Eastern Caribbean Currency Union: Staff Report for the 2004 Regional Surveillance
Author: International Monetary Fund
Publication Date:
22 Sep 2004
eISBN:
9781451811650
Language:
English
Keywords:
ISCR; CR; debt; GDP ratio; ECCU member; ECCU-region authorities; ratio; ECCU country authorities; private sector; economic activity; exchange rate; U.S. dollar; Fiscal stance; Caribbean; Global
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The staff report for the 2004 Regional Surveillance on the Eastern Caribbean Currency Union (ECCU) focuses on the economic developments and near-term prospects. The fiscal position of the governments in the region has deteriorated sharply in recent years and resulted in a marked increase in public sector debt. Efforts in the region have focused on strengthening the supervisory and regulatory regimes in both the domestic banking sector and the offshore financial sector. Enhanced regional cooperation could also help broaden markets and provide opportunities to achieve economies of scale.

Abstract

The staff report for the 2004 Regional Surveillance on the Eastern Caribbean Currency Union (ECCU) focuses on the economic developments and near-term prospects. The fiscal position of the governments in the region has deteriorated sharply in recent years and resulted in a marked increase in public sector debt. Efforts in the region have focused on strengthening the supervisory and regulatory regimes in both the domestic banking sector and the offshore financial sector. Enhanced regional cooperation could also help broaden markets and provide opportunities to achieve economies of scale.

I. Background

Economic perspective

1. Macroeconomic conditions in the ECCU countries have weakened considerably since the mid-1990s. GDP growth slowed sharply from nearly 5 percent a year during 1980–95 to about 2¼ percent a year since then.1 The slowdown in economic activity stemmed from increased competition from lower-priced tourist destinations, weaknesses in the global economy, the gradual reduction in preferential trade agreements, and closures of offshore banks. In an attempt to create employment opportunities, public expenditures as a share of GDP were raised sharply in the last few years. As a result, some countries are now facing high public debt and severe fiscal pressures. In this environment, preserving the currency board arrangement (CBA) and addressing several sources of vulnerabilities are key challenges.2

uA01fig01

ECCU: Public Debt, 1980-2003 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2004, 299; 10.5089/9781451811650.002.A001

Sources: ECCU country authorities; and Fund staff estimates.1/ ECCU countries that are members of the IMF are: Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines.

2. Public debt levels have risen rapidly since 1998, reaching 103 percent of GDP at end-2003. External current account deficits have been high—in the range of 10–20 percent of GDP—throughout the 1990–2003 period. During 1990–97, external current account deficits largely reflected private sector investment and were financed by foreign direct investments, helping to contain public debt to 60 percent of GDP. Since 1998, external current account deficits have been largely driven by increasing fiscal imbalances, resulting in the rapid accumulation of public sector debt. This pattern is noticeable across all six countries, although the public debt to GDP ratio ranges from 66 percent of GDP (St. Lucia) to 162 percent (St. Kitts and Nevis), placing them among the most indebted countries in the world.3 While external debt servicing costs—with interest rates averaging between 4 and 5 percent—are low by international standards, for the more indebted countries they have edged up to 7-8 percent, or even higher, on new debt in the last two years.

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ECCU: Ranking Among Most Indebted Emerging Markets

(Public Sector Debt-to-GDP Ratio, End-2002)

Citation: IMF Staff Country Reports 2004, 299; 10.5089/9781451811650.002.A001

Source: WEO.

3. Fiscal slippages account for the bulk of the rapid accumulation of public debt during 1998 – 2003.4 Public debt rose by an average of 7½ percent of GDP a year in 1998–2003, after falling by one half of one percent of GDP per year in 1990–97. While the refinancing of interest payments has been the largest contributor to the increase in debt (over 50 percent), the clear turnaround in the 1998–2003 period occurred in the deterioration of the primary fiscal balance—contrasting sharply with the 1990–97 period when primary fiscal surpluses helped reduce public debt. Other factors, which in the latter period were dominated by public sector assumption of private sector debt, have been important contributors to the turnaround. The positive contribution of growth to tempering the debt build-up was small, and declined in the second sub-period.

ECCU: Contributions to Debt Accumulation

(Averages, percent GDP, per year)

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Source: Fund staff estimates.

Others includes: valuation changes, debt relief, and the assumptions of private sector debt by the public sector.

