Barbados: Staff Report for the 1999 Article IV Consultation

This 1999 Article IV Consultation highlights that since the early 1990s, Barbados has been experiencing steady economic growth founded on prudent economic management and generally favorable external conditions. Economic policy has incorporated fiscal and wage restraint, consistent with the maintenance of the long-standing exchange parity with the U.S. dollar. In 1998, real GDP growth picked up, based on strong performances in the tourism and construction sectors, although a drought led to a decline in sugar output.

Abstract

This 1999 Article IV Consultation highlights that since the early 1990s, Barbados has been experiencing steady economic growth founded on prudent economic management and generally favorable external conditions. Economic policy has incorporated fiscal and wage restraint, consistent with the maintenance of the long-standing exchange parity with the U.S. dollar. In 1998, real GDP growth picked up, based on strong performances in the tourism and construction sectors, although a drought led to a decline in sugar output.

I. Introduction

1. The 1999 Article IV consultation discussions with Barbados were conducted in Bridgetown in early August 1999. The mission met with the Prime Minister (who is also Minister of Finance and Economic Affairs), the Governor of the Central Bank of Barbados (CBB), senior government and CBB officials, and business and labor union representatives.1

2. In concluding the last Article IV consultation on January 30, 1998, Executive Directors commended the authorities for their pursuit of restrained fiscal and incomes policies, the successful introduction of the value-added tax (VAT), and the adoption of new financial legislation. Noting the relatively high costs prevailing in the export sector, the still high unemployment, and the recent weakening of the fiscal position, Directors stressed the need for continued fiscal and wage restraint to help preserve the exchange rate peg, while enhancing external competitiveness by promoting labor market flexibility and accelerating structural reforms.2

3. The Barbados Labour Party (BLP), which has been in office since 1994, won a landslide victory in the January 1999 general elections. During the campaign, the Prime Minister highlighted the need for continuity in economic policy; however, he also promised to reverse an 8 percent cut in public servants’ wage payments that took place in 1991.

4. Barbados publishes monthly and quarterly data on a wide range of areas. However, data on the national accounts, the nonbank financial institutions, the public enterprises, and the external accounts have weaknesses with respect to consistency and timeliness, which may affect the assessment of economic developments and policy formulation.

II. Background and Recent Developments

5. Following a major adjustment effort in support of the exchange rate parity, which had come under pressure in the context of a balance of payments crisis in the early 1990s, Barbados has been experiencing steady economic growth since 1993 founded on prudent economic management and generally favorable external conditions. Economic policy has been based on the authorities’ commitment to fiscal and wage restraint, consistent with the maintenance of the long-standing exchange rate parity with the U.S. dollar. The country relies heavily on tourism, high-cost sugar exports to protected markets and, in recent years, offshore business services.

6. In 1998, real GDP growth picked up to 4.8 percent (Figure 1), while 12-month consumer price inflation fell below 2 percent by year-end (Table 1). Tourism performed very well as long-stay arrivals rose by about 8½ percent. The sugar crop declined by 26 percent because of a severe drought. Manufacturing output grew by 3½ percent, while construction activity grew by 15 percent bolstered by the expansion and refurbishment of hotels and tourist facilities. Offshore business services also expanded strongly as the number of registered offshore companies increased by 16 percent.3 The unemployment rate declined from 12.2 percent at end-1997 to 11.8 percent at end-1998.

Figure 1.
Figure 1.

Barbados: Selected Economic Indicators, 1988-98

Citation: IMF Staff Country Reports 1999, 142; 10.5089/9781451805963.002.A001

Sources: Ministry of Finance; Barbados Statistical Services; and Central Bank of Barbados.
Table 1.

Barbados: Selected Economic and Financial Indicators

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Sources: Barbadian authorities; and Fund staff estimates.

End of period.

Information Notice System; end of period.

Fiscal year (April-March).

In relation to liabilities of the banking system to the private sector at the beginning of the period.

Refers to central government and government guaranteed debt.

7. Despite a 6 percent increase in tourism receipts, the external current account moved from balance in 1997 to a US$9 million (½ percent of GDP) deficit in 1998 as sugar exports contracted (Table 2). Net capital inflows did not fully cover the current account deficit, in part due to the postponement of government’s planned external commercial borrowing because of unsettled international financial market conditions. Consequently, gross international reserves declined to the equivalent of about two and a half months of imports of goods and services. Short-term public debt was equivalent to about a quarter of official gross international reserves and external public debt was equivalent to less than 15 percent of GDP. Barbados’ real effective exchange rate remained basically unchanged during 1998 and through June 1999 (Figure 2).

Table 2.

Barbados: Summary Balance of Payments and External Debt

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Sources: Ministry of Finance; Central Bank of Barbados; Barbados Statistical Service; and Fund staff estimates.

Includes errors and omissions.

Includes central government and government guaranteed debt.

Defined as public debt minus net international reserves.

Figure 2.
Figure 2.

Barbados: Selected Price and Financial Indicators, 1988-98

Citation: IMF Staff Country Reports 1999, 142; 10.5089/9781451805963.002.A001

Sources: Central Bank of Barbados; and IMF Information Notice System.

