Eastern Caribbean Currency Union: Staff Report for the 2005 Regional Discussions

This 2005 Article IV Consultation highlights that economic activity in the Eastern Caribbean Currency Union (ECCU) has accelerated since mid-2003 owing to an acceleration of activity in the tourism and construction sectors. Inflation has been stable and monetary aggregates have been expanding rapidly, reflecting continued growth in the demand for money and confidence in the banking system and the quasi-currency board arrangement. Against this background, Executive Directors have called for strengthening fiscal consolidation, lowering the debt ratios, and ensuring the consistency of fiscal policies with the currency board arrangement.


This 2005 Article IV Consultation highlights that economic activity in the Eastern Caribbean Currency Union (ECCU) has accelerated since mid-2003 owing to an acceleration of activity in the tourism and construction sectors. Inflation has been stable and monetary aggregates have been expanding rapidly, reflecting continued growth in the demand for money and confidence in the banking system and the quasi-currency board arrangement. Against this background, Executive Directors have called for strengthening fiscal consolidation, lowering the debt ratios, and ensuring the consistency of fiscal policies with the currency board arrangement.

I. A Brief Perspective

1. The ECCU economies are small middle-income countries with strong social indicators, but living standards differ across the islands. Despite the close ties from sharing a common currency, there is considerable divergence in per capita incomes. Moreover, reflecting limited regional integration, the cross-country dispersion of per capita GDP, GNP, and GNDI (gross national disposable income, which includes net current transfers from abroad) has increased through time.1 Recorded poverty levels are relatively high, but this may reflect in part the use of nationally-defined poverty lines that are high by international standards, as well as weaknesses in available data.


ECCU: Standard Deviations of Real GDP, Real GNP and Real NDI Per Capita, 1980-2003

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

ECCU Countries: Social and Demographic Indicators

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Percentage of population living below each country's locally-defined poverty line in 2000.

2. A strong emphasis on social outcomes is a reflection of the political landscape, where most parties have their roots in the pre-independence labor movements. Democracy is deep-rooted in the region, with elections typically held every 4–5 years and active opposition parties in most countries. Political mandates, irrespective of the party in power, are heavily tilted towards achieving social goals—reducing unemployment and raising living standards.

3. Economic growth has declined since the start of the 1990s as the region struggled to cope with a series of shocks. Shocks of a more permanent nature included the erosion of trade preferences for traditional exports (bananas and sugar) and the decline of offshore financial sectors in 2000, after the inclusion of most ECCU countries in FATF’s list of “noncooperative jurisdictions.” In addition, the region suffered a steep decline in world tourism following the events of September 11, 2001. Longstanding structural rigidities, notably in the labor market, and continued disruptions in the aftermath of hurricanes and other natural disasters also served to constrain growth.


ECCU: Real GDP Growth, 1980-2004

(Annual percentage change, 3-year moving average)

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

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

4. The economies of ECCU countries are now dominated by services—particularly government, tourism and financial. The share of agriculture in GDP declined from 15 percent of GDP in the mid-1980s to about 6½ percent at end-2004, reflecting the effects of the erosion of trade preferences. Tourism and financial services have grown, but so has the government sector, which has often served as the employer of last resort during economic downturns.


ECCU: Share in total GDP by Sector, 2004

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

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

5. The ECCB operates a quasi-currency board arrangement (CBA) that has preserved exchange rate and price stability and fostered financial development, despite external shocks and domestic policy slippages. The ECCB has operated with a high degree of independence in managing the CBA: lending to member jurisdictions has been kept well within statutory limits and external reserve coverage is substantially in excess of the legal floor of 60 percent of demand liabilities. There have been no obvious periods of pressure on the EC dollar, and inflation remains in the low single digits, reflecting the very high import content of the consumption basket. The financial sector is deep relative to other countries at similar levels of economic development. Reflecting the confidence in the CBA, foreign currency deposits are very low.

6. The confidence engendered by the regional CBA and the development of domestic financial markets have enabled the region to increase their access to capital markets and use fiscal policy to temper economic downturns. With the exception of Antigua and Barbuda, where access to capital markets has been restricted for many years, the countries in the region have been able to borrow during economic downturns and thereby limit the procyclical nature of fiscal policy that is common in most developing and emerging market economies.2


ECCU: Fiscal Policy Procyclicality 1/

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

Source: ECCU--Selected Issues, Chapter II.1/ Calculated as the difference between average annual growth of central government real expenditure in good times (real GDP growth above median) and bad times (growth below median). Higher values are thus associated with greater procyclicality.

7. Absent an enforceable fiscal discipline mechanism, the regional CBA has induced a free-rider problem that is exacerbated by spending associated with election cycles.3 In effect, the costs of fiscal slippages—in the form of anticipated future inflation, higher interest costs or pressures on the currency board—are being deferred to the future or shared with member governments. Indeed, fiscal outcomes have steadily deteriorated relative to the benchmarks approved by the ECCB’s Monetary Council in 1998 (to be achieved by 2007), with just two countries meeting only one of the four benchmarks in 2004. Governments have granted wage increases, expanded civil service employment, and extended more concessions to both the public and the private sector in the run up to elections.

ECCU Countries: Election Calendar

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Based on elections since 1990.

The number of Caribbean countries with fixed and flexible exchange rate regimes are three and nine, respectively.

8. Public debt to GDP ratios throughout the region are amongst the highest in the world. Four of the six countries feature in the ten most indebted emerging market countries, with public debt in the region averaging more than 100 percent of GDP since end-2002.

9. While many of the challenges faced by the ECCU countries are similar to those of other Caribbean countries, they face additional constraints because of their small size. The erosion of trade preferences has impacted traditional producers of sugar and bananas throughout the region. Natural disasters—hurricanes, earthquakes, tropical storms, floods, and crop diseases afflict many countries in the region. With the slowing down of growth in recent years, several countries have attempted to stimulate their economies through large public sector investments that have resulted in very high public debt to GDP ratios. However, the extremely small size of the ECCU economies limit the scope of economic diversification, raise the cost of providing government services, and magnify the effect of natural disasters more than in other Caribbean countries.

10. The Fund has stepped up its work on the ECCU in response to the challenges facing the region. There are three key elements to this approach. First, the analytical basis of staff's advice has been deepened, as reflected in the Selected Issues papers accompanying the regional discussions for 2004 and 2005. Second, to increase policy coordination, common regional themes are developed and discussed with senior policymakers in each of the countries, as well as with key regional institutions. This approach is strengthened by staff visits to individual countries during budget preparations and the annual Article IV consultation discussions. Finally, several types of outreach activities are ongoing to help build ownership of reforms—a conference on the Caribbean region co-organized last year by the Central Bank of Trinidad and Tobago and the Fund received wide attention.4

ECCU: Compliance With Proposed Central Government Fiscal Guidelines 1/

(In percent of GDP, unless otherwise indicated)

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Excludes Anguilla and Montserrat.

Includes external arrears.

Excludes domestic debt amortization.


Public Sector Debt in Highly-Indebted Emerging Market Countries, end-2004

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

Sources: IMF, World Economic Outlook; and Fund staff estimates.

II. Recent Economic Developments and Near Term Prospects

11. Economic activity has accelerated since mid-2003—despite an active hurricane season in 2004—and, given the positive world economic outlook, near-term growth prospects appear strong. Growth has been driven by construction and a rapid expansion in tourism, with most economies in the region now running at or close to potential (Figure 1). The impact of Hurricane Ivan on Grenada was severe (Box 1), but because damage to other ECCU countries was limited, growth in the region was just above 3 percent compared to a pre-Ivan projection of 4 percent. Given the positive outlook in the region’s major tourism markets (the United States and the United Kingdom) and ongoing construction projects ahead of the 2007 Cricket World Cup, growth is likely to remain strong, at 3–3½ percent in 2005.