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ECCU: Central Government Revenue and Expenditure

(In percent of GDP)

Citation: IMF Staff Country Reports 2004, 299; 10.5089/9781451811650.002.A001

Sources: ECCU country authorities, and Fund staff estimates.

4. The deterioration in fiscal balances in 1998–2003 was triggered by policy slippages and the costs associated with adverse exogenous shocks. The overall balance weakened from an average deficit of about 2 percent of GDP in 1990–97 to a deficit of more than 6 percent in 1998–2003. Despite a halving of concessional financing as a share of GDP, current and capital expenditures rose sharply—by nearly 3½ and 1½ percentage points of GDP, respectively, in the second sub-period. While part of the increase in expenditure could be attributed to unanticipated reconstruction and disaster management-related costs in some countries, they also reflected an attempt to create employment and preserve wages as growth slowed.

Social and political context

5. While the economies are dominated by the service sector, agriculture remains very important politically and socially, despite its small and declining contribution to GDP. The share of services (including tourism) to ECCU output rose from 78 percent in 1990 to 86 percent in 2003, while that of agriculture fell from 12 percent to 7 percent during the same period (Figure 1). The agricultural sector remains very important politically, because of its social significance—it continues to employ about one-fifth of the labor force, and over half the ECCU population lives in rural areas.

Figure 1.
Figure 1.

ECCU: Sectoral Share of GDP 1/

(In percent)

Citation: IMF Staff Country Reports 2004, 299; 10.5089/9781451811650.002.A001

Sources: ECCU country authorities; Eastern Caribbean Central Bank; and Fund staff estimates.1/ Percentage contribution of gross domestic product by economic activity, at current prices.

6. Health and education levels are a source of considerable pride in the region, although the skill mix produced by local educational institutions does not seem to correspond to the region’s current needs.5 Infant mortality rates are moderate (about 18 per 1,000 live births) and life expectancy at birth is high (over 70 years). Primary and secondary education enrollment rates are at levels comparable to OECD countries. The region also boasts several professional schools of medicine and veterinary colleges, which attract students from the United States and Europe. However, based on the limited data available, local unemployment rates appear to be high, ranging between 10–25 percent. There is a constant brain drain from the region. The spread of HIV/AIDS is also a concern, as the Caribbean region has the world’s second highest rate of infection after Africa.6

ECCU: Political Cycles—Winners in the National Elections

(1979-2004 1/)

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Source: Internet.

Updated until April 2004. Acronyms for political parties are described in Appendix IV.

7. The ECCU countries have democratically-elected governments, with elections held generally every 4-5 years. Governments tend to be fairly stable in the region, with infrequent changes of the ruling party. However, as election cycles are not synchronized—since 1979, elections have taken place in at least one country in 18 of the last 26 years—it would have been difficult for governments to take a regional approach and coordinate the implementation of bold economic reforms. The major political parties in the region emerged from the pre-independence labor movements. Consequently, the political agenda and mandate, irrespective of which party comes to power, is heavily tilted towards meeting social goals—reducing unemployment and raising living standards—and the size of the governments tends to be large.

II. Recent economic developments and Near-term Prospects

8. Following weak growth in 2001-02, the region’s economies picked up strength in 2003, and are likely to grow moderately faster in 2004. A favorable external environment—revival of tourism as the global economy continues to recover, the depreciation of the U.S. dollar against major currencies, and the absence of natural disasters—contributed to the strengthened outcomes in 2003 and improved prospects for2004. Reserve coverage of the currency board has continued to increase well beyond the statutory level of 60 percent and inflation remains very low (Table 1).

Table 1.

ECCU: Selected Economic and Financial Indicators 1/

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

The ratios and growth rates for the ECCU region are constructed from the consolidated data of the territories in the region, and treat intra-ECCU transactions as transactions between residents for the monetary and external sector data.

Excludes Anguilla and Montserrat.

Includes errors and omissions.

ECCB’s foreign assets as a ratio of its demand liabilities.

ECCU: Selected Economic Indicators, 2000–04

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9. Despite the recent pick up, output remains well below potential. In 2003, output is estimated to be below potential in all the countries except St. Vincent and the Grenadines (Figure 2), with large output gaps—in excess of 4 percent of potential output—in Dominica, Grenada, St. Kitts and Nevis, and St. Lucia.7 Growth has largely stemmed from a rebound in tourism, as new facilities have opened and security concerns that reduced global tourism in the aftermath of September 11, 2001 have diminished. Growth in 2004 is anticipated to continue to be driven by tourism and tourism-related services.

