Eastern Caribbean Currency Union: Staff Report for the 2006 Regional Discussions

This paper discusses key findings of the 2006 Regional Discussions on the Eastern Caribbean Currency Union. Fiscal revenues have improved, but there has been only a modest improvement in the fiscal and debt positions. Tax revenues have strengthened with the uptick in economic activity, administrative efforts, and tax reforms. The financial system has been resilient, but additional efforts are needed to strengthen the supervisory framework in the face of emerging risks. Progress continues to be made in implementing the Financial Sector Assessment Program (FSAP) recommendations, but there is a need to ensure enforcement of the new regulatory framework.


This paper discusses key findings of the 2006 Regional Discussions on the Eastern Caribbean Currency Union. Fiscal revenues have improved, but there has been only a modest improvement in the fiscal and debt positions. Tax revenues have strengthened with the uptick in economic activity, administrative efforts, and tax reforms. The financial system has been resilient, but additional efforts are needed to strengthen the supervisory framework in the face of emerging risks. Progress continues to be made in implementing the Financial Sector Assessment Program (FSAP) recommendations, but there is a need to ensure enforcement of the new regulatory framework.

I. Background

1. During their first 25 years of independence, the countries of the ECCU have seen improved social outcomes but with deepening macroeconomic imbalances (Figures 1 and 2). Declining aid flows, the transition from traditional agriculture (bananas and sugar) to tourism as preferential access to European markets eroded, and natural disasters have presented difficult policy challenges. Governments, with political mandates to improve social conditions, generally accommodated shocks and have used the public sector to lead the development strategy. Rising government expenditures resulted in the rapid accumulation of a very heavy debt burden. Nonetheless, the regional quasi-currency board arrangement (CBA) has continued to deliver price and exchange rate stability, fostering a relatively deep and stable financial system.

Figure 1.
Figure 1.

ECCU: Key Characteristics

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Sources: IMF, WEO; World Bank, WDI; EM-Dat; ECCB; and Fund staff calculations.1/ Rank out of 184 countries, with “1” indicating the most exposed to natural disasters.
Figure 2.
Figure 2.

ECCU: External Environment Has Been Difficult

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Sources: World Bank, World Development Indicators; IMF, International Financial Statistics; IMF, World Economic Outlook; OECD, International Development Statistics; ECCB; and Fund staff calculations.

2. Supported by strong growth, important steps have been taken in the last few years to respond to the fiscal imbalances. Activity was driven initially by tourism—which was depressed in the aftermath of the 9/11 attacks—and subsequently by a construction boom ahead of the 2007 Cricket World Cup (CWC). Fiscal revenues have strengthened and countries are modernizing their tax systems based on the introduction of VATs and reduced reliance on trade taxes. Expenditure restraint has proven more difficult due to efforts to meet social priorities and enhance public infrastructure, including airports, to support the growing tourism sector. Dominica and Grenada have also put their debt on a more stable footing through an approach to creditors, while Antigua and Barbuda is moving in a similar direction.

3. The ECCU is also responding to a new political environment. As traditional development partners in Europe have scaled back their involvement in the region, new partners—China, Taiwan Province of China, and Venezuela—have become important providers of concessional support for public infrastructure projects. Regional integration within CARICOM has advanced and the ECCU countries joined the CSM in June 2006. At the same time, the framework for integration within the OECS is being revisited in the context of discussions on a revised OECS Economic Union Treaty.

4. Discussions focused on three key economic issues:

  • How to ensure a transition to a sustained growth path?

  • How to preserve macroeconomic stability and reduce imbalances?

  • How to promote the emergence of a dynamic but stable financial system?

II. Recent Economic Developments and Near-Term Prospects

5. Economic activity in the ECCU region is buoyant. Growth is at its strongest rate in more than 15 years, driven by tourism and construction. Construction activity reflects significant expansions in hotel capacity—particularly in Antigua and Barbuda and St. Lucia—grant‐financed investments in cricket stadia ahead of the 2007 CWC (Box 1), and supporting public infrastructure. Separately, inflation has picked up as countries gradually moved to a higher pass‐through of global oil prices, but remains in the low single digits. Despite the acceleration in activity, there are few signs of overheating, and labor shortages in the construction sector have been met with imported labor.

ECCU: Selected Economic Indicators, 2003-07 1/

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Sources: Country authorities, and Fund staff estimates.

Excluding Anguilla and Montserrat.

6. The growth acceleration has occurred despite high global oil prices and the further erosion of trade preferences. The ECCU countries are among the world’s most oil-import dependent economies and oil import bills increased by a cumulative 6 percent of GDP during 2003-05 (Box 2). Most governments delayed the pass through to retail prices, at a substantial fiscal cost, but, as the permanence of the shock became clearer, have begun to adjust domestic prices. With the further erosion of preferential access for banana and sugar exports to EU markets, production continues to decline and St. Kitts and Nevis closed its sugar industry in 2005.


ECCU: Contribution to Real GDP Growth by Sector 1/

(In percent)

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.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.

7. Notwithstanding improvements in tax revenues, higher infrastructure and CWC‐related spending limited the improvement in fiscal balances. Strong growth and administrative efforts have led to improved revenues, despite the delay in adjusting fuel prices, which are likely to increase further as ambitious tax reforms—notably the introduction of VATs in most countries—come into effect. A surge in CWC‐related capital expenditures, particularly on roads and airports, has meant that the region’s overall fiscal balance has not improved, even with output running at or beyond estimates of potential in most countries (Figure 3).