Figure 1.
Figure 1.

ECCU: Central Government Actual and Structural Budget Balances 1/

(In percent of potential GDP)

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

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

Grenada: Impact of Hurricane Ivan

On September 7, 2004, Hurricane Ivan—one of the strongest storms ever in the Caribbean—passed directly over Grenada causing extensive destruction. Damage was estimated at US$900 million, or more than 200 percent of GDP. Nearly 90 percent of the housing stock was damaged or destroyed, all education facilities had to be closed, and the electricity supply was significantly disrupted. The economy was also hit hard as most tourism facilities suffered considerable damage, and nutmeg plantations, which produce the principal export commodity, were largely destroyed. GDP growth which had been projected to reach over 4 percent in 2004 is now estimated at −3 percent, while the unemployment rate increased by at least 8 percentage points to more than 20 percent in the immediate aftermath of the hurricane. The banking system has proven to be resilient—deposits have risen as households received insurance payments and transfers from abroad—but profitability has declined significantly as loan loss provisioning rose sharply.


Grenada Real GDP Growth, 1998-2004

(In percent)

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

With external help, the government quickly stabilized the economic and social situation. Security and utilities were restored early and schools reopened gradually. Emergency relief supplies and reconstruction support were provided by the regional and international community and bilateral donors, as well as by nongovernment organizations.

The reconstruction effort is underway, but the arduous task of recovering fully from the shock will persist over the medium term. An Agency for Reconstruction and Development has been established to help in the recovery and reconstruction. At two donors’ conferences last year in Washington, D.C. and Grenada respectively, pledges of US$150 million (one-third of GDP), including over US$25 million in budgetary support, were marshaled. Grenada also purchased SDR 2.93 million (25 percent of quota) in November 2004 under the Fund’s emergency assistance policy for natural disasters (IMF Country Report 04/405: http://www.imf.org/external/pubs/ft/scr/2004/cr04405.pdf). Reconstruction of schools and the housing stock, and revitalizing agriculture, are ongoing. However, continued fiscal adjustment and further support from donors and creditors will be needed over the medium term to reconstruct the economy and close the large projected financing gaps.

ECCU: Selected Economic Indicators, 2001-2005

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Excludes Anguilla and Montserrat.

End-of-period (depreciation -), 1990=100.


ECCU: Contribution to Real GDP Growth by Sector 1/

(In percent)

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

Sources: Eastern Caribbean Central Bank; and Fund staff projections.1/ Excludes Anguilla and Montserrat.2/ Includes wholesale and retail trade, hotel and restaurant, air transport, and half of local transport.

12. The rebound in tourism helped to narrow the external current account deficit in 2004, but it remained large—at 17 percent of GDP—financed mostly by foreign direct investment (FDI). In the past two years, tourist arrivals have increased sharply with the easing of the global security concerns, the rebound in growth in the world economy, and the depreciation of the U.S. dollar against major currencies that has improved competitiveness in European markets. Imports continued to increase in relation to GDP, partly reflecting an increase in current transfers (largely to Grenada), which more than offset a modest decline in FDI flows. The external current account deficit is likely to widen marginally to 19 percent of GDP in 2005, mostly financed by capital inflows to finance investment, particularly construction activity.

13. Fiscal outcomes strengthened modestly in 2004. After a sharp adjustment in 2003, central government primary balances in the region improved modestly by ½ percent of GDP, but remained marginally in deficit. This reflected significant increases in primary balances in both Antigua and Barbuda—as the new administration attempted to contain fiscal imbalances—and in Grenada—where public sector investment was curtailed sharply. Fiscal positions were eased in the rest of the region, notably in St. Kitts and Nevis ahead of the elections. The pace of fiscal consolidation has been relatively slow and structural deficits have widened in four countries (see Figure 1).

14. Significant fiscal reforms are underway in several countries, but fiscal positions are likely to weaken in 2005, particularly if approved budgets are fully implemented. Approved budgets—even assuming that the implementation rate for capital expenditures will be at historical levels—would imply a deterioration of about 2 percent of GDP in fiscal outcomes for the region as a whole. However, important measures are being introduced in a number of countries that will strengthen fiscal positions over the medium term—civil service retrenchments and the overhaul of the tax system in Antigua and Barbuda, the ongoing fiscal consolidation in Dominica, efforts to strengthen revenues in Grenada, and the announced closure of the sugar industry in St. Kitts and Nevis. Both St. Lucia and St. Vincent and the Grenadines are due to hold elections no later than 2006, and the approved budgets suggest easing of fiscal stances, particularly in St. Lucia.5 The deterioration in the primary balance could be contained to ½ percent of GDP if additional measures, recommended during bilateral discussions with country authorities, are adopted.

15. Public debt remains at a very high level—at an average of 106 percent of GDP at end-2004—although progress has been made in reaching agreements with creditors on debt restructuring in three countries (Box 2). The strengthened fiscal outcomes and the revival of growth in 2003–04 have not been sufficient to steer public debt to GDP ratios on a downward path. Going forward, the public debt to GDP ratio in St. Lucia and St. Vincent and the Grenadines—countries with relatively lower debt levels—can be expected to rise in 2005, as fiscal policies are relaxed in anticipation of the elections. On the other hand, successful implementation of the ongoing debt restructuring in Antigua and Barbuda, Dominica, and Grenada will help bring down the regional debt burden. In St. Kitts and Nevis, the authorities anticipate substantial privatization proceeds over the next few years from the disposition of large holdings of government assets, including sugar lands which cover a wide area of St. Kitts.

Public Debt Restructuring in ECCU Countries

Antigua and Barbuda. After taking office in March 2004, the newly elected government initiated a dialogue with creditors with a view to regularizing relations—most loans have been in arrears for many years. A major step included an agreement with the Italian Government to clear US$196 million debt (one-third of external debt) through a bullet payment of US$18.5 million. A Debt Coordinating Committee was formed in mid-2005, with representatives from the public and private sectors, to facilitate this process.

Dominica. The authorities embarked on a cooperative restructuring strategy in late-2003. A debt exchange was launched in April 2004 and, as of end-May 2005, creditors—official and private—holding over 70 percent of eligible debt have agreed to the restructuring. The authorities continue to make good faith efforts to reach understandings with creditors who have not yet agreed to participate in the restructuring, and have committed to making payments into escrow accounts on restructured terms for such creditors.

Grenada. Following Hurricane Ivan, the authorities announced in early October 2004 their difficulty in servicing their debt in full and their intention to seek a cooperative solution with creditors. Following missed interest payments on external bonds in December 2004, Grenada was downgraded to “selective default” by Standard and Poor’s. The government is maintaining a dialogue with creditors. Financial and legal advisors are assisting the government in designing its strategy and a creditor committee has been formed. The official creditors are also being contacted but the process has become complicated with the severance of diplomatic relationship between Grenada and its largest official creditor, Taiwan Province of China.

16. Inflation has been stable and monetary aggregates have been expanding rapidly, reflecting continued growth in the demand for money and confidence in the banking system and the CBA. Broad money grew 9½ percent in 2003 and 13½ percent in 2004, but inflation remained at around 2 percent. The modest uptick in inflation from the early 2000s (when inflation was about 1½ percent) can be largely traced to the direct and indirect effects of rising global energy prices. External reserve coverage of monetary demand liabilities at the ECCB has risen to over 96 percent.