Figure 2.
Figure 2.

ECCU: Central Government Actual and Structural Budget Balances 1/

(In percent of potential GDP)

Citation: IMF Staff Country Reports 2004, 299; 10.5089/9781451811650.002.A001

Sources: ECCU country authorities; Eastern Caribbean Central Bank; and IMF staff estimates.1/ Actual balance is the overall balance (revenue and grants less expenditure), and is expressed as a percentage of actual output. Actual output is measured as gross domestic product (GDP) at factor cost.2/ The output gap is actual output less potential output, as a percent of potential output.3/ Structural balance is expressed as a percent of potential output. The structural balance is the budgetary position (overall balance) that would be observed if the level of actual output coincided with potential output. Structural balances also incorporate one-time expenditure adjustments.

10. Fiscal balances for the region as a whole strengthened significantly in 2003, in part due to one-off factors, but structural balances remain in large deficit (Table 2). The overall deficit for the ECCU region is estimated at 6 percent of GDP in 2003, an improvement of close to 5 percentage points over the previous year. The greatest adjustments occurred in Grenada, due to a one-off payment in 2002 of 11½ percent of GDP to terminate a number of leasing arrangements, and in St. Kitts and Nevis, largely due to the completion of projects to repair hurricane damage to key tourism infrastructure. Focusing on the current balance (which is not affected by these one-off factors), the adjustment is more modest—by 1½ percent of GDP to a current deficit of ¾ percent of GDP—reflecting significant improvements in all countries except St. Lucia; in Antigua and Barbuda, the improvement stemmed from ad hoc expenditure compression in response to the lack of available financing. However, structural deficits remain large throughout the region, with the exception of St. Vincent and the Grenadines (Figure 2).

Table 2.

ECCU: Selected Central Government Indicators by Country 1/

(In percentage of GDP)

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Sources: ECCU country authorities; Eastern Caribbean Central Bank; and Fund staff estimates.

Excludes Anguilla and Montserrat. Budget data for Dominica and St. Lucia are for fiscal years.

Includes external arrears.

11. Fiscal revenues have been mostly flat, despite the pick up in activity and efforts to improve tax policy and administration. Average revenues (including grants) have remained almost constant at 26–28 percent of GDP over the last few years, though there is significant variation amongst countries—ranging from an average of about 20 percent of GDP in Antigua and Barbuda to 26 percent of GDP in St. Lucia, and more than 30 percent of GDP in the other four countries. In 2003, total revenues and grants rose markedly only in Dominica and Grenada. The lack of buoyancy in the region’s tax systems reflects, in large part, the concentration of the recent economic rebound in the tourism sector, which is fairly lightly taxed as many of the large operators in the sector enjoy extensive tax concessions. A review of tax policy and administration in each of the countries was conducted by FAD and the Caribbean Regional Technical Assistance Center (CARTAC) in October–December 2002. Subsequently, a Tax Reform and Administration Commission comprising representatives of the member countries produced a draft report laying out a strategy for tax reform in the region that incorporated the key recommendations from the earlier report. The Commission is developing an implementation schedule for each country. Most countries in the region have accepted the objective of moving to a VAT or similar broad-based sales tax, though timeframes and implementation schedules are still being developed with assistance from CARTAC.8

12. Despite the fiscal strengthening and renewed growth, the debt to GDP ratio of the region increased to 103 percent in 2003 and is likely to remain at that level in 2004. The overall fiscal balance for the region is projected to improve only modestly in 2004—by less than ½ percent of GDP—driven by a reduction in noninterest expenditures. A significant strengthening of the fiscal position is foreseen in the approved 2004 budget in St. Kitts and Nevis, based on expenditure reduction and increased revenues due to administrative improvements implemented in 2003 and the ending of some tax breaks provided to a major new hotel. In other countries, particularly Antigua and Barbuda where the March 23 elections resulted in a change in government, the projected fiscal stance is highly uncertain. Even with the above-mentioned adjustments, the overall deficit for the region would remain at around 5½ percent of GDP in 2004, and debt to GDP ratios would not decline.

