Chapter

2 Stabilization, Debt, and Fiscal Policy in the Caribbean

Author(s):
David Robinson, Paul Cashin, and Ratna Sahay
Published Date:
September 2006
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Author(s)
Ratna Sahay

This chapter examines the macroeconomic performance of the Caribbean countries since the 1990s, with a special emphasis on their public debt accumulation. Most Caribbean countries have a high level of public debt. The rapid buildup of this debt can in large part be attributed to a deterioration in fiscal balances owing principally to a rise in expenditures rather than a fall in revenues. The rise in expenditures reflects both policy slippages and exogenous shocks. The main policy message is that there is a critical need for fiscal consolidation and a reinvigoration of growth in Caribbean countries, so that their debt might be brought down to more sustainable levels.

The Caribbean countries rank high on the Human Development Index, relative to other developing and emerging market economies (UNDP, 2005). Average illiteracy rates are very low, and life expectancy at birth is high at nearly 70 years. In contrast, average poverty levels (based on national surveys) are high, with nearly 30 percent of the population below the poverty line. Income inequality, while not as severe as in Latin America, is significant. Per capita incomes range from US$460 in Haiti to nearly US$16,700 in The Bahamas, as indicated in Table 2.1. Although virtually all Caribbean countries are endowed with natural beauty and a warm climate that attracts tourists, only two countries—Trinidad and Tobago and Suriname—have abundant natural mineral resources—petroleum and bauxite, respectively.

Table 2.1.The Caribbean: Selected Socioeconomic Indicators 1
Population 2

in thousands,

2003)
Nominal

GDP Per

Capita

(in U.S.

dollars,

2003)
Distance

from

United

States 3

(in miles)
Poverty

(percent of

population

below

poverty line,

most recent

year survey)
Income

Inequality

GINI

Coefficient4

(most recent

year

of survey)
Human

Development

Index

Ranking5

(out of 175

countries,

2002)
Illiteracy

(percent of

population

aged

15 years

and over,

2002)
Life

Expectancy

at Birth

(in years,

average

2000–05)6
Voice and

Accountability7

(percentile

ranking

2002)
Government

Effectiveness8

(percentile

ranking

2002)
Antigua & Barbuda7311,1241.33712505514745570
Bahamas, The31416,691112515678788
Barbados2709,6511,6111439290779187
Belize2563.8917679923717255
Dominica793,5541,4143330952473816b
Dominican Republic8,7451,8251,28621479816675742
Grenada804,1031,5673220936657067
Guyana7639111,62235431044636947
Haiti3,132460713661534850152
Jamaica2,6512,96252419387912766555
St Kitts & Nevis427,6411,2753110392707857
St Lucia1494,0481,4961943715738057
St Vincent & the Grenadines1203,3291,33733608717747957
Suriname4362,4701,360676715953
Trinidad & Tobago1,3037,8361,6222140542716668
Caribbean91,5615,3661,20328387812696858
Sources: American Airlines website (www.aa.com); UNDP (2002, 2003, and 2004); World Bank, World Development Indicators database; Economic Commission for Latin America and the Caribbean (2004); Kraay, and Mastruzzi (2003); World Bank governance index: http://info.worldbank.org/governance/kkz/; and country authorities.

The record of the Caribbean region on the political front is relatively favorable. Caribbean countries score well, for example, on a “voice and accountability” measure that gauges the strength of political rights and civil liberties, scoring nearly 70 on a scale of 0 to 100 (Table 2.1). A “government effectiveness” measure that attempts to capture the quality of public service provision, the quality of bureaucracy, the competence of civil servants, the independence of the civil service with respect to political pressures, and the credibility of the government’s commitment to policies, receives a lower score of 58.

Inflation has been stabilized in the overwhelming majority of Caribbean countries. The newly independent countries (most of which gained independence in the 1960s and 1970s) tended to peg their exchange rates to those of their former colonial powers as a means of ensuring confidence in the local currency. Over time, some of the countries introduced a greater degree of flexibility in their exchange rate regimes, while others chose to peg their currencies to the U.S. dollar. Whatever the exchange rate regime, inflation in most countries has been kept under control—where control over inflation has been lost, credible efforts have been made to rein it in (Table 2.2).

Table 2.2.The Caribbean: Macroeconomic Indicators, 1990–2004(In percent)
CountriesExchange Rate RegimeTotal

Public Debt 1
Overal

Balances 1,3
Primary

Balances 1,2
CPI Inflation 4GDP Growth 4
199720041990–

1997
1998–

2004
1990–

1997
1998–

2004
1990–

1997
1998–

2004
1990–

1997
1998–

2004
Antigua& BarbudaCurrency board10299−3.2−6.90.3−2.83.70.73.03.8
Bahamas, TheFixed peg4746−2.5−2.1−0.2−0.23.21.80.92.8
BarbadosFixed peg6786−2.2−4.22.10.73.71.21.8
BelizeFixed peg43102−3.9−8.0−2.2−4.22.91.15.76.9
DominicaCurrency board62115−3.4−6.4−1.1−1.82.61.22.70.1
Dominican RepublicIndependently floating52353−2.5−3.3−1.4−1.717.716.03.94.4
GrenadaCurrency board41129−3.9−6.4−1.3−2.92.61.62.83.1
GuyanaManaged floating5211166−9.2−6.28.01.330.15.35.90.6
HaitiManaged floating53340−3.9−2.1n.a.−1.323.216.8−0.40.1
JamaicaManaged floating51031390.2−8.48.79.132.68.91.01.2
St. Kitts & NevisCurrency board86179−1.7−11.81.0−6.13.52.54.52.5
St. LuciaCurrency board3570−0.1−2.80.7−0.63.12.02.31.4
St. Vincent & the GrenadinesCurrency board4879−1.5−3.1−0.2−0.63.61.23.33.2
SurinameFixed peg2649−3.9−5.3−1.8−3.6105.737.70.82.6
Trinidad & TobagoManaged floating 552450.2−0.56.74.86.64.32.07.1
Caribbean66593−2.8−5.21.4−0.716.36.82.62.8

Since the late 1990s, the Caribbean countries’ access to international capital markets has increased at the same time that their domestic financial markets were being developed. To pursue their economic goals and finance their development processes, governments began to develop their financial markets and borrow at home and abroad. Given relatively low and stable inflation, the relative political stability of democratic regimes, and the development of local and regional financial markets, governments for the most part have had easy access to financial resources.

Since the mid–1990s, average national public debt in the region has virtually doubled, rising to exceptionally high levels in many countries. At the same time, fiscal performance has deteriorated sharply. With the notable exceptions of Antigua and Barbuda, Guyana, and Jamaica, public debt was not a major economic problem until the mid–1990s.

The remainder of this chapter provides an overview of macroeconomic developments in 15 Caribbean countries; examines the factors that contributed to public debt accumulation in the very highly indebted countries in the region; documents the revenue and expenditure developments in these very highly indebted countries; and offers conclusions and policy implications.

Macroeconomic Performance

GDP growth in the Caribbean region relative to other developing countries during 1980–2004 was low (Figure 2.1).1 As shown in the top panel of Figure 2.1, average Caribbean GDP grew at about 3 percent a year during 1980–2004. Compared with other developing countries, this growth rate was only marginally higher than that of Latin America. Even the average rate of growth of all “small island states” in the world was higher than that of the Caribbean. At the other extreme, emerging Asian countries grew at nearly two and a half times the pace observed in the Caribbean.2 The bottom panel in Figure 2.1 provides a similar comparison on a per capita basis. The performance of the Caribbean improves marginally; it is higher than the average of the small island states, in addition to Latin America, but lower than the other regional groupings. (For details about the regional groupings, see Appendix 2.1).

