Eastern Caribbean Currency Union
2007 Discussion on Common Policies of Member Countries: Staff Report; and Public Information Notice on the Executive Board Discussion

Over the last decade, the Eastern Caribbean Currency Union (ECCU) macroeconomic performance has deteriorated relative to the rest of the Caribbean. Tourism accounts for three-fifths of exports, and the import content of consumption and investment is high. The ECCB-operated quasi-currency board arrangement (CBA) has continued to deliver price and exchange rate stability. The region has strong social indicators, but poverty, health, and crime remain concerns. Despite the implementation of ambitious revenue reforms, limited progress has been made toward fiscal consolidation. Credit has continued to expand rapidly.

Abstract

Over the last decade, the Eastern Caribbean Currency Union (ECCU) macroeconomic performance has deteriorated relative to the rest of the Caribbean. Tourism accounts for three-fifths of exports, and the import content of consumption and investment is high. The ECCB-operated quasi-currency board arrangement (CBA) has continued to deliver price and exchange rate stability. The region has strong social indicators, but poverty, health, and crime remain concerns. Despite the implementation of ambitious revenue reforms, limited progress has been made toward fiscal consolidation. Credit has continued to expand rapidly.

I. Background and Social Setting

1. ECCU countries are small, open, tourism-dominated island economies that are highly vulnerable to external shocks and natural disasters (Figures 1 and 2). 1 Tourism accounts for three-fifths of exports, and the import content of consumption and investment is high. While the share of value added from agriculture has declined sharply in recent decades, crops (particularly bananas) remain important in supporting rural incomes.

Figure 1.
Figure 1.

ECCU: Key Characteristics

Citation: IMF Staff Country Reports 2008, 094; 10.5089/9781451811711.002.A001

Figure 2.
Figure 2.

ECCU: Overview

Citation: IMF Staff Country Reports 2008, 094; 10.5089/9781451811711.002.A001

Sources: ECCB; World Bank; and Fund staff estimates.1/ Simple average of The Bahamas, Barbados, Belize, Dominican Republic, Guyana, Haiti, Jamaica, and Trinidad and Tobago.2/ A larger value indicates greater income inequality.

2. Over the last decade the ECCU’s macroeconomic performance has deteriorated relative to the rest of the Caribbean. Growth has declined since the mid-1990s, and debt levels increased substantially as fiscal deficits rose, partly as a result of many shocks, including natural disasters, the 2001 terrorist attacks, the erosion of trade preferences, and collapsing aid flows (Figure 3). Besides shocks, political cycles have also influenced national fiscal outcomes. Governments have repeatedly eased fiscal stances—chiefly through expansions of the civil service wage bill and increased capital spending—in the lead up to elections. 2

Figure 3.
Figure 3.

ECCU: External Environment, 1995–2006

Citation: IMF Staff Country Reports 2008, 094; 10.5089/9781451811711.002.A001

Sources: World Bank, World Development Indicators; IMF, International Financial Statistics; IMF, World Economic Outlook; OECD, International Development Statistics; ECCB; and Fund staff calculations.
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The Caribbean: Relative Ranking on Macroeconomic Performance 1/

(Comparison of Average Performance during 1990–97 and 1998–06)

Citation: IMF Staff Country Reports 2008, 094; 10.5089/9781451811711.002.A001

Sources: World Economic Outlook; country authorities; and Fund staff calculations and projections.1/ The ranking is based on total public debt in 2006, absolute change in public debt from 1990–97 to 1998–2006; average overall fiscal balance from 1998–2006, absolute change in overall fiscal balance from 1990–97 to 1998–2006; average CPI inflation from 1998–2004, absolute change in CPI inflation from 1990–97 to 1998–2006; average real GDP growth from 1998–2006, and absolute change in real GDP growth from 1990–97 to 1998–2006. Countries are ranked from 1 to 14 in each category, with the best performer receiving the highest scores. The scores are then summed for each country, with equal weight to each category of macroeconomic performance. Finally, the summed-up scores are normalized so that the scores for all countries range from 1 to 100. Haiti is excluded from the comparison since the data on the primary balance in period 1990–97 are not available.