17. The brisk growth of deposits and weak credit growth, particularly to the private sector, has left the banking system highly liquid. Deposit growth has been driven by the strengthening economy, continued large social security surpluses, the floor established by the ECCB on the savings deposit rate (set at 3 percent since September 2002), and a lack of alternative savings instruments. Liquidity has been increasingly channeled into government securities, with typically substantial oversubscription for issues floated in the Regional Government Securities Market (RGSM). Private sector credit growth has been slow, with the bulk of new loans related to real estate.

18. Progress continues to be made in strengthening the institutional framework for financial sector supervision and in developing broader capital markets. The ECCB has prepared revised prudential guidelines on capital adequacy, risk-based supervision, and corporate governance standards in line with some of the recommendations of the ECCU regional FSAP completed in 2004, though needed amendments to the Uniform Banking Act have not been enacted in any country.6 Capital markets have continued to develop, particularly the RGSM which has become a key regional market—only Antigua and Barbuda and Dominica have yet to place issues.7 The number of equities listed on the Eastern Caribbean Securities Exchange has continued to increase, but trading activity remains low. The ECCB has also supported the development of the Eastern Caribbean Home Mortgage Bank, the Eastern Caribbean Unit Trust, and the Eastern Caribbean Enterprise Fund.

III. Policy Discussions

A. Overview

19. In the past year, regional and country authorities have increasingly recognized the difficulty of their economic situation, which has weakened further by new shocks. As underscored in previous regional and Article IV consultation discussions with individual countries, the region is facing many external and domestic challenges. In addition, the region was hard hit by natural disasters during 2004: in September, Hurricane Ivan inflicted widespread destruction in Grenada and, to a lesser extent, St. Vincent and the Grenadines; and Dominica experienced an earthquake in November that registered 6.0 on the Richter scale. For Grenada and St. Vincent and the Grenadines, damage inflicted by Hurricane Ivan amounted to over 200 and about 5 percent of 2003 GDP, respectively; for Dominica, the estimated damage caused by the 2004 earthquake was about 7 percent of 2004 GDP. Moreover, oil prices have risen sharply and are expected to rise further.

20. The dialogue between Fund staff and the regional and national authorities has deepened, with the most indebted countries taking distinct steps to confront their challenges. The authorities agreed that reducing debt levels was a top priority for the region: progress is being made in Dominica under the ongoing PRGF arrangement; in Grenada in designing the reconstruction and macroeconomic stabilization strategy; in Antigua and Barbuda in addressing the deep fiscal and macroeconomic imbalances; and in St. Kitts and Nevis with the announcement of the closure of the sugar industry.8 However, the longstanding macroeconomic stability under the CBA has made it difficult to instill a sense of urgency in the public of the need for substantial policy adjustments, and there is a clear sense of complacency that such stability will continue going forward.

21. The Fund is increasingly viewed as a valued advisor and a catalyst for donor support in the region, but the appetite for formal Fund-supported programs remains limited. The authorities throughout the region appreciated the increased emphasis given to regional issues as well as the focus on growth and vulnerabilities—particularly high public debt levels, natural disasters, and repercussions of declining official assistance. They indicated that the long-term Fund engagements in Guyana and Jamaica were seen in a negative light by their populations, making it politically difficult for countries to request formal Fund arrangements. Staff noted that implementing and sustaining good policies with public support would be key to success, with or without a Fund-supported program.9

22. Ensuring the sustainability of ongoing reforms and initiating new ones will require further strengthening of outreach efforts with civil society. Staff noted the active discussions on political and social topics in the media, but expressed concern about the relative paucity of informed debates on economic issues. Many countries in the region are stepping up their outreach efforts through town hall meetings, public policy debates, regional conferences, and press conferences, including by the ECCB and at the conclusion of Fund missions.10 Indeed, recent elections in the region have focused on economic issues—fiscal management in Antigua and Barbuda, the IMF program in Dominica, and debt in St. Kitts and Nevis. Regarding the staff’s outreach efforts, the authorities took note of the recent initiatives, but pointed out that the Fund was still behind the World Bank in terms of the resources devoted to such activity.

23. Discussions focused on a wide range of policy challenges, embracing three broad themes:

  • Adjusting to a changing world environment and reinvigorating growth: in particular, confronting continued erosion of trade preferences and declining official development assistance flows, raising competitiveness, changing the role of the public sector, removing labor market rigidities, adapting the investment climate and maximizing the benefits of migration flows to support new growth opportunities, and regional cooperation and integration;

  • Addressing fiscal imbalances and the large stock of public debt, through fiscal consolidation, active debt management, and divestment of public assets; and

  • Managing the region’s high vulnerability to shocks, in particular: natural disasters, a narrow export base, and potential contagion through the financial system.

B. Adjusting to a Changing World Environment and Reinvigorating Growth

The changing world environment

24. Preferential trading arrangements that support traditional sectors—bananas and sugar—have been steadily eroding since the 1990s. While these sectors have long since ceased to be a key contributor to value added or export earnings, they continue to be a vital source of rural employment in the banana-producing countries—Dominica, St. Lucia, and St. Vincent and the Grenadines—and in St. Kitts and Nevis, which has traditionally produced sugar. The staff noted that the countries face substantial costs of maintaining the sectors going forward, while the annual income transfers derived from quota rents (stemming from the sale of bananas and sugar at above world market prices) will continue to decline. Staff supported the temporary use of measures to facilitate the transition away from these sectors—such as income transfers to farmers, and retraining programs. Following the closure of the loss-making sugar industry, the Government of St. Kitts and Nevis has established a committee, with donor support, to design a transition strategy including a land use management plan, land sales, and retraining programs for labor shed from the industry. The authorities in the banana-growing countries, however, saw opportunities for a continuation of the sector, although they acknowledged that continued support would be needed to enhance the efficiency of producers. They also expressed concern about the uncertainty created by the announcement of impending changes in the banana regime by the European Union.


Windward Islands Banana Exports, 1990-2004

(In Tonnes)

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

Source: Windward Islands Banana Development and Export Company.

Banana-Producing Windward Islands: Assistance from the European Union, 1993-2004

(In millions of euros)

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

Source: European Union, Delegation of the European Commission in Barbados and the Eastern Caribbean.

25. Foreign aid flows to ECCU countries have fallen sharply in recent years. While aid from OECD countries has waxed and waned with the timing of natural disasters in the region, overall official assistance has remained roughly constant in U.S. dollar terms since the mid-1970s, implying a significant decline in real terms and relative to GDP. The authorities noted that the reduced availability of grants—as well as, in some cases, the loss of access to concessional financing sources—had significantly impacted the economies and contributed directly to the rising public debt burdens seen throughout the region.

ECCU: Total Official Development Assistance Flows

(In percent of GDP)

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Sources: Organization for Economic Cooperation and Development; Eastern Caribbean Central Bank; and Fund staff estimates.

26. Indicators of competitiveness present a mixed picture, but with the depreciation of the U.S. dollar since 2002, the economies have become more competitive (Figure 2). While real wages in some countries have grown rapidly, traditional measures of the real effective exchange rate (REER) have fallen sharply since end-2001, and are currently below the level of the early 1990s. Both customer-based (reflecting demand-side influences) and competitor-based (reflecting supply-side factors) measures of the REER have declined recently.11 Indeed, tourist arrivals—both in absolute terms and as a share of the Caribbean Common Market (CARICOM)—have increased sharply since 2002.

Figure 2.
Figure 2.

ECCU: External Competitiveness, 1990–2004

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

Sources: Eastern Caribbean Central Bank; Caribbean Tourism Organization;ECCU country authorities; ECCU National Insurance Schemes; and Fund staff estimates.1/ An increase (decrease) indicates an appreciation (depreciation).2/ The sharp movements in the competitor-based real exchange rate in 2002-04 were largely driven by the Dominican Republic's peso.3/ Total tourist arrivals of CARICOM in 2003 does not include those of Haiti and Suriname.

