Dominica: Staff Report for the 1999 Article IV Consultation

Economic growth averaged about 2.5 percent a year in the 1990s, and the structure of the economy continued to move away from agriculture as the key banana sector contracted further. Broad money has continued to grow at a slightly higher rate than nominal GDP. At the same time, commercial banks expanded credit to the private sector at a fast pace during 1998–99. Executive Directors welcomed the authorities' plan to broaden the tax base by replacing a number of indirect taxes with a value-added tax.

Abstract

Economic growth averaged about 2.5 percent a year in the 1990s, and the structure of the economy continued to move away from agriculture as the key banana sector contracted further. Broad money has continued to grow at a slightly higher rate than nominal GDP. At the same time, commercial banks expanded credit to the private sector at a fast pace during 1998–99. Executive Directors welcomed the authorities' plan to broaden the tax base by replacing a number of indirect taxes with a value-added tax.

I. Introduction

1. The 1999 Article IV consultation discussions with Dominica were held in Roseau during September 9–23, and at headquarters on September 26. The minister of finance and other senior government officials participated in the discussions. The mission comprised Messrs. Rosales (Head), Loevinger, Mathai, Pearson, and Go (Assistant) (all WHD). Ms. Williams from the Eastern Caribbean Central Bank (ECCB) and Ms. Dawson from the Caribbean Development Bank (CDB) accompanied the mission. Messrs. van Beek and Yadav (both WHD), Mr. Bernes, Executive Director for Dominica, Ms. Turner-Huggins, Advisor-to the Executive Director for Dominica, and Mr. Samuel, Senior Director of the ECCB, participated in the final meeting. Dominica is a member of the Eastern Caribbean Currency Union (ECCU), which has a common central bank (ECCB) and currency (Eastern Caribbean dollar).

2. Dominica accepted the obligations of Article VIII, Sections 2, 3, and 4 in December 1978, and it maintains no restrictions on payments and transfers for current international transactions. There was no credit outstanding to the Fund at end-November 1999 (relations with the Fund are presented in Appendix I). Dominica has not accepted the Fourth Amendment to the Articles of Agreement but has consented to the increase in its quota under the Eleventh General Review of Quotas.

3. Dominica is on the standard 12-month consultation cycle. At the conclusion of the last Article IV consultation on August 25, 1998 (SM/98/201), Directors emphasized the need to diversify the economy, improve infrastructure, raise public saving, strengthen the external position, and move forward with structural reforms, particularly in the areas of price decontrol, privatization, civil service reform, and trade liberalization.

4. Dominica provides the core minimum data to the Fund. However, shortcomings in the quality, timeliness, and coverage of the data hamper adequate monitoring of economic developments. For instance, data on imports for 1998 are only available through May of that year, with this deficiency mirrored in a lack of official estimates of aggregate demand. Also, the government lacks the capacity to produce quarterly estimates for GDP, the public finances, and the external accounts, and to compile the components of aggregate demand in real terms (Appendix II).

II. Background and Recent Developments

5. The structure of the economy has continued to move away from agriculture as the contraction of the key banana sector has persisted (Table 1), with real GDP growth averaging about 2½ percent in the 1990s. The growth of output, however, was insufficient to reduce unemployment, which is believed to remain high.1 The resilience of economic activity in part reflects an expansion of utility services and the small manufacturing base, with the contribution of agriculture to GDP declining from 30 percent in the mid-1980s to 20 percent in 1998. As in other countries in the region, the factors behind the contraction of the banana sector have included plant disease, export price declines, and strong export dependence on uncertain preferential access to the European Union (EU) market.2 At the same time, further tourism development faces the challenges of regional competition3 and inadequate infrastructure.

Table 1.

Dominica: Selected Economic and Financial Indicators

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Sources: Dominica authorities; and Fund staff estimates and projections.

Based on the authorities’ plans.

Change relative to the stock of M2 at the beginning of the period.

The figure for 1999 corresponds to 12-month period ended June.

External current account balance with the sign reversed.

Fiscal year starts July 1.

6. Economic activity strengthened in 1998, while inflation remained low (Figure 1). Despite a contraction in agriculture and construction, real GDP grew by 3½ percent, largely as a result of a recovery in manufacturing production along with the continued expansion of services. The 12-month increase in consumer prices was 0.6 percent in September 1999, reflecting subdued import prices and the restrained credit policy of the ECCB, which has maintained the peg of the Eastern Caribbean dollar at EC$2.70 per U.S. dollar since July 1976.

Figure 1.
Figure 1.