3. The ECCB-operated quasi-currency board arrangement (CBA) has continued to deliver price and exchange rate stability. The ECCB has kept lending to member jurisdictions well within statutory limits, and international reserve coverage is near 100 percent of demand liabilities (the legal floor is 60 percent). There have not been any exchange rate pressures, and inflation has been anchored around the U.S. rate.

4. The region has strong social indicators, but poverty, health and crime remain concerns. An entrenched tradition of democracy has nurtured a strong social commitment in the ECCU to public health, education and protecting the vulnerable. As a result, the ECCU countries rank high on the Human Development Index relative to their income levels. While most social indicators are comparable to the OECD average, the region suffers from high unemployment and emigration rates. In addition, there has been a rapid acceleration in the spread of diabetes and hypertension, with associated implications for health spending. One quarter of the region’s population lives in poverty, and crime is a growing problem.

ECCU: Social Indicators

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Sources: ECCB; Fund staff estimates and projections; United Nations, Human Development Report 2007/08; http://www.sdnp.org.gy/ghdr/BOX1.1.html; and the World Bank, WDI 2006.

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

II. Recent Economic Developments and Near-Term Outlook

5. Growth was buoyant in 2006 (Table 1). Real GDP growth in the ECCU was close to 6 percent, the highest in more than 15 years, driven by construction, tourism, and financial services. Construction activity reflected significant expansions in hotel capacity, cricket stadia and supporting public infrastructure, in preparation for the Cricket World Cup (CWC) held in March–April 2007.

Table 1.

ECCU: Selected Economic and Financial Indicators, 2003–08

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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.

Includes errors and omissions.

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

ECCU: Selected Economic Indicators, 2003–08 1/

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Sources: Country authorities, and Fund staff estimates.

Excluding Anguilla and Montserrat.

6. Output is presently estimated to be above potential (Figure 4). In 2007, output is estimated to remain above trend in all countries, although the pace of economic activity is uneven—Antigua and Barbuda and St. Vincent and the Grenadines are expected to continue their strong performance, while growth in Dominica is expected to be minimal following the passage of Hurricane Dean. 3

Figure 4.
Figure 4.

ECCU: Central Government Actual and Structural Budget Balances, 2000–07 1/

(In percent of potential GDP)

Citation: IMF Staff Country Reports 2008, 094; 10.5089/9781451811711.002.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.
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ECCU: Contribution to Real GDP Growth by Sector, 2001–06 1/

(In percent)

Citation: IMF Staff Country Reports 2008, 094; 10.5089/9781451811711.002.A001

Sources: ECCB; 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.3/ Includes mining and quarrying.

7. Despite the CWC, tourism performance in 2007 has been weak. Notwithstanding strong tourism arrivals from Europe—partly reflecting the depreciation of the U.S. dollar (and thereby the EC dollar) against major currencies—U.S. and intra-Caribbean tourist arrivals have disappointed (Figure 5). This performance reflects CWC-related disruptions during the peak winter tourist season; more stringent rules on Caribbean travel for U.S. nationals; and problems with intra-regional airlift (¶24). 4

Figure 5.
Figure 5.

ECCU: Stayover Arrivals, 2005–07

(Annual percentage change)

Citation: IMF Staff Country Reports 2008, 094; 10.5089/9781451811711.002.A001

Sources: ECCB; and Fund staff calculations.
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ECCU: Output Gap, 1982–2007 1/

(In percent of potential GDP)

Citation: IMF Staff Country Reports 2008, 094; 10.5089/9781451811711.002.A001

Sources: ECCB; and Fund staff estimates and projections.1/ Data for 2007 are Fund staff projections.

8. Inflation has picked up. Rising world food prices, the depreciation of the U.S. dollar against major currencies, and the pass-through of higher world oil prices have put upward pressure on prices in the ECCU in 2007 (Figure 6 and Box 1). 5 Inflation is expected to reach 3¾ percent by end-2007, nearly twice the level at end-2006. The ECCB’s Monetary Council has established a working group to further investigate the inflationary pressures on a regional level, and CARICOM leaders have agreed on the elimination or reduction of the Common External Tariff on a selected group of items (by end-January, 2008). Individual countries have responded differently to rising price pressures, including by intensifying profit margin controls (Grenada, St. Kitts and Nevis), considering the provision of import duty concessions on food and other basic necessities (St. Kitts and Nevis), reducing taxes on certain products (Antigua and Barbuda, Dominica), providing limited subsidies to vulnerable groups (Grenada), and having national budgets absorb world price increases on petroleum products (St. Lucia).

