Abstract

Countries in the Caribbean have undertaken fiscal consolidation at various times with the primary objective of putting the debt-to-GDP ratio on a sustainable downward trajectory. Yet public debt levels in most of these countries remain high today, suggesting that past and ongoing fiscal consolidation efforts have not yielded durable benefits. Some questions immediately come to mind. Why are public debts levels not falling as one would expect? Would it be connected with the Caribbean approach to fiscal consolidation, country-specific circumstances, or some challenges unique to the region? What are the characteristics of fiscal consolidation in the region, and how different are they from the experiences around the world?

Countries in the Caribbean have undertaken fiscal consolidation at various times with the primary objective of putting the debt-to-GDP ratio on a sustainable downward trajectory. Yet public debt levels in most of these countries remain high today, suggesting that past and ongoing fiscal consolidation efforts have not yielded durable benefits. Some questions immediately come to mind. Why are public debts levels not falling as one would expect? Would it be connected with the Caribbean approach to fiscal consolidation, country-specific circumstances, or some challenges unique to the region? What are the characteristics of fiscal consolidation in the region, and how different are they from the experiences around the world?

This chapter takes a broad look at the Caribbean experience with fiscal consolidation, covering a sample of 14 countries, including six in a currency union, over three decades, 1980–2011.1 The aim is to provide useful insights into the nature of fiscal consolidation across the region and their possible implications for policy. In addition, the chapter assesses current fiscal consolidation efforts in the region with case studies of Barbados, Jamaica, and St. Kitts and Nevis. Further, it identifies a number of challenges to successful consolidation.

The analysis provides ample evidence of fiscal consolidation in the region, although the durations have generally been short, about a year on average, perhaps reflecting the difficulty in sustaining fiscal efforts. Concerning debt reduction, the success rate has been substantially higher, on average, than the consolidation rate, suggesting that it would be desirable for the authorities to engage in more fiscal consolidation as they tend to be successful nearly half the time. The findings also show that consolidation has been more successful in commodity-exporting countries than in tourism-intensive economies.2 The common challenges to fiscal consolidation include the already high debt, fiscal rigidity, high exposure to global economic conditions, and natural disasters.

The chapter begins by defining fiscal consolidation to identify consolidation episodes in the region. It then analyzes the features of those episodes and examines current consolidation efforts as well. Following that analysis, it extends the discussion to selected countries—Barbados, Jamaica, and St. Kitts and Nevis. Lastly, the chapter lays out the challenges to fiscal consolidation and offers a summary with some concluding observations.

Defining and Identifying Fiscal Consolidation3

The standard approach is to relate fiscal consolidation to a specific improvement in the cyclically adjusted primary balance (CAPB) as a percentage of potential GDP over a specific period. Nevertheless, the definitions of fiscal consolidation in the literature vary, partly reflecting different study objectives (Box 7.1). We adopt the following definition:

  • Fiscal consolidation is said to occur when the ratio of CAPB to potential GDP improves by at least one percentage point in one year, or over two consecutive years.

  • A consolidation episode continues as long as the CAPB improves, and it terminates if the change in the CAPB becomes zero or negative.

  • Fiscal consolidation is successful if after four years, the debt-to-GDP ratio drops 5 percentage points below its level prior to the start of consolidation.4

  • The size of a fiscal consolidation refers to the improvement in the CAPB in a year or over the course of an episode.

Features of Fiscal Consolidation in the Caribbean

On average, the likelihood of fiscal consolidation occurring appears moderate, and consolidation tends to succeed nearly half of the time. In 352 observations, the study identified 107 cases of fiscal consolidation, which represents 30.4 percent of the sample (Table 7.1). Of these 107 cases, 51 of them, about 47 percent, were successful. This suggests that, on average, the likelihood of fiscal consolidation occurring in the Caribbean would appear moderate, but the chance of success is much higher.5

Table 7.1

Fiscal Consolidation in the Caribbean, 1980–2011

article image
Source: Authors’ calculations.

Defining a Fiscal Consolidation Episode: Alternative Views from the Literature

There is no standard definition of fiscal consolidation. Reflecting a change in the underlying fiscal stance, fiscal consolidation is commonly defined as a specific improvement in the ratio of the cyclically adjusted primary balance (CAPB) to potential GDP (Alesina, Ardagna, and Gali, 1998; Larch and Turrini, 2011; and Alesina, Carloni, and Lecce, 2012). An alternative measure relates to changes in the ratio of the primary balance to GDP (Lambertini and Tavares, 2005; and Tsibouris and others, 2006). In addition to that last measure, Tsibouris and others (2006) consider changes in the ratio of the primary balance to government expenditure. Giavazzi, Jappelli, and Pagano (2000), defined consolidation as a persistent improvement in the fiscal impulse.

An episode is deemed to occur when the improvement in the CAPB or a related measure falls within a specified threshold. Studies of large fiscal adjustments impose tighter conditions and require an improvement of the CAPB or other measures by at least 1.5 percentage points in a year or in two consecutive years (Barrios, Langedijk, and Pench, 2010; Biggs, Hasset, and Jensen, 2010; Alesina, Carloni, and Lecce, 2012; and Larch and Turrini, 2011). Alternatively, the more gradual approaches consider an improvement of at least 1 percentage point (Ahrend, Catte, and Price, 2006; Kumar, Leigh, and Plekhanov, 2007) or by at least 1.25 percentage points (Von Hagen, Hallett, and Strauch, 2002). Generally, the episode continues as long as the measure of fiscal consolidation improves.