Dominica: Selected Economic Indicators

Citation: IMF Staff Country Reports 2000, 016; 10.5089/9781451810769.002.A001

Sources: Data provided by the Dominica authorities; and Fund staff estimates and projections.1/ Change relative to broad money at the beginning of the period.2/ Excludes transfers.

7. The public sector deficit remained broadly unchanged at 2½ percent of GDP in 1998/99 (fiscal year starts July 1), but public saving declined (Table 2). The central government deficit fell in relation to GDP due mainly to higher grant receipts, with government saving virtually unchanged. The surplus of the rest of the public sector declined, in part because arrears by the central government and private employers adversely affected the revenue of the social security agency (DSS). The stock of government arrears to the DSS rose slightly from end-June 1998 to end-June 1999, to about 3.2 percent of GDP. In August 1999, however, the government settled part of these arrears, with the stock declining to 2½ percent of GDP. The overall deficit of the Dominica Banana Marketing Corporation (DBMC) rose slightly as higher export prices did not make up for a decline in export volume, associated in part with the continuing exit of farmers from the sector (Table 1).

Table 2.

Dominica: Consolidated Accounts of the Public Sector

(In percent of GDP)

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Sources: Ministry of Finance; and Fund staff estimates and projections.

Based on the authorities’ plans.

Includes adjustment to reconcile with financing data.

Fees and licenses for offshore banks, gaming operations, and international business corporations.

8. The gross debt of the nonfinancial public sector rose slightly, to 59 percent of GDP at end-June 1999, with central government gross debt rising to just over 51 percent of GDP. The stock of external arrears4 was virtually eliminated (Table 3), and external debt-service obligations declined to 5 percent of exports of goods and nonfactor services, the lowest level in recent years. The ratio of central government external debt service to central government revenue (excluding grants) is estimated to have declined to 5 percent at end-June 1999.

Table 3.

Dominica: Public and Publicly Guaranteed External Debt 1/

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Sources: Ministry of Finance; and Fund staff estimates and projections.

Excludes arrears on contributions to regional organizations, which stood at US$2.1 million (0.8 percent of GDP) at end-June 1999.

Projection based on the authorities’ plans.

The decline in 1997/98 was aided by the substantial debt forgiveness (US$10.9 million) granted in October 1997 by the British government to Dominica under the debt agreements reached at the Commonwealth conference (Mauritius mandate).

Excludes debt forgiveness.

9. The external current account deficit is estimated to have narrowed to 7 percent of GDP in 1998 (Table 4). Although banana exports and tourism earnings fell, there was a strong recovery in soap exports and exports by a new toothpaste plant. Visitor arrivals grew by 4 percent in 1998, but the share of arrivals staying in hotels declined. Net current and capital transfers from emigrants, workers abroad and foreign donors remained substantial in 1998 (9.3 percent of GDP), helping to cover the large trade deficit, with capital transfers to the government amounting to almost half the total. Net capital inflows have been sufficient in recent years to cover the current account deficits and permit surpluses in the overall balance of payments (as reflected in the changes in Dominica’s imputed international reserves in the ECCB).

Table 4.

Dominica: Summary Balance of Payments

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Sources: Eastern Caribbean Central Bank (ECCB); and Fund staff estimates and projections.

Based on the authorities’ plans.

10. Broad money has continued to grow at a slightly higher rate than nominal GDP (Table 5). At the same time, commercial banks expanded credit to the private sector at a fast pace during 1998 and 1999, while maintaining a net external creditor position. Interest rates have declined somewhat since end-1997, with lending rates averaging around 11.3 percent per annum and deposit rates 4.1 percent per annum. Wide interest rate spreads have persisted, probably because of diseconomies of scale5 and the relatively high proportion of nonperforming loans. The ratio of nonperforming to total bank loans fell from 16 percent at end-June 1998 to 15 percent at end-June 1999. Meanwhile, the ratio of provisions to nonperforming loans increased from 27 percent to 40 percent.

Table 5.

Dominica : Summary Accounts of the Banking System

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Sources: Data provided by the Eastern Caribbean Central Bank; and Fund staff estimates.

Based on authorities’ plans.

Including deposits denominated in U.S. dollars.

Change relative to broad money at the beginning of the period.

Nominal GDP at market prices divided by the average of the year-end stock of broad money for the current and previous year.

Commercial banks; weighted averages of end-year rates per annum.

11. Some progress has recently been made in trade liberalization. Maximum tariff rates were reduced from 30 percent to 25 percent in January 1999, in line with Phase III of the scheduled reductions in the CARICOM common external tariff (CET).6 At that time, most remaining quantitative restrictions (on paints, plastic shoes, and fruits and vegetables) were replaced with tariffs that are to be reduced gradually over the medium term. Dominica is a member of the World Trade Organization (WTO) and maintains a liberal trade regime, with import-licensing limited to a small number of items mainly for health and security reasons.