Figure 6.
Figure 6.

ECCU: Inflation Developments, 2001–07

Citation: IMF Staff Country Reports 2008, 094; 10.5089/9781451811711.002.A001

Sources: IMF, Direction of Trade Statistics; Haver; ECCB; and Fund staff calculations.1/ Tradables are defined to include food, alcoholic beverages and tobacco, fuel and light, clothing and footwear, and household and furniture equipment.2/ Nontradables are defined to include housing and utilities, transportation and communication, medical care and expenses, education, personal services, and miscellaneous.

9. For 2007–08, indications suggest a ‘soft landing’ of the ECCU economy. Growth is expected to reach around 4 percent in 2007—closer to estimated trend growth of 3¼ percent—reflecting continuing strength in private construction, and despite disappointing tourism arrivals. Activity is expected to moderate further in 2008, to just above trend, due to the slowing world economy and moderating construction activity. Growth is thus likely to remain above the 2¾ percent “stall speed” associated with past regional recessions.

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The forecast is for a soft landing, as growth is estimated to remain above the historical “stall speed” of 2¾ percent.

Citation: IMF Staff Country Reports 2008, 094; 10.5089/9781451811711.002.A001

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

10. However, there are risks to this outlook. The upside potential from strong domestic demand due to the private construction boom is more than offset by downside risks as the turbulence in global financial markets may dampen consumption and tourism demand. In addition, construction activity may be affected by weaker expectations for real estate sales and tourism inflows. With oil import prices high, further dollar depreciation, and structural rigidities in the labor market, cost pressures could continue to elevate inflation.

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11. Despite the implementation of ambitious revenue reforms, limited progress has been made towards fiscal consolidation (Table 2). Stronger growth and far-reaching tax reforms have improved tax revenues, benefiting from broader tax bases and better tax collections, especially the introduction of new VATs. 6 Nevertheless, a surge in capital spending associated with the CWC led to a deterioration of actual and structural fiscal balances in 2006 (Figure 4). In 2007–08, lower spending is projected to improve primary balances before grants, but declining aid flows and higher interest rates are likely to more than offset this improvement, leaving the ECCU-wide overall deficit at around 5 percent of GDP.

Table 2.

ECCU: Selected Central Government Indicators by Country, 2003–08 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.

Includes external arrears.

ECCU: Selected Fiscal Indicators, 2003–08 1/

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Sources: Country authorities; and Fund staff estimates.

Excluding Anguilla and Montserrat.

12. Debt levels and debt servicing costs remain large. Notwithstanding recent strong economic growth and debt restructurings and writedowns in several countries, public sector debt is expected to remain above 100 percent of regional GDP (Figure 3). Debt servicing absorbs a substantial portion of revenues in most countries—the exceptions being Dominica and Grenada, reflecting previous debt restructuring agreements with creditors. In addition, St. Vincent and the Grenadines benefited in 2007 from a debt write-off from Italy equivalent to about 10 percent of GDP. The high burden of debt servicing is limiting fiscal space for much-needed social and poverty-reduction spending.

ECCU: Selected Indicators of Debt Burden, 2004–08

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Sources: Country authorities; and Fund staff estimates.

Includes only external amortization.

For 2005, the debt service incorporates amortization in relation to debt relief received by Antigua and Barbuda from Italy.

13. Credit has continued to expand rapidly. Broad money has grown faster than nominal GDP, and banks have run down their net foreign assets (Figure 7 and Table 3). Private sector credit expansion has accelerated, reflecting increased lending to tourism, construction, and consumers. As construction activities wind down in 2008, credit growth is expected to return to more sustainable levels. Reserve coverage of demand liabilities rose to above 100 percent at end-September 2007.

Table 3.

ECCU: Monetary Survey, 2003–08

(In millions of Eastern Caribbean dollars)

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Sources: ECCB; and Fund staff estimates.

Includes the national insurance schemes.

Figure 7.
Figure 7.

