Eastern Caribbean Currency Union
2010 Discussion on Common Policies of Members Countries—Staff Report; Informational Annex, and the Public Information Notice on the Executive Board Discussion
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International Monetary Fund
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Publication Date:
28 Jan 2011
eISBN:
9781455213900
Language:
English
Keywords:
ISCR; CR; ECCU country; ECCU region; financial crisis; economic crisis; OECS Financial; country authorities; banking system; private sector; economic activity; current account
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Real regional gross domestic product (GDP) contracted by 6 percent in 2009, reflecting a collapse in tourist arrivals and foreign direct investment (FDI)-financed construction activity. The global financial and economic crisis has also exposed areas of significant weaknesses, notwithstanding reforms implemented by a number of member countries. Executive Directors concurred that the urgent challenge is fiscal consolidation. They noted IMF staff’s assessment that the real effective exchange rate (REER) appears broadly in line with current fundamentals.

Abstract

Real regional gross domestic product (GDP) contracted by 6 percent in 2009, reflecting a collapse in tourist arrivals and foreign direct investment (FDI)-financed construction activity. The global financial and economic crisis has also exposed areas of significant weaknesses, notwithstanding reforms implemented by a number of member countries. Executive Directors concurred that the urgent challenge is fiscal consolidation. They noted IMF staff’s assessment that the real effective exchange rate (REER) appears broadly in line with current fundamentals.

I. Context and Recent Developments

1. The ECCU is at crossroads as vulnerabilities have intensified. The ECCU consists of eight small, open, tourism-dependent island economies which share a common currency pegged to the U.S. dollar (Figures 1 and 2).1 The regional currency board arrangement, which continues to be an appropriate exchange rate regime, has provided a strong anchor for macroeconomic stability, and facilitated financial system development. However, the global financial and economic crisis has brought to the fore pockets of significant weaknesses. Surging fiscal deficits, the lack of institutional arrangements for fiscal consolidation, unsustainable debt levels, and stress in the financial sector are threatening the very underpinnings of the currency union and the currency board. The authorities have responded on a number of fronts, but remedial action has been uneven and needs to be intensified in a number of areas and countries.

Figure 1.
Figure 1.

ECCU: Overview

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.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.Note: Antigua and Barbuda (ATG), Barbados (BRB), Dominica (DMA), Dominican Republic (DOM), Grenada (GRD), Guyana (GUY), Jamaica (JAM), St. Kitts and Nevis(KNA), St. Lucia (LCA), St. Vincent and the Grenadines (VCT), Trinidad and Tobago (TTO).
Figure 2.
Figure 2.

ECCU: External Environment, 1995–2009

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.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. The global recession has severely affected economic activity in the ECCU region through the collapse of tourism and FDI-financed construction, the two pillars of economic growth in recent years. Real regional GDP contracted by about 6.2 percent in 2009, after growing 1.9 percent in 2008 and an average of 3.2 percent during 2000–07. The contraction of 2009 was considerably deeper and more protracted than expected at the time of the previous Common Policies discussions. Stayover tourist arrivals fell by about 12 percent in 2009, reflecting the impact of very weak tourism demand from the key tourism markets in North America and Europe. While a recovery is on its way, it remains weak with stayover tourist arrivals growing by 2.6 percent yoy in 2010 Q1. Low tourism receipts, financing difficulties, and uncertainty associated with the speed of the tourism recovery have also put on hold the construction of tourism-related projects.

uA01fig01

ECCU: Stayover Arrivals, 2006-10Q1

(Annual percentage change)

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: ECCB; and Fund staff estimates.

3. The overall fiscal deficit has increased sharply, particularly in countries with weaker public finances, exacerbating already problematic fiscal imbalances. Recession-induced fiscal revenue losses, a deterioration of tax compliance, tax concessions and increases in public spending in most ECCU members aimed at mitigating the impact of the downturn, as well as higher debt servicing costs raised the region’s overall fiscal deficit to 8.3 percent of GDP in 2009 from 3.6 percent of GDP in 2008 (Figure 3). The public sector is characterized by large wage bills, while rising debt servicing costs crowd out needed social and development spending (Figure 4).

