Dominica: Staff Report for the 2002 Article IV Consultation and Request for Stand-By Arrangement

This paper examines Dominica’s 2002 Article IV Consultation and a Request for Stand-By Arrangement (SBA). The authorities' program for 2002/03, for which support through a one-year SBA is being requested, is aimed at restoring order to the public finances and relaxing the cash constraint to protect essential public expenditure and reduce public debt to the banking system. The IMF staff is of the view that the authorities’ economic program is consistent with the objective of laying a basis for sustained growth of output and employment over the medium term.

Abstract

This paper examines Dominica’s 2002 Article IV Consultation and a Request for Stand-By Arrangement (SBA). The authorities' program for 2002/03, for which support through a one-year SBA is being requested, is aimed at restoring order to the public finances and relaxing the cash constraint to protect essential public expenditure and reduce public debt to the banking system. The IMF staff is of the view that the authorities’ economic program is consistent with the objective of laying a basis for sustained growth of output and employment over the medium term.

I. Introduction

1. Discussions for the 2002 Article IV consultation and on an economic program that could be supported by a Fund arrangement were conducted in Roseau during two missions in March and May 2002.1 In a letter to the Managing Director dated August 13, 2002, (Attachment I) the authorities describe the policies they intend to follow during FY 2002/03 (year ending June 30) and request a one-year Stand-By Arrangement (SBA) in an amount equivalent to SDR 3.28 million (40 percent of quota). On the safeguard assessment of Dominica’s central bank (the Eastern Caribbean Central Bank—ECCB), an initial analysis of the detailed documentation that has been received does not appear to show widespread vulnerabilities that could compromise the safeguarding of Fund’s resources. The safeguard assessment should be completed by December 2002.

2. Dominica is eligible to use the Poverty Reduction and Growth Facility (PRGF) and the authorities have expressed an interest in that facility. However, in view of the severity of the economic and financial situation and the time needed to prepare an Interim Poverty Reduction Strategy Paper (I-PRSP), they have decided to request a one-year SBA at present. They expect to complete work over the next few months on an I-PRSP and a medium-term program that could be supported by a three-year PRGF arrangement starting in mid-2003.

3. Dominica is on the standard 12-month consultation cycle. In concluding the 2001 Article IV consultation on June 15, 2001, Executive Directors expressed particular concern about the continued weakness of the public finances, which had given rise to heavy government borrowing and a buildup of domestic arrears, especially to the social security system. They emphasized the need for strong fiscal consolidation and generating public savings, for supporting the investment needed to improve growth prospects. Directors felt that immediate steps needed to be taken to increase tax revenue and tighten expenditure, particularly by phasing out the extensive array of tax concessions, strengthening tax administration, restraining public sector wage increases, and rationalizing public investment. Directors welcomed the authorities’ intention to take further steps to strengthen the regulatory and supervisory framework of the offshore financial sector.

4. Dominica has a parliamentary form of government. The ruling coalition (comprising the Dominica Labor Party and the Dominica Freedom Party), which has a three-seat majority over the opposition United Workers Party in the 21-member House, was elected in January 2000. The next election is due by January 2005.

5. Dominica is one of eight eastern Caribbean islands with a common central bank, the ECCB,2 and a common currency, the Eastern Caribbean dollar, which has been pegged to the U.S. dollar since 1976. Dominica 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. Relations with the Fund, the World Bank, and the Caribbean Development Bank (CDB) are summarized in Appendices I through III.

6. Dominica provides the core minimum data to the Fund. However, deficiencies in the quality, timeliness, and coverage of the data hamper adequate monitoring of economic developments. The public sector, external, and national accounts are not regularly available, and the reporting frequency for key data is irregular (Appendix IV).

II. Background and Recent Developments

7. Over the past several years, output and employment growth have been on the decline reflecting the ongoing retrenchment of the key banana industry (due to weak export prices and the beginning of the phase out of preferential access to the European Union market), and the weak growth of nonbanana agriculture and stayover tourism. After growing on average by about 2½ percent during 1996-99, real GDP stagnated in 2000 and is estimated to have contracted by over 4½ percent in 2001, as banana production fell by 35 percent owing also to adverse weather conditions, and as other key sectors of the economy declined reflecting the slowdown abroad, the events of September 11, and an increasingly difficult fiscal situation (Table 1 and Figure 1). The downturn in the economy appears to have further increased unemployment3 and poverty, particularly in the rural areas affected by the continued displacement of banana farmers.4

Table 1.

Dominica: Selected Economic and Financial Indicators

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

Projections assume the adoption of proposed program measures.

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

Including errors and omissions.

Fiscal years ending June 30.

Including external financing gap.

In percent of exports of goods and services.

Imputed reserves at the ECCB.

Figure 1.
Figure 1.

Dominica: Selected Economic Indicators

Citation: IMF Staff Country Reports 2002, 223; 10.5089/9781451810783.002.A001

Sources: Dominican authorities; Eastern Caribbean Central Bank (ECCB); and Fund staff estimates and projections.1/ Change relative to broad money at the beginning of the period.2/ Excludes transfers.