8. The nonfinancial public sector balance is estimated to have shifted from a small deficit in FY 1997/98 to a small surplus in FY 1998/99 (fiscal years begin in April) (Table 3). The central government deficit remained at about ¾ percent of GDP in FY 1998/99 as higher current spending was broadly offset by a reduction in capital spending (Table 4). The rise in current spending partly reflected the introduction in September 1998 of government-subsidized mortgage facilities and other incentives to encourage home ownership, and increases in pensions. Reflecting administrative improvements, tax collection was buoyant despite a narrowing of the VAT base in October 19974 and a lowering of others taxes announced in September 1998.5 In relation to GDP, the combined deficit of the public enterprises declined reflecting lower capital spending, while the surplus of the National Insurance Scheme (NIS) remained unchanged. The public debt/GDP ratio fell to 43 percent.

Table 3.

Barbados: Summary Operations of the Public Sector 1/

(In percent of GDP at market prices)

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Sources: Minstry of Finance; National Insurance Scheme; and Fund staff estimates.

Fiscal year (April-March).

Includes capital revenue.

Excludes nonrecurrent operations.

Table 4.

Barbados: Summary Operations of the Central Government 1/

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Sources: Ministry of Finance; and Fund staff estimates.

Fiscal year (April-March).

Includes assumption of Barbados Development Bank debt, capitalization of Barbados National Bank, and divestment proceeds.

Includes national insurance contributions.

9. During 1998, monetary aggregates and credit expanded strongly. Broad money grew by 11½ percent, with the share of U.S. dollar denominated deposits in total deposits rising slightly to 13 percent (Tables 5 and 6). Bank net credit to the public sector declined slightly during 1998, while bank credit to the private sector rose sharply. As banks’ liquidity tightened, treasury bill rates rose steadily from a low of 1½ percent in mid-1997 to 5.9 percent in May 1999, but commercial bank interest rates on loans and deposits remained largely unchanged.6 The financial condition of commercial banks improved in 1998 partly reflecting the recapitalization in earlier years and ongoing restructuring of the state-owned Barbados National Bank (BNB), which accounts for 17 percent of total bank assets. At end-1998, commercial banks’ capital represented 11½ percent of total risk weighted assets (similar to a year earlier), while substandard loans had declined to 6¼ percent of total loans (8.7 percent at end-1997).

Table 5.

Barbados: Summary Indicators of the Banking System

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Sources: Central Bank of Barbados; and Fund staff estimates.

In relation to the monetary base at the beginning of the period.

In relation to liabilities to the private sector at the beginning of the period.

Table 6.

Barbados: Indicators of External Vulnerability

(In percent of GDP, unless otherwise indicated)

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Sources: Central Bank of Barbados; and Fund staff estimates.

Central government debt, net of holdings by statutory bodies and National Insurance Scheme.

Average rate of discount (end of period).

T-bill rate adjusted for actual year-on-year inflation.

Reserves exclude CARICOM facility and regional bilateral balances, which are not usable.

Short-term external debt refers to public sector amortization due in the following year (including to the Fund) and central bank short-term liabilities.

Refers to central government and government guaranteed debt.

Refers to public sector interest.

Refers to public sector amortization.

Moody’s.

Refers to data on commercial banks.

10. The authorities continued to implement a prudent incomes policy in 1998. In May 1998 representatives of the government, business, and labor signed a third social pact covering 1998–2000, which maintains productivity-based wage increases (Box 1). Recent wage settlements in the private sector have been on the order of 2 to 5 percent per annum, while public sector wages rose by 6¼ percent in FY 1997/98 and 3 percent in FY 1998/99. Industrial relations have been generally harmonious.

Barbados: Labor Market Issues

Legal framework

Four pieces of legislation provide a legal framework for labor relations in Barbados: (i) the National Insurance and Social Security Act of 1966 instituted the National Insurance Scheme, which insures against unemployment, sickness, employment injury, maternity, and other events; (ii) the Severance Pay Act of 1971, which establishes that all workers are entitled to severance pay after two years of employment, if their job is discontinued for any reason other than voluntary termination or justified dismissal; (iii) the Shops Act of 1989 (revised in June 1997), which establishes a minimum wage for attendants at retail stores; and (iv) a law guaranteeing a four-week paid vacation for all employees.

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Unemployment and Real Wages

Citation: IMF Staff Country Reports 1999, 142; 10.5089/9781451805963.002.A001

The protocols

Since the early 1990s, labor market relations in Barbados have been conducted under the framework of successive economy-wide arrangements or “protocols” among representatives of the government, labor, and business. These protocols were born out of the severe economic problems in 1990–91, with the realization that a restrained incomes policy was necessary in order to maintain the fixed exchange rate parity.

I. The first protocol for the Implementation of a Prices and Incomes Policy covered the period 1993 to 1995 and made provision for an economy wide wage freeze.

II. The second protocol (1995 to 1997) provided for a period of wage restraint in line with productivity changes.

III. The third protocol (1998–2000) maintained productivity guidelines for wage increases, and also emphasized issues of job security and training.

Private and public wages

Unionized labor accounts for 60 percent of the labor force. The government accounts for 20 percent of total employment and its wage settlements have a direct influence on private sector wages. Government wages are set in two-year contracts with the first year settlement generally being larger than the second: this accounts for the jagged pattern of public sector wages in the lower figure. Private sector wage contracts are generally longer and more staggered, resulting in a wage pattern that is close to the cycle of public sector wage changes but is much smoother.

uA01fig02

Public and Private Sector Wages

(Annual percentage change)

Citation: IMF Staff Country Reports 1999, 142; 10.5089/9781451805963.002.A001

Areas of concern

Although the unemployment rate has declined from 24 to 11 percent in early 1999 and labor market flexibility has improved, some areas of concern remain:

The definition of work practices included in labor contracts still imparts a degree of rigidity to the workplace, precluding the optimal allocation of workers across tasks by employers.