III. Policy Discussions

A. Overview

12. While inflation remains low and growth has picked up, unemployment continues to be high and Dominica faces a difficult medium-term outlook. Notwithstanding regional efforts to help resolve the banana trade dispute, preferential access to the EU market for banana exports remains uncertain, as the WTO maintains that the European Union’s modified system of trade preferences for ACP bananas contravenes world trade rules.7 To facilitate tourism growth and improve sports and recreation facilities in the country, the authorities are determined to start construction of an airport and a stadium during the current fiscal year.

13. The mission underlined the medium-term risk that—despite a likely acceleration of economic growth—the relatively high cost of the investment program would weaken the public finances and make the management of public debt difficult. It advised the authorities to downsize their investment program with assistance from multilateral banks, and to raise public saving and sell public assets to help fund it. The authorities acknowledged the need to secure multilateral assistance and raise public saving, noting that the latter is particularly challenging because of the relatively high tax burden and wage bill, which were about 24 percent of GDP and 15 percent of GDP in 1998/99 (Figure 2).

Figure 2.
Figure 2.

Selected Small Countries: Government Taxes and Wage Bill, and Population 1/ (1997-1999)

Citation: IMF Staff Country Reports 2000, 016; 10.5089/9781451810769.002.A001

Source: World Bank; and IMF.1/ ANT=Antigua and Barbuda, DOM=Dominica, GRE=Grenada, ICE=Iceland, LUX=Luxembourg, MLV=Maldives, MLT=Malta, NEA=the Netherlands Antilles, SEY-Seychelles, SKN-St. Kitts and Nevis, STL=Saint Lucia, and SVG=Saint Vincent & the Grenadines.

B. Fiscal Policy

14. Discussions centered on the economic and financial implications of the large-scale investments planned for the period through 2003. These include the building of an international airport and supporting infrastructure as well as a stadium at a combined cost of US$131 million (nearly 50 percent of estimated GDP for 1999). Taiwan Province of China has made a commitment to provide US$10 million in grants and another US$10 million in concessional loans (at an interest rate of 3.5 percent) to help finance the cost of the airport (US$111 million). In addition, the authorities hope to obtain US$14 million in grants from the EU for this purpose. Also, they have decided to earmark another US$20 million grant from Taiwan Province of China8 exclusively to cover the entire cost of the stadium.

15. Even with the substantial grants just mentioned, the airport and the stadium projects will require borrowing of nearly US$100 million in the near term, which would substantially increase debt service obligations in the period ahead, particularly if obtained on commercial terms. The authorities have already arranged the placement of US$70 million in bonds with two foreign banks, about half of which was disbursed in November 1999.9 On the basis of partial information provided by the authorities, the mission prepared medium-term scenarios with (modified baseline) and without (baseline) these projects, to estimate the differential effects on the public finances over the ten-year period through FY 2008/09 (Table 6 and Figure 3). Under the modified baseline scenario, real GDP would grow at an average annual rate of 4½ percent, or some 1 percent faster than in the baseline. Preliminary estimates suggest that following the completion of the projects, the gross public debt would be higher than in the baseline by nearly 30 percentage points of GDP and the annual public interest obligations by 2.7 percentage points of GDP; public saving would turn negative.

Table 6.

Dominica: Medium-Term Scenarios

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Sources: Ministry of Finance; and Fund staff estimates and projections.

Fiscal year starts on July 1.

Figure 3.
Figure 3.

Dominica: Total Debt Stocks and External Debt Service

Citation: IMF Staff Country Reports 2000, 016; 10.5089/9781451810769.002.A001

Sources: Ministry of Finance; and Fund staff estimates and projections.

16. The mission recommended that the public sector investment program be scaled down in order to avoid a large and abrupt rise in public debt. To this end, it advised the authorities to forego the stadium project, redirect the US$20 million grant earmarked for this purpose to help fund the construction of a smaller airport, and adopt measures to increase public saving. Also, the mission encouraged the authorities to press ahead with privatization and engage the multilateral development banks in order to seek funding on better terms and secure specialized technical support. Both the World Bank and the CDB have expressed reservations about the airport project, but remain open to further discussions with the authorities (the World Bank is planning to send a mission to Dominica in December 1999).

17. The authorities acknowledge that their plans are very ambitious, carry risks, and have potentially serious implications for the public finances, but they are determined to press ahead with a strategy of giving a big push to tourism in the face of the continuing decline of, and bleak outlook for, the banana sector. They hope the economy would eventually grow out of the increased debt burden. In their view, a new airport will permit diversification of tourism by adding all-inclusive resorts to the present ecotourism sites, and they do not see the lack of suitable beaches as an insurmountable obstacle to resort operations. The airport feasibility study (Box 1) will be made available to the public, and other project details will be posted on the Internet to ensure wide dissemination and transparency.