Figure 2.1.Real GDP Growth by Region

(Average annual growth rate, 1980–2004)

Sources: IMF, World Economic Outlook database; country authorities; and IMF staff estimates.

1 Eastern Caribbean Currency Union.

While inflation rates are low and have fallen in recent years, public debt levels have risen to very high levels in most Caribbean countries (Table 2.2). The period since 1990 is divided into two subperiods: 1990–97 and 1998–2004, based on the sharp increase in public debt levels observed in several countries in the second subperiod. Since 1998, average ratios of public debt to GDP in the region grew rapidly, from 65 percent in 1997 to over 90 percent by 2004, while the GDP growth rate marginally improved in the second subperiod relative to the first. However, the inflation performance improved significantly in the second subperiod: annual average inflation rates came down from over 16 percent over 1990–97 to less than 7 percent over 1998–2004.

Reflecting the debt buildup, fiscal accounts worsened sharply during 1998–2004 in the Caribbean. The average overall fiscal balance declined in every country (apart from The Bahamas, Guyana, and Haiti) during 1998–2004, compared with 1990–97 (Table 2.2). As public debt grew, interest costs also rose. Hence, part of the explanation for the deterioration in the overall fiscal balance is the rise in interest-related expenditures. However, looking at the overall balance excluding interest costs (defined as the primary fiscal balance), the performance is also worse in the second subperiod for every country except The Bahamas, where the primary balances in the two subperiods were about the same, and Jamaica, where the primary surplus increased in the second subperiod.

Table 2.3.The Caribbean: Economic Performance Under Fixed and Flexible Exchange Regimes(In percent)
Fixed Exchange

Rate Regime 1
Flexible Exchange

Rate Regime 2
Annual Inflation
1990–9713.522.0
1998–20045.110.2
Period 1998–2004 minus period 1990–97−8.3−11.8
Annual GDP Growth
1990–972.62.5
1998–20042.82.7
Period 1998–2004 minus period 1990–970.20.2
Overall Fiscal Balance (percent of GDP)
1990–97−2.6−3.0
1998–2004−5.7−4.1
Period 1998–2004 minus period 1990–97−3.1−1.1
Public Debt (percent of GDP)
1990–9755.584.4
1998–200495.588.4
Period 1998–2004 minus period 1990–9740.04.0
Sources: IMF, Annual Report of Exchange Arrangements and Exchange Restrictions, 2003; and IMF staff estimates.

Does the Exchange Rate Regime Matter?

Until 2004, 10 of the 15 Caribbean countries maintained fixed exchange rate regimes (currency boards or a fixed peg to a major currency) throughout the sample period under consideration—Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, and Suriname, while the Dominican Republic moved from a fixed peg regime to a float in mid–2003. The remaining four countries—Guyana, Haiti, Jamaica, and Trinidad and Tobago—had more flexible regimes (managed or independent floating) for most of the period.3

Confirming the experience of other developing countries, inflation outcomes under fixed exchange rate regimes in the Caribbean countries were generally better than those under floating regimes (Table 2.3).4 A common feature across the two sets of countries is that the average rate of inflation declined in both groups over 1998–2004 compared with 1990–97, reaching single-digit levels in the second subperiod. Under fixed exchange rate regimes, annual inflation declined from nearly 13½ percent over 1990–97 to 5 percent over 1998–2004, while under the more flexible exchange rate regime, inflation fell from 22 percent during 1990–97 to 10 percent during 1998–2004. The rapid decline in inflation rates in countries with flexible exchange rates in the second subperiod is impressive.

Countries with fixed exchange rate regimes grew faster in both subperiods. However, the difference across the two subperiods for each group of countries is not high: the average GDP growth in countries with fixed exchange rate regimes rose from 2.6 percent a year during 1990–97 to 2.8 percent during 1998–2004, while in countries with flexible exchange rate regimes, it increased from 2.5 to 2.7 percent a year.

Contrary to expectations, average fiscal outcomes in countries with fixed exchange rate regimes were worse than those with flexible regimes. Fixed exchange rate regimes should instill greater macroeconomic discipline than flexible regimes, since discretionary monetary policy is more constrained;5 however, this appears not to be the case in the region. The average overall fiscal deficit in the 11 countries with fixed exchange rate regimes was higher than in countries with flexible exchange rate regimes and has more than doubled in recent years—from 2.6 percent of GDP during 1990–97 to 5.7 percent during 1998–2004. In the four countries with more flexible regimes, the average overall deficit was somewhat lower at 3 and 4.1 percent of GDP, respectively, for the same subperiods.

The most alarming development is in countries with fixed rate regimes, where public debt has risen very rapidly—from just over 55 percent of GDP in the 1990–97 period to nearly 96 percent during 1998–2004. Apart from the fact that these developments reflected a weaker fiscal performance in countries with fixed exchange rate regimes, they also indicate that countries with fixed regimes and a stable inflation environment were able to access the global financial markets more easily when global interest rates were falling. Average public debt levels were much higher in the floating exchange rate regimes in both subperiods (at more than 80 percent of GDP), driven by Jamaica and Guyana.

In sum, countries with fixed exchange rate regimes had lower inflation rates and marginally higher GDP growth rates; on the other hand, they had higher fiscal imbalances and built up public debt faster. In fact, the large historical buildup of debt and fiscal imbalances under fixed exchange rate regimes in Guyana and Jamaica during the 1980s and the consequent pressures on the exchange rate peg and foreign external reserves, led to their abandoning their fixed exchange rate regimes.

How Have the Caribbean Countries Performed Relative to Each Other?

The average performance of the Caribbean countries presented in Table 2.2 masks significant diversity of experience. To compare how each country performed relative to the other countries in the region, an index of macroeconomic performance, ranging from 0 to 100, with 100 representing the best relative performance, was constructed.6Figure 2.2 presents the relative ranking based on macroeconomic performance. Note that a low score on the macroeconomic performance index reflects both the effects of negative exogenous shocks as well as policy performance (for example, St. Kitts and Nevis, the country with the lowest score, most likely suffered the highest costs due to natural disasters during the period under consideration).7

Figure 2.2.The Caribbean: Relative Ranking on Macroeconomic Performance 1

(Average performance during 1998–2004 compared with 1990–97)

Source: Author’s calculations.

1 The ranking is based on total public debt in 2004, absolute change in public debt from 1990–97 to 1998–2004, average overall fiscal balance from 1998 to 2004, absolute change in overall fiscal balance from 1990–97 to 1998–2004, average primary fiscal balance from 1998–2004, absolute change in primary fiscal balance from 1990–97 to 1998–2004, average real GDP growth from 1998 to 2004, and absolute change in real GDP growth from 1990–97 to 1998–2004. Countries are ranked from 1 to 14 in each category, with the best performer receiving the highest scores. The scores are then summed for each country, with equal weight to each category of macroeconomic performance. Finally, the summed-up scores are normalized so that the scores for all countries range from 1 to 100. Haiti is excluded from the comparison because the data on primary balance in period 1990–97 are not available.

Ranked relative to each other, Trinidad and Tobago and The Bahamas had the best macroeconomic performance, while St. Kitts and Nevis, Dominica, and Jamaica received the lowest scores. Both Trinidad and Tobago and Suriname (which is ranked third), countries with natural resources, are among the better performers. Of course, the existence of natural resources does not guarantee good macroeconomic performance—in fact, there is sufficient literature that provides arguments and evidence for a lower than average performance in resource-rich developing countries (Sachs and Warner, 1995). The Dominican Republic ranks fifth from the top because of its relatively good performance until the banking crisis in 2003.