A direct link between wage increases and productivity has been established in only some sectors.

The severance payments scheme needs to be reformed to improve coordination with unemployment compensation and retirement benefits.

11. Progress continued on structural reforms with support from the Inter-American Development Bank (IDB).7 In the last few years, there have been reforms in the financial system (including the closure of the state-owned Barbados Development Bank (BDB) and the restructuring of the BNB) and in the tax and trade areas, some restructuring of the financially troubled private sugar industry,8 and divestment of two partially state-owned enterprises. Also, new financial legislation became effective in July 1997 to strengthen prudential regulation and supervision of banks and deposit-taking nonbank financial institutions along the lines of the Basle Accord.9 In agreement with other members of the Caribbean Community (CARICOM), import duties were lowered in April 1998 from 5–25 percent to the agreed final range of 5–20 percent and the special import surcharges that replaced several nontariff barriers in early 1994 were reduced. Anti-money laundering legislation was passed in December 1998.

12. In the first half of 1999, real GDP is estimated to have grown by 2¾ percent (compared with a year earlier), while the unemployment rate fell to 10½ percent in June 1999. Domestic demand expanded strongly as the development of tourism facilities and private consumption responded to a 17 percent increase in credit to the private sector in the year ending June 1999. Also, there was an increase in government employment in the run-up to the general elections in early 1999, which had a negative effect on the public finances. The external current account deficit is widening: the U.S. dollar value of merchandise imports grew by 7 percent in the first half of 1999 (relative to the same period a year earlier), while tourism receipts declined slightly partly reflecting the closing of the two largest hotels for refurbishment and the redirection of some cruise ships to other destinations. Official gross international reserves, nevertheless, rose sharply during the first half of the year (to over three months of imports of goods and services) in large measure because of government borrowing in the regional capital market in April 1999.10 Inflation was down to 0.4 percent during the year ending June 1999.

13. The authorities have taken steps to slow the expansion of domestic demand, including delaying the implementation of certain public investment projects since the latter part of 1998, a 1 percentage point increase in the reserve requirement on bank deposits to 6 percent and an increase in the central bank discount rate from 9 percent to 10 percent in May 1999.11 However, a further boost to domestic demand is likely to come from the impending payment of public sector wage increases retroactive to April 1999.12

III. Policy Discussions

14. The authorities’ economic objectives are to keep inflation low and sustain the growth of output and employment based on service exports, while reducing vulnerabilities as the economy continues to open up and preparing for the aging of the population in the long term. Accordingly, their strategy is to maintain the finances of the nonfinancial public sector near balance in support of the exchange rate peg by taking steps to protect public saving, while carrying out a public sector investment program (PSIP) focused on economic and social infrastructure and environmental protection. The strategy also calls for tightening credit policy by increasing public sector deposits at the central bank to help build the official international reserve cushion and implementing structural reforms covering education, health, the public pension system, the regulation and supervision of utility monopolies and the nonbank financial sector, trade and corporate taxes, and privatization.

15. The authorities’ strategy appears appropriate in the context of Barbados’ ongoing successful transition from an economy based on agricultural exports to preferential markets to one based on service exports, in which it has comparative advantage. Indeed, the prospects for the tourism sector appear good: economic conditions in the main tourism markets remain strong and Barbados is well positioned to continue to sell high-end tourism services. Also, it is likely to continue to have access to substantial long-term external financing for its investment needs in the form of loans from the Inter-American Development Bank (IDB) and the Caribbean Development Bank (CDB), as well as private foreign direct investment.

16. Notwithstanding the favorable medium-term prospects, the economy’s vulnerability to exogenous shocks is a source of concern (Table 6). Although inflation is expected to remain under control, the strong growth of absorption is expected to lead to a widening of the external current account deficit to 2–2½ percent of GDP in 1999, from near balance in 1998. Such a deficit level is not worrisome per se—particularly because it is expected to be financed by long-term capital flows—but its further widening could make Barbados dependent on reversible short-term capital flows and increase the risk to the economy, for instance, from a prolonged tourism slowdown. Thus, the authorities remain committed to public expenditure and wage restraint, and stand ready to take further steps to tighten domestic credit conditions in order to slow the expansion of domestic demand and protect official international reserves.

A. Fiscal Policy

17. Largely reflecting an expected sizable jump in the central government wage bill, the finances of the nonfinancial public sector are projected to shift from a surplus of ¼ percent of GDP in FY 1998/99 to a deficit exceeding ½ percent of GDP in FY 1999/2000. In this context, the mission advised that public sector hiring be frozen immediately, and that payments to compensate for the 1991 public sector wage cut be paid over four years starting in FY 2000/01 so that overall public sector wage increases remain in line with inflation and productivity growth. Also, the authorities were cautioned against undertaking nonpriority capital outlays and introducing measures in the short run that could undermine tax collections (such as, widening ad hoc, sectoral tax incentives or reducing the corporate tax rate). Instead, it was important to take steps to strengthen tax administration further. The authorities noted that new hiring already has been restricted and stressed their continued commitment to implementing a prudent wage policy. In this respect, their intention was to spread the compensation for the 1991 wage reduction over several years, although the final formula would depend on the outcome of the negotiations with labor unions. They stressed that such payments would be subject to income taxes and social security contributions. Also, they indicated their intention to take steps to improve the administration of the property transfer tax, which is being evaded.