Figure 3.
Figure 3.

ECCU: Fiscal Revenue, 1997–2009

(In percent of GDP)

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: ECCB; Country authorities; and Fund staff calculations.1/ Non-tax revenue increased as a result of one-offs.
Figure 4.
Figure 4.

ECCU: Fiscal Expenditure, 1997–2009

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: ECCB; Country authorities; and Fund staff calculations.Note: Anguilla (AIA), Antigua and Barbuda (ATG), Bahamas (BHS), Barbados (BRB), Belize (BLZ), Dominica (DMA), Dominican Republic (DOM), Grenada (GRD), Guyana (GUY), Haiti (HTI), Jamaica (JAM), Montserrat (MTS), St. Kitts and Nevis (KNA), St. Lucia (LCA), St. Vincent and the Grenadines (VCT), Suriname (SUR), Trinidad and Tobago (TTO).

4. Extremely high and rising regional public debt in the context of a regional currency board arrangement has exacerbated the region’s vulnerability to shocks. The regional public debt jumped to above 100 percent of GDP at end 2009, from an average of 93 percent of GDP in 2006–08, reverting earlier gains in debt reduction. At current polices, debt is either on an explosive path or stubbornly high at least in some countries (Box 1).

ECCU: Selected Fiscal Indicators, 2006–10

article image
Sources: Country authorities; and Fund staff estimates.

5. Liquidity risk, large government exposures of some indigenous banks, and a deterioration of the private sector loan quality raise serious concerns about the stability of the banking system. Weaknesses in the ECCU financial sector have been aggravated by the contraction of economic activity in the region, although the presence of Canadian banks (which have been remarkably stable during global turbulence in 2008–09) has offered an important source of stability (Figures 5 and 6).

Figure 5.
Figure 5.

ECCU: Monetary Developments, 2001–June 2010

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: ECCB; and Fund staff calculations.1/ There was a break in the interest rate series in 2003Q2.2/ 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 requirementis 6 percent of deposits.
Figure 6.
Figure 6.

ECCU: Private Sector Credit Growth, 2004–June 2010

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.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.

ECCU: Selected Monetary Indicators, 2006–10

article image
Source: ECCB.

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

Defined as ratio of the ECCB’s gross foreign reserves to demand liabilities.

  • Private sector credit growth slowed sharply in 2008–09. The slowdown reflected both a tightening of lending standards and subdued credit demand against the backdrop of a sharp output contraction and heightened uncertainty.

  • Liquidity in the ECCU banking system tightened in 2008–09, particularly for some indigenous banks. The interbank market interest rate has edged up since the second half of 2008. The sharp deceleration in private sector deposit growth has resulted in the tightening of liquidity conditions. Net liquid assets as a percentage of deposits in the banking system declined from about 26 percent in January 2008 to 20 percent at end 2009, before recovering marginally in early 2010. Particularly pronounced was the tightening of liquidity in some indigenous banks where the net liquid assets to deposits ratio declined by 10 percentage points from end 2007 to end 2009. To a large degree, this reflected a flight to quality after the Stanford debacle resulted in a bank run on the Bank of Antigua. (Figure 7).

  • The ECCB’s reserve coverage of demand liabilities declined below 100 percent in early 2009 and averaged about 95 percent in the first half of 2010.2 Demand liabilities are mainly currency in circulation and commercial banks’ reserve at the ECCB.

  • While headline numbers suggest adequate capital, there are increasing concerns about the strength of some indigenous banks. Non-performing loans increased to 9.6 percent of total loans as of June 2010 in the banking system. In addition, the NPL average ratio masks heterogeneity, with some countries seeing increases of up to 8 percentage points from end 2008 reflecting the deterioration of loan portfolios in tourism and mortgages. Moreover, provisioning for loan losses covered less than 30 percent of total NPLs, and the NPL ratio is consistently higher for some indigenous banks.