Figure 2.3 refines the ranking in two ways—inflation performance is dropped and the primary fiscal balance (overall fiscal balance excluding interest payments) is added. The figure focuses on debt, fiscal, and growth performance. By this measure, The Bahamas is the best performer, while St. Kitts and Nevis continues to receive the lowest score. The striking change in rankings are in Belize, which moves from the fourth-best to the second-lowest performer, while St. Lucia improves its ranking from tenth to sixth place.

Figure 2.3.The Caribbean: Relative Ranking on Fiscal and Debt Performance 1

(Average performance during 1998–2004 compared with 1990–97)

Source: Author’s calculations.

1 The ranking is based on total public debt in 2004, absolute change in public debt from 1990–97 to 1998–2004, average overall fiscal balance from 1998 to 2004, absolute change in overall fiscal balance from 1990–97 to 1998–2004, average primary fiscal balance from 1998–2004, absolute change in primary fiscal balance from 1990–97 to 1998–2004, average real GDP growth from 1998 to 2004, and absolute change in real GDP growth from 1990–97 to 1998–2004. Countries are ranked from 1 to 14 in each category, with the best performer receiving the highest scores. The scores are then summed for each country, with equal weight to each category of macroeconomic performance. Finally, the summed-up scores are normalized so that the scores for all countries range from 1 to 100. Haiti is excluded from the comparison because the data on primary balance in period 1990–97 are not available.

Table 2.4.Caribbean Countries’ Public Debt and Primary Fiscal Balances(In percent of GDP)
Total Public Debt
Low to medium

debt (0 to 50)
High debt

(50 to 90)
Very high debt

(Higher than 90)
2004
Primary fiscal balance 1
Higher than 5Trinidad & TobagoJamaica
0 to 5SurinameBarbadosDominica, Grenada
Less than 0The BahamasDominican Republic,

St. Lucia,

St. Vincent &

the Grenadines
Antigua & Barbuda,

Belize, Guyana,

St. Kitts & Nevis
2001–04
Primary fiscal balance 2
Higher than 5Jamaica
0 to 5Suriname,

Trinidad & Tobago
Dominica
Less than 0The Bahamas,

Dominican Republic
Barbados, St. Lucia,

St. Vincent &

the Grenadines
Antigua & Barbuda,

Belize, Grenada,

Guyana,

St. Kitts & Nevis
Sources: IMF staff calculations based on data from country authorities; and IMF, World Economic Outlook database.Note: Dominica, the Dominican Republic, and Suriname are italicized to indicate that their relative positions have changed over time.

Fiscal Performance and Debt Accumulation

We now focus on two main economic concerns, highlighted in the previous section, that afflict the region: the rise in public debt and fiscal expansion. Table 2.4 presents information on public debt and primary fiscal balances in the Caribbean countries. The reason for the focus on the primary fiscal balance, rather than the overall fiscal balance (recall that the latter includes interest payments, while the former does not) is because the primary balance corresponds more closely to the government’s efforts to generate surpluses, and is therefore an indicator of the government’s policy stance. Unless circumstances are dire, governments do not choose the level of interest payments, which depends on the level of debt accumulated from previous years.8

Figure 2.4.Public Sector Debt in Highly Indebted Emerging Market Countries 1

(Public debt in percent of GDP, end–2004)

Sources: IMF, World Economic Outlook database; country authorities; and IMF staff estimates. Note: Caribbean countries are shaded in dark.

1 Guyana and Haiti are, strictly speaking, not emerging market economies because they do not have access to private capital markets. However, they are included in this figure to show their debt levels relative to other countries in the region.

The Caribbean countries are among the most indebted emerging market countries in the world. As shown in Figure 2.4, 14 Caribbean countries are in the top 30 most-indebted countries, while seven are among the top 10.9Table 2.4 (upper panel) lists the countries according to their primary fiscal balance and public-debt-to-GDP ratio in 2004. In general, public-debt-to-GDP ratios over 50 to 60 percent are considered high. By that measure, only three countries have low debt—The Bahamas, Suriname, and Trinidad and Tobago.10 Four countries—Barbados, the Dominican Republic, St. Lucia, and St. Vincent and the Grenadines—have debt in the range of 50 to 90 percent.11 The remaining seven countries—Antigua and Barbuda, Belize, Dominica, Grenada, Guyana, Jamaica, and St. Kitts and Nevis—have debt beyond 90 percent.

Table 2.4 indicates that countries are generating much lower primary fiscal surpluses than is needed to bring debt down—in fact, eight of the 14 countries have primary fiscal deficits. Assessing the fiscal effort in these countries from Table 2.4 shows that only Jamaica and Trinidad and Tobago generated primary surpluses of more than 5 percent of GDP in 2004. Four other countries—Babados, Dominica, Grenada, and Suriname—had primary surpluses that were positive but less than 5 percent of GDP. The remaining eight countries registered primary deficits. Deficits on the primary balance are sufficient evidence to infer that debt levels will rise in those countries. In fact, when debt levels are high, large primary surpluses must be run to prevent a further increase in the debt stock. The magnitude of the primary surpluses needed increases with interest rates and the size of the debt stock, but is reduced by real exchange rate appreciation and real GDP growth. Thus, for example, even though Jamaica has generated primary surpluses in the range of 8 to 13 percent of GDP for many years, public debt has continued to rise because of high interest costs and low growth.

Table 2.4 (lower panel) confirms that the average performance on primary fiscal balance and public debt during 2001–04 is similar to that reported in Table 2.4 (upper panel) for 2004. The pattern and cell entries in both tables are identical, with the exceptions of Barbados, the Dominican Republic, Grenada, Suriname, and Trinidad and Tobago.12 Fiscal performance improved in 2004 in Barbados, Grenada, Suriname, and Trinidad and Tobago. In fact, in the latter two countries, the recent primary surpluses helped reduce the public debt levels to under 50 percent of GDP. Public debt in the Dominican Republic increased sharply following the banking crisis in 2003 and the subsequent large exchange rate depreciation.

What Accounts for the Rise in Public Debt in the Average Caribbean Country?

To shed light on this question we focus our analysis on the six very highly indebted countries—those with public-debt-to-GDP ratios that exceeded 90 percent at end–2004. These countries are Antigua and Barbuda, Belize, Dominica, Grenada, Jamaica, and St. Kitts and Nevis—henceforth called the Caribbean–613.A debt accounting exercise is employed to decompose the sources of the public debt buildup in these countries.14

Equation (2) in Appendix 2.2. can be used to analyze the public debt accumulation process of the Caribbean–6.15 The analysis is divided into two subperiods, 1991–97 and 1998–2004, to mark the timing when debt began to rise sharply in most countries. Table 2.5 presents the results obtained from estimating equation (2) for the average debt accumulation in the six countries.

Table 2.5.Very Highly Indebted Caribbean Countries: Total Public Sector Debt Accumulation by Component 1(In percent of GDP)
YearTotal Public-

Debt-to-GDP

(in percent,

end of period)
Public Debt

Accumulation
Contribution to Increase in Debt-to-GDP Ratio
Primary

fiscal balance

(excluding grants)
GrantsPrimary Balance

(includes grants)
Interest

payments
Interest output

difference effect 2
price effectEvents and

measurement

errors 3
199072.7. . .0.6−1.9−1.4. . .. . .. . .. . .
199181.79.01.0−2.0−1.0−2.5−4.615.9−1.3
199267.8−13.9−0.2−1.3−1.53.21.6−13.7−0.3
199370.72.91.2−2.9−1.72.70.8−2.56.2
199468.1−2.61.2−1.9−0.73.00.9−3.40.6
199567.7−0.40.5−2.4−1.93.03.1−3.01.5
199666.6−1.11.5−2.2−0.74.12.0−4.21.8
199772.76.02.7−1.80.93.41.3−1.65.5
199884.111.52.6−2.9−0.34.82.9−2.411.2
199990.16.01.8−1.70.14.51.4−0.24.6
200099.89.72.8−2.60.24.61.00.18.4
2001106.16.34.8−1.73.04.74.4−2.71.6
2002128.222.16.9−2.04.94.63.80.712.7
2003130.62.42.3−3.5−1.26.82.8−3.24.0
2004127.2−3.4−2.5−2.67.64.0−3.7−1.1
1991–9770.8_1.1−2.1−0.92.40.7−1.82.0
1998–2004109.47.83.0−2.40.65.42.9−1.65.9
Change38.77.81.9−0.41.53.02.20.23.9
Source: IMF staff calculations based on data from country authorities.Note: A positive value means that the component contributed to an increase in the public-debt-to-GDP ratio, while a negative sign means that it contributed to a decline in the public-debt-to-GDP ratio.