Figure 3.
Figure 3.

ECCU: Central Government Actual and Structural Budget Balances 1/

(In percent of potential GDP)

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Sources: Country authorities; ECCB; 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.

ECCU: Selected Fiscal Indicators, 2003-07 1/

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Sources: Country authorities; and Fund staff estimates.

Excluding Anguilla and Montserrat.

The 2007 Cricket World Cup

The ninth Cricket World Cup (CWC) will be held in the West Indies from March 5 to April 28, 2007, and will be the largest sporting event ever held in the region. Organizers expect that close to 800,000 tickets will be sold, over 2 billion people worldwide will watch the matches by television, and about 100,000 non-Caribbean visitors will travel to the region. Games are to be played in Antigua and Barbuda, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines, as well as in other countries in the broader Caribbean.

Preparations for the CWC have been costly—both in terms of direct government expenditure and through the provision of new tax concessions—but it has been associated with a surge in private investment. Stadium construction costs have for the most part been covered by grants from China or Taiwan Province of China, though there have been significant nongrant financed public expenditures on roads, public utilities, and security, as well as planned improvements at airports in Antigua and Barbuda and St. Vincent and the Grenadines. In Antigua and Barbuda, Grenada and St. Lucia, large private sector investments in the tourism sector have been announced that could lead by end-2007 to a substantial increase in room capacity on these islands—an almost doubling in the case of Antigua and Barbuda. Private investors have received generous fiscal incentives that will erode the tax base going forward, and government recurrent expenditures will also need to rise to maintain the new facilities.

The net economic costs and benefits of the CWC are unclear. Studies of other states hosting large one-off sporting and cultural events (such as the 2003 CWC in South Africa and 2002 FIFA World Cup in Korea/Japan) generally find a small net positive effect. As with other countries, the key near-term impact in the ECCU has been a construction-led economic boom, which is providing some increase in revenues and, importantly, an opportunity to transition labor from traditional agriculture (or the public sector in the case of Antigua and Barbuda). The impact on tourism may be limited in 2007, as the CWC will be played during the peak winter tourism season when occupancy rates typically are already very high. Benefits are expected to be highest in those countries hosting major national teams and their traveling supporters (England and New Zealand in St. Lucia; Australia and South Africa in St. Kitts and Nevis). Over the longer term, the net benefit will be determined by how successful the countries are in attracting additional tourists to fill the expanded hotel room capacity and the use that can be made of the new stadia.

Macroeconomic Impact of Higher Global Oil Prices

The global increase in the price of oil from 2003 to mid-2006 posed difficult policy choices for ECCU governments. The countries are highly dependent on imported oil products both for direct consumption and for electricity generation—alternate energy sources, such as solar or geothermal, are at present little used. Most ECCU countries have maintained a fixed retail pricing regime with the price established based on the import price and fixed margins for wholesalers and retailers, with the consumption tax serving as the residual. Dominica (from September 2003), Grenada (from October 2006), and St. Kitts and Nevis (from December 2006) have flexible pricing mechanisms with full pass-through to consumers. Driven by social concerns, most governments resisted raising the retail price of petroleum products, which served to limit the inflationary impact of the price changes but aggravated the macroeconomic costs:

The current account impact has been around 6 percent of GDP over 2003-05, accentuated by the lack of adjustment in domestic consumption. Oil import bills have increased substantially—recent estimates from the World Economic Outlook identify the ECCU region as being among the worst affected by the increase in energy prices. Assuming a price elasticity of oil demand of -0.25, flexible pricing could have reduced oil imports in 2005—ranging from 0.5 percent of GDP in St. Kitts and Nevis to 0.9 percent of GDP in Antigua and Barbuda.1/


ECCU: First-Round Current Account Impact of Changes in Oil Prices, Cumulative 2003-05

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Government revenues have declined by as much as 1 percent of GDP annually as a result of the lack of adjustment in domestic prices. The ECCB Monetary Council agreed in October 2005 that the region should move to a flexible pricing mechanism. However, after some initial moves in late-2005, there have been few subsequent adjustments. Staff estimates suggest that a flexible pricing mechanism would (based on end-2005 prices) have generated an additional ¼–1 percent of GDP in revenues annually, depending on the country.

ECCU: Effective Gasoline Tax Rates, 2003–05 1/

(Yearly average)

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Sources: U.S. Department of Energy, ECCB, and Fund staff calculations.

In percent of c.i.f. price.

The growth impact is likely to have been large A World Bank study Assessing the Impact of Higher Oil Prices in Latin America, (April 2006), concludes that Caribbean islands are likely to suffer the largest losses in per capita growth due to increases in oil prices. For ECCU countries, the reduction in growth rates is estimated to range between 0.08 and 0.12 percentage points per annum, resulting from a 14 percent projected annual increase in prices between 2006–10 (the average spot price of petroleum increased almost 36 percent annually in 2004–05).

1/ Elasticity estimates for a group of non-OECD countries from D. Gately and H. Huntington, 2002, “The Asymmetric Effects of Changes in Price and Income on Energy and Oil Demand,” The Energy Journal, 23(1), pp. 19–55.

8. The region faces a substantial debt burden. Despite a sharp decline in 2005—largely due to a debt write-off provided to Antigua and Barbuda—average public sector debt remains above 100 percent of GDP (see Figure 2). Debt service absorbs a substantial portion of revenues in most countries—the exceptions being Dominica and Grenada who have made considerable progress in reaching agreements with creditors.