18. The execution of the large investment program envisaged by the authorities would likely magnify the problem of low public saving and could imperil the ability of the government to meet its financial obligations. The mission underlined the new urgency of fiscal action to prevent such severe deterioration of the public finances. An adjustment -program should focus on restraining current expenditure, in particular the wage bill, outlays on goods and services, and transfers. Thus, there would be a need to freeze the size of the civil service and maintain a policy of wage moderation. To address staffing constraints in key government areas, the mission suggested identifying staffing redundancies and redeploying staff to higher priority functions (including tax administration). Also, it stressed that the government should regularize its financial relations with the DSS, and clear remaining arrears.10 At the same time, the mission urged early action to reform indirect and property taxation, in line with FAD recommendations (Box 2),11 as well as to strengthen tax administration by allocating sufficient resources to the revenue department and providing it with support in the strict enforcement of the tax code and the timely application of penalties.

19. The authorities recognize that raising public saving should be a priority, including because of the conditionality set for continued EU assistance (Box 3), but see no scope for immediate strong action. In the meantime, they hope to secure increased external assistance and find ways to bring private participation into the operation and funding of the airport. They believe that the low level of government saving is a structural problem related to the narrow revenue base and high unit costs of administration in the small countries of the region. Nevertheless, they are looking forward to eventually establishing a timetable for the introduction of a VAT following ongoing consultations with various social sectors. They agree that replacing a number of indirect taxes with a VAT and streamlining exemptions would help broaden the tax base and improve efficiency and buoyancy. They also recognize the need to strengthen tax administration.

Dominica: Feasibility Study for a New Airport

Dominica currently has two airports—Canefield, a small facility close to the capital, and Melville Hall, a slightly larger facility located an hour’s drive away. Neither airport has the capacity to operate at night or accommodate jet landings. The authorities believe this limits the growth potential of the tourism industry,1 which they view as the main pillar of economic diversification. They believe tourists and charter operators will continue to choose other destinations over Dominica because of the lack of jet -service, direct service from Europe and the United States, and night landing capacity, which compels tourists from Europe and the Western United States to spend one to two days in transit. A feasibility study commissioned to private consultants developed three scenarios, based on assumptions about the growth of hotel rooms and tourist arrivals. The study concluded that Melville Hall will reach full capacity during 2004-06. It argued that airlines will only be willing to increase service if they can use jets, and called for an airport capable of handling 300-seat jets and a terminal capable of handing 300 passengers per hour.

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As recognized in the feasibility study, its tourism projections are highly optimistic. Even under the most pessimistic of the scenarios, the growth in hotel rooms and tourist arrivals in 1998-2010 would be unprecedented in the region. Given that growth in tourist arrivals 1998-99 was much less than had been projected, there is a chance that capacity at Melville Hall will be sufficient through 2010.

The authorities are of the view that lower cost alternatives (lighting the existing runway and/or building a more modest runway) would not yield significant savings. While there is widespread agreement about the need to install night landing capacity, there appears to be little support in the business community for building a costly new airport with jet landing capabilities. Lower cost and smaller scale airport improvements may be better alternatives particularly as airlines are emphasizing hub and spoke operations and neighboring islands with large airports could serve as transit points for Dominica-bound tourists. There is some evidence that requiring passengers to change planes, may not have limited the growth of air travel in the United States and Europe. Also, the British Virgin Islands receives roughly 250,000 stayover arrivals per year with only turboprop service, which suggests that the lack of jet service might not be a major constraint to tourism in Dominica.

1 Building all-inclusive resorts and attracting charters are part of the authorities’ strategy to broaden the base of the tourism sector.

Dominica: Tax Reform1

Dominica’s system of indirect taxation is complicated and distortionary. Most indirect tax revenue stems from a 25 percent consumption tax (which is largely collected at the import stage), a 3 percent retail sales tax, and a 5 percent hotel occupancy tax. In addition, there are import duties, customs charges, customs surcharges, stamp duties, and other levies, many apparently generating too little revenue to merit their administrative costs. Exporters receive no credit for taxes paid; tax cascading is common; and the fast-growing service sector is almost completely uncovered, adversely affecting revenue buoyancy. This is a matter of concern given Dominica’s commitment to reduce external tariffs within CARICOM, which will likely lead to a decline in import duty collections. In response to these problems, the authorities have granted a plethora of ad-hoc tax concessions (exemptions and zero-rating), which further distort relative prices and harm the revenue base.