During the 1991–97 period, the average public-debt-to-GDP ratio in the Caribbean–6 did not grow, while during 1998–2003 it rose rapidly—by 7.8 percent of GDP a year. Almost 40 percent of the 7.8 percent growth of public debt—amounting to 3 percent of GDP—is attributable to the deterioration of fiscal primary balances (excluding grants), and 2.9 percent of GDP to the combined effect of interest payments and output growth. The price effect (due both to inflation and appreciation of the real exchange rate) and grants together helped reduce the debt ratio by 4 percent of GDP. “Events” (such as the assumption by the government of private sector debt) and measurement error explain about 6 percent of GDP a year. Given that the measurement errors are positive, this indicates that the fiscal accounts consistently understated the accumulation of debt.

There are several notable changes from the 1991–97 to the 1998–2003 subperiods: (1) the significant worsening of the primary balance and its relative contribution to debt accumulation; (2) the rise in interest costs relative to GDP growth; and (3) measurement error, indicating a possible underestimation in recording the magnitude of the fiscal deficits in the second subperiod or the realization of government guaranteed debt in the first subperiod.

What Do the Individual Country Data Show?

St. Kitts and Nevis had the highest public-debt-to-GDP ratio, at almost 180 percent at end–2004, but this ratio rose most rapidly in Grenada between 1997 and 2004 (growing by 14.6 percent of GDP a year).Table 2.6 compares the performance across the six countries. Jamaica stands out as the only country that generated primary fiscal surpluses in both subperiods, averaging nearly 9 percent of GDP a year during the entire 1991–2004 period. All other countries registered primary fiscal deficits in both subperiods.

Table 2.6.Very Highly Indebted Caribbean Countries: Total Public Sector Debt Accumulation by Component 1
YearTotal Public-

Debt-to-GDP

(in percent,

end of period)
Public Debt

Accumulation
Contribution to Increase in Debt-to-GDP Ratio
Primary fiscal

balance

(excluding

grants)
GrantsPrimary

Balance

(includes

grants)
Interest

payments
Output

growth
Interest-

output

difference

effect 2
price

effect
Events and

measurement

errors 3
Highly Indebted Caribbean Countries
1991–9770.81.1−2.1−0.92.4−1.70.7−1.82.0
1998–2004109.47.83.0−2.40.65.4−2.52.9−1.65.9
Change38.77.81.9−0.41.53.0−0.82.20.23.9
Antigua & Barbuda
1991–97108.7−1.70.9−0.60.23.4−3.10.3−2.80.5
1998–2004122.5−0.43.5−0.53.04.1−4.5−0.4−1.6−1.6
Change13.71.32.60.12.80.7−1.4−0.71.2−2.0
Belize
1991–9736.22.54.1−1.32.81.6−1.30.3−0.6
1998–200477.68.55.3−1.24.23.6−4.2−0.60.14.8
Change41.46.01.20.11.42.0−2.9−0.90.74.8
Dominica
1991–9768.5−1.14.8−4.10.72.3−1.50.9−2.2−0.4
1998–200498.57.77.4−5.41.94.90.15.0−1.42.1
Change29.98.82.6−1.41.22.51.64.10.82.5
Grenada
1991–9743.5−2.13.5−2.90.62.4−1.01.4−1.3−2.8
1998–200482.612.67.1−4.32.93.6−1.52.0−1.28.8
Change39.114.63.7−1.42.21.2−0.50.60.211.6
Jamaica
1991–97107.6−2.2−8.6−8.62.6−0.71.9−2.16.5
1998–2004134.55.1−9.3−9.311.8−1.710.1−2.16.4
Change26.97.3−0.7−0.79.1−1.08.2−0.2
St. Kitts & Nevis
1991–9760.04.52.1−3.5−1.52.0−2.4−0.4−1.88.2
1998–2004141.113.34.1−3.11.04.3−2.91.4−3.614.4
Change81.18.82.00.42.42.3−0.51.9−1.96.2
Source: IMF staff calculations based on data from country authorities.Note: A positive value means that the component contributed to an increase in the public-debt-to-GDP ratio, while a negative sign means that it contributed to a decline in the public-debt-to-GDP ratio.

In the case of Jamaica, the sharp increase in the interest payments component was the most important factor for rapid public debt accumulation between 1997 and 2004. In fact, interest payments rose by 9.1 percent a year between the two subperiods, surpassing the annual rise in the debt-to-GDP ratio.16 This rise in interest payments occurred during a period when global interest rates were falling, indicating the importance of countryspecific factors in affecting interest costs. In all other countries, interest payments also increased, contributing positively to debt accumulation.17

In summary, the single most important factor contributing to the rise in the ratio of public debt to GDP in all cases except Jamaica is the deterioration in the primary balance (including and excluding grants). In the case of Jamaica, the sharp rise in interest costs exceeded the increase in the public-debt-to-GDP ratio. In virtually all countries, output growth helped reduce the debt in both subperiods. However, there was substantial variation across countries in the quantitative contribution of GDP growth in reducing debt-to-GDP ratios.

Fiscal Expansion: Policy Slippages versus Exogenous Shocks

As noted in the previous sections, the rapid buildup of public debt since 1997 in the region’s very highly indebted countries—the Caribbean–6—is in large part due to a deterioration in fiscal balances. This section explores whether the deterioration stemmed from revenue declines or expenditure increases. Also, to what extent was the fiscal deterioration due to unanticipated shocks rather than fiscal policy slippages?

Did Government Revenues Fall, or Did Expenditures Rise?

Over 1998–2004, the overall fiscal balance deteriorated in each of the Caribbean–6 cases, mostly on account of a rise in expenditures. Figures 2.5 to 2.7 and Table 2.7 summarize developments in overall fiscal balances and central government revenues and expenditures in the six countries. Except in Belize, fiscal revenue as a share of GDP increased in the second subperiod in all countries. On the other hand, there is clear evidence that expenditures rose quite sharply in virtually all countries. Total current expenditures increased in all cases except Grenada, while capital expenditures also rose in all countries except Jamaica. Within current expenditures, interest expenditures rose in all six countries, while the noninterest component rose in four countries (exceptions were Belize and Grenada). In summary, the fiscal deterioration occurred in spite of an improvement in revenue performance, and was caused by a combination of rising interest costs, higher public investments, and larger noninterest current expenditures.

Figure 2.5.Very Highly Indebted Caribbean Countries: Central Government Revenue and Expenditures 1

(In percent of GDP)

Sources: Country authorities; and IMF staff estimates.

1 Very highly indebted Caribbean countries are defined as countries that have a ratio of public debt to GDP greater than 90 percent.