ECCU: Selected Indicators of Debt Burden

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Sources: Country authorities; and Fund staff estimates.

Includes only external amortization.

For 2005, the estimates include a restructuring of Antigua and Barbuda’s debt with Italy.

9. Access to new financing has been maintained, though funding sources have changed. Over the past decade, in response to the collapse in aid flows and reduced access to concessional multilateral and bilateral financing, governments have increasingly relied on commercial financing. On the external side, this has led to a sharp increase in the cost of funds; though recently, governments have tapped concessional funds from nontraditional donors such as China, Venezuela, and Taiwan Province of China. Domestic funding has come from commercial banks and social security surpluses, facilitated by the development of the Regional Government Securities Market (RGSM) since 2001 on which almost 6 percent of outstanding central government debt at end-2005 was raised. Borrowing costs were significantly below those of other emerging market sovereigns, though the spread has been eliminated as emerging market spreads have narrowed.


ECCU: Composition of Public Debt, 1995 and 2005

(In Percent of Total Public and Publicly Guaranteed Debt)

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Sources: Country authorities; ECCB; World Bank, Global Development Finance; and Fund staff estimates.Note: Due to a lack of a comprehensive database on debt, these statistics have been compiled by combining various data sources. Debt is classified based on issuance as information on ultimate holders is unavailable.

Comparison of Sovereign Bond Spreads

(In basis points over U.S. treasury yield of the same maturity)

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Sources: Bloomberg; and Eastern Caribbean Central Bank.Note: ATG denotes Antigua and Barbuda, KNA denotes St. Kitts and Nevis, LCA denotes St. Lucia, and VCT denotes St. Vincent and the Grenadines.

ECCU: Selected External Indicators, 2003–07

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10. Stronger growth contributed to a widening of external current account deficits in 2005 and into 2006, to well over 20 percent of GDP. Higher oil prices and construction activity spurred an increase in imports; while, growth in travel receipts slowed due to one‐off factors such the impact of Hurricane Ivan in Grenada. Exports of agricultural products also declined as a result of preference erosion and hurricane damage. Foreign direct investment and grants (linked to both CWC and the reconstruction effort in Grenada) largely covered the deficit, and a dip in reserves at end‐2005 was more than reversed by mid‐2006.

ECCU: Selected Monetary Indicators, 2003–07

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Twelve-month change in percent of broad money at the beginning of the period.

11. Monetary aggregates continue to expand rapidly, with a credit boom in the private sector. Broad money expanded in line with nominal GDP, and banks have slowed their acquisition of net foreign assets. Instead, credit to the private sector has grown to finance increased tourism capacity and the mortgage market. Nonetheless, reserve coverage of demand liabilities by the CBA rose to over 96 percent at end-2005.

12. Available indicators are generally reassuring regarding banking system soundness, but information on nonbank financial institutions is sparse. The banking system has withstood recent large shocks (Box 3) and continues to be highly liquid, with capital adequacy ratios well above prudential norms. NPL ratios are declining, though this in part reflects the rapid recent credit growth (Figure 4). However, exposures to government are very high, and issues with the recognition and provisioning for NPLs potentially imply an overstatement of capital in some cases. A system of harmonized supervision of nonbank financial institutions is under preparation.

Figure 4.
Figure 4.

ECCU: Banking System Vulnerabilities 1/

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Sources: Eastern Caribbean Central Bank; and Fund staff calculations.1/Prudential indicators are reported by commercial banks, with infrequent onsite verification by the ECCB.

ECCU Banking System: Financial Soundness Indicators, September 2006

(In percent)

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Sources: ECCB. Estimates are based on bank submissions with infrequent onsite verification.

Locally incorporated banks only.

Quarterly return.

The Resilience of the ECCU Banking System

Despite frequent large shocks, there have been few instances of banks coming under severe stress. In just the past two years, Grenada has been hit by two hurricanes, with Hurricane Ivan alone causing over 200 percent of GDP damage in September 2004. In the same period, the Governments of Dominica, and Grenada undertook debt restructuring operations. Since its establishment in 1983, the ECCB has only intervened in two banks—the Bank of Montserrat in 1993, and the Nevis Cooperative Bank in 1995. In neither case did depositors suffer a write-down.

The stability appears to stem from three factors:

  • Inflows of insurance payments as well as external assistance in the aftermath of a natural disaster help preserve a high level of liquidity in the banking sector. Grenada’s financial indicators were among the strongest in the region prior to Hurricane Ivan and have been largely stable since. Debt-servicing moratoria in the months following the disaster, together with some loan renegotiations, helped maintain solvency.

  • Sovereign debt restructurings have been designed to minimize the impact on the domestic banking system. In both Dominica and Grenada, treasury bills were not restructured in order for the government to retain market access for liquidity purposes. Where the banking sector was included, for instance in Grenada, syndicated loans and overdrafts were restructured on terms more favorable than for other instruments. Resultant capital losses have been manageable.

  • Confidence in the currency board has not wavered. The ECCB has demonstrated its independence by not bailing out member countries as fiscal pressures mounted, so that fiscal crises have not resulted in pressures on the exchange rate. In addition, the presence of large well-capitalized foreign banks provides additional stability in that, in the event of pressures on the system, deposits are likely to flow to foreign banks rather than out of the system, helping to mitigate pressures on the exchange rate.