  • Commercial banks’ gross exposure to the government sector has increased substantially, mirroring rising public sector debt in the ECCU. Gross exposure of the ECCU banks to the public sector increased by 82 percent over the period 2003–2009, reaching close to 30 percent of regional GDP (Figures 8, 9 and 10). The public sector exposure of indigenous banks stood at 24 percent of total assets in end 2009‥

Figure 7.
Figure 7.

ECCU: Bank Liquidity, January 2008–June 2010

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Source: ECCB.1/ Net liquid liabilities in St. Lucia largely reflect branches of foreign banks bringing in funds to lend to the private sector.
Figure 8.
Figure 8.

ECCU: Banking System’s Gross Exposure to the Public Sector, 2003–09

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Source: ECCB.
Figure 9.
Figure 9.

ECCU: Decomposition of Commercial Banks’ Gross Exposure to the Public Sector, 2004–2009

(In percent of public sector exposure)

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: ECCB; and Fund staff calculations.1/ Monetary data on home country statutory bodies include debt of St. Kitts Sugar Manufacturing Corporation (SSMC) in the amount of EC$350 million although it has been reclassified as central government debt by the authorities.
Figure 10.
Figure 10.

ECCU: Banking System Vulnerabilities, 2004–June 2010 1/

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: ECCB; and Fund staff calculations.1/ Prudential indicators are reported by commercial banks, with infrequent onsite verification by the ECCB.
uA01fig02

ECCU: Net Liquid Assets to Deposits Ratio of Indigenous Banks, 2008-09

(ln percent)

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Source: ECCB
uA01fig03

ECCU: Total Deposits by Origin of Banks, March 2008-June 2010

(In millions of EC dollars)

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Source: ECCB.
uA01fig04

ECCU: Gross International Reserve’s Coverage of Demand Liabilities, 2008-10

(In percent)

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Source: ECCB and Fund staff calculation.
uA01fig05

Change in NPL to total loans ratio between December 2008 and June 2010 1/

(In percentage points)

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

1/ The decline in the NPLs of banks in Antigua and Barbuda largely reflected the debt renegotiation between some of these banks and the government of Antigua and Barbuda.Source: ECCB

ECCU: Financial Soundness Indicators

(in percent)

article image
Source: ECCB.

The foreign branches have consolidated capital positions with their parent banks.

Non-performing loans.

As of December 2009.

uA01fig06

ECCU: Commercial Banks’ Gross Public Sector Exposure

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: ECCB; and Fund staff.

Commercial Banks’ Public Sector Exposure: By Country, December 2009

article image
Source: ECCB

6. The collapse of the Trinidad and Tobago-based CL Financial Group in January 2009 has exposed weaknesses in the region’s regulatory framework for nonbanks and highlighted the risks of spillovers both across countries and between nonbanks and the banking system. CL Financial offered fixed-term deposit-like financial products through the group’s insurance subsidiaries operating in the ECCU—CLICO Life Insurance (CLICO) and British American Insurance (BAICO), with yields far in excess of those offered by commercial banks. They also served as investment vehicles for some indigenous banks. The combined exposure of CLICO and BAICO to policy and deposit holders in the ECCU amounts to about 17 percent of ECCU GDP (Box 2). ECCU countries have committed to a regional solution aimed at avoiding system risk and protecting as far as practicable the interest of depositors and investors.

7. External imbalances declined but remain elevated. After increasing marginally to 37 percent of GDP in 2008, preliminary estimates suggest that the external current account deficit narrowed substantially to about 27 percent of GDP in 2009. Lower imports more than offset the continued impact of lackluster tourism performance, reflecting largely the decline of FDI-financed construction-related imports and weak domestic demand. The current account deficit was financed predominately by FDI inflows, together with some public sector long-term loans and the drawdown of net foreign assets by commercial banks (Figure 13 and 14).

Figure 11.
Figure 11.