18. The authorities intend to keep the overall fiscal deficit near balance in the medium term, consistent with a decline of the public debt/GDP ratio and balance of payments viability. At the same time, they would seek to make room for capital spending and for higher recurrent outlays on maintenance of the physical capital stock and for the expansion of critical services as the economy develops and the population ages. The authorities agreed with the mission that achieving these objectives calls for: (1) the implementation of a cautious wage policy and restraint in public sector hiring; (2) steps to hold down the growth of central government spending through cost recovery measures in the delivery of key public services,13 while maintaining full subsidies in the delivery of these services only for the poorest; (3) a comprehensive reform of the current public pay-as-you-go pension system to secure its long-term solvency and its continued contribution to national saving; and (4) steps to strengthen tax administration.14 The authorities will be seeking financial and technical assistance from the IDB and the World Bank for the design and implementation of reforms and investment projects in these areas.

19. With the aim of reducing production costs and improving competitiveness and the investment environment, in late August 1999 the authorities announced several measures that on balance are expected to weaken the public finances by ½ percent of GDP on an annual basis. These include: (1) the creation of a Commission on Competitiveness to reduce red tape and bureaucratic impediments to investment in Barbados; (2) reductions in taxes on energy products and in seaport rates as part of a program to bring energy and port costs in line with other Caribbean countries; (3) new fiscal incentives for tourism, fishing, and agriculture; (4) replacement of import licenses on a few manufactured items (processed food, detergent, and cotton shirts) by tariffs from April 2000; and (5) measures to improve the collection of property transfer and land taxes.

B. Exchange Rate and Credit Policies

20. The authorities are committed to the maintenance of the exchange rate peg to the U.S. dollar which, together with the implementation of prudent fiscal, credit and incomes policies, has been essential for promoting low inflation and confidence. To help secure the peg, they intend to build the cushion of official international reserve assets, while keeping the external public debt/GDP ratio low and continuing to refrain from undertaking short-term external borrowing. External competitiveness is not a problem at present as the outlook for tourism is positive and private investment in the export sectors is strengthening; unemployment is declining in the context of a manageable external current account deficit that is largely financed by long-term capital inflows (including sizable direct foreign investment); and the real effective exchange rate has remained broadly stable. Nevertheless, the authorities intend to implement a PSIP and structural reforms (discussed below) aimed at strengthening competitiveness and securing the continued export growth in the medium term.

21. Additional actions to tighten domestic credit conditions may be needed to help slow the fast expansion of domestic demand. The authorities felt that the credit tightening measures implemented in May have had limited impact. To tighten credit conditions further, the authorities have begun to move government deposits out of the commercial banks and into the central bank. Also, they are ready to take additional credit tightening measures (such as, placing government debt instruments in the domestic market, with the proceeds sterilized in the central bank) if necessary to ensure that credit expansion slows satisfactorily.15

22. CBB officials highlighted the progress that has been made in improving the efficiency of financial intermediation and the health of the financial system in recent years. Of particular importance has been the closing of the BDB, the capitalization and restructuring of the BNB (whose profitability has been restored in preparation for its privatization next year), and the strengthening of the regulation and supervision of the commercial banks and other deposit taking financial institutions (merchant banks, trust and finance companies) in the context of the Financial Institutions Act, which became operational in July 1997. The authorities now are looking into revising legislation covering offshore financial services to ensure that CBB jurisdiction is consistent with the Core Principles of Banking Supervision; adjusting prudential requirements to increase disincentives to high risk bank loans (e.g., credit card lending); strengthening the regulation and supervision of credit unions and insurance companies; and setting up a securities commission to regulate the commercial paper market, in line with international standards and practices. Although the authorities acknowledged that the minimum deposit rate (which is currently binding on certain deposits) introduces rigidity in interest rate determination, they considered it useful in encouraging financial savings in Barbados.

C. Incomes Policy and Labor Market Issues

23. The authorities, as well as representatives of the labor unions and employers, indicated their strong support for the latest incomes policy arrangement which, if properly implemented, should help protect external competitiveness and maintain strong output and employment growth. In this context, the tripartite National Productivity Council, which is charged with developing and disseminating productivity measurements, should be strengthened as careful attention needs to be paid to productivity changes as a guideline in making wage adjustments at the enterprise level. Technical assistance from the IDB or the World Bank in this area would be highly desirable.

24. Severance pay arrangements, the unemployment insurance scheme and other social contributions are burdensome and adversely affect private investment, external competitiveness, and employment growth. For instance, the duplication of benefits across the unemployment and severance payments schemes lead to high labor costs for employers, while the lack of portability of the latter contributes to labor market rigidity.16 Also, in the private sector total social contributions constitute 17¾ percent of the wage, of which 9¾ percentage points are paid by the employer. Thus, it would be desirable to consolidate the unemployment and severance systems and avoid increases in social contribution rates (which are being considered as part of a pension system reform).