To assess the success of fiscal consolidation, alternative approaches have been adopted, including using the primary balance, debt, and growth as criteria. The primary balance approach aims to safeguard fiscal consolidation by requiring that the improvement in the CAPB, or in the primary balance a few years after the event, remains within a given threshold (Larch and Turrini, 2011; Lambertini and Tavares, 2005). This criterion excludes as successful a consolidation not arising from fiscal efforts. The debt approach, which is commonly applied, considers fiscal consolidation as a necessary condition for debt reduction and therefore ties success to the reduction in the debt-to-GDP ratio of some 5 percentage points over a three- to five-year period. In this context, a very successful fiscal consolidation is one that reduces debt over a three-year period. A third approach, also referred to as the expansionary criterion, proposes that GDP growth should improve after a consolidation (Hernandez de Cos and Moral-Benito, 2012; and Giudice, Turrini, and in’t Veld, 2007).

Although the frequency of fiscal consolidation in the region has consistently declined over time, the experience has been broadly comparable to what findings show for consolidations in advanced countries.6 The consolidation rate in the region declined from 38 percent in 1980–89 to 28 percent in 2000–11 (Figure 7.1). Similarly, the success rate declined from 50 percent to 45 percent in 2000–11.

Figure 7.1
Figure 7.1

Episodes of Fiscal Consolidation: Success Rates and Distribution by Decade, Caribbean Region, 1980–2011

(Percent)

Source: Authors’ calculations.

Focusing on large adjustments (1.5 percent improvement in the CAPB) outside the Caribbean region, findings by Larch and Turrini (2011) indicate a consolidation rate of about 25 percent and a success rate of 33 percent in 27 EU member countries. In a sample of 19 Organization for Economic Co-operation and Development (OECD) member countries, Alesina, Carloni, and Lecce (2012) find a 45.5 percent consolidation rate for any improvement in the fiscal position, and a 9 percent rate for large adjustments.7

The rate of consolidation differs significantly across countries. Notably, the pattern of consolidation in tourism-intensive economies is similar to the pattern of the overall sample, declining consistently over time (Figure 7.2). The commodity-exporting economies exhibited a somewhat different pattern, with fiscal consolidation picking up in 2000–2011 (Figure 7.3). In particular, The Bahamas and the Dominican Republic have the lowest rates of consolidation, 20.9 percent and 21.8 percent, respectively (Figure 7.4). The rate is high for Antigua and Barbuda at 40 percent; Dominica, 38.5 percent; Grenada, 36.4 percent; and Belize, 34.3 percent. The prevailing economic conditions in each country, which indicate the need for fiscal adjustment, would account for the differences in the rates.

Figure 7.2
Figure 7.2

Consolidation Success Rates and Distribution by Decade, Caribbean Tourism-Intensive Economies, 1980–2011

(Percent)

Source: Authors’ calculations.
Figure 7.3
Figure 7.3

Consolidation Success Rates and Distribution by Decade, Caribbean Commodity-Exporting Economies, 1980–2011

(Percent)

Source: Authors’ calculations.
Figure 7.4
Figure 7.4

Rates of Consolidation and Success by Country, 1980–2011

Source: Authors’ calculations.

The success rates indicate mixed performances. The success rate of fiscal consolidation in the tourism-intensive economies has declined consistently over time. On average, the rate is about 5 percentage points below the average of the overall sample over the period. In contrast, the commodity-exporting economies have substantially higher success rates, exceeding the overall sample average by about 22 percentage points.

Available data further suggest that consolidation efforts have not been successful in St. Lucia, while four other countries also recorded low success rates, including The Bahamas at 20 percent, Barbados at 25 percent, Dominica at 40 percent, and Grenada at 37.5 percent. The historically low public-debt-to-GDP ratios of The Bahamas and St. Lucia could explain why fiscal consolidation as defined in the study failed to achieve significant debt reductions in those countries.

The size of fiscal consolidations is substantial but it is falling over time. Slightly more than half of the fiscal consolidation episodes recorded improvement in the CAPB in excess of 2 percent of GDP in a year during the full sample period. However, perhaps reflecting a waning appetite for consolidation, a similar sized adjustment occurred in about half of the episodes in 2000–11, as compared with 55 percent and 68 percent in 1990–99 and 1980–89, respectively (Figure 7.5). Notably, large adjustments occurred regularly in Jamaica, St. Lucia, and Suriname, and occasionally in other countries. Relative to previous findings, Tsibouris and others (2006) identified 300 episodes of fiscal adjustment exceeding 5 percent of GDP. In two-thirds of the consolidation cases identified by Larch and Turrini (2011), the CAPB improved by 1.5 percentage points.

Figure 7.5
Figure 7.5

Distribution of Consolidation Episodes by Size and Decade, Caribbean Region, 1980–2011

(Percent)

Source: Authors’ calculations.Note: ΔCAPB = change in the cyclically adjusted primary balance.

Successful fiscal consolidations are not necessarily associated with large adjustments in the year in which they occured. In some cases, the improvement in the CAPB was relatively moderate, while in others they were quite substantial. However, in many of the successful cases, the CAPB improved significantly preceding the year of success. For example, Barbados achieved a 5 percentage point debt reduction in 1994 by improving the CAPB by 1.1 percentage points that year. However, before this episode, in 1991–92, the country had recorded a higher improvement in the CAPB without significantly reducing the debt.