Recognizing these difficulties, the Minister of Finance, in his July 1998 budget address, raised the possibility of replacing a number of indirect taxes with a value-added tax (VAT). Technical assistance from the Fund was requested to this end, and in May 1999 a Fiscal Affairs mission recommended replacing the consumption, sales, hotel, and other minor taxes with a credit-method value-added tax, applicable at a single rate, that would include most services and be subject to very few exemptions. With such a broad base, distortionary effects would be minimized; buoyancy would be increased, and credits for taxes paid on inputs would redress tax cascading. The mission recommended zero-rating for exports, and supplementing the VAT with excise taxes on fuels and a few other goods. The mission estimated that a VAT rate of 18 percent would be consistent with revenue neutrality. It was felt that an 18-month period would be necessary to draft the legislation, conduct public information campaigns, and hire and train new auditors. The Inland Revenue Service (1RS) would likely need 20-25 additional employees to handle the demands of the VAT.

The FAD mission recommended that equity concerns be addressed with the following combination of policies: (1) an exemption for completely unprocessed agricultural foods; (2) direct cash transfers to the poor; (3) an exemption for healthcare and education; and (4) an exemption for small businesses (with annual turnover of less than EC$60,000), as these firms are more likely to be patronized by poorer customers (and because such small firms would likely be ill-equipped to handle the paperwork requirements of a VAT).

1 Based on “Dominica: Introducing a Value-Added Tax,” Fiscal Affairs Department, IMF, May 1999.

Dominica: Stabex Grants and Conditionality

Since the early 1990s, the European Union (EU) has supported the banana industry in Dominica—as well as in the other Windward Islands and in other ACP nations—not only through preferential access to the EU market, but also with direct cash payments under the system of stabilization of export earnings from agricultural commodities (Stabex). The cumulative allocation of these Stabex transfers to Dominica for the five year period 1993-97 has amounted to ECU 37.2 million.

Stabex grants are intended, most narrowly, simply to compensate for losses in export earnings due to adverse climatic and market conditions. More broadly, they are also meant to help improve the local industry’s competitiveness by funding investments in irrigation systems and other modernization measures.

The recent World Trade Organization (WTO) ruling against the EU regime calls into question the future of (he banana industry in Dominica and other high-cost countries. While in 1988 there were 7,000 banana farmers in Dominica, one decade later, the number had dropped to less than 3,000, and it seems likely that this trend will continue. In recognition of this reality, the share of Stabex funds channeled into the banana sector has, over the past few years, steadily declined. Instead, funds arc now allocated to a variety of programs aimed at promoting agricultural and economic diversification, easing farmers’ transition out of the banana industry, and redressing the poverty and social displacement that could result from such major structural change. Stabex programs include farmer retraining, road rehabilitation, tourism development, and general education and health.1

The Stabex allocations for the years 1996 and 1997 (which are scheduled to be disbursed in three annual tranches over the period 1999-2001) are governed by a Framework of Mutual Obligations (FMO). This document specifies the total amount of money which the EU is committing as well as the manner in which funds are to be disbursed, the types of ventures that will be supported, and the corresponding obligations of the Government of the Commonwealth of Dominica. As described by the FMO, Stabex funds can go either to the general funding of the Public Sector Investment Program (PSIP) or to fund specific projects. The following chart provides a breakdown of PSIP versus project funding, as well as the amounts (in Euros) allocated to different sectors:

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Disbursement of the project-related funds depends on favorable cost-benefit analyses of the projects in question. Also, the PSIP funds are conditional on maintaining certain economic policies (and on previously committed funds having been disbursed at least at a 70 percent rate). First is the requirement to preserve fiscal discipline; central government saving must be 1 percent of GDP in 1998/99, 1.6 percent of GDP in 1999/2000, and 1.8 percent of GDP in 2000/01; similarly, public sector saving is required to be 1.4 percent of GDP, 1.7 percent of GDP, and -2.1 percent of GDP in those years. This requirement is intended to ensure sufficient counterpart funds for Stabex-related projects, and to allow Dominica to comply with the second major requirement of the FMO: to keep current expenditures on health and education at least constant in real terms, and to maintain capital expenditures for these sectors at least at the levels programmed in the PSIP for 1998-2000. The third major requirement was met when Dominica implemented Phase III of CARICOM’s Common External Tariff (CET) on January 1, 1999, with Phase IV to be carried out prior to the disbursement of the second tranche.

1 The EU is also currently considering a ten-year “special system of assistance” to complement the system of Stabex grants.