13. Commercial creditors, principally private domestic and foreign-owned banks, were the largest holders of total public debt at end-2002, the latest year for which data are available (Table 3). Commercial creditors held around 40 percent of external debt, with the remaining amount split equally between bilateral and multilateral lenders. Private domestic banks held half of domestic debt at end-2002, with the rest held by various creditor groups, depending on the country. With the launching of the Regional Government Securities Market (RGSM) in November 2002, countries placed local currency debt with ECCU region banks on better terms than those available in their local markets. Grenada, St. Kitts and Nevis, and St. Vincent and the Grenadines have made the most active use of this market. Given its relatively better economic indicators, St. Vincent and the Grenadines has been able to access this market at steadily declining interest rates.9

Table 3.

ECCU: Creditor Composition of Public Debt at End-2002 1/

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Sources: Eastern Caribbean Central Bank; and Fund staff estimates.

Excludes Anguilla and Montserrat.

14. The external current account deficit is estimated to have remained at 19½ percent of GDP in 2003, despite the fiscal adjustment and the large real depreciation of the Eastern Caribbean dollar (Table 4). Following a period of sustained appreciation over the last decade, the Eastern Caribbean dollar depreciated (in real effective terms) by over 15 percent during 2002 and 2003—owing in large part to the sharp depreciation of the U.S. dollar against major currencies since the second half of 2002. An increase in export receipts (including tourism) was offset by a rise in imports, in part due to a sharp increase in capital imports related to direct foreign investment inflows (mainly in construction, hotels, and telecommunications—following the liberalization of the sector in several countries in the region) to about 13 percent of GDP, still somewhat below the levels of the late 1990s. Despite the large current account deficits, the overall balance of payments position of the ECCU has remained in surplus, reflecting both the large direct foreign investment inflows and portfolio investment inflows as governments placed debt instruments on international markets. As a result, gross international reserves of the ECCB increased by US$35 million, reaching US$540 million (4½ months of imports) at end-2003.

Table 4.

ECCU: Summary Balance of Payments

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Source: Eastern Caribbean Central Bank

Includes errors and omissions.

15. Monetary aggregates have continued to expand rapidly, relative to the region’s output growth rates, despite increasing pressures on the health of the banking system (Tables 5 and 6). Broad money (M2) grew in real terms by 5½ percent in 2002 and by 8 percent in 2003, as deposits with the banking sector rose despite a reduction in the minimum savings deposit rate from 4 percent to 3 percent in September 2002. Net lending to the public sector contracted sharply, as governments made increasing recourse to external borrowing and government social security funds built up deposits with the banking system. Private sector credit growth—principally loans to individuals, mostly for housing—declined to 2 percent in 2002 and to 1 percent in 2003, as interest rates did not adjust to the excess liquidity in the banking system and banks accumulated foreign assets. Despite the high interest rate spread, the rate of return on bank assets is low.10

Table 5.

ECCU: Summary Accounts of the Banking System

(In millions of Eastern Caribbean dollars)

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Sources: Eastern Caribbean Central Bank; and Fund staff estimates.

Includes the national insurance schemes.

Table 6.

ECCU: Selected Vulnerability Indicators

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Sources: Eastern Caribbean Central Bank; and Fund staff estimates.

Gross reserves defined as foreign assets of ECCB. Net reserves defined as net foreign assets of ECCB.

Defined as external current account deficit plus external amortization.

End-September for 2003.

Foreign assets as a percentage of demand liabilities.

III. Policy Discussions

A. Overview and Strategic Considerations

16. Policy discussions focused on bringing a regional perspective to the current economic difficulties, and identifying the main sources of vulnerability and risks. Two broad themes emerged:

  • Addressing fundamental economic problems in the region: ensuring long-run debt and fiscal sustainability, and regional coherence in economic polices to support growth and preserve the currency board arrangement.

  • Facing near-term risks: taking immediate measures to reduce vulnerabilities and increasing preparedness to respond to a negative event, if it cannot be prevented.