The adjustment duration is short, perhaps reflecting the difficulty in sustaining fiscal efforts (Figure 7.6). Half of the episodes lasted for a year, while about two-fifths lasted for two to three years. In particular, fiscal consolidation was predominantly of one to two years’ duration in Antigua and Barbuda, Dominica, Guyana, and St. Lucia. It was between one and three years’ duration in Barbados, Belize, the Dominican Republic, and Grenada. The episodes were of two to three years’ duration in Jamaica, while in The Bahamas and Suriname they lasted one year and three years, respectively. Three countries had consolidation spells that lasted for four years: St. Kitts and Nevis (2003–2006), St. Vincent and the Grenadines (1993–1996 and 1998–2011), and Trinidad and Tobago (1999–2002). Over the longer episodes, the improvement in the fiscal position was much larger, reflecting the persistence of fiscal efforts. Figure 7.7 illustrates these varying durations alongside the frequency of episodes of each country.

Figure 7.6
Figure 7.6

Distribution of Episodes by Duration, Caribbean Region, 1980–2011

Source: Authors’ calculations.
Figure 7.7
Figure 7.7

Duration and Frequency of Episodes by Country, 1980–2011

Source: Authors’ calculations.

The adjustment duration in the Caribbean region has been consistent with the experience in advanced countries. Tsibouris and others (2006), in a global sample of over 165 countries, find diversity in both the length and the pace of fiscal adjustments, noting that two-thirds of the adjustments were concentrated in the first year. Findings by Alesina and Ardagna (2009) from a panel of OECD countries show that 65 of 107 episodes (about 60 percent) lasted for one year, 13 lasted for two years, 4 lasted for three years, and only one lasted for four years.

Current Efforts in the Region

Fiscal consolidation efforts in the Caribbean have been slow and steady. A number of countries have embarked on consolidation with the objectives of putting the debt-to-GDP ratio on a sustainable downward path and improving external stability. Recently, the emphasis has been on maintaining social stability and mitigating the impact of the global financial crisis.

These countries have adopted various tax and expenditure measures to reduce their fiscal deficits. While there is little ambiguity about the fact that they need to move swiftly to lower debt, answers to questions about how much of the adjustment should come from spending cuts or tax increases and which areas of government activity they should tackle will depend on country-specific circumstances.

In most of the region, the emphasis has been on raising revenues as opposed to making spending cuts. However, in countries with IMF-supported programs, expenditure controls have been an important aspect of the strategy, as well as reducing losses in public enterprises. In a small number of countries where spending has been restrained, countries have preferred to reduce capital spending rather than current spending.

Even though these consolidation efforts are ongoing, countries are generating much lower primary fiscal surpluses than they need to reduce their debt-to-GDP ratios. Examining the current high debt levels and fiscal prospects, we identified the fiscal adjustment needed (defined as debt stabilizing primary balance minus actual primary balance) to stabilize and reduce debt in the medium term. We found that when debt levels are high, large primary surpluses must be run to reduce the debt stock. The magnitude of the primary surpluses needed increases with interest rates and the initial debt stock, but it varies inversely with real GDP growth.

Our debt sustainability analysis suggests that stabilizing public-debt-to-GDP ratios at 2011 levels would require fiscal adjustment efforts ranging from 1.6 percent of GDP (for Barbados) to 6.0 percent (for St. Lucia) (see Chapter 6). For the average Caribbean country, the adjustment would be around 1 percent of GDP. If the adjustments were to come mainly from spending cuts, this would translate into large real spending cuts for a number of countries. Reducing public debt ratios to 60 percent of GDP by 2020 would require even stronger fiscal adjustments.

Fiscal consolidation in the Caribbean has been accompanied by debt restructuring in some countries, including Antigua and Barbuda, Belize, Jamaica, and St. Kitts and Nevis. These countries recognized that fiscal adjustment alone could not ensure debt sustainability unless accompanied by a meaningful reduction in the public debt service burden, requiring burden sharing by all stakeholders. Antigua and Barbuda reached an agreement with the Paris Club in September 2010 on the rescheduling of the country’s public external debt. The goal of its debt restructuring was to reduce the government’s interest bill to 4½ percent of GDP in 2010, from 9 percent of GDP. St. Kitts and Nevis undertook a comprehensive and substantive public debt restructuring. Overall, its debt restructuring was expected to yield substantial interest savings to help put public debt on a firm downward trajectory over the medium term. Similarly, early in 2013, Belize and Jamaica had debt restructurings. Of note, Belize’s exchange of its “super-bond” for new U.S. dollar-denominated bonds is also expected to bring in substantial cashflow relief.

Efforts in Select Caribbean Countries

This section reviews recent fiscal consolidation efforts in Barbados, Jamaica, and St. Kitts and Nevis and draws common lessons from their experiences. Following the global financial crisis and the resulting huge increase in the debt-to-GDP ratio, these three countries started consolidating government finances in order to reduce public debt and enhance external sustainability.

A look at their fiscal consolidation experiences reveals three commonalities: (1) a holistic approach, (2) quick implementation of short-term measures, and (3) steady progress on structural reforms. Fiscal consolidation efforts in these countries involved a holistic approach that considered all possible improvements in revenue and expenditure reduction that could help deliver the expected results.

Since multipronged consolidation efforts often take some time to materialize, quick implementation of short-term measures, such as a temporary freeze of public wages and a temporary increase of a tax rate, have been helpful in showing governments’ commitments and in creating some instant fiscal space. These countries have also made steady progress on structural reforms, which is important to successful fiscal consolidation. However, weak tax administration and debt management capacities, vulnerability to spillovers from the global economy and to natural disasters, and optimistic assumptions in fiscal consolidation plans have all continued to slow the pace of fiscal reforms in these countries.

