigation policies, which will require fiscal outlays, can improve welfare and achieve economic sustainability. A long-term policy package should include higher resilient infrastructure spending, an optimal insurance framework against natural disasters, and renewable energy transition investment. In this regard, setting up a SWF based on international best practices with an aim to accumulate national wealth, finance resilient investment, and ensure adequate buffers should be a priority.

43. Continued structural policy efforts are needed to strengthen competitiveness, labor market development and economic diversification. Ongoing efforts to improve the access and delivery of education and TVET should be complemented by ALMPs with an emphasis on better integrating training with the labor market to reduce skill mismatches and promote job opportunities. Linkages between the hospitality sector and the rest of the economy can be leveraged to provide more diversified and higher-quality job opportunities. The transition to renewable energy could help lower energy costs and boost potential growth.

44. The business model of the systemically important bank should be revisited with emphasis on de-risking. The systemic bank is responsible for keeping government and SSB deposits but faces high risks from a large and risky investment portfolio and high NPLs. The bank’s management has taken important steps to de-risk its investment portfolio and to write off some legacy NPLs, but further progress is needed. Public sector deposits should be ring-fenced from the risks inherent in any single bank, ideally through a separate arm-length structure, such as a SWF. In the non-bank segment, credit unions require close monitoring, including their restructured loans. The authorities should continue their work on advancing the AML/CFT agenda.

45. It is recommended that the next Article IV consultation takes place on the standard 12-months cycle.

Figure 2.
Figure 2.
Figure 2.

Kitts and Nevis: Fiscal Sector Developments

Citation: IMF Staff Country Reports 2023, 130; 10.5089/9798400239748.002.A001

Sources: National authorities; and IMF staff calculations.

Figure 3.
Figure 3.

St. Kitts and Nevis: Financial Sector Developments

Citation: IMF Staff Country Reports 2023, 130; 10.5089/9798400239748.002.A001

Sources: ECCB authorities; and IMF staff calculations.

Figure 4.
Figure 4.

St. Kitts and Nevis: Structural Indicators

Citation: IMF Staff Country Reports 2023, 130; 10.5089/9798400239748.002.A001

Sources: ECCB authorities, national authorities, United Nations Development Program; and IMF staff calculations.

Figure 5.
Figure 5.

St. Kitts and Nevis: Labor Market Developments

Citation: IMF Staff Country Reports 2023, 130; 10.5089/9798400239748.002.A001

Sources: ECCB authorities, national authorities, Henn et al. (2020); and IMF staff calculations.

Figure 6.
Figure 6.

St. Kitts and Nevis: Alternative Fiscal Scenario

Citation: IMF Staff Country Reports 2023, 130; 10.5089/9798400239748.002.A001

Sources: National authorities; and IMF staff calculations.

Table 1.

St. Kitts and Nevis: Basic Data

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Sources: National authorities, ECCB, UNDP, World Bank; and IMF staff estimates and projections.

In June 2021, the National Statistics Office revised historical GDP series.

The series for monetary aggregates have been revised consistent with the 2016 Monetary and Financial Statistics Manual and Compilation Guide.

Consolidated general government balances. Primary and overall balances are based on above-the-line data.

Excludes CBI budgetary fees, and Investment proceeds and CBI due diligence costs.

Includes only central government deposits at the commercial banks.

Table 2a.

Kitts and Nevis: General Government Fiscal Operations, 2019–281/

(In millions of Eastern Caribbean dollars)

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Sources: National authorities; and IMF staff estimates.

Combined accounts of the Federal Government of St. Kitts and Nevis and the Nevis Island Administration.

Includes buybacks of land related to the debt-land swap.

Based on actual data of 10 public sector corporations and estimates for 4 others. No audited financial statements have yet been published for St. Kitts Electricity Company (SKELEC).

Table 2b.

St. Kitts and Nevis: Federal Government Fiscal Operations, 2019–281/

(In percent of GDP)

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Sources: National authorities; and IMF staff estimates.

Combined accounts of the Federal Government of St. Kitts and Nevis and the Nevis Island Administration.

Includes buybacks of land related to the debt-land swap.

Based on actual data of 10 public sector corporations and estimates for 4 others. No audited financial statements have yet been published for St. Kitts Electricity Company (SKELEC).

Table 3.

St. Kitts and Nevis: Balance of Payments, 2019–281

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Sources: ECCB; and IMF staff estimates and projections.

Reflect the outcome of the debt exchange offer to bondholders and external commercial creditors.