17. While acknowledging the deterioration of their economic conditions since the mid-1990s, the authorities maintained that key causes were unfair global trading practices and the series of negative shocks that had hit their economies. The dismantling of preferential trade arrangements starting in the 1990s had triggered a decline of traditional agricultural crops (bananas and sugar), despite efforts to sustain them via domestic subsidies and European Union compensation projects (Box 1).11 The authorities pointed to the labor-intensive nature of the production of agricultural crops, and the strong linkages of this industry to other sectors of the economy. They expressed frustration with the double standards they considered were imposed by industrial countries in agriculture—transferring large subsidies to their own agricultural sectors while preventing developing countries from providing subsidies to their domestic agricultural sectors, and removing preferential arrangements—that had undermined the region’s ability to compete on world commodity markets.12 They also noted that the new global rules imposed by industrial countries (who, they noted, did not necessarily comply with them themselves) via the Financial Action Task Force (FATF), had abruptly shut down the offshore financial centers, severely retarding the emergence of a new growth sector for the region (Box 2). The authorities also pointed to much diminished levels of external concessional assistance flows from developed countries, which had hampered their efforts to undertake growth-enhancing investment in human and physical capital. In addition, the economies had been subject to adverse weather conditions (including several hurricanes), crop diseases, and the 2001 terrorist attack on the United States which had been a severe setback for the tourism sector, the mainstay of the economies of the ECCU.13 In sum, they argued that the forces of globalization presented difficult challenges to small open economies, disrupting traditional cultures and lifestyles.

ECCU: Total Official Development Assistance Flows

(In percent of GDP)

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Sources: OECD; Eastern Caribbean Central Bank; and Fund staff estimates.

Caribbean Preferential Trade Arrangements: Bananas and Sugar

The Windward Islands (Dominica, Grenada, St. Lucia, and St. Vincent and the Grenadines) have a preferential trade arrangement in bananas with the European Union (EU), while St. Kitts and Nevis, together with other Caribbean countries, have a preferential agreement with the EU in sugar.

The EU Banana Regime

Prior to the establishment of a Single European Market in 1993, EU countries had bilateral arrangements with their ex-colonies in the Caribbean, Africa and the Pacific (“ACP” bananas). Between 1993–98, the unified European Union (EU) banana regime operated on the basis of an annual ACP banana quota for duty-free export to the EU by 12 traditional producers, and an annual quota for bananas from Latin America (“dollar” bananas), subject to a tariff. Given the quantity restrictions and subsidies paid to EU banana producers, the price of bananas in the EU averaged about 80 percent more than the world price.

From the start, the EU banana regime was controversial. Following several legal challenges at the GATT and WTO, reforms to the system were introduced in various stages from January 1, 1999. The reforms introduced regional (rather than country-specific) quotas, progressively reallocated quotas to Latin American producers and simplified licensing procedures. A key modification, to be introduced on January 1, 2006, is the move to a tariff-only regime (no quotas or licenses) for dollar bananas as of January 1, 2006, but allows the tariff preference, at a level yet to be determined, for ACP bananas to remain until 2008.

The EU Sugar Regime

Since 1975, the ACP countries, under the Lome Convention, have supplied raw sugar to the EU at guaranteed prices subject to a quota that could be increased in the event of a shortfall in the supply of sugar to EU refiners. The average price currently paid by the EU to ACP sugar producers is about twice the international price of sugar. Australia and Brazil filed a complaint at the WTO in February 2003, which concerned the fact that the EU imports raw sugar from the ACP countries at above-market prices, then refines the sugar and re-exports it at below-market price, resulting in unfair competition.

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Real Sugar Prices, January 1990–February 2004

(U.S. cents per pound)

Citation: IMF Staff Country Reports 2004, 299; 10.5089/9781451811650.002.A001

Source: International Monetary Fund, Commodity Price System.Notes: Sugar (USA) is the U.S. import price, CSCE nearest futures, c.i.f. New York; sugar (EU) is the European Union negotiated import price for raw unpackaged sugar from ACP countries, c.i.f. European ports; sugar (world) is the free market price, CSCE nearest futures, c.i.f. New York. Dashed lines are measures of the longrun trend (smoothed versions) of the respective real price series. All nominal price series were deflated using the Fund’s manufacturers’ unit value index.

This preferential scheme is being dismantled and by 2007, the Caribbean sugar industries will have to compete in the international market. Given that production costs in the ECCU region are significantly above international prices, the dismantling of the regime could result in large losses in employment.