Barbados

Barbados was severely affected by the global economic crisis, the impact of which continues to be felt throughout its economy. Economic activity contracted by a cumulative 5 percent between 2008 and 2010 with adverse impacts on the labor market. The unemployment rate almost doubled from 6.7 percent to 12.1 percent in June 2011. The government responded to the economic slump by increasing current spending to limit employment losses and shield vulnerable groups. These efforts widened the fiscal deficit and have increased public debt by more than 20 percentage points of GDP since 2008, exacerbating an already high debt level (Figure 7.8). In light of the deteriorating public finances, the government developed a Medium-Term Fiscal Strategy (MTFS) in early 2010 to reduce the fiscal deficit, balance the budget and reduce the debt-to-GDP ratio. However, the MTFS went off track in the first year of implementation due to weak global conditions and low revenues.

Figure 7.8
Figure 7.8

Barbados: Fiscal Deficit and General Government Debt, 2003–12

(Percent of GDP)

Source: Authors’ calculations.

Fiscal consolidation in Barbados began with a front-loaded adjustment based on revenue enhancing measures. The government increased the value added tax (VAT) rate from 15 percent to 17.5 percent for a period of 18 months and increased excise taxes on gasoline by 50 percent. Tax-free allowances for travel and entertainment were eliminated, bus fares were raised, and some fees and charges for dispensary services were adjusted.

The government also enumerated a number of expenditure reduction measures, but political economy considerations have made their implementation very difficult. The expenditure measures outlined in the MTFS include these:

  • Containing public sector wages by restricting wage growth to be equivalent to the amount normally paid as increments,

  • Reducing the level of spending on goods and services by increasing the efficiency of public procurement through better sourcing, and

  • Capping transfers to statutory boards, statutory corporations and state-owned enterprises and allowing some state-owned enterprises to borrow directly from the National Insurance Scheme.

Progress on lowering expenditures has been slow, and the 2012–13 budget contained no expenditure-cutting measures since expenditures were projected to broadly remain unchanged as a percent of GDP. The IMF has advised the authorities to discourage direct lending by the National Insurance Scheme to public enterprises.

Fiscal consolidation has helped improve Barbados’ fiscal performance. The central government deficit in fiscal year 2011–12 narrowed to 4.5 percent of GDP from 8.3 percent of GDP in 2010–11. This outturn reflected the cuts in capital spending and lower transfers to state-owned enterprises, as a large sum (1½ percent of GDP) was taken off-budget and replaced by loans from the National Insurance Scheme directly to those enterprises. The 2012–13 budget targeted a central government deficit of 4.3 percent of GDP, but high expenditure during the 2012–13 election cycle meant that the target was missed by a wide margin.

With the country’s public debt on an unsustainable path, the IMF has advised the authorities to make MTFS more ambitious and, at a minimum, to aim at reducing the public debt by about 15 percentage points of GDP over 5 years. Debt sustainability analysis suggests that the envisaged fiscal target under the MTFS would not be enough to reduce the vulnerability of public debt. Public debt would not follow a sustained downward path under most standardized shocks unless a more ambitious fiscal consolidation plan is implemented to reduce debt further in the medium-to-long term. The IMF has also stressed the need for MTFS to cover state enterprises and to be based on realistic macroeconomic assumptions. In particular, the current assumption of average GDP growth of around 2.5 percent in the medium term seems on the optimistic side.

The IMF has also recommended focusing fiscal consolidation on expenditure reduction, with revenue measures focusing on improving tax administration and reducing exemptions. Since room for further tax increases is limited, measures to contain wage spending and reduce transfers to public enterprises need to remain key elements of the MTFS. The IMF has also recommended extending the temporary increase in the VAT rate, which the authorities have implemented, and developing a plan to reduce tax exemptions estimated at 5.6 percent of GDP in 2011–12.

Jamaica

Jamaica has a history of low growth and high debt. Real GDP growth over the past three decades has been relatively low, perhaps reflecting deep-rooted competitiveness problems, exposure to natural disasters, and macroeconomic risks arising from fiscal and external imbalances. At the same time, public debt, which is very sensitive to exchange rate and interest rate shocks, remains among the highest in the world, at about 138 percent of GDP in 2011–12 (Figure 7.9).

Figure 7.9
Figure 7.9

Jamaica: Real GDP Growth and Public Debt, 2000–11

Source: Authors’ calculations.

The combination of a high interest burden, heavy wage bill, and losses from public enterprises poses further challenges. The country has maintained large primary surpluses, on average, of some 8 percent of GDP to finance the interest bill, which during 2009–10 rose to 17.1 percent of GDP (Figure 7.10). Since the mid-1990s, public sector wages in percent of GDP have fluctuated between 10 and 12.5 percent, as the government is the largest employer of labor.

Figure 7.10
Figure 7.10

Jamaica: Interest Payments, Wage Bill, and Primary Balance, 2000–11

(Fiscal year, percent of GDP)

Source: Authors’ calculations.

In the context of the 2010 Stand-By Arrangement, the government had a domestic debt restructuring in January 2010. The Jamaican Debt Exchange, which covered domestic debt, secured close to 100 percent participation and achieved a net present value (NPV) reduction of 15–20 percent through lower coupon rates. As a result, the public sector interest bill fell to 10 percent in 2011–12 from 17 percent in 2009–10. At the same time, the maturity profile of domestic debt increased from 4.5 to 9.8 years. Positive market reception of the fiscal consolidation embedded in the Jamaican Debt Exchange lowered interest rates. Overall, the exchange could be considered as a temporary alleviation of the debt problem.