27. The authorities agreed that competitiveness needed strengthening, but stressed that this should be achieved through fiscal and structural reforms. The authorities noted that there was full confidence in the exchange rate peg, which had contributed substantially to macroeconomic stability. They observed that the peg had withstood natural disasters, the erosion of trade preferences, the September 11 shock to tourism, political cycles, the fiscal deterioration and debt build-up, and the slowing down of growth. The underlying challenge was viewed as one of raising productivity levels, and that this should not be addressed through a change in the exchange rate peg. The staff broadly concurred with this assessment. An adjustment to the peg would be unlikely to yield significant benefits, due to the high level of pass-through of imported prices to domestic ones, the significant foreign currency component of public debt, the potential weakening of the financial sector, and the low price elasticity of demand for tourism services. However, staff pointed out that maintaining the peg would require determined efforts to bring fiscal and debt positions to more sustainable levels, and to increase the flexibility of labor and product markets.

Constraints to growth

28. Growth rates in the region in the past decade have been disappointingly low, relative to the high spending on physical and human capital (Box 3). Robust growth in the 1980s was driven by high public investment financed by official assistance, preferential access for traditional exports, and the emerging tourism sector. In the 1990s, official assistance began to dry up, preferential access to markets started to erode, and the high initial growth spurt in tourism abated. With the slowdown of growth, ECCU governments responded by increasing public investments—financed by accessing external capital markets and tapping the fast-growing domestic financial sector—yet with disappointing growth outcomes.

Are Growth Rates in the ECCU Too Low?

Simulation analyses show that the per capita real GDP growth rates in the ECCU have been lower than expected based on cross country comparisons. Barro (1991) uses variations in initial per capita income, human capital and government consumption to explain growth rates across a wide number of countries. Levine and Renelt (1992) use, in addition to Barro’s variables, investment and population growth as additional determinants of growth. Table 1 presents predicted per capita growth rates for the ECCU countries using these models and compares them to the actual experience. The results are striking—with one exception; realized growth rates are lower than predicted by either model for any of the ECCU countries. Overall, the ECCU growth rates forecast by the Levine-Renelt equation are much higher (and consequently the difference with the realized rates larger) than those predicted by Barro’s equation—highlighting the fact that investment, which is very high in the ECCU, has not been productive.1/

Table 1.

Actual and Predicted Annual Per Capita Growth Rates (1990-2003)

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1/ Barro, R. J., 1991, “Economic Growth in a Cross-Section of Countries,” Quarterly Journal of Economics, Vol. 106, pp. 407–443. Levine, R. and D. Renelt., 1992, “A Sensitivity Analysis of Cross-Country Growth Regressions,” American Economic Review, Vol. 82, pp. 942–963.
1/ Barro, R. J., 1991, “Economic Growth in a Cross-Section of Countries,” Quarterly Journal of Economics, Vol. 106, pp. 407–443. Levine, R. and D. Renelt., 1992, “A Sensitivity Analysis of Cross-Country Growth Regressions,” American Economic Review, Vol. 82, pp. 942–963.

29. Higher public investment in recent years has not succeeded in raising growth rates. Indeed, public investments rose at the same time that growth rates declined—this pattern was particularly visible in the 2000s. Moreover, since the mid-1990s, public expenditure has been reoriented away from economic infrastructure towards social sectors and general public services.12 Country authorities indicated that much of the public investment had been either to replace capital or protect the population following the series of natural disasters that hit the region in the second half of the 1990s, or to put in place needed infrastructure—such as international airports—without which tourism could not have expanded.

30. Public projects in recent years have been adopted with little oversight by governments, donors, or financing agencies. Staff recommended that large public investment programs be cutback or reprioritized towards those that are complementary to private sector development. In addition, an overhaul of the legislation and systems governing the contracting, management, and disclosure of public investment and debt, including contingent liabilities, should be undertaken. The process of strengthening public sector investment programs has begun with the help of CARTAC and, at the initiative of the ECCB, debt management workshops have been held at the Fund and in St. Kitts and Nevis.

31. Realizing the region’s growth potential will require a paradigm shift away from the public sector as the main engine of growth toward strengthening the investment climate. While the authorities agreed that the private sector should take the lead in stimulating growth, they expressed disappointment at the lack of initiative by local entrepreneurs. Staff pointed out that the private sector faced several hindrances, in particular labor market rigidities, skill shortages, a distortionary tax regime, a weak regulatory environment in several areas, and limited regional integration, and stressed the role of the public sector in addressing these hindrances.


ECCU: Central Government Investment and GDP Growth

(3-year moving average)

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

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

32. Labor market rigidities in the ECCU are high and are reflected in relatively high wages in the face of high unemployment. Wage rates across different categories of skills in the ECCU are significantly higher than in other Caribbean countries and upper middle income countries. While data are scanty, available evidence points to skill mismatches relative to the needs of the region, low access to tertiary education and job training, high unemployment, predominance of public sector, strong labor unions, significant cost in hiring and firing workers, and relatively low intra-regional mobility.

Indices of Labor Market Flexibility 1/

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Index range is from 0 to 100, higher values indicate greater rigidity.


Selected Wage Rates, 2002

(Annual Wage in Thousands of US Dollars)

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

Source: Towards a New Agenda for Growth: Organization of Eastern Caribbean States, World Bank, (2005).

33. Shortages in skilled labor are reported by both public and private sectors as the key constraint to enhancing efficiency and competitiveness throughout the region. Staff recommended raising the quality of education, reorienting education and training programs to better suit the needs of the region, undertaking civil service reform, introducing performance and productivity based wage increases, and allowing freer movement of labor among islands. While the authorities generally agreed with these recommendations, some pointed out that labor codes precluded introducing procedures to link wages to performance, and productivity could not be measured accurately owing to data constraints. Several countries are setting up new training centers in hospitality services to better serve the tourism sector.

34. To attract FDI, the ECCU region has relied primarily on costly fiscal incentives (or tax concessions). In the authorities’ view, tax concessions had contributed strongly to growth. Staff noted that while FDI had remained significant, it had come at the expense of large fiscal losses (forgone customs revenue alone equivalent to 4–12 percent of GDP) and a distorted, nontransparent, and administratively burdensome investment regime (Box 4). Moreover, a World Bank survey of firms operating in the region indicated that fiscal incentives were given a low weight in attracting FDI, ranking 16th of the 40 identified determinants of the investment climate.

Tax Concessions in the ECCU 1/

Tax concessions have been used extensively by ECCU member countries in an attempt to promote private investment and support social objectives.

Concessions for investment in sectors such as tourism and light manufacturing, have generally been provided through tax holidays and import duty exemptions. Agriculture and fisheries have often been exempted from taxes on investment and inputs. Also benefiting from concessions have been the government, statutory bodies, utilities, and nongovernmental organizations, such as churches.

Considerable discretion has been applied in the granting of concessions. Available data from Dominica and St. Vincent and the Grenadines show that investment-related concessions account for nearly 50 percent of total customs duty concessions, whereas concessions granted by discretionary Cabinet decisions account for about 20 percent.

Revenue losses from concessions are large, and have increased significantly in two countries.

Estimated effective corporate income tax rates are about 40 percent of the statutory rates, and account for revenue losses of 3–6 percent of GDP per year.

Effective import-related tax rates are about 60 percent of the statutory rates, and account for revenue losses of 4–12 percent of GDP per year. In Antigua and Barbuda and in St. Kitts and Nevis, concessions rose sharply over the past decade.