III. Sustaining Growth

13. Discussions focused on the need for policies to help ensure that the current construction boom translates into sustainable growth. Substantial private sector investments in the tourism sector are underway throughout the Caribbean, implying a sharp increase in the hotel room stock over the next couple of years. Complementary public infrastructure investments—for example roads and airports—are planned to support this expansion. Even allowing for a marketing boost from the CWC, it is unclear whether tourism demand—historically strongly correlated with advanced countries’ growth—will keep pace with the expansion in tourism capacity.

14. The authorities generally saw little risk of a hard landing. Most governments considered that their tourism sectors serve a niche market and are, therefore, unlikely to be significantly impacted by the increased room stock in other countries. Further, they noted that many of the large new investments were by international hotel chains with well-established marketing channels that could reasonably be expected to fill their rooms. Staff suggested that there was a risk that the new capacity would intensify pressures on the older hotel stock, which is typically locally-owned and with exposure to local banking sectors.

15. The authorities were concerned, however, that new passport requirements for U.S. citizens traveling to the Caribbean have exacerbated downside risks. Under the U.S. Western Hemisphere Travel Initiative—designed to enhance security—all U.S. citizens returning to the U.S. from the Caribbean will be required to hold passports from January 23, 2007 for air and from January 1, 2008 for cruise- ships. WTTC estimates suggest that the loss of tourism receipts could amount to as much as 4 percent of GDP a year if those without passports do not travel.1 This is likely an upper bound on the economic impact.


ECCU: U.S. Visitors without Passports and Associated Tourism Expenditure

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Source: World Travel and Tourism Council.1/ In percent of total tourists.2/ In percent of 2005 GDP.

16. Growth is expected to slow in the next few years. Several countries have seen a clustering of construction projects ahead of the CWC as investors sought to take advantage of the additional incentives that had been provided. However, others such as Grenada, St. Kitts and Nevis, and St. Vincent and the Grenadines have substantial investment projects that are still at the design phase and which could serve to maintain the region’s growth momentum in the latter part of the decade.

17. The staff noted that most measures point to a significant improvement in competitiveness in recent years (Figure 5). The depreciation of the U.S. dollar in recent years has resulted in the real effective exchange rate—measured relative to either trade weights, tourism competitors, or tourism source markets—reaching its most depreciated level in more than 15 years. Exports of goods and nonfactor services have declined, but this may reflect data weaknesses.2 It was agreed that the region remains a high-cost destination for tourists, but the authorities argued that this reflected the niche nature of the tourism market together with the scale of the industry that made it impossible for the region to compete purely on the basis of price. They also noted that the high levels of FDI inflows—albeit supported by large tax concessions—suggested the absence of a competitiveness problem.

Figure 5.
Figure 5.

ECCU: External Competitiveness, 1990–2006

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Sources: ECCB; Caribbean Tourism Organization; and country authorities; World Travel and Tourism Council; 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 Suriname are not included in 2003, and those of Haiti are not included in 2003, 2004 and 2005.4/ Scaled from 1 to 100. A higher value means that the country is more competitive in the tourism market.

18. The authorities reiterated their strong commitment to the exchange rate peg. They stressed that the peg had yielded a long period of price stability and that if clear evidence of a misalignment of the exchange rate were to emerge, it was best addressed via structural reforms. The staff broadly concurred with this assessment, but stressed 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.

19. Staff noted that while the region has seen high investment, the growth returns have been disappointing.3 The low impact of investment on growth may reflect the fact that some investment is directed to repairing hurricane damage rather than providing a net increase in the capital stock.4 Nonetheless, staff noted the need to examine structural impediments that could lead to either a misallocation of capital or prevent the realization of productivity gains. The low return on public sector investment reflects the absence of an effective PSIP mechanism in many countries, and a lack of prioritization of capital spending.


ECCU: Ratio of Investment to GDP, 1992‐2004

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

20. In this context, staff questioned the efficacy of tax incentives to spur investment and growth. In particular, the region’s share in world FDI has been declining, even relative to other small-island economies.5 Moreover, the generous terms of these concessions in the ECCU—tax holidays can be granted for up to 30 years and tend to be renewed—have pernicious effects:

  • Tax bases have been eroded, forcing higher tax burdens on nonfavored sectors.

  • The average annual revenue foregone from concessions, for 2000-03, is estimated at between 10-16 percent of regional GDP. This has squeezed resources available for social and infrastructure expenditures and contributed to the debt build up, with negative implications for fiscal sustainability and growth.

  • To the extent that incentives are linked to the size of the investment, the regime discriminates against smaller (typically locally-owned) projects in favor of large projects (typically foreign-owned).


ECCU: Marginal Effective Tax Rate on Investment, 2003

(In percent)

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Source: Sosa, S., 2006, Tax Incentives and Investment in the Eastern Caribbean, IMF Working Paper WP/06/23.Note: METRs are calculated for the tourism sector, the asset considered is machinery, with financing a weighted average of debt (35 percent) and equity (65 percent).

21. Views differed within the region on the desirability and modalities of changing the concessions regime. The authorities generally stressed that given the shallowness of domestic capital markets, their economies were very dependent on FDI in the tourism sector for employment generation and growth, and that regional competition for FDI was fierce. Efforts are underway in many countries to contain concessions through a tightening of administration, and by eliminating the granting of discretionary concessions. A more fundamental overhaul is being introduced in Grenada to a system based on accelerated depreciation and loss carry-forward provisions, so that the incentives are clearly tied to new investment. Regional coordination—such as through a common incentive regime as had been under discussion within CARICOM since 1973, might also play a role in limiting the degree to which investors could induce governments to compete against each other, though it was acknowledged that it would be difficult to design an effective enforcement mechanism.