However, the planned fiscal consolidation failed to materialize. The 2010 Stand-By Arrangement was broadly on track, initially. However, policy slippages in 2011, especially on the fiscal front, led to program targets being missed by wide margins. The failure of fiscal consolidation reflects higher-than-anticipated public sector wages following a decision to clear the full amount of wage back-payments, lower tax revenues (associated with widespread use of tax incentives and waivers, and weak administration), and delays in the privatization of the loss-making Clarendon Alumina Plant.

Despite progress with structural reforms, more is needed to improve competitiveness and growth. The government has successfully divested from loss-making public enterprises, such as Air Jamaica and the sugar estates; a new fiscal responsibility law was passed in 2010; and a new Tax Administration Jamaica was created, which is functional. Nonetheless, key fiscal reforms have been delayed, including public sector rationalization, tax and pension reforms, a reform of the Central Treasury Management System, and divestment from the Clarendon Alumina Plant, while the new tax administration has yet to address the erosion of the tax base. Furthermore, while interim measures to cap discretionary waivers were introduced in November 2010, a more comprehensive reform to scale back incentives is lacking. The authorities have developed an economic program to address the challenges of low growth, fiscal sustainability, and high debt.

The IMF recommended a prompt and strong up-front fiscal adjustment to put public debt on a clear downward path. The strategy is based on a significantly higher and sustained primary surplus of the central government over the medium-term—7.5 percent of GDP commencing from 2012–13 and rising to 7.9 percent of GDP in 2015–16. The approach should center on high-quality measures supported by domestic ownership and broad national consensus. While the IMF emphasized the importance of early action, it noted that public debt would still remain high, with continued adverse effects on growth even after a sustained fiscal adjustment. The authorities favored a gradual approach, which aims to balance the central government budget and reduce the debt-to-GDP ratio to 100 percent by March 2016. The authorities’ plan proposed a primary surplus of 5.2 percent of GDP in 2012–13, gradually rising to 6.0 percent by 2015–16.

A new government, which came into office in January 2012 following a decisive election victory in December 2011, started tightening fiscal policy in 2012–13. The government introduced a budget for the fiscal year that aimed at raising the central government primary surplus to 6 percent of GDP from 3.2 percent the previous year. A tax package, with full-year effect estimated at 1.6 percent of GDP, was passed during the year. Further, the government strengthened its Fiscal Responsibility Framework, including a sanctions regime for unbudgeted spending. Although fiscal outcomes improved during the year, preliminary IMF staff estimates indicate that the primary surplus (5¼ percent of GDP) fell short of the target due to weaker than anticipated revenues, despite recent improvement in tax collection efforts.

The authorities have developed a comprehensive economic program to address the challenges of low growth, fiscal sustainability, and high debt. The four-year program seeks to avert the immediate crisis risks and create conditions for sustained growth through significant improvement in the fiscal and debt positions. The main pillars of the program are as follows: (1) structural reforms to boost growth and employment; (2) actions to improve price and non-price competitiveness; (3) up-front fiscal adjustment, supported by extensive fiscal reforms; (4) debt reduction, including a debt exchange, to place debt on a sustainable path, while protecting financial stability; and (5) improved social protection programs, with a floor to safeguard social spending. The new reform program focuses on actions to strengthen public financial management, introduce a fiscal rule, reform the tax system, improve the business climate, move toward inflation targeting, and reform the securities dealers sector.

St. Kitts and Nevis

A series of shocks have led to a sizable accumulation of debt in St. Kitts and Nevis over the last decade. Following a succession of hurricanes in the late 1990s, the sharp drop in tourism after the September 11 attacks, and the closure of the loss-making sugar industry, the central government debt quickly increased in the early 2000s from 62 percent of GDP in 2000 to 109 percent of GDP in 2006. Although the outstanding debt in percent of GDP declined in 2007 and 2008, due to a buoyant economy and strengthened tax administration, it strongly increased again in the wake of the global economic crisis in 2008. This led to a fall in tourism and construction resulting from foreign direct investment, which had been driving growth in recent years.

Rising debt service costs have been a challenge for the government. In addition to a high debt level, the increased use of the expensive overdraft facility since 2005, which reflects the government’s limited access to other forms of financing, has exacerbated the heavy debt service burden (Figure 7.11). Interest payments reached their peak at 7.6 percent of GDP in 2006 (Figure 7.12). Although the government successfully reduced the overdraft in 2008, it returned to tapping the overdraft in 2009, responding to the economic slump. High debt service costs, which have taken over 20 percent of total government revenue in recent years, leave little room for maneuver to respond to adverse shocks.

Figure 7.11
Figure 7.11

St. Kitts and Nevis: Fiscal Balance and Outstanding Debt, 2000–11

(Central government, percent of GDP)

Source: Authors’ calculations.
Figure 7.12
Figure 7.12

St. Kitts and Nevis: Outstanding Debt and Interest Payment, 2000–11

(Central government, percent of GDP)

Source: Authors’ calculations.

Faced with increasing fiscal imbalances, the government started to implement a strong fiscal adjustment program in 2010. On the revenue side, it introduced a VAT and implemented a number of tax reforms. Other measures implemented include streamlining import duty exemptions, strengthening the auditing and monitoring of duty-free shops, introducing an environmental levy on new vehicles, restructuring the Housing and Social Development Levy, and increasing electricity tariffs. On the expenditure side, the government froze public wages. The expected benefits from these revenue reforms and expenditure cuts started to materialize in 2011.

In order to achieve fiscal and debt sustainability, the government set up a multipronged reform agenda and requested support under a 36-month IMF program in 2011. The strategy was focused on: (1) achieving ambitious primary fiscal surpluses; (2) lowering the debt service burden; and (3) further strengthening the financial sector. Notwithstanding the fiscal adjustment, it was also agreed that a comprehensive and timely public debt restructuring was crucial for the program to be fully financed and to achieve debt sustainability. Debt restructuring, it was argued, would complement the ongoing fiscal effort, ensuring burden sharing by all stakeholders.