20. On present trends and policies, the public sector deficit is projected to widen to 9 percent of GDP in 1999/2000. This would be the result mainly of the large increase in public investment associated with the start of the airport and stadium projects as well as with upgrades in the water and sewerage infrastructure carried out by the water company (DOWASCO). While the overall deficit of the central government would reach about 10 percent of GDP, the combined overall position of the rest of the nonfinancial public sector would remain in surplus. However, the weakness in the finances of the DBMC would persist notwithstanding ongoing efforts to restructure the banana industry, improve farmer efficiency, and run the industry on a strictly commercial basis. Public saving is projected to decline further and government saving to turn negative.

C. Monetary and External Policies

21. In the context of the currency union, the Dominica authorities exert little control over monetary and exchange rate policy. The credit policy of the ECCB is aimed at providing strong foreign exchange backing for currency issued, thereby supporting the fixed exchange rate.12 Economic growth and confidence in the currency have continued to contribute to the private sector’s demand for credit and domestic financial assets in recent years. Since 1984, the ECCB has maintained a floor of 4 percent on interest rates on passbook savings deposits, which account for over half of bank deposits in Dominica. In the view of the authorities, the minimum deposit rate protects small depositors from oligopolistic bank practices.

22. The authorities agree on the need to maintain vigilance over the financial sector. The ECCB, which is responsible for banking supervision in the region, recently reinforced its bank inspection procedures and surveillance over nonperforming loans. ECCB representatives acknowledged that the share of nonperforming loans in the total loan portfolio remains high; however, they noted that provisioning appears adequate and that most commercial banks are branches of large, well-capitalized Canadian and British banks.13

23. There is scope to strengthen surveillance over the operations of the large credit union sector and the growing number of offshore institutions. The mission recommended that supervision of nonbank financial intermediaries be intensified by improving data reporting requirements and transferring supervisory responsibility over credit unions to the finance ministry. It supported efforts to establish stronger regulations for the credit union industry, including provisions to ensure adequate reserves (Box 4), noting that Dominica has approved the “Harmonized Cooperatives Societies Bill” which aims to harmonize the regulatory framework faced by credit unions and other cooperatives in the OECS member countries. Calling attention to the granting of tax incentives to a mutual fund company in which the state-owned National Commercial Bank (NCB) and the DSS have a controlling stake, the mission stressed the need for uniform tax treatment of potential entrants to the mutual fund industry.

Dominica: Regulation of Credit Unions

Credit unions account for around one-quarter of the financial sector’s loans and deposits. The largest, Roseau Credit Union, holds about two-thirds of credit unions’ loans and deposits. Because credit unions are not required to maintain unremunerated reserves, their deposit rates are generally higher, and lending rates lower, than those of commercial banks.

The Ministry of Community Development and Women’s Affairs has supervisory responsibility over credit unions. It uses nonbinding guidelines developed by the Caribbean Confederation of Credit Unions to assess the financial condition of credit unions. In practice, however, credit unions set their own prudential norms on capital adequacy, provisioning, and lending to individuals.1 The Dominica Cooperative Credit Union League provides examiners to members for internal audits. At the same time, credit unions transmit quarterly data to the ECCB on their balance sheet, operating income and expenditure, employment and nonperforming loans.

Liquidity requirements and practices appear weak. Currently, credit unions must set aside 20 percent of each year’s net earnings as reserves. However, rather than holding reserves in low risk, liquid assets, many credit unions relend them. To improve reserve management, the Credit Union League established a common fund and suggested that credit unions place 25 percent of their reserves in it. However, in addition to holding Dominica government securities and bank deposits, the League lent to and placed deposits in member credit unions.

To strengthen the legal and regulatory framework, the authorities are developing new regulations based on the Organization of Eastern Caribbean States Model Cooperatives Act. Key provisions of the draft regulations include:

  • Requiring that reserves equal at least 10 percent of liabilities be placed in a separate demand account in another financial institution;2

  • Limiting loans to any individual to no more than 10 percent of capital;

  • Requiring that provisions increase with the time loans remain non-performing, and that loans be written off when they have been non-performing for two years;

  • Limiting the time interest may accrue before a loan is declared non-performing;

  • Prohibiting credit unions from counting as income any interest which has accrued but has not been paid for certain periods;

  • Requiring credit union employees and directors to recuse themselves from decisions on loans to firms with which they have a fiduciary relationship;

  • Restricting loans to employees and directors, as well as to firms controlled by them;

  • Granting the ministry authority to demand operational changes if necessary to protect depositors; and

  • Requiring each credit union to hold liquid assets and establish lines of credit as necessary to maintain sufficient liquidity.