18. Staff noted the authorities’ concerns on the adverse impacts of globalization, but pointed to the opportunities for raising growth rates that it afforded. Staff suggested a two-pronged approach: first, to continue to confront inequities in trade practices, in coordination with other developing countries in the context of the WTO, by pushing for freer and fairer trade, rather than continuing protectionism. Second, to pursue regional and national strategies that would take advantage of the new global environment. In particular, opportunities clearly existed in tourism, where the ECCU countries have only just begun to exploit the sector’s vast potential. Education and health levels, that are well ahead of other developing nations and comparable to OECD levels, could be adapted to correspond to the current needs of the region. Finally, the richness of the soil and favorable climate in the region lends itself to developing new agricultural products for export to both regional and world markets, as well as for local consumption, including by the tourism sector.

The Re-emergence of Offshore Financial Centers in ECCU Economies

By end-2000, several offshore financial centers (OFCs) were operating in the ECCU region. Available data indicate that at end-2000, OFC employment ranged from about 8 percent of the labor force in Antigua and Barbuda to only one-half of one percent of the labor force in Dominica. Income from fees accounted for, on average, 5.8 percent of central government current revenues, ranging from about 7 percent in Antigua and Barbuda to 0.7 percent in Dominica. A majority of the fee income was generated from international business companies (IBCs) and, in Antigua and Barbuda, from internet gaming companies. However, the net revenue contribution from the sector averaged only 2.3 percent, after taking into account the business and supervisory cost of maintaining an OFC.

Annual Fee Income to Governments from OFCs, 2000

(as percent of central government revenue)

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Source: Suss, Williams, and Mendis, “Caribbean Offshore Financial Centers: Past, Present, and Possibilities for the Future,” IMF Working Paper 02/88, May 2002.

The listing of four ECCU countries by the Financial Action Task Force (FATF) as “noncooperative” starting in mid-2000, generated an overhaul in the regulatory framework, which resulted in a sharp contraction in the level of offshore activities. Dominica, Grenada, St. Kitts and Nevis, and St. Vincent and the Grenadines were identified by the FATF as noncooperative territories, but all countries in the region took steps to strengthen their regulatory frameworks. The number of offshore banks fell drastically, with many folding voluntarily as supervision tightened. The adverse publicity associated with the listing has also negatively affected other offshore institutions such as IBCs and trust companies. Data on IBCs are only available for St. Vincent and the Grenadines, but indicate that the total number of IBCs fell by about 13 percent in 2002 and a further 23 percent during 2003.

Number of Active Offshore Banks, 2000 and 2003

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Source: ECCB

There are 7 licensed banks, only one of which is authorized to conduct banking business.

By June 2003, all four countries had been de-listed by the FATF and the strengthened and more reputable environment has enabled the re-emergence of OFCs. On the basis of the partial data that are available, the remaining offshore banks expanded their assets between 2001 and 2003. In St. Lucia, a new offshore bank will begin operation in 2004. In St. Vincent and the Grenadines—the only country for which recent revenue data on the OFC are available, the fee income from insurance companies tripled in 2003, and that from offshore banks increased marginally—as the authorities charged offshore banks new fees to cover strengthened due diligence and on-site inspection. Fee income generated from the IBCs declined by 35 percent in 2003, but the number of IBCs has begun to increase in 2004.

19. The authorities did not consider that the weaker economic outcomes of the last few years had significantly elevated risks in the region.14 They noted that the region had withstood a series of large adverse shocks and that many events—such as large public sector wage arrears, defaults to certain classes of creditors, deposit runs, sharp decline in export receipts—that had triggered crises in other parts of the world, had occurred somewhere within the region in the last few years without resulting in a crisis. Both Dominica, due to its small size within the ECCU (representing about 8½ percent of ECCU GDP), and Antigua and Barbuda, due to its long history of fiscal difficulties and arrears to creditors, were regarded in the region as outliers whose actions did not reflect on the other members of the ECCU.

20. The mission noted that implementation of ambitious front-loaded macroeconomic adjustments in all countries, as in Dominica, would reduce the risk of disorderly adjustments later. Staff cautioned that the ECCU region needed to begin adjusting now so that it can be done in an orderly way and avoid prolonged economic stagnation. Gradual adjustments—the preferred approach in most countries in the region—raised concern because the already large macroeconomic imbalances could become even larger, given the vulnerability to negative shocks. At the same time, the authorities of the region expressed favorable views on the progress of the Fund-supported program with Dominica, stating that the successful completion of the program was necessary to correct for past fiscal profligacy and ensure growth (Box 3).