Since the inception of the IMF program in July 2011, the authorities have steadfastly implemented their economic program and begun to achieve positive results. Although the economic outturn has been weaker than projected, the authorities have met all quantitative performance criteria and completed the structural benchmarks of the IMF program. They have also made progress in a comprehensive debt restructuring, including successfully completing the restructuring of bonds and external commercial debt and reaching an agreement on the debt-land swap with domestic creditors and an agreement with their Paris Club creditors. Discussions with other bilateral official creditors are aimed at obtaining comparable terms as those in the Paris Club agreement. Negotiations on debt not covered by the debt-land swap and those held by the Social Security Board are still ongoing.

Although the restructuring of the public debt is expected to place it on a declining trajectory, the debt sustainability analysis indicates that the debt trajectory could be flattened by an adverse growth shock. This highlights the importance of safeguarding the implementation of the program and planning for contingencies on an ongoing basis.

Overall, the whole debt restructuring is anticipated to lead to a sizable reduction in total public debt and to set debt on a sustainable medium-term trajectory, together with the continued strong fiscal consolidation efforts. Going forward, it will be essential to sustain the pace of both fiscal and structural reforms in order to achieve the medium-term fiscal goals, including a debt-to-GDP ratio of 112 percent in 2017, even if the sluggish global environment continues. Ongoing efforts in broadening the tax base are also encouraged to secure additional tax revenue. In addition, it is important to ensure that the debt-for-land swap does not impair the resilience of the domestic financial sector by proceeding with resulting land sales at a swift pace.

Challenges in the Region

Common challenges to fiscal consolidation in the region include high levels of public debt, fiscal rigidity, high exposures to global economic conditions, and natural disasters. Many countries in the Caribbean have high levels of public debt, which put pressure on expenditure by increasing the interest payment burden and could limit their capability of accessing additional financing. Limited flexibility in fiscal adjustment, which is also common, typically stems from a large share of non-discretionary spending (such as wages and interest payments). The region is highly exposed to global economic conditions through tourism and commodity prices and to natural disasters, which pose risks to continuous implementation. Fiscal consolidation is also hindered by the limited scope for significant revenue increases in some countries.

High Debt Levels

The high debt levels of the region make fiscal consolidation very difficult. Interest payments of the central government co-moved with the debt level in the Caribbean, except for the period of debt restructuring in Antigua and Barbuda and Jamaica (see Figure 7.13). For many Caribbean countries, interest payments comprise a significant proportion of total expenditure (Figure 7.14). The high debt level also implies that a substantial fiscal adjustment is needed to consolidate government finances.

Figure 7.13
Figure 7.13

Outstanding Debt and Interest Payments, Caribbean Region, 2000–11

(Central government, percent of GDP)

Source: Authors’ calculations.
Figure 7.14
Figure 7.14

Share of Interest Payments in Total Expenditures, 2011

(Central government, percent)

Source: Authors’ calculations.

Fiscal Rigidities

In many countries in the Caribbean, fiscal expenditures are mostly committed to wages, interest payments, and social security, limiting the flexibility of fiscal adjustment. In order to quantify and compare the degrees of fiscal flexibility across countries and regions, we consider a simple index of fiscal flexibility, defined as the size of government spending that can be characterized as discretionary. We define fiscal flexibility index as:

FFI=(1NDSTGS)*100,

where TGS is total government spending and NDS is nondiscretionary spending, defined as expenditure on wages and salaries, transfers, and interest payments. The maximum value of this index without any correction factor is 100, indicating total fiscal flexibility. We also consider another fiscal flexibility index, controlling for the size of government spending in the country’s economy:

FFI*=FFI*(1+TGSGDP).

This adjusted index evaluates fiscal flexibility according to the size of the government; the larger the government’s size, the more the adjusted index evaluates the country’s fiscal flexibility.

The analysis, illustrated in Figure 7.15, shows that fiscal rigidities are smaller in Latin American countries than in the Caribbean countries, making fiscal adjustment much more difficult in the region. The two flexibility indices just defined consistently show a higher flexibility for Latin American countries. Lower fiscal flexibility in the Caribbean indicates that there is less room available for relatively easy spending reductions.

Figure 7.15
Figure 7.15

Simple Fiscal Flexibility Indices by Country

Source: Authors’ calculations.Note: “Latin” is the simple average of Brazil, Chile, Colombia, Peru, and Uruguay.

The degree of actual rigidity differs across components of the government expenditures, based on historical data. Current expenditure tends to be more rigid than capital expenditure, when revenue growth slows down (see Figure 7.16). Current expenditure as a percentage of total revenues rose in a period of slow revenue growth, meaning that current expenditures were not adjusted along with revenue growth. The rise in current expenditure as a percentage of total revenue was larger during 2009–2011, when the slowdown of revenue growth was more pronounced.

Figure 7.16
Figure 7.16

Caribbean Region: Current and Capital Expenditures, 2000–11

(Percent of revenue)

Source: Authors’ calculations.Note: Years of slow revenue growth are shaded.

Rigidity in current expenditure is accounted for by nondiscretionary expenditures, including transfers, wages and salaries, and interest payments (Figure 7.17). In 2009, all of these expenditures in percent of revenue increased by over 3 percentage points. Transfers and wages and salaries have not returned to their pre-crisis levels. The decline in interest payments in 2010 was due to the large debt restructurings in Antigua and Barbuda and Jamaica. A higher rigidity in current expenditure than in capital expenditure was observed in many countries during the crisis period from 2009 to 2011. Measured as a percent of revenue, current expenditure increased after the crisis in most countries, while capital expenditure in percent of revenue did not follow a similar pattern (see Figures 7.18 and 7.19).