Apart from the early approval of the proposed regulations, it would be important to set minimum liquidity requirements, and penalties for non-compliance as recommended in the Confederation’s guidelines.

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Source: Eastern Caribbean Central Bank.

Capital =(Assets - Nonperforming loans) - (Liabilities - Reserves).

1 For example, the Roseau Credit Union limits loans to any individual to EC 240,000. At end-June 1999, the Roseau Credit Union had set aside provisions, which cover only about 7½ percent of its outstanding non-performing loans.2 Current holdings of short and medium-term government securities would still count as reserves.

24. The external current account deficit is estimated to increase to about 12 percent of GDP in 1999, reflecting strong growth in imports and stagnant banana exports. Capital inflows to finance public sector operations, direct investment, and net borrowing by commercial banks would help maintain a surplus in the overall balance of payments. The stock of public and publicly guaranteed external debt, which is still mostly on concessional terms, would increase substantially as a result of the borrowing associated with the airport project, but the scheduled debt-service ratio would remain low.

25. The authorities are satisfied that the present exchange rate arrangement has served the country well. Measured for Dominica, the Eastern Caribbean dollar appreciated in real effective terms by 4 percent from end-1990 to end-September 1999 (Figure 4). As the Eastern Caribbean dollar is pegged to the U.S. dollar, movements in its real effective exchange rate are related largely to changes in the value of the U.S. dollar vis-à-vis other major currencies. From the viewpoint of tourism activity, Dominica’s regional competitiveness appears to have been broadly adequate, as Dominica’s share in Caribbean tourism arrivals has remained largely unchanged (Appendix III), with net travel receipts growing at an annual rate of about 6 percent in recent years (Table 4).

Figure 4.
Figure 4.

Dominica: Exchange Rate Developments

(Index 1990=100)

Citation: IMF Staff Country Reports 2000, 016; 10.5089/9781451810769.002.A001

Sources: IMF Information Notice System; and Fund staff estimates and projections.1/ The real effective exchange rate estimated as a trade-weighted index of nominal exchange rates deflated by seasonally adjusted relative consumer prices. An increase means an appreciation.

26. Dominica, along with the other ECCB members, maintains exchange controls on capital and nontrade current transactions. The indicative limit on foreign exchange purchases was increased in October 1997 to EC$250,000 per person per year, from EC$100,000. Purchases of amounts above this limit require approval from the ministry of finance, but all bona fide requests are routinely approved. ECCB representatives indicated that the gradual phasing out of the exchange controls is likely to continue in the period ahead.

D. Structural Policies

27. The priorities in the structural area are to downsize the civil service, advance trade liberalization, abolish remaining price controls, and reduce state participation in economic activity. The authorities do not envisage immediate progress in downsizing the civil service, but intend to further reduce the maximum tariff to the 20 percent target rate as soon as the CARICOM secretariat completes a study of the possible effects on industry and tax revenue. The authorities are trying to garner public support for the removal of the price controls still in effect, which are not being enforced (except for those on cement and fuels), and have created a commission of private sector representatives that is to advise on their eventual elimination.

28. The mission argued for moving ahead with privatization and deregulation. In particular, it advised selling the government’s controlling stake in the NCB and the remaining stake in the telecommunications company, which would help fund the airport project. The authorities are noncommittal about the sale of these assets. However, they are considering the elimination of the monopoly held by the state-owned Dominica Export-Import Agency (DEXIA) on the importation and distribution of bulk rice and sugar. They intend to transfer the trading of commodities other than bulk sugar and rice from DEXIA to a new entity, which subsequently could be privatized.

29. The mission stressed that success in diversification would depend on maintaining competitiveness and urged the authorities to exercise restraint on public sector wages in order to avoid sparking demands for higher wages in the private sector. It also drew attention to the reportedly high labor cost of moving cargo through the port and the cross-subsidization of residential users of water and electricity by commercial users. In the regulatory area, regional efforts continue with the aim of modifying the terms under which the foreign-owned telephone company operates, with a view to reducing the period granted to the company to maintain monopoly over the telecommunications business.

E. Poverty Alleviation and Environmental Protection

30. The authorities are persuaded that economic growth and education are essential for reducing poverty. Their objective is to extend universal education to the secondary level, where the shortage of classrooms is a key constraint. A program to expand and improve school infrastructure is being supported by the World Bank and the British government. Dominica has a modest safety net program that provides targeted assistance, including monthly stipends to the very poor.

31. Development of ecotourism requires efforts to conserve the environment. To this end, the PSIP includes projects to improve the water and sewage infrastructure and to protect the coastal areas. Cost recovery through fees continues to be regarded as important, including for waste management and ecotourism site maintenance.

