Grenada
2007 Article IV Consultation-Staff Report; Staff Supplement; and Public Information Notice on the Executive Board Discussion

The 2007 Article IV Consultation with Grenada discusses strong economic rebound in the aftermath of a hurricane devastation and broadly favorable economic prospects, with major tourism investments under way and the gradual recovery of the agricultural sector. The government’s highly successful debt restructuring is now largely complete and has resulted in substantial debt service savings. Executive Directors welcomed the efforts being made by the authorities to enhance the business climate and improve competitiveness, including through the recently developed national export strategy and other measures to reduce business costs.

Abstract

The 2007 Article IV Consultation with Grenada discusses strong economic rebound in the aftermath of a hurricane devastation and broadly favorable economic prospects, with major tourism investments under way and the gradual recovery of the agricultural sector. The government’s highly successful debt restructuring is now largely complete and has resulted in substantial debt service savings. Executive Directors welcomed the efforts being made by the authorities to enhance the business climate and improve competitiveness, including through the recently developed national export strategy and other measures to reduce business costs.

I. Context for Discussions

A. Background

1. In recent years, a series of exogenous shocks have buffeted Grenada, causing sharp fluctuations in output and putting pressure on the fiscal accounts (Figure 1). Hurricanes in 2004 and 2005 wreaked unprecedented damage (estimated at more than 200 percent of GDP), compounding the sharp dropoff in tourism after the September 11, 2001 attacks in the United States.

Figure 1.
Figure 1.

Grenada: Economic Developments

(In percent of GDP)

Citation: IMF Staff Country Reports 2008, 351; 10.5089/9781451816501.002.A001

Sources: Grenada authorities; and Fund staff estimates.
uA01fig01

Grenada: Debt-to-GDP Ratio

Citation: IMF Staff Country Reports 2008, 351; 10.5089/9781451816501.002.A001

Sources: Ministry of Finance; and Fund staff estimates and projections.

2. Grenada’s public debt rose sharply in this period. Initially, the authorities tapped international capital markets, nearly doubling public debt ratios. Subsequently, the massive destruction caused by the hurricanes complicated the authorities’ nascent efforts to tackle the large fiscal imbalances. They recognized that public debt was unsustainable and initiated a collaborative debt restructuring.

3. In 2006, the authorities launched a comprehensive medium-term economic reform program, developed in consultation with civil society groups. Its key objectives are sustained high economic growth, restoring fiscal and debt sustainability, reducing vulnerabilities, and alleviating poverty.

4. The Fund supported the authorities’ program with a PRGF arrangement approved in April 2006, but the first review has not yet been completed.1 Large fiscal slippages in 2006 (which have continued into this year) resulted in missing the performance criterion on the central government primary balance by a substantial margin. The slow pace of structural reforms also contributed to the delay with the review. Lack of action in addressing the longstanding issue of an unregulated bank was another key factor. The situation with the bank has been complicated by the bank’s lawsuit against the government and the Eastern Caribbean Central Bank (ECCB), with the validity of the bank’s license in contention and the resulting lack of clarity over supervisory authority.

5. While Grenada has been very receptive to the Fund’s policy advice, implementation has been challenging. The authorities have actively sought Fund and CARTAC technical assistance, particularly in the areas of tax policy, debt management, statistics, and the financial sector regulatory framework. However, limited capacity (e.g., staffing constraints, difficulties with intensive economic monitoring) and political constraints contributed to implementation difficulties. In hindsight, the government also viewed some aspects of the original PRGF program as being too ambitious.

6. Social indicators are somewhat weaker than in other ECCU countries. Grenada is currently undertaking a Country Poverty Assessment (CPA)—a key component of the Poverty Reduction Strategy Paper (PRSP)—to gain a clearer picture of developments on the social front since the hurricanes. The CPA’s results should be available by end-2007, and a full PRSP is expected to be completed by June 2008.