ECCU: Monetary Developments, 2001–06

Citation: IMF Staff Country Reports 2008, 094; 10.5089/9781451811711.002.A001

Sources: ECCB; and Fund staff calculations.1/ Includes interbank float, reserves held with the ECCB, and other unclassified assets.2/ Includes tourism, entertainment, and half of transport, distributive trade and professional services.3/ Excess reserves is defined as the excess of bank reserves (cash holdings and deposits of commercial banks with the ECCB) over required reserves. The current reserve requirement is 6 percent of deposits.

ECCU: Selected Monetary Indicators, 2003–08

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Source: ECCB.

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

14. Prudential indicators of the financial sector have strengthened (Figure 8 and Table 5). Nonperforming loans (NPLs) of local banks have continued to decline and are close to the ECCB’s prudential target (5 percent of total loans). However, provisioning has continued to fall, and the decline in the NPL ratio partly reflects the ongoing rapid credit expansion—raising the importance of effective financial sector supervision. Exposures to government remain high, and are concentrated in some state-owned local banks (Figure 9).

Table 4.

ECCU: Summary Balance of Payments, 2003–12

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Source: ECCB; and Fund staff estimates and projections.

Includes errors and omissions.

Table 5.

ECCU: Selected Vulnerability Indicators, 2003–08

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Sources: ECCB; and Fund staff estimates and projections.

Excludes Anguilla and Montserrat.

Defined as external current account deficit plus external amortization.

Figures for 2007, as at end-September.

Foreign assets as a percentage of demand liabilities.

Figure 8.
Figure 8.

ECCU: Banking System Vulnerabilities, 2002–07 1/

Citation: IMF Staff Country Reports 2008, 094; 10.5089/9781451811711.002.A001

Sources: ECCB; and Fund staff calculations.1/ Prudential indicators are reported by commercial banks, with infrequent onsite verification by the ECCB.
Figure 9.
Figure 9.

ECCU: Decomposition of Commercial Banks’ Exposure to the Public Sector, 2004–07

(In percent of public sector exposure)

Citation: IMF Staff Country Reports 2008, 094; 10.5089/9781451811711.002.A001

Sources: ECCB; and Fund staff calculations.

ECCU Banking System: Financial Soundness Indicators, September 2007

(In percent)

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Source: ECCB.

Local banks.

Quarterly return.

15. The ECCB has strengthened banking sector supervision, but vulnerabilities remain. The uniform Banking Act has been implemented in all ECCU jurisdictions, offsite reporting and data verification have been strengthened, new prudential guidelines have been issued (on provisioning for government arrears, corporate governance, liquidity risk management, and related-party transactions) and corporate governance has been enhanced. Some progress has been made in establishing national single regulatory units (SRUs) for the supervision of nonbank financial institutions (NBFIs), but legislation providing for uniform regulation (of ECCU credit unions, money transfer institutions, and domestic insurance companies) has not yet been introduced in all ECCU jurisdictions. While several countries have enhanced supervision of their offshore financial sectors, there has been little progress in aligning the prudential regimes of offshore banks with those of domestic banks, as recommended by the 2004 FSAP. 7

16. The external current account deficit widened in 2005–06, accompanied by strong capital inflows (Figure 10 and Table 4). The increase in the deficit since 2004 has been driven by imports related to hotel construction and public capital expenditure for the CWC, rising energy imports, and disappointing tourism receipts. Hotel construction is financed mostly through FDI, and is expected to slow in the medium term as new tourism capacity comes online. CWC-related construction was financed largely through external grants. In 2007–08 the current account deficit is expected to narrow, due to slowing CWC-related imports. Gross international reserves are expected to continue to grow, reaching about US$770 million by end-2007 (over 4½ months of imports), with capital inflows (chiefly FDI flows) largely covering the current account deficit.

Figure 10.
Figure 10.

ECCU: Trade and Capital Account, 1996–2006

Large and worsening current account deficits are financed by surging FDI flows and transfers.

Citation: IMF Staff Country Reports 2008, 094; 10.5089/9781451811711.002.A001

Sources: Country authorities; ECCB; and Fund staff estimates.1/ A positive (negative) number indicates borrowing from (lending to) foreigners.