22. Staff suggested that more emphasis is needed on regulatory, administrative, and legal reforms to help lower the cost of doing business. The 2006 Doing Business Indicators, while providing a generally positive evaluation of the region—St. Lucia was ranked highest at 27th in the world, with all countries in the top half—also identified a number of areas of weakness. In particular: the cost of capital is high and access to finance is limited; it is difficult and costly to register property; property rights and contract enforcement are weak; and there are obstacles to closing a business. Public utilities, particularly electricity, also tend to be relatively expensive and unreliable.

ECCU: Doing Business Indicators Country Rankings, 2006

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Source: Doing Business Indicators Database, World Bank.

23. The authorities agreed that the CSM held the promise of improving efficiency in the region, but many obstacles to closer integration remained. The ECCU countries formally joined the CSM in June 2006, though only after a number of requirements—particularly the proposed liberalization of the Alien Land Holdings Acts—were postponed. It was agreed that the key benefit to the region would likely arise over the medium term following the greater liberalization of labor markets that would enable the timely elimination of skill shortages that have frequently cropped up in the region. The authorities had mixed views on the feasibility of the free movement of labor within CARICOM, which on the one hand would provide valuable opportunities for national populations, but at the same time risked overwhelming small societies and overburdening their health and education systems. The authorities stressed that the Regional Development Fund, which has been established with an initial capitalization of US$130 million (with an aim of reaching US$250 million through contributions by international donors), is a key component of the CSM and should be used to finance infrastructure and education projects in the smaller states to enhance their competitiveness.

24. The authorities expressed concern over the impact of changes in the EU’s trade regime for bananas and sugar on rural populations and employment. Staff estimates suggest that the value of implicit assistance derived from EU banana preferences has declined from about 15 percent of GDP in the early 1990s to about 2 percent of GDP in 2005.6 Dominica, St. Lucia, and St. Vincent and the Grenadines could all experience a permanent loss of between 1–2 percent of GDP and a deterioration in fiscal balances of ½–1 percent of GDP. The sugar sector in St. Kitts and Nevis has already been closed. The authorities agreed with staff’s assessment that the growth impact was likely modest, but emphasized that the key challenge was in relation to employment, as a significant part of the labor force is still dependent on these sectors.7 In terms of policy responses, staff suggested that the movement of labor be facilitated—through temporary income transfers to farmers, retraining programs, and limited subsidies on agricultural inputs—and urged authorities to accelerate the redeployment of land to generate alternative investment and growth opportunities. The authorities stressed the need to move cautiously, emphasizing the sensitivities associated with land in small economies and that they were under severe resource constraints for transitioning labor.

25. The authorities expressed deep frustration with traditional development partners—particularly the EU—for failing to deliver on pledged transition assistance. The authorities noted the complex bureaucratic procedures for obtaining disbursements from the EU which they argued explained the very low level of disbursements.

ECCU: Status of EU Banana Support 1/

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Source: Delegation of the European Commission, Barbados.

Under Special Framework of Assistance. As at end-September 2006.

IV. Preserving Macroeconomic Stability

26. The growth up-tick, orderly debt restructurings, and structural fiscal improvements have strengthened the currency union, but significant vulnerabilities remain. The staff’s DSAs clearly illustrate that the still very high debt level leaves little room for maneuver in the event of an adverse shock, and that a key risk is that fiscal policy does not deliver a lasting improvement relative to recent years (Figures 6a and 6b).8 While the external DSA highlights a growth shock as a key concern, the region’s ability to continue to run very large current account deficits will depend critically on private sector inflows (including FDI) and the public sector’s ability to access financing from capital markets and official creditors. Discussions focused on two key questions:

Figure 6a.
Figure 6a.

ECCU: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Source: Fund staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent one-fourth standard deviation shocks applied to real interest rate, growth rate, and primary balance.3/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2006, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).
Figure 6b.
Figure 6b.

ECCU: External Debt Sustainability: Bound Tests 1/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Source: Fund staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent ¼ standard deviation shocks applied to real interest rate, growth rate, and current account balance.3/ One-time real depreciation of 30 percent occurs in 2007.
  • How to ensure that fiscal policies are consistent with the needs of both the currency union and national objectives; and

  • How to prepare for the fiscal consequences of population aging.

Fiscal benchmarks

27. The fiscal benchmarks introduced in 1998 were unsuccessful in achieving fiscal convergence by the target date of 2007. Indeed, fiscal outcomes moved progressively further from the benchmarks, which the authorities noted did not reflect a lack of commitment, but rather the consequence of a series of shocks in the second half of the 1990s (hurricanes, erosion of preferences, decline of official development assistance), and then the disruption to tourism following the 9/11 attacks.


ECCU Countries: Total Number of Fiscal Benchmarks Met,1998-2005

(Out of 24)

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

ECCU: Fiscal Benchmarks

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Source: Eastern Caribbean Central Bank.

28. A new system of fiscal benchmarks was approved by the ECCB’s Monetary Council in July 2006. In addition to pushing compliance back to 2020, the new benchmarks place increased emphasis on integrating annual budget objectives with the achievement of the medium-term goals. The authorities noted that Source: Eastern Caribbean Central Bank. there was little appetite for an enforcement mechanism based on economic sanctions—which they considered had been ineffective in the European Union. The credibility of the new system would be maintained through a system of peer review in the Monetary Council, and greater transparency.

