Statement by Ian E. Bennett, Executive Director for Dominica

This paper examines the First Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility for Dominica. The authorities were encouraged by the stronger-than-envisaged performance, but considered it premature to change the macroeconomic framework. The recent encouraging developments on the growth front enhanced the credibility of the macroeconomic framework and increased the chances of success. The authorities embraced the ambitious structural reform agenda as a necessary course of action to address the complex problems faced by Dominica.

Abstract

This paper examines the First Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility for Dominica. The authorities were encouraged by the stronger-than-envisaged performance, but considered it premature to change the macroeconomic framework. The recent encouraging developments on the growth front enhanced the credibility of the macroeconomic framework and increased the chances of success. The authorities embraced the ambitious structural reform agenda as a necessary course of action to address the complex problems faced by Dominica.

While the economic situation in Dominica remains fragile, the PRGF arrangement continues to provide a solid foundation for macroeconomic stability and is off to a promising beginning. Economic indicators point to a bottoming out of the severe economic retrenchment of recent years; an early recovery is underway. Economic activity is on the rise in manufacturing, construction, and tourism sectors (although production in the banana sector continues to adjust). Moreover, larger than expected tax collections and rapid import growth are further indications of an incipient recovery. While not all numbers are in, it now looks like growth was flat for 2003, as opposed to the projected decline of between 1 and 3 percent.

My Dominican authorities are well aware, however, that they will need to follow through on an ambitious and comprehensive set of fiscal and structural reforms to sustain and give further momentum to the economic recovery. It is, therefore, important to note that, notwithstanding the sudden death of Prime Minister Charles shortly after the program’s approval, the political situation in Dominica has remained stable; a prompt and orderly transition took place and the government’s commitment to the PRGF program remains firm. Indeed, program implementation has, thus far, been commendable as reflected by the observance of all end-December performance criteria.

Debt Restructuring

The government and its creditors, including the IMF, World Bank, and the Caribbean Development Bank (CDB), have agreed that Dominica’s debt burden, which stands at nearly 115 percent of GDP, is unsustainable. The Executive Board concurred with this assessment at its meeting on December 19th, 2003. Therefore, the overriding immediate-term priority is to decisively resolve the debt overhang problem, which has seriously undermined Dominica’s growth potential.

Thus far, the debt restructuring process is proceeding as envisaged and an exchange offer will be made available to private creditors shortly. The authorities have been negotiating in good faith with their creditors and are committed to upholding the principles of transparency and inter-creditor equity. In particular, the government has engaged in discussions with the CDB on a specific debt restructuring proposal, and consultations with private and bilateral creditors are proceeding. While they are hopeful that a comprehensive debt deal can be finalized by mid April –thus avoiding the re-emergence of acute financing pressures– there is still a risk that the agreement may fall short of what is needed to restore sustainability despite the authorities’ best efforts. The international communities’ continued support of the authorities’ debt restructuring efforts, particularly bilateral creditors, will be critical in moving this process forward and securing restructuring terms that are consistent with the sustainability assumptions within the program.

Fiscal Adjustment

Even if the debt strategy is successfully implemented, Dominica’s debt dynamics will remain fragile for some time to come. Fiscal consolidation will, therefore, remain a program centerpiece. The government is committed to the objective of moving to a 3 percent primary surplus in 2006/07. If achieved, this would constitute an overall 7½ percent swing in the structural primary balance since embarking on the predecessor SBA in 2002. The authorities are currently on track to post a ½ percent primary surplus in FY2004.

The proposed fiscal package places a heavy emphasis on expenditure measures that will secure permanent gains consistent with long-term sustainability. In addition to maintaining an expenditure freeze on non-interest current spending, the government is set to increase the retirement age and decrease the wage bill by 5 percent, based on reductions in the number of employees. On balance, the government intends to reduce the public wage bill by a total of 10 percent in the next two fiscal years through comprehensive public sector reform. This is on top of the 5 percent nominal wage cut that was introduced in the 2003/04 budget.

On the revenue side, while progress has been made to eliminate discretionary tax exemptions, there is still room for improvement. As elaborated in Box 1 of the staff report, managing tax exemptions is a complex area. The distinction between statutory and discretionary exemptions is at times blurred which, when combined with inherent capacity constraints, implies that monitoring and enforcement is extremely difficult. The authorities are resolved to address inefficiencies and will present possible solutions in June. As part of this effort, they would welcome input from FAD.

Financial Sector and Monetary Issues

Preserving domestic financial sector stability throughout the debt restructuring period and beyond is a key priority. Thus far, market reaction to the debt announcement has been benign and liquidity remains abundant. Indeed, domestic bank deposits have been stable and there is no evidence to indicate financial turbulence at a regional level. And, while a restructuring of domestic bank claims is a part of the debt strategy, the authorities are mindful of the need to strike a delicate balance to prevent an excessive and destabilizing erosion of balance sheets.

On balance, the authorities are confident that financial sector stability will be preserved, but intend to be proactive in terms of ongoing initiatives to further strengthen domestic financial institutions. Indeed, they endorse the recommendations coming out of the regional FSAP concerning the need to strengthen the Eastern Caribbean Central Bank’s (ECCB) prudential regulations and step up its monitoring activities. For Dominica’s part, the government has divested its majority share of the National Commercial Bank (now renamed the National Bank of Dominica) and reduced the number of government-appointed Directors on its board to improve governance. Moreover, a strategy is being worked out to advance a new round of on-site inspections of systemically important non-bank financial institutions.

On monetary policy issues, Dominica is constrained given its participation in the Eastern Caribbean Currency Union. Nevertheless, the authorities are of the view that eliminating the ECCB’s minimum savings deposit rate could strengthen monetary management while at the same time remove a recessionary bias in the economy. They will express these views at the next meeting of the ECCB monetary council.

Structural Reform Agenda

The structural reform agenda is largely embodied in the package of measures that underpin fiscal objectives, including pension and public sector reform. Mindful of the need for fiscal sustainability, the authorities also intend to: i) increase the efficiency of the tax system by introducing a VAT as early as 2005; ii) strengthen budgetary procedures by making use of three-year rolling budgetary projections; and, iii) bring forward (to the extent possible) the introduction of a fiscal responsibility law to guide policy over the business cycle and to safeguard fiscal sustainability.

Conclusion

Dominica has made strides in terms of reorienting fiscal policy and advancing structural reform to restore macroeconomic stability. This has paid early dividends, which in turn has strengthened the authorities’ resolve to persevere and implement the full set of reforms under the PRGF. My Dominican authorities will continue to consult with civil society and domestic stakeholders to strengthen this growing national consensus, including through discussions to finalize the Poverty Reduction Strategy Paper. The government is hopeful that the IMF Board will continue to endorse Dominica’s ongoing efforts to engineer a smooth economic transformation by supporting the completion of the First Review of the PRGF. Finally, my Dominican authorities would like to express their gratitude to the IMF and the donor community more generally, for the provision of timely financial support and technical assistance in support of structural adjustment.

Dominica: First Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility and Financing Assurances Review
Author: International Monetary Fund