The benefits in terms of increased foreign direct investment (FDI) appear to have been limited. While FDI as a share of GDP remained significant or even rose in some countries, the FDI performance of the ECCU countries relative to the rest of the world, declined sharply in the mid- to late-1990s. A preliminary empirical analysis suggests that tax concessions played a very limited role in attracting FDI. Instead, the key factors attracting FDI are good governance, a generally low and broad-based corporate tax regime, and the absence of FDI restrictions.


ECCU: Statutory and Effective Corporate Income Tax Rates

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001


ECCU: Statutory and Effective Import-related Tax Rates

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

Table. ECCU: FDI Performance Index 1/

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Performance index is the share of a country's FDI inflow in the world's FDI inflow, divided by the share of the country's GDP in the world's GDP.

1/ This box is based on “Tax Concessions and Foreign Direct Investment in the ECCU” by J. Chai and R. Goyal, Chapter V in Eastern Caribbean Currency Union—Selected Issues.

35. While all country authorities voiced their concerns regarding the pressures they faced from neighboring countries in granting concessions, opinions differed on where to draw the line. Some considered that the investment climate should be strengthened in other ways and tax concessions reined in to protect tax bases and reduce distortions facing domestic investors. Others considered the existing system of tax incentives to be broadly appropriate, arguing that in their absence investment—and, therefore, employment and tax revenues—would be significantly lower. Staff noted that regardless of where the line was drawn, there was room for improving transparency (by eliminating the granting of discretionary concessions and publishing the cost of all concessions granted in a tax expenditure annex to the budget), and limiting the size, duration, and scope of statutory concessions.13 To encourage investment, tax credits for investment, accelerated depreciation, and loss carrying forward provisions could be considered.

36. Staff recommended additional steps to strengthen the investment climate:

  • Revamping the regulatory framework. Complex and cumbersome laws and amendments in tax and custom administration preclude the effective monitoring and collecting of taxes. Greater efficiency can be achieved by stepping up e-government, reducing trade barriers, and allowing greater competition in domestic markets, including by eliminating remaining state monopolies for distribution of imported goods. The regulatory framework for utilities, energy, and transport services need to be strengthened to attract private investment and promote competition and efficiency.

  • Improving infrastructure. While access to basic infrastructure to the general population is high, the reliability, quality, and costs to the productive sector need to be improved further. Maritime transportation is irregular, vessels are in poor condition, and freight and port costs are high.

  • Building private sector capacity. Private sector activity can be encouraged by donor financing of feasibility studies, providing information on best practices, supporting business incubators, and creating the right incentives for firms to train and innovate. In addition, governments could pool resources for seminars and roundtable discussions with foreign and local businesses for exchanging ideas, information, hearing concerns and attracting investments.

Growth opportunities

37. Notwithstanding the lackluster growth performance in the past decade, considerable growth potential exists in the ECCU region. A recent World Bank study identifies significant growth potential in niche products based on the geographical location, natural beauty, the rich culture, and the English-speaking population.14 These areas include diversification of tourism activities, increasing interlinkages between tourism and the agriculture and other sectors of the economy, offshore education, information and communications technology (ICT) enabled products and services, health and wellness activities, and offshore financial services.

38. High migration from the region has created a large diaspora that represents a potential source for investment and entrepreneurial skills.15 Staff noted that emigration rates were among the highest in the world—during 1970–2000, between 40 and 70 percent of the skilled labor force had emigrated.16 This large-scale emigration has produced a steady flow of remittances, but it is unclear if emigration has been a net benefit as it has drastically lowered domestic stocks of human capital and entrepreneurial skills. The authorities agreed that high emigration rates had contributed to the shortage of skills, but noted that it was inevitable given the limited range of opportunities available on small islands. Staff recommended that contacts with the diaspora be enhanced in order to build networks for trade, investment promotion, and tourism. Some countries are already tapping the diaspora—Dominica, for example, is trying to formulate an explicit diaspora strategy based on input from Dominicans living abroad.


Percent of Skilled Labor Force that has Migrated to the OECD, 1970-2000

(Top 20 countries in the world, ranked by emigration rates) 1/

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

Source: Eastern Caribbean Currency Union—Selected Issues, Chapter VI.1/ Skilled are defined as having more than 12 years of completed schooling.

39. While several initiatives in regional cooperation have met with success, there remains substantial scope for furthering this process (Table 7).17 Successes and ongoing initiatives include the stability provided by the common CBA, the broadening and deepening of regional capital markets, the common judiciary, centralized procurement of pharmaceuticals, the common diplomatic missions at the World Trade Organization (WTO), greater competition and cost reduction in telecommunications under the auspices of the Eastern Caribbean Telecommunications Authority, and addressing security issues under the Directorate of Civil Aviation. At the same time, staff pointed out that there remained considerable room for expanding collective provision of government services—for example in tax administration, debt management, evaluation of public investment projects, procurement, security, and regulatory environment for transport, energy and infrastructure.

40. Regional integration initiatives in the ECCU have had limited impact in promoting trade and growth. Many regional initiatives, such as free movement of labor and a free trade regime in services, are yet to be implemented, and a number of important exceptions to free trade in goods remain.18 In addition, while the average tariff rate of CARICOM’s Common External Tariff (CET) is fairly low at around 10 percent, effective protection for certain products is much higher due to the presence of exemptions in the regime as well as nontariff barriers—given the virtual absence of a manufacturing sector in the ECCU, the CET serves to support the larger CARICOM economies at the expense of consumers in the ECCU region. While intra-regional travel is permitted for limited duration or by those with specified skills, considerable barriers exist in most occupations, serving to reduce the aggregate pool of labor supply and magnify skill mismatches.

41. The staff urged the speedy implementation of initiatives to foster closer economic integration both within the OECS and CARICOM. The Caribbean Single Market and Economy (CSME), Free Trade Area of the Americas (FTAA), and the WTO offer opportunities for ECCU countries to integrate with the regional and global economy, and the staff encouraged the authorities to pursue regional integration vigorously as a stepping stone to greater integration at the global level. The authorities’ views on the prospects for deeper regional integration of labor markets were mixed—some considered this a key mechanism for obtaining needed skills and, in many cases, formalizing the unofficial labor flows that already occur. Others expressed concern about higher local unemployment and the increased fiscal burden of providing social services to non-nationals—education, health, and social security.

42. Increased regional cooperation could reduce tax competition and strengthen the region’s negotiating position in dealings with large multinationals, but would be difficult to enforce. In the area of concessions, a regional cooperative approach could prevent a “race to the bottom” as potential investors played off the islands against each other. Some regional agreements are already in place for statutory concessions—for example, the Harmonization of Fiscal Incentives to Industry Act which establishes similar statutory concessions in each island. However, the authorities noted that this is used as the starting point in negotiations by multinationals, with large investors insisting on more generous packages. The authorities also stressed that even if the ECCU countries coordinated their approach, they would face stiff competition from other neighboring islands. More generally, the authorities noted that their small size placed them at a significant disadvantage in negotiations with large multinational companies, which also had the support of strong lobbying groups in their home countries—a case in point is cruise ship tourism, where the cruise ship owners have been able to get the islands to compete against each other resulting in the bulk of the proceeds from this trade accruing to the cruise ship companies.

43. To give regional integration renewed vigor, at the initiative of senior policymakers, a new treaty on economic union of the OECS countries was being considered. The regional authorities noted that in view of the changing global environment and their desire to integrate within the OECS before integrating within the CARICOM, the current treaty needed to be revamped. This treaty would allow for a common approach to policymaking and institution building. Common legislative framework would be drafted for consideration by individual parliaments. So far, all national constitutions had been reviewed and needed amendments identified.