ECCU: Social Indicators

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Sources: United Nations, Human Development Report 2006; World Bank, WDI 2006; and Fund staff estimates.

B. Recent Developments and Outlook

7. The economy has largely recovered following Hurricanes Ivan and Emily:

  • Economic activity has rebounded strongly, with annual real GDP growth averaging 7 percent during 2005–06, driven by reconstruction, preparations for the Cricket World Cup (CWC), and revival of the tourism sector.

  • Inflationary pressures have dissipated. After peaking at almost 6 percent at end-2005 following a large adjustment to domestic fuel prices, 12-month CPI inflation declined to 2.5 percent by May 2007. Notwithstanding this sharp decline in headline inflation, rising food prices have led the government to use moral suasion with importers of basic food items to reduce their margins.

  • External developments have been driven by post-hurricane effects. Following a spike in 2005 due to the post-hurricane construction boom, imports declined during 2006. Exports also fell, reflecting the depletion of nutmeg stocks and the long lead time required for nutmeg production to recover. The current account deficit in 2006 improved slightly, with rising tourism receipts nearly offsetting the decline in insurance payouts after 2005. The evolution of the current account in 2005–06 reflected the impact of the hurricanes, as indirect indicators suggest an improvement in competitiveness (Figure 2). Foreign direct investment financed about 40 percent of the current account deficit. During January–May 2007, stayover tourist arrivals grew nearly 10 percent over the previous year, toward pre-hurricane levels. In the first quarter of 2007, cocoa exports came back on line, while the value of other exports remained broadly constant. With imports picking up and a decline in income and transfers, the first quarter current account deficit widened slightly.

  • Monetary developments have been favorable. Growth in credit to the private sector, which had declined sharply after Hurricane Ivan, picked up pace in 2006 and 2007. The leading contributors to the rise in credit were construction and tourism, while loans to agriculture fell.

Figure 2.
Figure 2.

Grenada: Competitiveness Indicators

Citation: IMF Staff Country Reports 2008, 351; 10.5089/9781451816501.002.A001

Sources: Grenada authorities; ECCB; Caribbean Tourist Organization; and Fund staff calculations.1/ An increase (decrease) indicates an appreciation (depreciation).
uA01fig02

Grenada: Inflation and Fuel Prices

Citation: IMF Staff Country Reports 2008, 351; 10.5089/9781451816501.002.A001

Sources: Ministry of Finance; ECCB; and Fund staff calculations.
uA01fig03

Grenada: Credit to Private Sector and Broad Money 1/

(12-month percentage change)

Citation: IMF Staff Country Reports 2008, 351; 10.5089/9781451816501.002.A001

Source: ECCB.1/ A spike in broad money growth in 2005 followed by a dip in 2006 reflected, respectively, insurance inflows for hurricane damage and subsequent drawdowns to pay for reconstruction.

8. Fiscal performance deteriorated markedly in 2006 (Figure 3). Tax collection was lower than programmed during 2006, the result in part of negotiated revisions to the parameters for the National Reconstruction Levy (NRL) (with a rate of 3 percent rather than the planned 5 percent). At the same time, spending on goods and services was greater than projected, reflecting higher utility costs and transfers to households. Government investment reached 20 percent of GDP, about 5 percentage points higher than envisaged, on the back of higher-than-expected costs for reconstruction and preparations for the CWC. These expenditure overruns led to a primary deficit almost 7 percentage points of GDP higher than targeted (measured on a below-the-line basis). The resulting deficit was financed through the accumulation of domestic arrears (which they intend to clear, as soon as they have the resources), a drawdown of deposits, and an increase in public debt that raised the debt-to-GDP ratio from 120 percent at end-2005 to 125 percent by end-2006.

Figure 3.
Figure 3.

Grenada: Fiscal Sector Indicators

(In percent of GDP)

Citation: IMF Staff Country Reports 2008, 351; 10.5089/9781451816501.002.A001

Sources: Grenada authorities; ECCU country authorities; and Fund staff estimates.1/ Adjusted and reflecting revised GDP.2/ Includes 11.4 percent of GDP paid in 2002 to extinguish lease arrangements.