Figure 2.6.Very Highly Indebted Caribbean Countries: Current Expenditures of the Central Government: Interest versus Noninterest 1

(In percent of GDP)

Sources: Country authorities; and IMF staff estimates.

1 Very highly indebted Caribbean countries are defined as countries that have a ratio of public debt to GDP greater than 90 percent.

Figure 2.7.Very Highly Indebted Caribbean Countries: Composition of Central Government Expenditures, Capital versus Current Expenditure 1

(In percent of GDP)

Sources: Country authorities; and IMF staff estimates.

1 Very highly indebted Caribbean countries are defined as countries that have a ratio of public debt to GDP greater than 90 percent.

Table 2.7.Very Highly Indebted Caribbean Countries: Changes in Central Government Revenues and Expenditure 1(In percent of GDP)
Overall

Fiscal

Balance
RevenuesCentral Government
Non interest

current

expenditures
Interest

expenditures
Capital

expenditures
Current

expenditures
Antigua & Barbuda
1990–97−3.221.418.43.52.622.0
1998–2004−7.121.621.34.13.325.4
Change
Belize
1990–97−3.625.717.11.610.618.6
1998–2004−8.023.216.23.111.519.3
Change
Dominica
1990–97−3.432.324.22.29.326.4
1998–2004−6.834.826.24.810.531.1
Change
Grenada
1990–97−3.927.521.72.57.124.2
1998–2004−6.430.620.43.613.123.9
Change
Jamaica
1990–970.325.612.38.44.620.7
1998–2004−5.228.517.014.42.231.4
Change
St. Kilts & Nevis
1990–97−1.727.622.62.74.025.3
1998–2004−11.832.127.65.710.633.3
Change
Source: IMF staff estimates from country authorities’ data.

Did Exogenous Shocks Contribute to Expansionary Fiscal Policy?

Quantifying the full effects of exogenous shocks on fiscal performance is difficult. There are multiple sources of shocks and many of them are not easily observable (such as productivity shocks). Moreover, the authorities do not categorize expenditures separately for the shocks. Finally, second-round indirect effects of shocks that can be observed cannot be easily accounted for. Hence, the attempt in this subsection is simply to provide a qualitative analysis to the extent possible, given the information at hand.

Many types of unanticipated shocks can affect fiscal management in Caribbean countries. First, global interest rates can increase, raising interest payments unexpectedly. Second, oil price hikes are a major supply shock that can slow economic growth and reduce government revenues when increases in international oil prices are not fully passed through to domestic prices. Third, a slowdown in global economic growth can adversely affect small open economies that depend heavily on external demand for their products, such as tourism. Fourth, terms of trade shocks—such as secular declines in the price of bananas, sugar, and cotton—can also decrease the growth potential and a permanent source of revenues. Finally, natural disasters to which many Caribbean countries are prone can have devastating effects on economies. Each of these factors will be examined in turn by asking whether there was a perceptible change in their nature or frequency during 1998–2004 compared with 1991–97 that caused fiscal imbalances to rise in the second subperiod.

Figure 2.8 a shows developments in the average Caribbean growth rates (for all 15 countries)—and world real interest rates as measured by the 6-month LIBOR (the London interbank offer rate divided by the industrial countries’ inflation rate). focuses on the Caribbean–6 from 1990, and also shows developments in interest-related current expenditures. There was an increase in interest payments during 1998–2004 in the Caribbean–6 countries, even though global interest rates were declining during that subperiod. Interest payments rose during 1998–2004, primarily because the Caribbean countries were able to place greater volumes of debt in international markets as global investors appear to have been rebalancing their portfolios in the aftermath of the financial crises in Asia in 1997, Russia in 1998, and Argentina in 2001. Domestic borrowings also increased as local financial markets deepened. Counterintuitively, there appears to be a positive relationship between the Caribbean growth rates (both the Caribbean–15 and Caribbean–6) and world interest rates. This can happen if growth is influenced by policy, such as public sector expansion or structural reforms that benefit private sector investments, or due to lower access to concessional financing, as was indeed the case.18

Figure 2.8.Caribbean GDP and World Interest Rate

Sources: IMF, World Economic Outlook database; country authorities; and IMF staff estimates.

1 World interest rate is the six-month London interbank offer rate.

2 Very highly indebted Caribbean countries are defined as countries that have a ratio of public debt to GDP greater than 90 percent.

Figure 2.9 a shows developments in oil prices since 1980 and GDP growth in the 15 Caribbean countries, while focuses on the Caribbean–6 since 1990. While there is a negative relationship between oil prices and GDP growth rates in the wider Caribbean, this relationship is weaker for the Caribbean–6, reflecting in part the fact that increases in international oil prices were not fully passed through to domestic prices in the highly indebted countries.

Figure 2.9.Caribbean GDP Growth and Oil Prices

Sources: IMF, World Economic Outlook and Commodity Price System databases; country authorities; and IMF staff estimates.

1 Very highly indebted Caribbean countries are defined as countries that have a ratio of public debt to GDP greater than 90 percent.

The comovement between industrial countries’ GDP growth rates and those of both the wider Caribbean and the Caribbean–6 is striking (Figure 2.10). In most countries, the key source of growth is the tourism sector. Figure 2.11 shows how the stay-over tourist arrivals evolved in the Caribbean–6 countries. The sharp dip in tourism performance in Grenada in 2004 reflects the impact of Hurricane Ivan, while the sharp increase in St. Kitts and Nevis mainly reflects the doubling of capacity for stay-over tourists through the opening of the Marriott Hotel. In Antigua and Barbuda and Belize, tourism performance appears to have been much more sluggish than in other countries.

Figure 2.10.GDP Growth of Caribbean and Industrial Countries

Sources: IMF, World Economic Outlook database; country authorities; and IMF staff estimates.

1 Highly indebted Caribbean countries include Antigua and Barbuda, Belize, Dominica, Grenada, Jamaica, and St. Kitts and Nevis.

Figure 2.11.Very Highly Indebted Caribbean Countries: Tourism Developments 1

Stayover arrivals, in thousands; 1990 = 100)

Sources: National Tourism and Statistical Offices; and IMF staff estimates.

1 Very highly indebted Caribbean countries are defined as countries that have a ratio of public debt to GDP greater than 90 percent.

Of the Caribbean–6 highly indebted countries, Dominica (bananas), Belize (bananas and sugar), and St. Kitts and Nevis (sugar) have been affected by the erosion of preferential trade agreements through the 1990s.19. Figure 2.12 illustrates price movements for bananas and sugar—in the case of sugar, the key concern is the decrease in the volume that can be exported to the protected (higher price) markets in Europe. While these shocks are permanent in nature, they have been anticipated for some time and prices have been declining slowly. They have affected both the production and profits of the agricultural sector as well as government revenues from this sector. The impact on the economies is hard to assess, but limited evidence indicates that the shocks have generated significant fiscal losses. In St. Kitts and Nevis, for example, the state-owned sugar industry has suffered losses of 3 to 4 percent of GDP a year over the past several years.

Figure 2.12.Very Highly Indebted Caribbean Countries: Tourism Developments

(January 1990-December 2004)
(January 1990-December 2004)

Source: IMF, Commodity Price System database.

Notes: Sugar (U.S.) is the U.S. import price, CSCE nearest futures, c.i.f. New York; sugar (EU) is the European Union negotiated import price for raw unpackaged sugar from the African, Caribbean, and Pacific countries, c.i.f. European ports; sugar (world) is the free market price, CSCE nearest futures, c.i.f. New York. All nominal price series were deflated using the IMF’s manufacturers’ unit value index. Banana (Central American and Ecuador) is the U.S. importer’s price, f.o.b. U.S. ports, U.S. dollars per metric ton (Chiquita, Dole, and Del Monte). The nominal price series was deflated using the IMF’s manufacturers’ unit value index.