21. The mission welcomed the work being undertaken by the authorities to design home-grown stabilization programs, yet urged the authorities to make greater use of this work in their policymaking deliberations.15 Each country, with technical support from CARTAC (the main regional technical assistance center) is developing a framework to implement stabilization program under the Structural Adjustment and Technical Assistance Project (SATAP) initiative. This initiative could prove to be a powerful tool for ensuring macroeconomic stability, dealing with debt problems, and implementing reforms to embrace new opportunities for growth. Staff pointed out that the success of these programs, however, would depend critically on the ambitiousness of the programs and the determination with which they were implemented, the integration of SATAP programs with policy making and monitoring, and the quality and technical expertise of their staff.

Dominica—Progress in Stabilization and Regaining Sustainability

Dominica has faced similar economic problems to those confronting the rest of the ECCU. A combination of external shocks—which affected tourism and included the dismantling of preferential trade agreements and the closure of most of the offshore banks—and inappropriate policy responses led to a rapid deterioration in fiscal performance and accumulation of public debt. An attempt to stabilize the economy in August 2002, supported by a Stand-By Arrangement (SBA), fell short of expectations due to difficult conditions and weak political support. The economy continued on a downward trend, reaching a budgetary crisis, as arrears accumulated rapidly. By mid-2003, the economy was in a deep recession, with output falling by about 10 percent in the previous two years. In 2002/03, the structural primary fiscal balance deteriorated to a deficit of 5 percent of GDP and public debt reached 112 percent of GDP, more than double its level in 1998.1

A two-stage strategy of stabilization and structural reforms introduced in mid-2003 is proving effective in paving the way for an economic recovery and averting a budgetary crisis. The first stage consisted of a short-term stabilization program for the second half of 2003, supported by an extended and modified SBA. Political commitment was strengthened and a tight budget for 2003/04 was adopted, including a 5 percent cut in nominal wages. All performance criteria and structural benchmarks under the SBA were observed, helping mitigate a budgetary crisis and arresting a further contraction in output.

Dominica: Macroeconomic Framework, 2002-2006

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Sources: Dominican authorities; and Fund staff estimates.

Fiscal years beginning July 1.

In the second stage, measures to revive growth and regain sustainability have been adopted at end-2003 in the context of a PRGF arrangement. The key elements of the program include an ambitious fiscal consolidation effort, a comprehensive debt restructuring, and an ambitious structural reform agenda, including fiscal and financial sector reform and the deregulation of the economy to improve competitiveness. As a consequence, the structural primary fiscal position is expected to swing from a deficit of almost 5 percent of GDP in 2002/03 to a surplus of 3 percent of GDP by 2006/07. The authorities have embarked on a consensual and comprehensive debt restructuring, and have adopted best practices in their negotiations with creditors, including the principles of transparency and inter-creditor equity. The debt restructuring process is progressing as envisaged; the debt exchange offer was announced on April 6. The authorities are targeting the completion of the debt restructuring in May 2004.

1 The structural primary balance is calculated as the actual primary balance with capital expenditures and grants set equal to their historic averages of 7 and 3½ percent of GDP respectively (see IMF Country Report No. 04/6).

22. In addition to implementing individual country economic programs, staff urged the authorities to take a regional perspective in designing their programs. This perspective, in the staff’s view, had two aspects.

  • Building on the achievements of the past—in particular, the currency board arrangement (CBA). Staff stressed that the currency and inflation stability provided by the CBA could not be taken for granted, and that the authorities had to be mindful of the negative regional externalities that could be generated by large fiscal slippages and high levels of public debt in any one country, as these could threaten the stability long enjoyed by all.

  • Meeting the challenges of globalization and the opportunities it created by breathing new life into institution building and regional cooperation. National labor, capital, and goods markets are small and prevent the individual countries from realizing their full potential (Box 4). Pursuing greater outward orientation of the economies—including through deepening regional markets—would assist in overcoming this hindrance to growth.

23. Discussions with civil society revealed limited acceptance of the implications of the changes in the global environment and a lack of awareness of the gravity of the economic difficulties. Staff considered there was a need to improve public awareness of two issues:

  • The implications of a changing world environment. Specifically, that the loss of preferential trading access for traditional crops meant that, in the period ahead, they would inevitably play a smaller role in the economy, and that rural livelihoods would need to adjust a