D. Structural Issues

25. The authorities aim to sustain public investment and bolster private investment in the medium term. The PSIP includes projects largely in the areas of transportation infrastructure (the expansion and improvement of roads, the airport, and the port), human capital (primary and secondary education and health), and environmental protection (sewerage and solid waste management and coastal conservation) (Box 2). The authorities acknowledged the importance of accelerating the implementation of these projects (which involve administrative changes in the corresponding ministries and public enterprises, as well as policy reforms, which are supported by the IDB and the CDB), while refraining from implementing nonpriority projects that do not carry associated external financing and could be undertaken by the private sector. Also the authorities, with IDB assistance, are planning to restructure the regulatory framework covering public utility monopolies (e.g., in telecommunications, electricity, and potable water) and encourage private investment and the expansion of service delivery, while lowering domestic production costs. To promote investment in tourism and offshore services, the authorities are planning to rationalize a number of uncoordinated, ad hoc tax incentives, and reduce the corporate income tax rate as fiscal and macroeconomic conditions allow.

26. Further privatizations of public entities are planned to help improve economic efficiency and bolster investment. The authorities intend to divest the state-owned insurance company by the end of this year and the BNB in the first half of next year. Six other entities (including the airport and the Bridgetown port) would be privatized in the medium term. The proceeds from privatization would be used to help attract private investment in commercially viable joint ventures in tourism and for tourism infrastructure. To improve the terms of privatization, divestment of these entities should be opened to international competition.

Barbados: Public Sector Investment Program

Pace of public sector investment

From a low of 2 percent of GDP in the early 1990s, the public sector investment program (PSIP) has steadily recovered to reach over 5 percent of GDP in fiscal years 1997/98 and 1998/99. In late 1998, the Government slowed down its overall investment spending to reduce the pressures on an overheating economy.

Medium-term priorities

During the past four years, the government has concentrated on investments in solid waste and sewerage disposal systems, coastal conservation, highway expansion, airport rehabilitation, and primary school infrastructure. The medium term PSIP is aimed at improving human resources, the economic infrastructure and the environment to support economic growth based on the export of services, mainly tourism. Some of the main projects are:

uA01fig03

Public Sector Investment Program

(In percent of GDP)

Citation: IMF Staff Country Reports 1999, 142; 10.5089/9781451805963.002.A001

  • Edutech 2000 is a comprehensive education sector enhancement program launched in 1998 and estimated to cost US$180 million, with financing mainly by the Inter-American Development Bank (IDB) (US$85 million) and the Caribbean Development Bank (CDB) (US$30 million). The project, to be implemented over seven years, supports reforms of curricula and teacher training and seeks to improve teaching infrastructure, including by equipping all primary and secondary schools with state of the art computer equipment. It also would reform the Ministry of Education to deal with a more technology based education service.

  • Expansion of the Bridgetown port is intended to facilitate higher value added from cruise ship tourism and to ease congestion in the harbor. It is estimated to cost US$36 million, with financing mainly from the IDB, and implemented over three years beginning in 2000.

  • Rehabilitation of the Grantley Adams International Airport is already underway and is intended to sustain higher rates of air arrivals and increased cargo. The total project cost is US$82 million, to be financed in part by the CDB and European Investment Bank (EIB) over four years.

  • Improvements to the road infrastructure are continuing, including the introduction of new bypass roads to improve traffic management programs in the capital, Bridgetown. The projects would cost about US$27 million, of which US$18 million would be provided by the IDB.

  • Projects to improve the water supply involve reform in the Barbados Water Authority, programs to replace mains (to curb extensive distribution losses) and new development of underground water resources to complement a privately-run desalination plant that will be in operation by late 1999.

  • The south coast sewerage project is ongoing and involves comprehensive collection systems to relieve the pressure of underground sewerage contamination and near-shore pollution. The IDB would provide US$50 million of this US$80 million project.

  • A west coast sewerage project, which is likely to be supported by the IDB, is in an advanced stage of preparation and is intended to improve coastal water quality along the West Coast, while reducing contamination of underground aquifers.

  • A Coastal Conservation Program is being drawn up to address the issues of beach erosion, water quality, and conservation of coastal flora and fauna.

27. The authorities are planning a comprehensive pension system reform. The latest actuarial report on the operations of the NIS forecast a decline in income from contributions relative to pension outlays and the depletion of its reserves by 2022. Steps taken thus far to deal with this situation are insufficient17 and the authorities are contemplating a more comprehensive reform, including restructuring the current pay-as-you-go system, introducing mandatory “defined contribution” pensions and voluntary funded private accounts, and institutional strengthening of the NIS and the Office of Insurance Supervision.

28. The authorities intend to continue opening the economy in the context of initiatives for liberalizing intra-Caribbean trade and capital movements18 and in preparation for a more open hemispheric trading environment early in the next century. The authorities intend to remove remaining import surcharges on a wide range of imported manufactured goods by April 2000, and replace the remaining few nontariff barriers to imports from outside CARICOM, largely covering some agricultural products and processed food, with tariffs consistent with Barbados’ WTO commitments.

E. Other Issues

29. Barbados ranks very high in terms of social and economic indicators. The 1998 Human Development Report of the United Nations Development Program (UNDP) puts Barbados in first place in the Caribbean region and 24th in the world based on the UNDP’s Index of Human Development. The coverage of primary and secondary education services and preventive and curative health services is very high. However, a 1997 IDB study estimated that, despite a fairly extensive social safety net that mitigates the effect of high unemployment, 13 percent of the population was living in poverty. It is expected that continued strong output and employment growth should help reduce poverty. Moreover, to improve the efficiency and targeting of the social safety net, a new ministry has been formed with a view to consolidating, streamlining and more closely integrating the operations of entities responsible for social safety net services.