29. Staff noted that while the modifications were a pragmatic step, there was a clear need to credibly demonstrate commitment to the new benchmarks. Ensuring the credibility of the adjustment path is increasingly critical given the increased reliance on market sources of financing for government and the anticipated diminution of social security surpluses as regional pension systems mature. In this context, it would be important to establish and meet annual targets that are appropriately ambitious and plausibly consistent with achieving the medium-term objectives even in the event of adverse shocks. The emphasis on public sector, rather than central government, targets is a welcome step but creates a need for countries to regularly compile such data and, in some cases, enforce reporting requirements on statutory bodies.

30. Achieving and sustaining the fiscal effort needed to meet the benchmarks will require a broad and durable social consensus on the importance of fiscal prudence. Staff noted that revenue reforms were well underway, so that much of the fiscal adjustment going forward would stem from expenditure restraint. Staff suggested a public discussion on the role of government in the economy to establish expectations on expenditure entitlements that would be consistent with available fiscal envelopes. Such discussions could occur in the context of an OECS commission on expenditure, as had been done successfully in the area of tax policy. Key components could include:

  • Development of comprehensive poverty-reduction strategies—such as those articulated in the PRSP of Dominica, and I-PRSPs in St. Vincent and the Grenadines and Grenada—including well-targeted social safety nets.

  • A clear statement of the services to be provided by government and an assessment of the most effective means of delivering such services.

  • Civil service reform to ensure appropriate incentives for the efficient provision of government services and to help reduce the size of government wage bills which, while they have been reduced in some countries, remain very high by international standards.

  • Well-prioritized Public Sector Investment Programs (PSIPs), including economic cost-benefit analysis, and consistent approval and evaluation procedures.

  • Options for providing further services at the regional level, for example in debt management.


Central Government Wage Bill in Select Countries, 2005

(In percent of GDP)

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Sources: Country authorities; and Fund staff estimates.

31. The authorities agreed on the importance of fiscal prudence, but considered that curbing expenditure would be difficult given a changing global environment and development needs. They expected that government would need to continue to lead the development process, especially in light of the erosion of trade preferences, lower aid flows, and pressures by industrial countries on offshore financial sectors and online gaming. Also, in some cases, substantial public infrastructure investments—for example new international airports—would be needed to secure future employment opportunities and that this would imply debt ratios rising further in some countries in the coming years. Accordingly the burden of fiscal adjustment would continue to fall on efforts to mobilize revenues.

Population aging

32. The ECCU region is likely to see a rapid aging of its population over the next few decades, creating additional pressures for fiscal expenditures. The share of seniors in the population is projected to more than triple in most countries over the next 30-40 years, owing to increased longevity, lower birth rates, and returning migrants. The demographic shift will place increased pressure on both social security finances and health care systems.


Share of Seniors in Total Population 1/

(In percent)

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Source: U.S. Census, International Population DataBase.1/ Aged 60+.

33. Pension reforms are needed in a number of countries to ensure viability going forward. While national social security schemes were intended to be fully funded, pension liabilities in some countries are significantly larger than assets.9 Staff urged prompt action—involving adjustments to contribution rates, benefits formulae, the retirement age, and portfolio management—to ensure long-term sustainability of social security and bring parameters more in line with other Caribbean islands. Civil service pensions—noncontributory and provided in addition to social security pensions—had been addressed in Dominica, Grenada, and St. Lucia, and staff urged the remaining national authorities to take steps to limit this potentially massive fiscal liability. All country authorities recognized the concerns and the urgency of reform; some noted that they have already begun a process of public consultations to build social consensus for the needed reforms—Dominica has recently approved a reform package that is expected to eliminate its unfunded liability.

Net Pension Liabilities 1/

(Percent of 2004 GDP)

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Figures for ECCU based on a 60-year horizon and a 5.5 percent discount rate.

Caribbean Countries: Selected Pension System Parameters, 2004

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Sources: U.S. Social Security Administration, ILO, Social Security in The English‐speaking Caribbean, and IMF country desks.

34. Early action is needed to contain the growth of health care costs. The incidence of noncommunicable diseases is increasing rapidly, with diabetes already among the leading causes of death in many countries. The authorities expressed their deep concern over this trend, noting that the impact of noncommunicable diseases significantly exceeded that of HIV/AIDS which was being addressed through grant financed programs. Staff noted that the resources devoted to public health systems are already large and likely to grow with population aging, so that careful consideration was needed of the government’s role in providing health care (Figure 7). Balancing public provision of health care within available fiscal envelopes, requires a multi-pronged approach—exploiting efficiency gains through regional sharing arrangements, encouraging healthier lifestyles, and alternative financing arrangements such as well-targeted user fees and private insurance. The authorities agreed but noted that it was very difficult for any government—particularly for a small state—to deny health care to a needy person and that there were pressures to introduce universal health care systems.

Figure 7.
Figure 7.

ECCU: Health Care

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Sources: U.S. Census Bureau; World Health Organization; International Financial Statistics; and Fund staff estimates.1/ Hypothetical health spending that would arise, if each country has the same proportion of its population above the age of 65, as Canada (Esmail, 2006). It assumes an elasticity of health spending in percent of GDP to the share of population over 65 of 0.698.