Figure 7.17
Figure 7.17

Caribbean Region: Detailed Items of Current Expenditure, 2000–11

(Percent of revenue)

Source: Authors’ calculations.Note: Years of slow revenue growth are shaded.
Figure 7.18
Figure 7.18

Current Expenditure to Revenue Ratio, 2006–11

(Percent)

Source: Authors’ calculations.Note: ATG = Antigua and Barbuda, BHS = The Bahamas, BRB = Barbados, BLZ = Belize, DMA = Dominica, GRD = Grenada, GUY = Guyana, JAM = Jamaica, KNA = St. Kitts and Nevis, LCA = St. Lucia, VCT = St. Vincent and the Grenadines, SUR = Suriname, and TTO = Trinidad and Tobago.
Figure 7.19
Figure 7.19

Capital Expenditure to Revenue Ratio, 2006–11

(Percent)

Source: Authors’ calculations.Note: ATG = Antigua and Barbuda, BHS = The Bahamas, BRB = Barbados, BLZ = Belize, DMA = Dominica, GRD = Grenada, GUY = Guyana, JAM = Jamaica, KNA = St. Kitts and Nevis, LCA = St. Lucia, VCT = St. Vincent and the Grenadines, SUR = Suriname, and TTO = Trinidad and Tobago.

Transfers were responsible for a greater part of the rigidity in current expenditure during the crisis. Transfers in percent of revenue sizably increased after the crisis in some countries, ranging from about 7 percent in Barbados to 15 percent in Trinidad and Tobago (see Figure 7.20). The rise in transfers in percent of revenue partly reflects countercyclical components, such as unemployment benefits. Wages and salaries in percent of revenue also increased in most countries and accounted for some of the rigidities in current expenditure (see Figure 7.21).

Figure 7.20
Figure 7.20

Transfers to Revenue Ratio, 2006–11

(Percent)

Source: Authors’ calculations.Note: ATG = Antigua and Barbuda, BHS = The Bahamas, BRB = Barbados, BLZ = Belize, DMA = Dominica, GRD = Grenada, GUY = Guyana, JAM = Jamaica, KNA = St. Kitts and Nevis, LCA = St. Lucia, VCT = St. Vincent and the Grenadines, SUR = Suriname, and TTO = Trinidad and Tobago.
Figure 7.21
Figure 7.21

Wages and Salaries to Revenue Ratio, 2006–11

(Percent)

Source: Authors’ calculations.Note: ATG = Antigua and Barbuda, BHS = The Bahamas, BRB = Barbados, BLZ = Belize, DMA = Dominica, GRD = Grenada, GUY = Guyana, JAM = Jamaica, KNA = St. Kitts and Nevis, LCA = St. Lucia, VCT = St. Vincent and the Grenadines, SUR = Suriname, and TTO = Trinidad and Tobago.

Global Economic Conditions

The current weak global growth and high commodity prices raise serious concerns about how Caribbean countries can revamp growth (see Figures 7.22 and 7.23). High commodity prices continue to exert pressure on the fiscal stance and the current account for commodity-importing countries.

Figure 7.22
Figure 7.22

Commodity Prices, 2000–13

(Index: 2005=100)

Source: World Economic Outlook database.
Figure 7.23
Figure 7.23

Economic Growth, 2000–13

(Percent)

Source: World Economic Outlook database.

Limited Scope for Tax Increases

Some countries have very little room for strong fiscal efforts on the revenue side given that tax collections are already very high. Tax collection in Barbados, for instance, amounted to around 26 percent of GDP in 2011 (Figure 7.24).

Figure 7.24
Figure 7.24

Tax Revenue by Country, 2011

(Percent of GDP)

Source: World Economic Outlook database.

Natural Disasters

The Caribbean region is prone to frequent natural disasters, such as hurricanes, tropical storms, and floods, whose social and economic impacts can be catastrophic. Hurricane Omar, which passed St. Kitts and Nevis in 2008, caused flooding in its major tourism resort and destroyed roads and coastal infrastructure. The impact on the tourism receipts in 2009 was estimated at more than 3 percent of GDP. The passage of Hurricane Sandy in 2012 also badly impacted broad economic activities in Jamaica; the hurricane’s total cost there was estimated at more than US$55 million. Natural disasters pose challenges to fiscal consolidation by putting extra pressures on both the revenue side and the expenditure side. Severe disasters are followed by economic slowdowns and necessary reliefs, which reduce tax revenues, and by the rebuilding of damaged infrastructure, which increases expenditures.

Despite these challenges to fiscal consolidation, there is a need to reorient fiscal policy in the region given that debt levels are so high. Unlike in the past, there is currently no fiscal space that can be used to boost economic growth. Rather, countries need to adjust to lower their debt ratios. Fiscal multipliers in the Caribbean are quite low (see Chapter 8), suggesting that any negative impact of fiscal consolidation on growth would be smaller than in other countries. Caribbean countries can learn from successful fiscal consolidations in other regions to guide their current efforts (see Chapter 5).