30. The authorities agreed to participate as a pilot case for implementation of the Fund’s General Data Dissemination System (GDDS). To this end, they cooperated with the Fund in the preparation of the metadata, which includes plans for improving data quality. The authorities are working to improve the quality and timeliness of national account statistics, but further efforts are needed to improve the quality and timeliness of balance of payments and financial statistics. A work program (including the need for technical assistance) should be developed as part of these efforts.

31. The authorities’ efforts to deal with the year 2000 computer problem have included several public education programs. Available information suggest high levels of readiness to deal with this issue in the energy, banking, telecommunications, air and maritime transportation, health care, and government sectors. Contingency plans are in place in the above sectors and have been tested in the energy, telecommunications, air transport, and some government sectors.

F. Medium-Term Outlook

32. The staff developed an illustrative medium-term scenario based on the assumed implementation of the authorities’ economic strategy, as set out above (Table 7). In the scenario, the driving force of the economy would continue to be tourism and other export services, with real GDP growth expected to average 3 percent a year and inflation 2 percent, and the unemployment rate is expected to fall to around 8 percent by 2004.

Table 7.

Barbados: Medium-Term Economic Outlook

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Sources: Central Bank of Barbados; Ministry of Finance; and Fund staff estimates.

Fiscal year (April-March).

Includes capital revenue.

33. National saving would increase moderately during 2000–04 to make room for a somewhat higher domestic investment to GDP ratio, while containing the external current account deficit. The strengthening of national saving would reflect prudent public sector wage adjustments and strict control on public sector hiring, efficiency improvements and the introduction of cost recovery in public services, a comprehensive reform of the public pension system, and productivity gains ensuing from tax and trade changes, the privatization of public entities, and an improved regulation of private monopolies.

34. The ratio of the external current account deficit to GDP would be expected to decline to 2 percent in the medium term. Exports of goods and services would expand strongly as a result of enhanced competitiveness arising from tax reductions and structural reforms, while import growth would be in line with nominal GDP. Capital inflows, largely long-term borrowing and foreign direct investment, would be sufficient to cover the external current account deficit and increase official international reserves to around four months of imports of goods and services. Gross external public debt would rise from 16 percent of GDP in 1999 to 18 percent of GDP in 2004; however, the external public debt net of international reserve assets would fall sharply.

35. If financial and incomes policies remain prudent and priority investments and structural reforms are implemented, slower export growth or less private capital inflows would lead to somewhat lower investment and output growth, while the balance of payments would remain viable. In contrast, if there is a weakening of the public finances, a relaxation of incomes policy, delays in implementing PSIP projects and a failure to implement structural reforms, investment and the growth of exports, output and employment would be significantly less than in the above scenario; and the external current account deficit would be higher and long-term capital inflows and official international reserves lower, thereby substantially increasing economic vulnerabilities.

IV. Staff Appraisal

36. Barbados’ recent strong economic performance reflects the stabilization policies and structural reforms that have been implemented since the early 1990s, as well as a generally favorable external economic environment. Nonetheless, unemployment is still high and Barbados remains vulnerable to exogenous shocks because of an undiversified economic base. It also faces the medium-term challenge of maintaining adequate output and employment growth, while dealing with an aging population in the context of a welfare system that provides for free public education and health, as well as public pensions.

37. The authorities are to be commended for their continued commitment to macroeconomic and structural policies aimed at keeping inflation low, promoting national saving and investment, boosting external competitiveness in the context of the exchange rate peg, sustaining strong output and employment growth, and reducing the economy’s vulnerability. These policies comprise a high level of public savings in support of public investment, a prudent credit policy that provides for building official international reserves, and key structural reforms.

38. In the short term, keeping the fiscal deficit near balance will temper the expansion of domestic demand, contain the expected widening of the external current account deficit and reduce pressures on official international reserves. An essential element is the exercise of strict restraint on the wage bill through firm control on both public sector hiring and wage increases. Wage adjustment should be in line with projected inflation and productivity growth; this would necessarily entail spreading payments to compensate for the 1991 wage reduction over several years. It also would be important to apply strict priorities on capital spending and to refrain from taking further steps that undermine tax collection, while acting to strengthen tax administration.

39. In the medium term, maintaining the public finances broadly in balance would be required in order to lower the public debt to GDP ratio and to allow continued strong private investment, while securing balance of payments viability. To do so, while keeping an appropriate level of public investment spending and expanding the delivery of essential services (health, education, social security, environmental protection, and infrastructure maintenance), it will be necessary not only to continue implementing a cautious wage policy and restraining public hiring, but also to raise the efficiency and introduce cost recovery in the delivery of public services and to undertake a comprehensive reform of the public pension system. The authorities are seeking financial and technical support from the official international community for their efforts in these areas.