9. Data through the first half of 2007 indicate that fiscal slippages have continued. Despite a substantial shortfall in grants relative to pledges, expenditures have not been kept in check, with transfers higher than projected and capital spending outpacing grant financing.2 The overall deficit during the first half of 2007 reached 2.2 percent of annual GDP, compared with the revised program target of 1 percent for the whole of the year. This deficit was financed primarily through overdrafts and the drawdown of deposits. In addition, the government accumulated arrears amounting to EC$20.3 million on unrestructured domestic debt to the nonbank public due on June 30.3

10. Implementation of the authorities’ structural reform program has been uneven:

  • with solid progress in the implementation of fiscal measures. The politically-difficult NRL came into effect in early 2006. An automatic fuel pricing mechanism was adopted in October 2006 to protect revenues from oil price fluctuations. The collection of tax arrears is being strengthened. Publication of information on tax concessions has begun. Work towards the implementation of a VAT is proceeding, with the authorities aiming for introduction in early 2008.

  • and important steps toward reducing vulnerabilities. Grenada recently established a single regulatory agency—Grenada Authority for the Regulation of Financial Institutions (GARFIN)—to strengthen supervision over the nonbank financial sector. To mitigate the risk of further natural disasters, Grenada signed up for the World Bank’s Caribbean Catastrophe Risk Insurance Facility (CCRIF) and is taking steps toward giving the Building Code force of law.

  • but with delays in advancing other structural reforms. Under their economic reform program, the authorities set out seven measures (structural benchmarks under the PRGF program); so far, only three have been met, two with delay. The biggest stumbling block was on tax concessions, as the authorities continued to grant tax holidays, based on their experience negotiating with several large investors. The benchmarks on legislative action regarding tax concessions will only be met by end-2007, and in modified form. An agreement with trade unions on the public service wage path is yet to be reached, reflecting trade unions’ skepticism about the accuracy of official inflation data. Resolving the issue of the unregulated bank remains outstanding (see ¶27). Other reforms—from public sector modernization to the one-stop shop for investors—have been delayed, mainly reflecting capacity constraints.

Status of Structural Benchmarks Under the Program

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11. The economic outlook is favorable. Boosted by the initiation of several major upscale tourism projects and the continued gradual recovery of agriculture, real GDP is projected to grow at 3 percent in 2007 and 4 percent thereafter. The investment projects are expected to generate significant spillover effects on the broader economy, including increased employment; linkages with the agricultural and other sectors; and substantial one-off financial resources for the government in the form of land transfer taxes and proceeds from land sales. The effects are already being felt, with land prices having doubled in parts of Grenada over the past year.

12. The political environment for reform remains challenging, as the government has a one-vote majority in the Parliament. Although elections are not due until February 2009, there is speculation that the government might call an early election. The political cycle appears to be in full swing, complicating the prospects for fiscal adjustment and other structural reforms.

II. Policy Discussions4

Discussions centered on the key macroeconomic challenges facing Grenada: restoring fiscal and debt sustainability, safeguarding financial sector stability, managing vulnerabilities, and enhancing competitiveness to underpin growth.

A. Restoring Fiscal and Debt Sustainability

13. The overarching objective of the government’s reform program is to restore fiscal and debt sustainability. The government’s highly successful debt restructuring (now largely complete) has resulted in substantial debt service savings (Box 1). Furthermore, as noted above, a number of structural measures have been implemented to address the difficult fiscal situation. However, the government’s plan to halve the debt-to-GDP ratio to 60 percent (the ECCB’s established benchmark) by 2015 has been set back by the large fiscal slippages in 2006 and 2007. In light of emerging shortfalls in pledged grants, implementing the capital program for 2007 as budgeted would imply an overall fiscal deficit of 7½ percent of GDP.