Finally, natural disasters have frequently affected the Caribbean countries, triggering disaster management and reconstruction expenditures.

Figure 2.13 provides evidence that the frequency of natural disasters was higher in the second half of the 1990s than in the first half, with the exception of Jamaica. However, there is not sufficient information to infer whether the severity of the natural disasters and the associated fiscal costs were higher in the second subperiod.

Figure 2.13.Very Highly Indebted Caribbean Countries: Real GDP Growth and Natural Disasters 1, 2

(In percent of GDP)

Sources: Emergency Disasters Database (EM-DAT) (CRED, 2005); country authorities; and IMF staff estimates

1 Very highly indebted Caribbean countries are defined as countries that have a ratio of public debt to GDP greater than 90 percent,

2 The natural disasters include: For Antigua and Barbuda, Hurricane Gustav (1990), Hurricane Luis (1995), Hurricane Georges (1998), Hurricane Jose (1999), and Hurricane Lenny (1999). For Dominica, Hurricane Luis (1995), Hurricane Lenny (1999), and Hurricane Iris (2001). For Grenada, Hurricane Arthur (1990), Hurricane Lenny (1999), and Hurricane Ivan (2004). For St. Kitts and Nevis, Hurricane Gustav (1990), Hurricane Luis (1995), Hurricane Georges (1998), and Hurricane Lenny (1999). For Belize, cold wave (1990), flood (1990), flood (1995), Hurricane Mitch (1998), Hurricane Keith (2000), Hurricane Iris (2001), and Hurricane Chantal (2001). For Jamaica, disease (1990), flood (1991), flood (1993), Tropical Storm Gordon (1994), Tropical Storm Marco (1996), drought (2000), Hurricane Michelle (2001), flood (2002), Hurricane Lili (2002), Hurricane Isidore (2002), and Hurricane Ivan (2004).

Table 2.8 provides a summary picture of exogenous shocks in the Caribbean–6. The two shocks that did affect fiscal balances more negatively in the second subperiod are natural disasters and the decline in preferential agreements. On the other h and, higher oil prices in the second subperiod do not appear to have caused the slowdown in growth or an increase in current expenditures. The rise in interest expenditures during the second subperiod was also not caused by a rise in global interest rates (since interest rates actually declined during that subperiod), but rather by the increase in the stock of debt and a decline in concessional financing. Given the high correlation between growth in the Caribbean and the industrial countries, the Caribbean should have grown faster, as GDP growth in industrial countries was somewhat higher in the second subperiod. However, the September 11th shock to tourism economies directly reduced growth in 2001–02.

Table 2.8.Caribbean–6: Exogenous Shocks and Economic Policies and Outcomes
Policies/Outcomes
Global ShocksCountry-Specific ShocksCentral

government

noninterest

expenditures

(percent of GDP)
Central

government

interest

expenditures

(percent of GDP)
LIBOR

(in percent)
Oil prices

(U.S.dollars

per barrel)
World GDP

growth

(per year,

in percent)
Decline in

perferential

agreements
Natural

disaters

(number

of events)
GDP growth

(per year,

in percent)
Antigua & BarbudaNo
1991–19972.321.83.123.018.43.5
1998–20041.824.43.733.821.34.1
Change−0.42.50.510.92.80.6
BelizeYes (Sugar, bananas)
1991–19972.321.83.115.717.11.6
1998–20041.824.43.746.916.23.1
Change−0.42.50.531.2−0.91.5
DominicaYes, Bananas
1991–19972.321.83.112.724.22.2
1998–20041.824.43.720.126.24.8
Change−0.42.50.51−2.72.12.6
GrenadaNo
1991–19972.321.83.102.821.72.5
1998–20041.824.43.723.120.43.6
Change−0.42.50.520.3−1.31.0
JamaicaNo
1991–19972.321.83.141.012.38.4
1998–20041.824.43.751.217.014.4
Change−0.42.50.510.24.76.0
St. Kitts & NevisYes (Sugar)
1991–19972.321.83.114.522.62.7
1998–20041.824.43.722.527.65.7
Change−0.42.50.51−2.05.03.0
Sources: IMF staff estimates from country authorities’ data; and IMF, World Economic Outlook database.

The conclusion is that the rapid increase in fiscal imbalances in recent years appears to be related to policy slippages, insufficient fiscal planning for anticipated adverse shocks, and, to some extent, unanticipated shocks. The decline in preferential access was an anticipated adverse shock. In fact, some countries began to adjust their production structures in anticipation of this shock in the 1980s. Given the high frequency of natural disasters, countries should have saved in good times to be able to cover, at least in part, expenditures related to natural disasters. In contrast, the September 11th attack on the United States was an unanticipated shock that slowed growth significantly for 18 months or so in the tourism-dominated economies.

Debt Sustainability in the Very Highly Indebted Countries

Going forward, the implications for sustaining public debt at such high levels in the Caribbean–6 are grave. Table 2.9 presents an analysis of public debt sustainability in the Caribbean–6 countries based around three questions: (1) What is the primary fiscal surplus needed to reduce the public-debt-to-GDP ratio to 60 percent in five years?20 (2) What is the primary surplus needed to prevent debt from rising and simply stabilize it at the current (very high) levels? and (3), If current policies are pursued, what would be the level of debt by 2010? The current situation in the primary balance and public sector debt is presented in Table 2.9..

Table 2.9.Very Highly Indebted Caribbean Countries: Public Debt Sustainability Assumptions 1(In percent of GDP)
Current Situation 2
Public debtPrimary balance
St. Kitts & Nevis173.7−4.1
Jamaica142.010.4
Grenada129.43.7
Dominica115.03.4
Antigua & Barbuda99.4−0.8
Belize93.2−7.9
Sources: Country authorities and IMF staff estimates.

As shown in Table 2.10, to reduce debt to 60 percent of GDP over the next five years, the primary surpluses needed are exceptionally large, requiring a substantial turnaround in all six countries. Jamaica would need to generate the highest primary fiscal surpluses—23 percent of GDP in each of the next five years, followed closely by St. Kitts and Nevis at 19 percent, Grenada (17.6 percent), Antigua and Barbuda (6.3 percent), Dominica (4.1 percent), and Belize (4 percent). These are extremely demanding fiscal efforts by any standards. Compared with the current levels of primary fiscal balances, these would require a substantial increase or turnaround (over 10 percent of GDP) in primary balances in all countries except Antigua and Barbuda and Dominica.

Table 2.10.Very Highly Indebted Caribbean Countries: Policy Questions on Public Debt Sustainability 1,2(In percent of GDP)
Primary Balance Needed

to Reduce Public-Debt-to

-GDP Ratio to 60 Percent

in Five Years 3,4
Primary Balance Needed to

Stabilize Public Debt-to-GDP

Ratio at Current Level 3
Public Debt in 2010 under

Current Policies 4
Jamaica (23.1)

St. Kitts & Nevis (19.0)

Grenada (17.6)

Antigua & Barbuda (6.3)

Dominica (4.1)

Belize (4.0)
Jamaica (8.6)

Dominica (1.3)

Antigua & Barbuda (–0.3)

Grenada (–0.7)

St. Kitts & Nevis (–2.0)

Belize (–3.1)
St. Kitts & Nevis (231.1)

Grenada (147.5)

Jamaica (131.8)

Belize (115.4)

Antigua& Barbuda (101.3)

Dominica (66.0)
Sources: Country authorities; and IMF staff estimates.