40. The rapid expansion of bank credit to the private sector has been contributing to the strong growth of domestic demand. In this context, the staff fully supports the actions recently taken by the authorities to tighten domestic credit conditions and boost official international reserves, and encourages them to develop market based instruments of monetary control. They should also act quickly to strengthen the frameworks of financial regulation and supervision, particularly covering the nonbanks and offshore financial services, in line with international best practices to reduce risks to the financial system and protect the interests of depositors. Satisfactory progress in the area of prudential regulation and supervision and the removal of the floor on deposit interest rates would facilitate foreign capital inflows, reduce borrowing costs, and strengthen private investment.

41. In recent years, wage restraint has been essential to maintaining export competitiveness and the strong growth of output and employment. A commendable spirit of cooperation between the labor unions, employer associations, and the government has permitted agreements on a series of income protocols, which have been vital to securing wage restraint and stable labor relations. The continuation of such cooperation would be of great importance for satisfactorily implementing the current incomes protocol and securing its renewal. Moreover, the authorities should take steps to strengthen the institutional framework for measuring productivity changes, which guide wage adjustments under the protocol Steps also are needed to promote labor market flexibility and contain nonwage labor costs, including through a consolidation of the unemployment insurance and severance schemes and through avoidance of increases in social contribution rates.

42. The exchange rate peg to the U.S. dollar, supported by the implementation of prudent fiscal, credit and incomes policies, has been essential for keeping inflation low and upholding confidence. In this context, and in view of the authorities’ commitment to the peg and their demonstrated willingness to implement policies to defend it, its maintenance is appropriate. Nevertheless, the authorities should implement policies to increase the official international reserve cushion to increase the peg’s resilience in the context of the economy’s vulnerability to exogenous shocks. At the same time, they should continue their efforts to implement trade and tax changes and structural reforms to bolster external competitiveness and secure the growth of service exports in the medium term.

43. Barbados’ future growth prospects will be enhanced by sustaining the pace of public investment in key areas, as well by pursuing reforms to improve the functioning of markets and bolster private investment and productivity. Particularly relevant in these respects are the projects that entail significant policy reforms, cost recovery and efficiency gains in the areas of education, health, environmental protection, and infrastructure. Also encouraging is the planned restructuring of the regulatory framework covering utilities, which is needed to secure private investment for service expansion and to lower domestic production costs. Also, the authorities should redouble efforts to privatize state-owned entities and to design and implement a comprehensive social security reform that secures the funding of pensions as the population ages and fosters an appropriate level of national saving well into the next century. A rationalization of tax incentives (rather than the use of inefficient, ad hoc fiscal incentives) and reduction of corporate tax rates once fiscal and macroeconomic conditions allow, also should help maintain private saving and investment strong.

44. The national accounts, balance of payments and financial data provided to the Fund for conducting surveillance have certain weaknesses with respect to their quality and timeliness, some of which are being addressed. The authorities should develop and implement a comprehensive action plan to improve the quality and timeliness of economic and financial statistics in order to provide a better basis for economic policy formulation. The GDDS is an appropriate framework for this effort.

45. The authorities’ intention to release the Article IV staff report under the pilot project is welcome. It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

Appendix I Barbados—Fund Relations

(As of August 31, 1999)

I. Membership Status: Joined December 29, 1970; Article VIII

II. General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans: None

V. Financial Arrangements:

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VI. Projected Obligations to the Fund (SDR Million):

(Based on existing use of resources and present holdings of SDRs):

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VII. Exchange Rate Arrangements:

The Barbados dollar has been pegged to the U.S. dollar since mid-1975 at BDS$2.00=US$1.00. On July 31, 1995 the official buying and selling rates for the U.S. dollar were BDS$1.9975 and BDS$2.0350, respectively, per US$1.

There are no restrictions on the making of payments and transfers for current international transactions subject to approval under Article VIII. There are exchange controls on invisibles, but bona fide transactions are approved. All capital outflows and certain capital inflows require approval. The authorities accepted the obligations of Article VIII sections 2, 3, and 4 on November 3, 1993.

VIII. Last Article IV Consultation:

The 1997 Article IV consultation discussion was concluded by the Executive Board on January 30, 1998 (EBM/98/10); the documents were (staff report) SM/97/294 and (recent economic developments) SM/98/13. Barbados is on the standard 12-month consultation cycle.

IX. Technical Assistance:

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X. Resident Representative:

The resident representative post was closed in January 1995.

Appendix II Barbados: Relations with the lnter-American Development Bank

I. Active Loans to Barbados as of June 30, 1999

(In millions of U.S. dollars)

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II. Net Cash Flow of IDB Convertible Resources

(In millions of U.S. dollars)

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Appendix III Barbados—Outstanding Statistical Issues

Barbados cooperated with the Fund in the pilot implementation of the General Data Dissemination System (GDDS). The draft metadata, including plans for improvement of the quality of data, should be updated and finalized soon by the Barbadian authorities.

1. Real sector

Figures for gross domestic product at constant prices are based on 1974 price weights, but the authorities are in the process of updating the weights to 1994.

2. Nonfinancial public sector

Fairly comprehensive and up-to-date data above the line are available for the central government, but there is a lag in the reporting of transfers. As a result of net errors and omissions in the recording of financing transactions, a significant discrepancy exists between the deficit/surplus and financing data. Data on public enterprises are not systematically and promptly reported to the Ministry of Finance.