Status of Debt Restructuring

Commercial debt

Progress to date. A highly successful debt exchange was undertaken in November 2005. Overall participation reached 91 percent of eligible debt, or about US$237 million (about 40 percent of total public debt). The restructuring involved a net-present-value reduction of 40–45 percent (using a 9 percent discount rate), for exit yields in the 9–10 percent range, and reduced debt servicing costs by 83 percent during 2005–08.

Outstanding issues. The authorities are making good faith efforts to find and engage the nonparticipating creditors. They have offered to one of them, holding about 5 percent of the eligible debt, a settlement on the same terms as the debt-exchange participants received. They are inviting remaining creditors to come forward.

Debt to official bilateral creditors

Progress to date. In May 2006, the Paris Club agreed to reduce debt service to Paris Club creditors by more than 90 percent for the duration of the PRGF arrangement. The Paris Club also agreed in principle to consider a further restructuring of Grenada’s debt, if needed, at the end of the PRGF program. The authorities have signed bilateral agreements with Belgium, France, and the United States. Agreement is close with the United Kingdom, and have contacted the Russian Federation.

Outstanding issues. Under Paris Club rules, the rescheduling could be suspended if the first review under the PRGF is not completed. For non-Paris Club creditors, agreement is yet to be reached, including on the debt (and arrears) owed to Taiwan Province of China, Grenada’s largest bilateral creditor. In March 2006, the Ex-Im Bank of Taiwan Province of China sued the Grenadian Government in New York, and the authorities are seeking an amicable resolution.

14. The current debt sustainability analysis (DSA) indicates that Grenada is at high risk of debt distress.5 Even a concerted effort to reduce debt would still leave the country highly vulnerable to another external shock. Moreover, Grenada’s debt sustainability outlook has deteriorated since the last DSA.6 While some of this deterioration is due to a change in underlying assumptions,7 most is caused by the fiscal slippages of the last 12–18 months.

15. The authorities recognized that corrective action was needed to address the slippages. They explained that the expenditure overruns resulted from greater-than-anticipated costs of reconstruction, combined with pressing development needs and CWC preparations. As a corrective action, the government agreed to work closely with line ministries to reprioritize capital projects, with the aim of substantially lowering capital expenditure this year. They have also been trying to reach agreement with trade unions on a public sector wage package which, although allowing for a real increase in wages, would still reduce the wage bill as a percent of GDP over time. The authorities also expect substantial divestment proceeds this year from the sales of land for prospective tourism projects and of equity shares in some companies; they plan to use half of such proceeds to pay down expensive debt and the remainder to finance their capital program. These measures taken together should be sufficient to contain the overall deficit to about 3¼ percent of GDP this year and the primary deficit (including grants) to about 1 percent of GDP.

16. The mission stressed that Grenada’s high public debt leaves little room for maneuver, reducing the country’s flexibility to respond to any future shocks. If another strong hurricane were to strike, this could substantially delay the achievement of fiscal and debt sustainability. Moreover, the recent reliance on unsustainable financing sources raises the risk of disorderly adjustment and could further undermine the government’s financial reputation.8 The mission, therefore, stressed the need to adopt the stronger policy framework proposed in the active scenario discussed below. Such a stance would help unlock disbursements of grants and concessional financing from the donor and creditor community, including the European Union (EU) and the Caribbean Development Bank (CDB).9

17. Under the active scenario, the authorities could reach their debt-to-GDP ratio of 60 percent by 2017, three years ahead of the ECCB’s revised regional target date. This scenario entails a small overall fiscal surplus and a primary surplus (including grants) of about 3 percent of GDP (Tables 2c and 2d) to be sustained over the next decade. This would require that capital expenditure in 2007 be limited to just under 9 percent of GDP, consistent with the fact that reconstruction is largely completed, and to 8 percent thereafter, in line with the historical average before the recent shocks. It would also require implementing some additional revenue-enhancing measures over the medium term (e.g., an inflation adjustment to the fuel surcharge); and keeping real wages and spending on transfers, goods, and services constant over the medium term. The scenario assumes that all divestment proceeds would be used to clear arrears and pay down expensive debt, rather than to finance additional budgetary expenditures. This would prevent the erosion of the government’s net asset position, as the reduction of its assets would be fully offset by the reduction in liabilities. In contrast, with the baseline scenario using current fiscal plans (Tables 2a, 2b and Box 1 in the supplemental DSA), the targeted debt ratio of 60 percent is only reached by 2025.