C. Fiscal Consolidation and Reduction of Public Debt

44. Public debt levels in the region are very high, and in two countries, there still appears to be a lack of urgency in addressing the debt situations. In St. Lucia and St. Vincent and the Grenadines, the two countries with lower public debts but with elections due during 2006, the approved budgets target a significant expansion in public sector investment. The authorities in St. Lucia and St. Vincent and the Grenadines view such investment as necessary to support growth, and they maintain that their fiscal imbalances are not worrisome given their relatively low levels of debt. The staff argued that there was no room for complacency as debt levels throughout the region—even in the lower debt countries—are significantly above the levels at which other countries had experienced either financial or exchange rate crises. The authorities noted that levels of debt tolerance in small economies appeared to be different from larger emerging market economies. They pointed to their excellent record (with the long-time exception of Antigua and Barbuda) of servicing their debt and continued access to capital markets as evidence of the markets’ confidence. They also contended that unlike other highly indebted countries, large public debts had not discouraged FDI flows.


Public Debt Ratios at Which Countries Experienced Crises

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

Note: Figures for the ECCU countries are public debt ratios as a percent of GDP in 2004. The remaining bars list middle income countries that underwent an adverse credit event during 1970-2001, as identified by Reinhart, Rogoff, and Savastano (2003), “Debt Intolerance,” NBER Working Paper No. 9908, with the figures referring to public debt as a percentage of GNI in the year of the event.

45. Staff noted that the continued access to capital markets enjoyed by most countries in the region, despite high and rising debt levels, reflected in part financial market distortions. Demand for EC dollar assets—both bank deposits and government paper—appears to have been buttressed by the ECCB mandated floor on savings deposit rates and implicit restrictions on the asset portfolios of social security schemes. While this has resulted in lower debt service costs for some governments—in St. Vincent and the Grenadines, the interest spread has declined to only 100 basis points over U.S. treasury bills—this has been achieved at the expense of higher borrowing costs for the private sector. The artificially high levels of liquidity have also served to mitigate the potential role of the RGSM as a fiscal disciplining device. While interest rates do vary by creditor, with those countries with lower debt levels generally securing lower interest rates, the overall level of interest rates may not fully reflect the underlying riskiness of the securities.19

RGSM Auction Results, 2003-2005 1/ by type of instrument

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Data for 2005 are through end-April.


St. Vincent and the Grenadines: Interest Rate, 91-Day Treasury Bills, 2003-05

(In percent)

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

Sources: Eastern Caribbean Regional Government Securities Market; and U. S. Federal Reserve.1/ March and May 2004 rates for St. Vincent and the Grenadines are interpolated.2/ U. S. rate is interest rate on 13-week Treasury bills.
  • Floor on savings deposit rates. While initially introduced to protect depositors from a perceived lack of competition amongst deposit-taking institutions, the legislated floor on savings deposit rates may no longer be needed. Indeed, staff noted that the floor has limited the responsiveness of lending rates to changing liquidity conditions, thereby slowing the growth of private sector credit and discouraging locally-funded private sector investment. Staff encouraged the authorities to gradually remove the floor on deposits to reflect the true cost of funds and thereby eliminate the distortionary effect it has on the financial system. The authorities agreed that the floor could be withdrawn once financial markets were sufficiently well-developed, hence the question was just one of timing.

  • Concentration of the investment portfolios of the social security schemes in government securities. Staff noted that large exposures to national and regional government securities imply a concentration of risk that should be reduced by greater diversification of the asset portfolios of social security schemes into instruments held outside the region. The authorities commented that in some countries there were no formal restrictions on the asset portfolios of the national social security schemes, and viewed the development of the RGSM as providing significant opportunities for risk diversification, particularly given the high rates of return available.

46. The fiscal benchmarks approved by the ECCB’s Monetary Council have not, to date, been sufficient to ensure the consistency of national fiscal policies with the CBA. While the benchmarks are only to be achieved by 2007, staff noted that they appear to have had little impact on fiscal policies as fiscal outcomes have increasingly diverged from the targets since their introduction in 1998. The authorities argued that the deviations from the benchmarks had been deliberate policy decisions in response to shocks. Thus, the targets had not been ignored, but rather overtaken by other priorities. However, the authorities acknowledged that most benchmarks would not be achieved by the target date.

47. Despite the large deviations, the authorities were unanimous that the fiscal benchmarks should not be eliminated. However, opinions differed as to whether the targets needed to be modified: some country authorities saw moral hazard in changing the targets at this stage, while others saw benefit in revisiting the specification of the targets to ensure that they were realistic and corresponded to the needs and risks faced by the region. Several authorities believed that setting annual benchmarks that could differ across countries, depending on their starting conditions, could facilitate the achievement of targets, albeit at different points in time. In this context, staff recommended that the definition of debt should be clarified to include all public and publicly-guaranteed debt, rather than solely central government and government-guaranteed debt, as it would provide a more meaningful indicator of the magnitude of liabilities that the budget may have to sustain. In addition, the national authorities were encouraged to publish and widely disseminate performance relative to the established benchmarks on a quarterly or annual basis.

48. There is little appetite for creating a supra-national authority to enforce the fiscal benchmarks. The country authorities were uniformly opposed to any loss of sovereignty over national fiscal policies that would be implied by the creation of a supra-national body. They also pointed to the experience in the Euro Area, where ensuring compliance with the fiscal targets remained a challenge despite the existence of such a supranational body. Going forward, they considered that the most effective means for ensuring compliance would be peer pressure at the level of meetings of the prime ministers. At the technical level, they pointed out, mechanisms have recently been established with assistance from CARTAC—the SATAP (Structural Adjustment and Technical Assistance Project) program—to enable policymakers to set, monitor, and achieve the benchmarks. However, effective feedback from the SATAP units to the policymakers needs to be substantially strengthened.

49. In light of the large public debt positions, staff urged that substantial fiscal consolidations be pursued on the basis of broadening the tax base, streamlining expenditures, and strengthening fiscal institutions. Notwithstanding the authorities’ efforts at restructuring their debt in an orderly manner, staff stressed that debt restructuring should not be viewed as a substitute for fiscal consolidation. Regarding specific measures, as statutory tax rates are already fairly high in the region, measures to broaden the tax base should be implemented, including reducing tax concessions, enhancing tax compliance, strengthening tax and customs administration, assessing property at market value for tax purposes, and introducing a broad-based consumption tax (or VAT). Consideration could be given to lowering the high marginal tax rate in the medium term, concurrent with the phasing out of tax concessions. On the expenditure side, staff emphasized civil service reforms to reduce the wage bill and over-employment in the public sector, but at the same time, allowing for greater wage differentiation to reflect skills and performance. In addition, there is a need to strengthen expenditure management systems, improve debt management, and reprioritize and monitor overly ambitious public sector investment programs. While many of these measures are already underway, civil service and tax concession reforms are not yet on the priority list—with the notable exceptions of Antigua and Barbuda and Dominica.

D. Living with the Region’s High Vulnerability to Shocks

50. The ECCU region faces significant vulnerabilities—many beyond the control of regional policymakers—posing challenges to economic management. There are three principal sources of vulnerabilities:

  • Natural disasters. Measured in terms of natural disasters per square mile, all the ECCU countries rank in the top ten in the world. The region is located in the Atlantic Basin hurricane belt that experienced 9 hurricanes and 14 tropical storms during 2004, with a similar number expected this year.20 The region is also located on a geological fault line, producing occasional earthquakes—most recently in Dominica in November 2004.

  • Global economy. The significance of tourism in the economies makes the region particularly vulnerable to the world business cycle and shocks to global security. The region also imports all its oil and, given the very high debt levels, is susceptible to global capital market conditions.