To stabilize public debt at the current level, three countries would still need to increase primary fiscal balances beyond their current levels. Supposing that the countries were less ambitious and aimed merely to prevent debt from rising further. The second column in Table 2.10. indicates how much primary surplus would need to be generated to stabilize debt at current levels. Three countries—St. Kitts and Nevis, Antigua and Barbuda, and Belize—would still have to increase their primary balances beyond their current levels, although by more modest amounts than if they were planning to reduce the public-debt-to-GDP ratios substantially. While this may be an interesting hypothetical question, it is certainly not advisable to have such a modest goal. The main reason is that countries with such high debt levels are extremely vulnerable to even otherwise small shocks and to financial crises.

If policies followed in the last five years were to continue in the medium term, public debt would rise to extreme levels and endanger macroeconomic stability (Table 2.10.). If current policies are measured by their current primary fiscal balance, debt in all countries except Dominica would remain in the triple-digit range, rising significantly in three of the six countries over the next five years.

Taking Stock: Conclusions and Policy Implications

Most Caribbean countries have a high level of public debt, and today, 14 of the 15 Caribbean countries are among the 30 most indebted emerging market countries in the world. Given the large vulnerabilities emanating from exogenous shocks in the region and high debt, the probability of financial crises has risen. The potential problems faced by governments could be compounded, since social security funds or public commercial banks have typically financed the fiscal deficits in several countries.

Reducing public debt should be a key macroeconomic goal going forward. There are five key elements of efforts to successfully reduce publicdebt to more sustainable levels and help countries achieve their growth potential: fiscal consolidation, prudent debt management strategies, asset sales/privatization, reducing vulnerabilities to exogenous shocks, and growth-enhancing structural reforms. Given the exceptionally high levels of debt in many countries, a combination of these elements is needed.

One of the most important messages derived from this chapter is the need for fiscal consolidation—the average fiscal deficit of more than 5 percent of GDP at the end of 2004 is very high by any standard. Several developments have been noted: average fiscal performance in every country, except Jamaica, deteriorated in 1998–2004, compared with 1991–97; a rise in expenditures, rather than a fall in revenues, was the main cause of the worsening of the fiscal accounts; and, notably, interest payments steadily rose during the latter period, when global interest rates were on a downward trend. Going forward, the scope for sustaining such expansionary fiscal policies is limited because not only have public debts risen rapidly, but also the global financial environment has been turning unfavorable. Moreover, cross-country studies have shown that fiscal consolidation can help raise growth rates by increasing the credibility of economic reform programs, thereby attracting foreign investors and creating room for the private sector to flourish (Gupta and others, 2002; and Baqir, Ramcharan, and Sahay, 2004).

Given the Caribbean region’s high human development indexes and natural tourist attractions, its economic growth potential clearly has not been fully exploited. Some of the key ways in which reforms can help its countries achieve their growth potential or even expand it are to increase labor market flexibility; achieve greater regional cooperation in the economic spheres; create an enabling environment for the private sector—especially the local private sector; and reduce the role of the public sector, including the high levels of employment in the government sector.

Active debt management can help lengthen maturities of debt and reduce the overall cost of servicing the debt. Many countries are already involved in active debt management. Dominica, Dominican Republic, and Grenada have embarked on a debt restructuring strategy that involves both official and private sectors, while a few others have approached their creditors for debt relief. Guyana’s official debt was cancelled recently. Debt restructuring and debt forgiveness are, however, typically one-time events that follow a series of large exogenous shocks or recurrent policy slippages. Many other countries (such as St. Kitts and Nevis and St. Lucia) are lengthening the maturities and reducing the average interest costs of their debts by replacing high-interest-bearing and short-term debt with lower-interest-bearing and long-term debt. The room for such active debt management, however, will remain limited, especially as global interest rates rise.

The scope for raising revenues and retiring debt stock through asset sales and privatization varies widely across countries, but these steps cannot be relied upon to produce large reductions in debt. There are three lessons from previous asset sales/privatization experiences of other developing, market-based economies. First, privatization receipts in general have been disappointingly low, rarely exceeding 5 percent of GDP in a year. Second, to maximize revenues, privatization schemes need to be carefully planned and distress sales should be avoided. Third, the privatization process should be transparent to ensure that the process is conducted fairly.

The Caribbean region is highly vulnerable to adverse exogenous shocks. Natural disasters are common—hurricanes, floods, and crop disease have been known to disrupt lives and fiscal planning only too often. Indeed, the huge losses inflicted by Hurricane Ivan in Grenada in September 2004 pushed the authorities to approach their creditors in October 2004 for debt relief. Disaster mitigation and management capacities are still relatively weak and need to be strengthened (see also Chapters 7 and 8).

In addition, the Caribbean region is highly susceptible to the external global environment, such as the threat of terrorist attacks, global slowdowns in growth, rising interest rates, and petroleum price hikes. Countries also need to adjust to the anticipated and continuing shock of the erosion of the preferential access of their traditional agricultural commodities to industrial countries.

Vulnerability to external shocks is compounded by existing domestic vulnerabilities, which include weaknesses in financial systems, very high debt, large fiscal deficits, and the combination of a fixed exchange rate regime and high debt. Financial sector weaknesses include large holdings of government paper by public pension systems and domestic banks, poor-quality loan portfolios, and weak financial sector regulation and supervision. The recent crisis in the Dominican Republic revealed only too painfully how a relatively well-performing country can face a crisis because of weaknesses in its financial sector. The earlier banking crisis in Jamaica had a similarly disruptive effect on the economic reform strategy. The Asian crises of the 1990s and the crises in Jamaica and Argentina showed that countries with fixed exchange rate regimes, large fiscal deficits, and very high debts are particularly vulnerable to currency attacks. There are at least two lessons to be learned from other countries’ experiences with financial crises. First, addressing domestic vulnerabilities ex ante will go a long way toward preventing crises and avoiding the devastating effects of financial crises. Second, financial crisis-management capacity should be built up so the country can respond effectively in the event a crisis cannot be avoided.

In conclusion, the Caribbean region has the natural and human resources to grow more rapidly and to further raise its already high standard of living. Given the existing economic weaknesses in most countries, decisive policy actions on several fronts are needed now if the Caribbean is to achieve its economic potential.

Appendix 2.1. Regional Groupings
Eastern Caribbean Currency Union
Antigua and Barbuda
Dominica
Grenada
St. Kitts and Nevis St. Lucia
St. Vincent and the Grenadines
Carribean
Antigua and BarbudaGrenadaSt. Vincent and the
Bahamas, TheGuyanaGrenadines
BarbadosJamaicaSuriname
BelizeHaitiTrinidad and Tobago
DominicaSt. Kitts and Nevis
Dominican RepublicSt. Lucia
Latin America and the Caribbean
Antigua and BarbudaEcuadorParaguay
ArgentinaEl SalvadorPeru
Bahamas, TheGrenadaSt. Kitts and Nevis
BarbadosGuatemalaSt. Lucia
BelizeGuyanaSt. Vincent and the
BoliviaHaitiGrenadines
BrazilHondurasSuriname
ChileJamaicaTrinidad and Tobago
ColombiaMexicoUruguay
Costa RicaNetherl and s AntillesVenezuela
DominicaNicaragua
Dominican RepublicPanama
Small Island States
Antigua and BarbudaGuinea-BissauSeychelles
Bahamas, TheGuyanaSolomon Islands
BarbadosHaitiSt. Kitts and Nevis
BelizeJamaicaSt. Lucia
Cape VerdeKiribatiSt. Vincent and the
ComorosMaldivesGrenadines
CyprusMaltaSuriname
DominicaMauritiusTonga
Dominican RepublicPapua New GuineaTrinidad and Tobago
FijiSamoaVanuatu
GrenadaSão Tomé and Príncipe
Emerging Asia
BangladeshLao PDRSamoa
BhutanMalaysiaSolomon Islands
CambodiaMaldivesSri Lanka
ChinaMyanmarThail and
FijiNepalTonga
IndiaPakistanVanuatu
IndonesiaPapua New GuineaVietnam
KiribatiPhilippines
Appendix 2.2. Accounting For Public Sector Debt