Summary and Conclusions

This chapter analyzed the fiscal consolidation experiences of 14 countries in the Caribbean region, covering a sample period from 1980 to 2011, with differences in size across countries, due to data availability. It found that relative to the overall sample, the rate of fiscal consolidation in the region is 30 percent, on average, which seems moderate and broadly consistent with findings in advanced countries. The consolidation efforts, as reflected in the consolidation rate and the size of adjustment, appear to have waned over time. However, in terms of achieving a debt-to-GDP reduction of at least 5 percentage points, the success rate is 47 percent, on average. This would suggest that it would be desirable for the authorities to engage in more fiscal consolidation, since they tended to be successful nearly half the time. The analysis also reveals that fiscal consolidations have been more successful in commodity-exporting economies than in tourism-dependent economies.

Although fiscal consolidation in the region has consistently declined over time, the experience is broadly comparable with the findings for advanced countries. Likewise, as in other countries, the duration of fiscal adjustments in the Caribbean is generally short, possibly reflecting the difficulty of sustaining consolidation efforts. Meanwhile, the historically low public-debt-to-GDP ratios in some countries, such as The Bahamas and St. Lucia, could explain why fiscal consolidation, as defined in this chapter failed to achieve significant debt reductions in these countries over the period.

Even though fiscal consolidation efforts are ongoing in the region, these countries are generating much lower primary fiscal surpluses than is needed to reduce the public-debt-to-GDP ratio. Debt sustainability analysis suggests that stabilizing those ratios at 2011 levels would require a fiscal adjustment of around 1 percent of GDP. If the adjustments were to come mainly from spending cuts, this would translate into large real spending cuts for a number of countries. Reducing public debt ratios to 60 percent of GDP by 2020 would require even stronger fiscal adjustments.

Fiscal consolidation in the Caribbean therefore faces a number of challenges: high debt levels, fiscal rigidity, natural disasters, a weak global environment, and the limited scope for high revenue increases in some countries. Despite these challenges, there is a need to reorient fiscal policy in the region given that the debt levels are so high. There is currently no fiscal space that can be used to boost economic growth, however. Rather, the countries will need to adjust to lower their debt ratios. Fiscal multipliers in the Caribbean are quite low, suggesting that any negative impact of fiscal consolidation on growth would be smaller than it would be elsewhere. Caribbean countries can learn from successful fiscal consolidation in other regions to guide their current efforts.

References

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1

The sample includes Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, the Dominican Republic, Grenada, Guyana, Jamaica, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, and Trinidad and Tobago.

2

Tourism-intensive economies include Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, the Dominican Republic, Grenada, Jamaica, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines. Commodity-exporting countries include Guyana, Suriname, and Trinidad and Tobago.

3

For the purpose of duration analysis, multiyear fiscal adjustment will constitute a single episode.

4

The sample includes cases in which the reduction in the debt-to-GDP ratio was reversed.

5

The primary source of data is the World Economic Outlook database. This was supplemented with data compiled by IMF desk economists. The sample size differs across countries, reflecting data availability. The data that are available are primarily from the 1990s. The debt data, most of which cover general government debt, were obtained from the IMF Historical Public Debt Database compiled by the Fiscal Affairs Department.

6

The findings in the literature are not easily comparable because of varying definitions of fiscal consolidation and their successes.

7

In a study by Barrios, Langedijk, and Pench (2010), fiscal consolidation succeeded in only one-third of cases, about 34.5 percent, in 15 EU countries. In another study covering advanced countries, Alesina and Ardagna (2009) identified 107 fiscal consolidation episodes, representing a 15.1 percent consolidation rate, and 17 successful episodes implying a success rate of 15.8 percent.

Tackling Fiscal and Debt Challenges
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    Episodes of Fiscal Consolidation: Success Rates and Distribution by Decade, Caribbean Region, 1980–2011

    (Percent)

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    Consolidation Success Rates and Distribution by Decade, Caribbean Tourism-Intensive Economies, 1980–2011

    (Percent)

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    Consolidation Success Rates and Distribution by Decade, Caribbean Commodity-Exporting Economies, 1980–2011

    (Percent)

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    Rates of Consolidation and Success by Country, 1980–2011

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    Distribution of Consolidation Episodes by Size and Decade, Caribbean Region, 1980–2011

    (Percent)

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    Distribution of Episodes by Duration, Caribbean Region, 1980–2011

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    Duration and Frequency of Episodes by Country, 1980–2011

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    Barbados: Fiscal Deficit and General Government Debt, 2003–12

    (Percent of GDP)

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    Jamaica: Real GDP Growth and Public Debt, 2000–11

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    Jamaica: Interest Payments, Wage Bill, and Primary Balance, 2000–11

    (Fiscal year, percent of GDP)

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    St. Kitts and Nevis: Fiscal Balance and Outstanding Debt, 2000–11

    (Central government, percent of GDP)

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    St. Kitts and Nevis: Outstanding Debt and Interest Payment, 2000–11

    (Central government, percent of GDP)

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    Outstanding Debt and Interest Payments, Caribbean Region, 2000–11

    (Central government, percent of GDP)

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    Share of Interest Payments in Total Expenditures, 2011

    (Central government, percent)

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    Simple Fiscal Flexibility Indices by Country

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    Caribbean Region: Current and Capital Expenditures, 2000–11

    (Percent of revenue)

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    Caribbean Region: Detailed Items of Current Expenditure, 2000–11

    (Percent of revenue)

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    Current Expenditure to Revenue Ratio, 2006–11

    (Percent)

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    Capital Expenditure to Revenue Ratio, 2006–11

    (Percent)

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    Transfers to Revenue Ratio, 2006–11

    (Percent)

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    Wages and Salaries to Revenue Ratio, 2006–11

    (Percent)

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    Commodity Prices, 2000–13

    (Index: 2005=100)

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    Economic Growth, 2000–13

    (Percent)

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    Tax Revenue by Country, 2011

    (Percent of GDP)