Diabetes Prevalence in Eastern Caribbean Countries, 2000 and 2030

(In Number of Cases)

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Source: Wild et al. (2004), “Global Prevalence of Diabetes: Estimates for the year 2000 and projections for 2030” Diabetes Care, vol. 27, pp. 1047-53.

Spending on Health, 2003

(In percent of GDP)

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Source: World Health Organization.

V. Fostering a Sound and Dynamic Financial System

35. The authorities noted the progress made in implementing FSAP recommendations to strengthen the regulatory framework for banks (Box 4). In particular, the harmonized Banking Act has been passed in all countries, and new prudential guidelines have been implemented, including requiring provisioning for nonperforming government debt. Staff welcomed the progress made but cautioned that enforcement remained a challenge, especially with regard to banks that have delayed taking remedial measures. Progress in developing a risk-based supervisory framework has also been slow and resource constraints have limited the scope and frequency of on- site inspections by the ECCB.

36. Stress tests conducted by the ECCB pointed to the robustness of the banking system to plausible shocks, but identified credit risk as a concern. In particular, interest rate risk, foreign exchange risk, and liquidity risk, were not found to be significant risk factors. Credit risk is a weakness throughout the region—and NPLs are already relatively high. However, ECCB staff did not view the current credit boom as exacerbating these risks as it reflected improved long-term prospects, rather than just the CWC. Government exposures, which differ significantly among countries, were found to be a particular vulnerability in just one country. More generally, staff noted the importance of strengthening accounting and auditing standards to ensure the accuracy of banks’ balance sheet data to enable an accurate assessment of capital and underlying risks. They suggested that weaknesses in the legislative frameworks for foreclosures and collateral realization had contributed to the high and persistent NPLs. The authorities concurred but stressed the sensitivities associated with evicting borrowers from their homes and that an effective education program would be needed so that the public recognized the problem as one of protecting depositors’ rights.

37. Progress is underway in introducing a harmonized framework for supervising nonbank financial institutions (NBFIs), but this remains an area of concern. The authorities agreed that there is a gap in the supervision of NBFIs at present, with little monitoring or data collection. Some progress has been made in setting up single regulatory units in each country, although the development and subsequent approval of harmonized legislation was a time-consuming process.

38. The ECCB’s frameworks for liquidity support and crisis management need to be kept under close review. The authorities noted that the institutional setup of the CBA implied that liquidity and risk management at individual institutions was the first line of defense. They considered that previous experience with past banking problems had demonstrated that coordination and information-sharing between the various constituencies could be handled effectively by the Monetary Council, so that there was no need for a commonly agreed and fully articulated crisis management framework—an FSAP recommendation.

Implementation Status of FSAP Recommendations on Banking Supervision

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39. Efforts to develop regional capital markets are bearing fruit. Key markets include:

  • Interbank market. Market volumes have increased significantly and the ECCB has not participated in the market since 2002. Interbank rates are slowly converging to those on international markets.

  • Regional Government Securities Market (RGSM). The total issue amount is small relative to the size of total central government borrowing (around 6 percent at end-2005), but several national governments—Antigua and Barbuda, St. Lucia, and St. Vincent and the Grenadines—regularly access the market and all countries have at least one issue listed. Reflecting the high level of liquidity within the ECCU—notably at the national social security schemes and at local banks—about 50 percent of primary issues have been taken up by ECCU investors.

  • Eastern Caribbean Stock Exchange (ECSE). Market capitalization has increased sharply following the cross-listing of two CARICOM conglomerates in 2005. However, the volume of trading remains very limited.


Federal Funds Rate, LIBOR, and the ECCU Interbank Rate 1996‐2006

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Sources:ECCB; and IMF, International Financial Statistics.

ECCU: RGSM Market Capitalization, EC$ million

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Source: ECCB.

Liquidity in Selected Stock Exchanges, 2002‐04 1/

(Period average, in percent)

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Sources: Caribbean Trade and Investment Report, 2005; and ECSE.1/ This is the ratio of total share value traded to total domestic market capitalization.2/ Includes Bermuda, Argentina, Colombia, Peru, Mexico, Chile, and Brazil.

40. Regional markets remain fairly segmented, despite the absence of capital controls, and with fairly rigid pricing. Staff noted that while volumes on the RGSM had increased, the nonresponsiveness of regional interest rates to changes in global interest rates was puzzling. The authorities explained that rates on the RGSM remained largely determined by local market conditions. Thus the high level of liquidity of local markets and the portfolio allocation decisions of social security funds had generated a high level of demand for locally issued securities, despite the generally high debt levels.


ECCU: Interest Rate on 91‐Day Treasury Bills Compared with U.S., 2003-06

(In percent)

Citation: IMF Staff Country Reports 2007, 096; 10.5089/9781451811698.002.A001

Sources: Eastern Caribbean Regional Government Securities Market; and U. S. Federal Reserve.1/ Grenada rate is on 13‐week T‐bills issued on March 2003 and 1‐year T‐bills issued since.2/ March‐03, May‐03, and Feb‐06 rates for St. Vincent and the Grenadines are interpolated.3/ U. S. rate is the interest rate on 13‐week Treasury bills.