  • Domestic or regional shocks. Financial sectors have proven resilient to a broad range of shocks. However, the sources and nature of possible shocks are constantly evolving as financial sectors develop and cross-border linkages deepen, raising the risk of contagion.

Natural disasters

51. Natural disasters are a fact of life in the region, and efforts to both mitigate the impact of disasters and facilitate recovery should be stepped up. While ECCU countries have invested in disaster risk mitigation activities (such as strengthening building codes) and in national and regional disaster response agencies, staff recommended that these efforts, and their enforcement, should be enhanced. Existing national and regional disaster contingency funds are inadequate, and traditional insurance markets in the Caribbean are characterized by relatively concentrated coverage, high prices and low-risk transfer (see the Annex).21 Staff encouraged the authorities to work with multilateral agencies—particularly the World Bank and the Commonwealth Secretariat—in developing new schemes, such as regional insurance pools. The authorities noted that the devastation caused by Hurricane Ivan in Grenada had refocused their attention on these issues. In some cases, the coverage of publicly-insured infrastructure was being increased, but full coverage was not possible given the fiscal challenges facing the region. Several countries urged the international donor community to take a more proactive role by providing an ex ante pool of disaster relief funds to be used in an emergency, as well as grant financing for insurance of public infrastructure.

Global economy

52. The emergence of tourism as the dominant sector in the region has created a significant dependency on the world business cycle and global security developments. Growth in each of the countries is highly correlated with world output and, as seen in the aftermath of the September 11, 2001 attacks, a downturn in world output or world security could induce a recession throughout the region. The authorities were well aware of the risks stemming from the tourism sector, noting that the dependence is much greater now than when the economies were based on traditional agricultural sectors. Staff cautioned that options for diversification away from tourism and related linkages are limited, but ensuring diversity in the source country of tourists—through, for example marketing campaigns in various regions of the world as well as regionally—could reduce risks.


ECCU: Correlation Between Domestic Output and World Output

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

Source: Eastern Caribbean Currency Union—Selected Issues, Chapter I.

53. The ECCU countries are heavily dependent on oil and energy imports, with some countries now exploring alternative energy sources. The small size of the economies prevents the emergence of a competitive market in oil products, so that oil prices are tightly regulated throughout the region. In most countries, there is an explicit formula linking the retail price of oil to the imported price, but the retail price is adjusted only infrequently and in the past few years has been used to shield consumers from the full increase in oil prices. The infrequent price adjustments have served to limit the impact of oil price fluctuations on domestic output, but the cost is born by the budget in the form of reduced tax revenues as well as through a loss of efficiency in production, consumption, and distribution services. The staff urged increased flexibility in oil pricing—as in Dominica where oil price fluctuations are fully passed through to domestic prices. The authorities agreed that the fiscal burden of maintaining artificially low oil prices was substantial, but expressed concern about the social and growth consequences of permitting full pass-through. Several countries are examining options to harness alternative energy sources, such as geothermal energy.


ECCU: Correlation Between Domestic Output and Crude Oil Price

Citation: IMF Staff Country Reports 2005, 304; 10.5089/9781451811674.002.A001

Source: Eastern Caribbean Currency Union—Selected Issues, Chapter I.

54. The high debt ratios of ECCU countries make them particularly vulnerable to capital market conditions. During the last year there has been a shift away from external financing towards increased reliance on domestic sources, in part reflecting the low interest rates available on the RGSM. Many of these placements have been at fairly short maturities, raising concerns as to rollover risk. Given that global interest rates appear likely to rise over the medium term, staff urged the authorities to prepare in advance for these adverse prospects through improved debt management as well as the implementation of fiscal reforms to reduce debt levels.22

Domestic or regional shocks

55. Financial markets have shown remarkable resilience to the many large shocks that have hit the region, but this resilience cannot be taken for granted going forward. While banking systems in each country remain highly liquid and with reported capital positions above prudential norms, exposures to the government are high and NPLs are rising, pointing to the existence of significant vulnerabilities as confirmed by stress tests on the banking system (Box 5).

Banking System Vulnerabilities

Financial soundness indicators provide a mixed picture of the health of the banking system. While measures of capital adequacy appear strong, nonperforming loans (NPLs) and exposure to the government are very high in some countries. Moreover, weaknesses in the legal frameworks in some countries for property disposal and lengthy court procedures contribute to persistently high NPL levels, for instance in Dominica and St. Lucia.

ECCU Banking System: Financial Soundness Indicators, December 2004 1/

(In percent)

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ATG (Antigua and Barbuda), DMA (Dominica), GRD (Grenada), KNA (St. Kitts and Nevis), LCA (St. Lucia), and VCT (St. Vincent and the Grenadines).

Indigenous banks.

Banking system vulnerabilities appear to be concentrated in locally incorporated banks. The exposure of local banks to the government amounted to 21 percent of total assets in 2004, about three times the level at foreign banks. While the capital adequacy ratio of locally incorporated banks was more than double the 8 percent prudential requirement, potential underprovisioning and sovereign risks could reduce that amount.

ECCU: Financial Soundness Indicators, end-2004

(In percent)

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The foreign branches have consolidated capital positions with their parent banks in Canada and Barbados.

Non-performing loans.

The financial sector has been remarkably stable, despite the buildup in banking sector exposure to the government, high public debt levels, and the regular occurrence of natural disasters. The stability appears to reflect the continued confidence in the currency peg, the credibility of the ECCB in the region, and the lack of any major banking crises in the past.

However, adverse shocks such as a major hurricane or a sudden stop of tourism arrivals, could lead to insolvency of some systemically important banks in the region. The banks in the region appear particularly vulnerable to shocks that disrupt tourism and/or trigger government sector defaults. For example, an adverse shock that results in an additional 5 percent of total loans in loan losses and a 10 percent nonrepayment on government obligations could lead to the undercapitalization of about half of the local banks. While the impact would be more severe in some countries than others, the undercapitalized banks account for on average one-third of total deposits, and could trigger a more general confidence effect in the region. The stability of the banking sector in Grenada (which had among the strongest prudential indicators in the region prior to the hurricane) in the face of an even larger shock suggests that additional factors—such as the possibility of capital injections for foreign banks—also need to be considered.

56. Cross-border linkages are low but rising as regional capital markets develop. As the volume of activity on the RGSM and other regional markets increases, the linkages among financial systems in the region will strengthen, potentially raising contagion risks. These linkages are currently small: holdings of other ECCU government securities are no more than 3½ percent of bank assets in any country; claims on other ECCU banks are higher as a share of assets but appear to be dominated by cross-border deposits between banks operating in different countries but sharing the same parent bank. Trade linkages are also very low.

ECCU: Cross Border Linkages

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December 2004

Average, 1998-2004

57. Enhancing the effectiveness of financial sector supervision will be key to containing potential risks. While acknowledging the progress made in revising the ECCB’s prudential regulations and in strengthening supervision over offshore financial centers, staff expressed concern that the enhanced prudential regulations were not fully effective, and that the number of on-site banking inspections conducted each year—an average of four institutions per year during 2000–04—should be raised. The authorities noted that the needed legislation to strengthen prudential regulations was proceeding through national parliaments but that this was a time-consuming process. In terms of the frequency of on-site inspections, the authorities argued that they conduct off-site inspections frequently and had sufficiently detailed information on banks and substantial contacts with those banks to be able to identify at an early stage any emerging problems. Regarding the regional FSAP’s recommendation to transfer the power to revoke bank licenses from the national authorities to the ECCB, several country authorities vehemently opposed it, arguing that it would impinge on national sovereignty.