Equation (1) describes the accumulation of public sector debt, with variables measured in foreign currency. (For the calculations, the U.S. dollar is used as the foreign currency. Below we use foreign currency and U.S. dollar interchangeably.) Ft and Dt are, respectively, foreign and domestic public debt at the beginning of period t, with the latter denominated in domestic currency. St+1 is the nominal exchange rate at the beginning of period t + 1 measured in units of foreign currency per unit of domestic currency. GBALt is the government’s primary fiscal balance during period t, while GRANTSt represents the grant component of government revenue, which can be used to finance deficits without creating new debt. The interest rate on domestic-currency-denominated debt is denoted by it, while rt denotes the interest rate on foreign-currency-denominated debt. Finally, EVTt (event) represents any event that does not appear in the fiscal accounts but modifies the public debt at time t:21

In equation (2), this study expresses variables in equation (1) as shares of GDP. Let Zt denote the country’s GDP in U.S. dollars. Thus, Zt=Yt*Pt, where Yt is the real GDP and Pt is the U.S. dollar price index. Dividing both sides of equation (1) by Zt and rearranging terms, we obtain equation (2), where

is the public-debt-to-GDP ratio at the beginning of period is the public-debt-to-GDP ratio at the beginning of period t + 1, and gbalt, grantst, and evtt are, respectively, the primary balance (excluding grants), grants, and value of “events” as shares of GDP. Ŷt and Pt^ denote, respectively, the percent change of real output and of U.S. dollar-denominates prices.22 Finally, rt¯(1at)it+atrt+(1at)(1+it)St is the U.S. dollar interest rate, with α denoting the share of foreign-currency debt in the total of public debt. Notice that the last term of the formula captures the change in the value of domestic currency debt due to changes in the nominal exchange rate—the “price effect:”

Two features of equation (2) are worth noting. First, in this study, we have chosen to work with a U.S. dollar interest rate instead of a real interest rate. This was done to facilitate a comparison across countries, given that changes in real exchange rates tend to produce large swings in ex-post real interest rates, and this complicates the accounting. This does not affect the analysis, since U.S. dollar inflation was low and stable during the period under analysis. Second, we separate the grants component of the primary balance (which is not a policy variable) from the nongrants component (which is a policy variable).

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    United Nations Development Program (UNDP), 2004, “Human Development Index,”in Human Development Report 2004(New York: UNDP).

    United Nations Development Program (UNDP), 2005, “Human Development Index,”in Human Development Report 2005(New York: UNDP).

Countries included in each regional grouping in Figure 2.1 are listed in Appendix 2.1.. The average numbers presented in Figure 2.1 are simple arithmetic means, so as to give equal weight to each country, irrespective of the population or size of the GDP.

Within the Caribbean, the countries in the Eastern Caribbean Currency Union (ECCU) grew at a much higher rate of 4 percent, comparable to the average of all developing countries. However, this relatively high number reflects the high growth rates in the 1980s; since the 1990s, growth has decelerated sharply.

Suriname has multiple exchange rates.

See Ghosh and others (2003) for similar evidence in other developing countries.

However, Tornell and Velasco (2000) show that, contrary to conventional wisdom, fixed exchange rate regimes may not foster greater fiscal discipline, owing to the scope for postponing costs of fiscal overspending to the future under fixed exchange rates, which is not possible under flexible regimes. See Chapter 3 of this volume for an empirical assessment of this argument for Caribbean countries.

The ranking was based on the ratio of total public debt to GDP in 2004, the absolute change in the public debt ratio from 1990–97 to 1998–2004, average overall fiscal balance (as a share of GDP) over 1998–2004, absolute change in overall fiscal balance (as a share of GDP) from 1990–97 to 1998–2004, average consumer price index (CPI) inflation during 1998–2004, absolute change in CPI inflation from 1990–97 to 1998–2004, average real GDP growth in 1998–2004, and absolute change in real GDP growth from 1990–97 to 1998–2004. Countries are ranked from 1 to 15 in each category, with the best performer receiving the highest score. The scores are then aggregated for each country, with the same weight given to each indicator of macroeconomic performance. Finally, the aggregate scores are normalized so that the scores for all countries range from 1 to 100.

Haiti is excluded from this comparison because data on public debt in the initial subperiod are not available.

However, active debt management can reduce debt service or interest costs—for example, by lengthening the maturity and contracting new debt at lower interest rates.

Strictly speaking, we should exclude Guyana and Haiti from this list because these two countries do not have access to private capital markets and would not be considered emerging market countries.

Since data on primary balances in Haiti are not available, it is excluded from Table 2.4.

The Dominican Republic’s painful experience, involving a more than doubling of public sector debt following the government bailout of the banking sector in August 2003, indicates that ensuring low public debt alone is not sufficient to avoid crises—weaknesses in the banking sector need to be independently addressed.

Dominica, the Dominican Republic, and Suriname are italicized in Table 2.4 to indicate that their relative positions have changed over time.

Even though the public-debt-to-GDP ratio is very high in Guyana, it is a special case because Guyana is receiving debt relief under the Heavily Indebted Poor Countries (HIPC) Initiative. Barbados, although not included, has a high debt level of 86 percent of GDP.

A more extensive discussion of the economic issues in the Eastern Caribbean Currency Union countries is available in IMF (2004 and 2005).

See Helbling, Mody, and Sahay (2004) for a detailed discussion on the debt accounting exercise.

The increase in the interest payments component has to do both with an increase in interest rates and with a higher public-debt-to-GDP ratio. The latter is partly related to a major bailout of domestic financial institutions in 1996–97, which generated substantial fiscal costs in subsequent years. The low value of the interest payments component in the first subperiod is the result of the substantial decline in the U.S. dollar value of domestic currency debt in 1991 as a consequence of the large depreciation of the Jamaican currency that occurred that year.

Antigua and Barbuda’s debt was, in part, restructured and reduced, while arrears have been incurred on most public sector debt.

Alternatively, an improvement in global economic conditions would positively impact both world interest rates and Caribbean growth rates.

Grenada is also a banana producer, although over time it has successfully diversified away from this activity.

While the target debt ratio could be higher or lower than 60 percent of GDP and acceptable levels do depend on the specific circumstances of each country (Reinhart, Rogoff, and Savastano, 2003), the ECCU countries set this goal in 1998 for themselves, as did the European Union countries in the context of setting their convergence criteria.

Several such events can be identified. Antigua and Barbuda reduced its debt by more than 13 percent of GDP in 1998 by negotiating with its creditors on reducing its arrears. In Belize, previously unaccounted debt became publicly guaranteed during privatization of the electricity and water companies (1999–2002). The government in Grenada borrowed more than 10 percent of GDP in 2002 to terminate lease arrangements that had not been previously included as debt. In Jamaica, public contingent liabilities were recognized over time, and public enterprises in St. Kitts and Nevis increased their debt by nearly 9 percent of GDP in 1997.

Changes in domestic prices when measured in U.S. dollars can occur either because domestic prices change relative to foreign prices (i.e., changes in the real exchange rate) or due to inflation of U.S. dollar-denominated prices (in this case both foreign and domestic prices change at the same rate). The second effect is usually larger in absolute value than the first effect, but it is also more stable. On the other h and, the first effect, although in general small in absolute value, may have large swings, especially in periods of crisis due to the changes real exchange rates exhibit during those times.

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