8. Dominica’s economic performance in recent years has been also weak in the context of the ECCB region. While the average growth rate of real GDP in ECCB member countries amounted to more than 2 percent during the period 1998-2001, Dominica’s growth rate was flat. The decline in banana production was a major factor in this performance, although other factors such as the relative share of tourism and the banana sector in the economy, were also important.5

9. Inflation in the ECCB member countries tends to be in line with that in the United States and other major trading-partner countries, mainly reflecting the openness of the economies and the regional currency peg. However, fixed domestic fuel prices have prevented consumer prices to fully reflect imported inflation. As measured by the 12-month change in the CPI, inflation in Dominica remained just under 2 percent in 2001.

10. The public finances have deteriorated in recent years as capital expenditure has increased sharply, while saving has been declining. The deficit of the consolidated public sector almost quadrupled over the period 1997/98-2000/01 (years ending June 30) to about 12½ percent of GDP and public savings fell by 3½ percent of GDP, mainly reflecting the deterioration in central government finances (Table 2 and 3). The public sector’s overall deficit is estimated to have declined from 12½ percent of GDP in 2000/01 to about 10 percent of GDP in 2001/02, mainly reflecting sharply lower capital expenditure.

Table 2a.

Dominica: Summary Accounts of the Nonfinancial Public Sector 1/

(In millions of EC dollars)

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

Fiscal years ending June 30.

On a cash basis.

Difference between identified financing and overall balance.

Table 2b.

Dominica: Summary Accounts of the Nonfinancial Public Sector 1/

(In percent of GDP)

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

Fiscal years ending June 30.

On a cash basis.

Difference between identified financing and overall balance.

Table 3a.

Dominica: Summary Accounts of the Central Government 1/

(In millions of EC dollars)

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Sources: ministry of finance; and Fund staff estimates and projections.

Fiscal years ending June 30.

Includes collection of revenue arrears of EC$2.4 million in FY 2002/03.

On a cash basis.

Difference between identified financing and overall balance.

The figure for 2002/03 includes the issuance of bonds (equivalent to EC$56.4 million) to the social security system and the water and sewer company for clearance of government arrears to these entities.

Table 3b.

Dominica: Summary Accounts of the Central Government 1/

(In percent of GDP)

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

Fiscal years ending June 30.

Includes collection of revenue arrears of 0.47 percent of GDP in FY 2002/03.

On a cash basis.

Difference between identified financing and overall balance.

The figure for 2002/03 includes the issuance of bonds (equivalent to 7.7 percent of GDP) to the Social Security System and the Water and Sewer Company for clearance of government arrears to these entities.

11. The overall deficit of the central government (after grants) is estimated to have declined slightly to about 10½ percent of GDP in 2001/02. The deficit continued to be financed by external borrowing, recourse to the banking system, and arrears accumulation, especially to the social security system and public and private enterprises. Central government dissaving is estimated to have reached 6¾ percent of GDP in 2001/02, as current revenues declined sharply largely reflecting the economic contraction. While current expenditure remained unchanged in relation to GDP, capital expenditure is estimated to have declined to 6 percent of GDP from 16¾ percent of GDP in 2000/01, reflecting the completion of major investment projects in the areas of infrastructure and education, as well as emerging financing constraints.

12. During 2001, broad money increased by about 7½ percent, fueled by net credit to the nonfinancial public sector, as well as a steady inflow of remittances and private transfers from abroad (Table 4). In contrast, banking system credit to the private sector declined by over 3 percent, in line with the downturn in economic activity. As a result, commercial banks built up their net foreign asset positions. The share of nonperforming loans in the total loan portfolio of banks rose from about 18⅓ percent at end-2000 to nearly 21½ percent at end-2001, reflecting rising loan delinquency rates in the agriculture and tourism sectors (Table 5). Meanwhile, provisioning for loan losses fell from 38 percent of nonperforming loans at end-2000 to 32 percent at end-2001.

Table 4.

Dominica: Summary Accounts of the Banking System

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

Includes debt assumed from DBMC in Q1 of FY02/03.

Including deposits denominated in U.S. dollars.

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

Commercial banks; end-of-period rates, percent per annum.

Table 5.

Dominica: Financial and External Vulnerability Indicators

(In percent of GDP, unless otherwise indicated)

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

Projections assume the adoption of proposed program measures.

Treasury bill rate adjusted by end of period inflation.

Includes errors and omissions.

Imputed reserves at the ECCB.

Refers to public sector debt.

13. The external current account deficit, which averaged about 11½ percent of GDP in 1998-99, widened to about 18⅓ percent of GDP in 2000, on account of a sharp decline in banana exports, stagnant receipts on services (including tourism), and higher interest payments, following the substantial buildup of public sector external debt of previous years (Table 6 and 7). The external current account deficit narrowed to about 16½ percent of GDP in 2001, due to lower imports. The capital account remained in surplus, leading to a small increase in imputed reserves (compared with a decline in 2000).

Table 6.

Dominica: Balance of Payments

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

Projections assume the adoption of proposed program measures.

Includes stores and bunkers.

Includes external financing gap.

Table 7.

Dominica: Public and Publicly Guaranteed External Debt

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

Projections based on contracted debt.

Excludes debt forgiveness.

Average interest rate based on actual interest paid relative to debt stock.