F. Other Issues

32. There was broad agreement about the importance of addressing statistical deficiencies, Y2K compliance, and the publication of the staff report. The mission encouraged the authorities to improve data compilation and dissemination, and to allocate sufficient resources to the statistical function. In particular, it highlighted the urgent need for quarterly public finance statistics (presently prepared on a fiscal year basis) and balance of payments data (presently prepared on a calendar year basis), to ensure consistency with the national accounts (presently prepared on a calendar year basis). As regards Y2K readiness, the government has appointed a national team to coordinate and oversee Dominica’s effort at ensuring Y2K compliance. The authorities have agreed to participate in the pilot project for the publication of the staff report, but reserve the right to withdraw their decision once they have read the document.

IV. The Medium Term

33. The authorities’ medium-term objectives are set out in the “Medium-Term Economic Strategy Paper” that was presented to the Consultative Group for Cooperation in Economic Development in June 1998.14 These are to maintain low inflation and return the economy to a higher growth path based on a more diversified productive base. That document identifies pursuit of sound public finances as a principal policy to achieve these objectives.

34. The staff has developed three illustrative medium-term scenarios (Table 6 and Figure 3). These represent the continuation of present trends and policies (baseline), the implementation of the authorities’ ambitious investment program without the adoption of adjustment measures (modified baseline), and the implementation of a smaller investment program along with adjustment measures (alternative). A summary of the effects of the modified baseline scenario (relative to the baseline) was presented in paragraph 15. The modified baseline and the alternative scenarios assume that hotel construction by foreign investors will sustain growth following completion of the airport and stadium projects. As noted, the public finances deteriorate substantially in the modified baseline scenario, as debt and debt service obligations rise sharply and public saving turns negative over the second half of the 10-year period of analysis. The high public borrowing requirement proves burdensome to the domestic banking system, with its net foreign assets declining sharply and its capacity to lend to the private sector greatly reduced.

35. A smaller scale investment program and fiscal adjustment would result in a more manageable macroeconomic situation over the medium-term. In the alternative scenario, grants presently earmarked for the stadium are used to fund a somewhat smaller airport project (Table 7). Also, it is assumed that multilateral loans for about US$10 million permit an early amortization (2001/02) of some of the bonds already placed with Trinidad and Tobago banks. The proposed adjustment measures include freezing the size of the civil service, maintaining wage moderation, and restraining the growth of other noninterest current spending. The annual yield of these measures would be equivalent to 2 percent of GDP. It is further assumed that a revenue-neutral tax reform is introduced in 2002/03, with a VAT replacing a number of indirect taxes, maximum external tariff rates reduced, and exemptions on income, import, and other taxes streamlined. Also, privatization proceeds of about US$10 million are assumed to be derived from the sale of shares in the NCB and the telecommunications company in 2001/02.

Table 7.

Dominica: Cost and Funding Scenarios for Key Government Projects

(In millions of U.S. dollars; unless otherwise indicated)

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Sources: Ministry of Finance; and Fund staff estimates.

Involves building both airport and stadium as currently envisioned by the authorities.

Involves building a somewhat smaller airport only.

Proceeds from assumed sale of government shares in National Commercial Bank and Dominica Electricity Services, Ltd.

Grants that the authorities expect will be disbursed by Taiwan, Province of China and the European Union by the end of the projected construction period (June 2003).

Early redemption of part of the bonds placed with Trinidad and Tobago banks. An assumed loan for US$10 million by multilateral banks would be used in part to fund this pre-payment.

Average of loans, weighted by principal.

Evaluated at discount rate of 8 percent.

36. With the proposed adjustment measures, the public sector would be able to meet the debt service obligations incurred to build the smaller airport and reduce its debt in relation to GDP at a swift pace, aided by the strong growth in economic activity (Table 8). The preservation of a manageable fiscal situation would help maintain private sector confidence and the capital inflows that finance the external current account deficit. Following a rise during the airport construction period, this deficit would decline, to 9 percent of GDP in 2004, and would be financed largely by capital transfers and direct investment (Table 9). The external current account would remain sensitive to shocks affecting tourism and/or banana exports. For example, if beginning in 2000, banana export earnings were to decline to half the 1998 level; the external current account deficit would average about 14.5 percent of GDP over 2000-09.

Table 8.

Dominica: Medium-Term Public and Publicly Guaranteed External Debt

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Sources: Ministry of Finance; and Fund staff estimates and projections.

Increase in 2001/02 reflects a prepayment of part of the Trinidad and Tobago airport bonds.

Table 9.

Dominica: Medium-Term Balance of Payments

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Sources: Eastern Caribbean Central Bank (ECCB); and Fund staff estimates and projections.