Table 1.

Grenada: Selected Economic and Financial Indicators, 2003–09

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Sources: Ministry of Finance; Eastern Caribbean Central Bank; United Nations, Human Development Report 2006; World Bank, WDI 2006; and Fund staff estimates and projections.

Based on the baseline (current policies) scenario.

Does not include goods procured in ports by carriers.

As a percent of broad money at the beginning of the year.

Measured using above-the-line information.

Includes debt of PetroCaribe Grenada Ltd.

Table 2a.

Grenada: Medium-Term Central Government Finances, Baseline Scenario, 2003–09 1/

(In millions of Eastern Caribbean dollars, unless noted otherwise)

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Sources: Ministry of Finance; and Fund staff estimates and projections.

After debt restructuring in 2005.

Taxes on property include both property taxes and transfer taxes. Property taxes are expected to increase starting in 2008 due to the program to revalue real estate. Transfer taxes are expected to return to their recent historical trend after a jump in 2007 due to one-off sale of assets.

The sharp drop in taxes on international transactions and the concurrent rise in taxes on domestic goods and services reflect the expected introduction of the VAT in 2008.

Difference between overall balance and identified financing.

Includes debt of PetroCaribe Grenada Ltd.

Table 2b.

Grenada: Medium-Term Central Government Finances, Baseline Scenario, 2003-09 1/

(In percent of GDP, unless noted otherwise)

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Sources: Ministry of Finance; and Fund staff estimates and projections.

After debt restructuring in 2005.

Taxes on property include both property taxes and transfer taxes. Property taxes are expected to increase starting in 2008 due to the program to revalue real estate. Transfer taxes are expected to return to their recent historical trend after a jump in 2007 due to one-off sale of assets.

The sharp drop in taxes on international transactions and the concurrent rise in taxes on domestic goods and services reflect the expected introduction of the VAT in 2008.

Difference between overall balance and identified financing.

Includes debt of PetroCaribe Grenada Ltd.

Table 2c.

Grenada: Medium-Term Central Government Finances, Active Scenario, 2003-09 1/

(In millions of Eastern Caribbean dollars, unless noted otherwise)

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Sources: Ministry of Finance; and Fund staff estimates and projections.

After debt restructuring in 2005.

Taxes on property include both property taxes and transfer taxes. Property taxes are expected to increase starting in 2008 due to the program to revalue real estate. Transfer taxes are expected to return to their recent historical trend after a jump in 2007 due to one-off sale of assets.

The sharp drop in taxes on international transactions and the concurrent rise in taxes on domestic goods and services reflect the expected introduction of the VAT in 2008.

Difference between overall balance and identified financing.

Includes debt of PetroCaribe Grenada Ltd.

Table 2d.

Grenada: Medium-Term Central Government Finances, Active Scenario, 2003-09 1/

(In percent of GDP, unless noted otherwise)

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Sources: Ministry of Finance; and Fund staff estimates and projections.

After debt restructuring in 2005.

Taxes on property include both property taxes and transfer taxes. Property taxes are expected to increase starting in 2008 due to the program to revalue real estate. Transfer taxes are expected to return to their recent historical trend after a jump in 2007 due to one-off sale of assets.

The sharp drop in taxes on international transactions and the concurrent rise in taxes on domestic goods and services reflect the expected introduction of the VAT in 2008.

Difference between overall balance and identified financing.

Includes debt of PetroCaribe Grenada Ltd.