Crisis management

58. Contingency planning for a crisis scenario should form a key part of prudent macroeconomic management. While every possible attempt should be made to prevent a crisis, the possibility of a crisis cannot be ruled out. Consequently, the staff encouraged the ECCB and country authorities to develop a contingency plan to deal with that possibility, including a clear delineation of the responsibilities of the ECCB and of the national governments.

E. Statistics

59. Efforts are underway to improve the quality, timeliness, and dissemination of statistical series in the region to permit more effective policy monitoring. Staff welcomed the emphasis placed by the ECCB on urging national authorities to strengthen the availability and quality of statistics throughout the region. In view of the need for more comprehensive data on the household sector, it was disappointing that more use had not been made of the data from the census conducted in 2001. The authorities indicated that there had been technological problems with the processing of census returns, so that the results were not yet available in all countries.

IV. Staff Appraisal

60. The ECCU countries are facing several challenges. With the erosion of preferential access to markets in bananas and sugar and the decline in official development assistance, the external environment worsened considerably in the last decade. Natural disasters have been frequent, often inflicting substantial damage to the economies, and the September 11 attacks on the United States clearly demonstrated the vulnerability of the economies to shocks to tourism. In the past few years, the ECCU countries have also faced a sharp increase in petroleum import prices. The resultant deceleration of growth since the early 1990s, combined with the relaxation in fiscal stances, has considerably weakened domestic economic conditions and produced a rapid accumulation of public debt.

61. There is increasing recognition of the difficulty of the current economic position and bold steps are being taken in several countries to address these challenges. The importance of responding to the economic challenges has been highlighted by the prominence given to economic issues in recent electoral campaigns in Antigua and Barbuda, Dominica, and St. Kitts and Nevis. Staff welcomes the key measures now underway in the more highly indebted countries to tackle the economic difficulties: in Antigua and Barbuda, Dominica, and Grenada, determined actions to strengthen fiscal positions and reduce debt levels are being undertaken; and in St. Kitts and Nevis, the authorities have announced the closure of the long-time loss-making sugar industry which should significantly enhance fiscal and growth prospects in the coming years.

62. While progress towards fiscal consolidation was made in 2003–04, a more rapid adjustment is needed to place debt on a clearly downward path. In view of the positive global growth outlook in the near and medium term, and strong prospects for tourism-dominated economies, the present time is opportune for a more forceful fiscal adjustment. Other means of addressing the fiscal imbalances—such as reducing debt by seeking a cooperative solution with creditors and privatization—will not be sufficient to achieve debt sustainability. Fiscal institutions, tax systems, budget processes, expenditure management, public debt management, and public sector investment programs need to be strengthened in tandem to preclude fiscal slippages in the future.

63. Ensuring the consistency of fiscal policies with the CBA needs to be assured if macroeconomic stability is to be maintained. The CBA has delivered a long period of exchange rate and price stability even in the presence of frequent large adverse shocks, fiscal indiscipline, and rigid labor markets. However, this stability has been maintained by the governments’ ability to borrow by remaining current on debt obligations and tapping the captive social security surpluses. Moreover, liquidity in the banking system has been sustained at a high level by attracting deposits through the imposition of a floor on savings rates. This situation cannot continue indefinitely. Preserving the exchange rate peg—which is uniformly supported by the wider population in the region—will require individual governments to make good on their commitments to policy coordination by achieving the fiscal benchmarks approved by the ECCB’s Monetary Council. Staff urge the setting of interim annual targets and a broader dissemination of performance relative to the benchmarks as a means of generating discipline and building ownership of fiscal positions.

64. Raising productivity is key for maintaining competitiveness and supporting the exchange rate peg. Growth rates since the 1990s have been much lower compared to countries with similar levels of spending on human and physical capital, pointing to a low level of efficiency in investment. Enhancing labor market flexibility will be important for unlocking the economy’s growth potential, and ensuring that the economy adjusts to shocks. The depreciation of the U.S. dollar in the last few years has provided some breathing room, but going forward competitiveness can only be sustained if wages are kept in line with productivity growth.

65. Several key steps can be taken to provide a supportive investment climate for the private sector to flourish. The distortionary, nontransparent, and costly tax concessions regime should be reformed. The regulatory environment in utilities, energy, and transportation should be improved. Importantly, the skill level in the region needs to be raised, and education and training programs reoriented to better serve the needs of the region. In view of the high migration rates of skilled labor, the Caribbean diaspora should be tapped more aggressively to support private investment in home countries.

66. Realizing the growth potential will require redefining the role of the public sector. The public sector should focus on creating a conducive investment climate, rather than attempting to create employment and generate growth by further expansions. Public sector investment programs that are critical for private sector development should be implemented only after careful project evaluation and prioritization, with continuous oversight and monitoring during the implementation phase. More generally, the institutional capacity of the public sector should be enhanced in order to facilitate the needed fiscal reforms and assure higher quality of public services.

67. The potential benefits from regional integration and cooperation are extremely high and should be exploited. Given the small size of the economies, and the high fixed costs of providing government services, there is tremendous scope to increase the collective provision of select government services both to cut costs and achieve efficiencies. Steps need to be taken towards further integration of markets, particularly goods and labor, to benefit from economies of scale and to lower product and labor costs.

68. High public debt levels limit the ability of the ECCU governments to use fiscal policy to respond to external shocks, underscoring the need for measures to reduce the region’s vulnerabilities. Natural disasters occur regularly, so that disaster mitigation and preparedness efforts need to be stepped up, even as better insurance mechanisms are sought. Given the increasing dependence of the countries on tourism and tourism-related products, diversification can be achieved by attracting tourists from a larger group of customer countries and increasing interlinkages between tourism and other sectors, particularly agriculture.

69. Further action to enhance the effectiveness of financial sector supervision is needed to contain potential risks. As regional capital markets deepen, financial sector linkages are likely to rise and any adverse event in one country will likely affect neighboring ones, underscoring the need to constantly strengthen financial sector supervision. An increase in the frequency of banks’ on-site inspections was needed, as recommended by the FSAP. Amendments to the Uniform Banking Act, the ECCB Act, and the prudential guidelines, should be enacted soon.

70. Contingency planning for an untoward event should be undertaken by both country and regional authorities. While every possible attempt should be made to prevent a crisis, the possibility of a crisis cannot be ruled out. Preparing in advance, irrespective of the likelihood of the event, could significantly reduce the financial and output costs associated with such events.

71. While the quality and depth of the dialogue between Fund staff and the authorities has intensified in the past year, a further strengthening of statistics and outreach activities are warranted. Staff welcomes the stepped up efforts in most countries to increase transparency and generate public consensus on reforms. However, in view of the far-reaching reforms that need to be implemented, greater debate on economic issues and outreach activities is recommended. To facilitate better policymaking and permit regular monitoring of the impact of reforms on living standards, it is imperative that statistics in all areas be improved, but particularly on labor markets, poverty, and other social indicators.

72. It is proposed that the next regional discussions with the ECCU take place in 12 months, with an update of regional developments in about six months time.

Table 1.

ECCU: Selected Economic and Financial Indicators, 2000–2005

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Excludes Anguilla and Montserrat. ECCU aggregates are calculated as weighted averages of individual country data; ratios to GDP are then calculated by dividing this sum by the aggregated GDP of the region.

Includes errors and omissions.

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

Table 2.

ECCU: Selected Central Government Indicators by Country, 2000–2005 1/

(In percent of GDP)

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Excludes Anguilla and Montserrat. Fiscal years for Dominica and St. Lucia.

Includes external arrears.

Table 3.

ECCU: Summary Balance of Payments, 2000–2005

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Includes errors and omissions.