41. Markets are expected to deepen with progress toward CSM and further infrastructure improvements. The authorities noted that the technological infrastructure is state-of-the-art, with an electronic trading platform with T+1 settlement and a dematerialized Central Securities Depository System. Trading costs are high by international standards, but comparable to those in other Caribbean stock exchanges. They noted that it would take time for capital markets to develop—especially given the absence of market makers, the prevalence of family-owned businesses, and the predominance of “buy and hold” investors in the region. The Exchange Control Act was recently revoked—eliminating remaining capital controls except for a few prudential restrictions 10—which should boost the integration of ECCU markets with those in the broader Caribbean and provide opportunities for regional investors to raise capital at lower costs. Additional steps that are underway are the introduction of a master REPO agreement to facilitate secondary trading in government securities, and to develop an Eastern Caribbean Unit Trust to enhance trading in equities and create an additional savings vehicle.

VI. Institution Building

42. The authorities noted that small states faced difficult capacity constraints when implementing policy reforms. They welcomed, therefore, the technical assistance from CARTAC, the Fund, and donors in supporting both the design and implementation of key measures.11 As the policy reform agenda remained large, they foresaw additional needs for technical assistance, especially for the implementation of VATs, strengthening financial sector supervision, improving public expenditure management systems, and in debt management.

43. Data weaknesses remain a key impediment to policymaking, consensus building, and surveillance in the region. Particular concerns are data on: (i) operations of the broader public sector; (ii) domestic and external debt of the public sector; (iii) balance of payments and national accounts—particularly the coverage of tourism and foreign direct investment;12 (iv) indicators of competitiveness, such as labor market outcomes; (v) financial soundness indicators; and (vi) poverty and other social indicators.

VII. Staff Appraisal

44. The ECCU region is benefiting from a welcome resurgence of economic activity, but the challenge will be to sustain the growth momentum in 2007 and beyond. Growth has reached a 15-year high, reflecting the effects of the preparations for the CWC as well as a pick up in private investment. This has helped create new employment opportunities and ameliorate the adverse effects of both the decline in traditional agriculture and, in some countries, a scaling back of public sector employment. Although the risk of a hard landing following the CWC seems manageable, the region still faces significant headwinds, including still high world energy prices, declining trade preferences, and a massive public debt burden.

45. The CBA continues to serve the ECCU well. The exchange rate peg has underpinned a prolonged period of price stability that has contributed importantly to economic development in the region. Available indicators suggest that the currency remains competitive, reserve coverage has been adequate, and the significant new private investment underway in the tourism sector points to continuing strong prospects in the key sector of the economy.

46. Nonetheless, the region’s exchange rate peg and vulnerability to natural disasters and other shocks makes it even more critical to place fiscal positions on a sustainable path. The public debt ratio remains among the highest in the world, and fiscal situations are likely to become even more challenging in coming years as population aging causes social security surpluses to wane and increases pressures on public health systems. Against this background, the improvement in fiscal and debt positions in recent years appears too modest, especially given growth and revenue buoyancy. Going forward, the key priorities include:

  • Early and sustained progress toward meeting the new fiscal benchmarks: Demonstrating commitment to the revised timeline is essential given the failure of the previous benchmarks to ensure fiscal convergence.

  • Effective tax reform: Encouraging steps have been taken to strengthen tax systems throughout the region, and care will be needed to ensure that VAT implementation is effective, with limited exemptions.

  • Expenditure consolidation: With CWC spending pressures easing and domestic fuel prices now largely having been adjusted, it will be important to establish firmer spending controls and to allow increased tax revenues to support rapid and sustained declines in debt positions. Civil service reform—both to enhance the efficiency of government service provision and to reduce wage bills that remain very high—will be a key component of the expenditure consolidation. In addition, domestic and regional approaches to building a social consensus on the role of government could be useful, especially in the area of health care, where demands are likely to rise sharply in the coming years.

47. Efforts are also needed to foster the conditions that support private-sector-led growth. Tax concessions have proven to be extremely costly and appear to be relatively ineffective in encouraging new investment, and the region would benefit from coordinated approaches to disciplining the provision of concessions. Increased focus on strengthening the regulatory, administrative, and legal impediments to private business activity is also important for encouraging investment. Moreover, the CSME provides an important opportunity to further liberalize factor markets and allow the region to benefit more fully from the opportunities provided by globalization.

48. Financial sector supervision needs to be strengthened to contain emerging risks and provide a reliable basis for further financial market development. Progress has been made in strengthening the supervisory framework for the banking system, but the framework needs to be translated into effective interventions to bring banks into compliance with the norms. Supervision of the nonbank financial sector needs to be bolstered and while existing initiatives to harmonize and consolidate regulation and supervision are welcome, expeditious implementation will be key.

49. Weaknesses in the quality, timeliness, and dissemination of statistics is a constraint on effective economic management and public transparency. Innovative solutions, possibly including a greater role for regional entities in compiling and analyzing data, are needed to overcome the capacity constraints inherent in small economies. While transparency has improved in many countries through greater use of public consultations on key policy issues, enhanced dissemination of relevant data would both enable a more informed debate and provide a better basis for creditors and investors.

50. It is proposed that the next consultation on ECCU policies take place in 12 months.

Table 1.

ECCU: Selected Economic and Financial Indicators, 2002–07

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

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.

Figure for 2005 corresponds to 12-month percentage change until September.

Includes errors and omissions.

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

Table 2.

ECCU: Selected Central Government Indicators by Country, 2002–07 1/

(In percent of GDP)

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Sources: Country authorities; and Fund staff estimates.

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

Dominica’s primary balance is measured by below-the-line financing and may not equal the above-the-line definition.

Government and government guaranteed debt stock. Includes external arrears.

Table 3.

ECCU: Summary Balance of Payments, 2002–07

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Source: Eastern Caribbean Central Bank.

Includes errors and omissions.