3. Financial sector

The coverage, quality and timeliness of central bank accounts have improved recently, but important weaknesses remain. More timely reporting by commercial banks and other financial institutions is also required. The Central Bank of Barbados (CBB) classifies loans to nonresidents in domestic currency as credit to the private sector, and domestic currency deposits of nonresidents as part of the broad money stock. The staff recommends that these two items be classified under the net foreign assets of the commercial banks for consistency with the balance of payments methodology. The exclusion of offshore banks’ accounts from money and banking statistics is a major weakness of the monetary statistics in Barbados. In addition, the concept of residency applied in monetary statistics is not fully consistent with that of the fifth edition of the Balance of Payments Manual. For example, nonnational individuals are recognized as residents only after they have continuously resided in Barbados for at least three years. Also, accounting conventions underlying monetary data compiled by the CBB are in need of improvement. The CBB data are on a cash basis and do not include accrued receivables and payables. Commercial banks’ positions are recorded on an accrual basis; however, the accrued interest receivable and payable is classified under other assets or other liabilities respectively rather than under the appropriate category of domestic credit. Marketable securities are recorded at the acquisition cost and revalued to market value only on an annual basis (as of December 31). Short-term zero-coupon securities (treasury bills) are recorded at acquisition cost and are not revalued to market value until redemption at maturity. Positions with the IMF (SDR holdings, Reserve Tranche Position, and SDR Allocation) are valued at the IMF holdings rate rather than at the end-of-period market rate.

4. External sector

Lags in the compilation of merchandise trade data limit the timeliness of estimating the external current account balance. Estimates of the components of the investment account need to be strengthened.

Barbados: Core Statistical Indicators

as of August 31, 1999

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Preliminary estimate. Actual data provided with a lag of two to three months.

W-weekly, M-monthly, Q-quarterly.

A-direct, reporting by central bank, ministry of finance, or other official agency N-official publication and press release.

C-facsimile.

C-for unrestricted use.

1

The mission consisted of Mr. Guzmán (Head), Ms. Bjornland, and Messrs. Hilaire and Medeiros (all WHD). The mission was assisted in its work by Mr. Michael Tharkur, the economist for Barbados at the Inter-American Development Bank. Mr. Askari-Rankouhi (Advisor to the Executive Director) participated in the closing discussions.

2

Barbados has accepted the obligations of Article VIII, Sections 2, 3, and 4 and maintains an exchange system free of restrictions on payments and transfers for current international transactions. Fund relations is summarized in Appendix I.

3

Most of the companies are international business companies and foreign sales companies. There are also about 360 companies dealing with insurance business and 44 offshore banks.

4

The VAT was introduced in January 1997 to replace 11 other indirect taxes. The standard VAT rate is 15 percent, but hotel accommodation bears a lower rate of 7½ percent. To relieve the effect on the cost of living for the poor, the government zero-rated a basket of 35 basic food items in October 1997.

5

Namely, a lowering of taxes for small businesses; enhanced tax incentives for manufacturers and small hoteliers; and an increase in tax allowances for low income earners.

6

The CBB sets minimum savings and time deposit rates but not lending rates.

7

The IDB is Barbados’ major external creditor and, in its lending operations with the country, takes into consideration the Fund staff assessment of Barbados’ policies through the Article IV consultations. See Appendix II.

8

The government’s involvement in the sugar industry intensified in 1993 when it arranged the restructuring of the industry’s large debt to a state bank.

9

A summary description of the legislation and the new regulations was included in Box 2 of the StaffReport for the 1997 Article IV consultation (SM/97/294).

10

The government placed a US$75 million bond in the Caribbean capital market and gross reserves rose to US$386 million by June 1999. Amortization payments of international bonds would total US$53 million in FY 1998/99–FY 1999/2000.

11

The additional requirement for banks to hold 20 percent of their deposits in government securities was maintained, as well as the 4 percent floor on saving and time deposit rates.

12

Wage negotiations currently underway cover FY 1999/2000–FY 2000/01. The negotiations include payments to compensate public workers for the pay reduction that took place in 1991.

13

In particular, attention should be paid to bus fares; water and sewage fees; airport and seaport charges; rents charged by the housing authority and the Barbados Industrial Development Corporation; and fees for tertiary education and for the delivery of health services to the nonpoor. Government transfers to the nonfinancial public enterprises and covering free tertiary education were equivalent to 3 percent of GDP in FY 1998/99. Spending on free health services amounted to 3.8 percent of GDP in FY 1997/98.

14

Such as, institutional and technological changes to help focus administration efforts on the large taxpayers and to facilitate the cross-checking of tax returns and payments to the different tax collection agencies.

15

Open market operations have been rarely used actively in Barbados. In 1997, the central bank sterilized some of the excess liquidity through open market sales of treasury bills.

16

To qualify for unemployment insurance, a worker who has lost his job or has had earnings reduced by more than 50 percent (i) must have been insured for at least one year; (ii) must have made at least 20 weekly contributions within the last 3 consecutive quarters of employment; and (iii) must be actively seeking work. Unemployment insurance is based on 60 percent of weekly earnings and benefits are limited to 26 weeks. Workers are entitled to severance pay if dismissed without cause, or laid off after 2 years of employment. The benefits are 2½ weeks of pay for each year of service up to 10 years, rising to 3½ weeks of pay between 20 years and 33 years of service. Pay is determined by the wages at the time the employment is terminated.

17

In September 1998, the government adjusted some of the contribution rates and outlined plans to transfer the cost of noncontributory benefits to the treasury on a phased basis over a number of years.

18

All capital outflows and certain capital inflows require approval.