ECCU: Regional Government Securities Market (RGSM), 2002–10

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: ECCB and ECSE.1/ Interest rates on 3-month treasury bills by St. Vincent and the Grenadines.2/ Spreads on St. Vincent and the Grenadines 3-month treasury bills over U.S. interest rate on 13-week treasury bills.3/ Stock as of June 2010.4/ Others include business, private investors, and pension fund.5/ Stock as of March 2010.
Figure 12.
Figure 12.

Eastern Caribbean Securities Exchange

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: Eastern Caribbean Securities Exchange (ECSE);Caribbean Trade and nvestment Report 2005; and Fund staff estimates.1/ Data through end-March 2010.2/ Size of bubble indicates country GDP in millions of U.S. dollars.
Figure 13.
Figure 13.

ECCU: External Sector Developments, 1997–2009 1/

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

1/ Projected figures for 2009.Sources: Country authorities; ECCB; and Fund staff estimates.2/ A positive (negative) number indicates borrowing from (lending to) foreigners.3/ Excluding SDR holdings.
Figure 14.
Figure 14.

ECCU: Stayover Arrivals, 2006–10

(Annual percentage change)

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: ECCB; and Fund staff calculations.

8. The authorities have committed to a coordinated regional response to the economic downturn through the Eight-point Stabilization and Growth Program, signed by ECCU governments in December 2009. It focuses on the implementation of a stabilization package covering financial programs, fiscal reforms, and debt management; a stimulus package (public sector investment programs (PSIP) and social and financial safety nets); and a more structural focused package, comprising the amalgamation of some indigenous banks and reform of the insurance sector.

9. There have been renewed efforts to step up integration. Driven in part by the fallout from the economic and financial crisis, the authorities stepped up their efforts to deepen regional integration by signing the Organization of Eastern Caribbean States (OECS) Economic Union Treaty.3 The new OECS Treaty, to be ratified by the respective member countries by January 2011, would pave the way for the free movement of people, goods, services, and capital among participating countries. The Treaty also allows for the transfer of legislative powers in five specific areas from national parliaments to the OECS Authority, comprising the heads of government, thereby strengthening the institutional set up of a full-fledged economic and monetary union. However, fiscal policy continues to be under the purview of national governments (Box 3).4

II. Outlook and Risks

10. Economic activity in the region is expected to remain subdued throughout 2010 and likely to recover only slowly in 2011. Weakness in labor markets in advanced economies will continue to weigh on tourism. Financial sector stress and the urgently needed large fiscal consolidation will dampen domestic demand. Inflation, which declined sharply to an average of 0.8 percent in 2009 reflecting the widening output gap and falling prices of imported food and energy, is expected to gradually revert to its long run average of about 2 percent, given the anchor of the currency peg.

11. While the region’s overall fiscal deficit is projected to narrow in 2010, imbalances will remain elevated and—in some countries—increase further. Reflecting in large part the fiscal adjustments envisaged under Fund programs with Antigua and Barbuda and Grenada—the fiscal deficit for the region is projected to decline, but remain elevated at about 4.4 percent of GDP for 2010–15, while public debt will stay above 100 percent of GDP through 2015. Some ECCU countries have embarked on ambitious adjustment programs, but others are still on an unsustainable path, risking the viability of the currency union.

12. The external current account deficit in 2010 is projected to remain broadly unchanged from the level in 2009, but to narrow over the medium term. The current account deficit in 2010 will be mostly financed by FDI inflows—albeit at a much lower level than during the FDI-boom years in 2006–08—as well as public sector long-term borrowing. The current account imbalances are expected to narrow in line with a gradual recovery in tourism receipts and fiscal consolidation over the medium term. In turn, FDI inflows will likely remain subdued and external official flows will return to pre-crisis levels.

13. There are considerable downside risks associated with this outlook.

  • A slower recovery of the global economy than currently envisaged, including a double-dip recession in the United States, would further undermine tourism demand and remittance flows, causing another decline in economic activity in the ECCU.

  • A lower than expected recovery in FDI flows would place additional pressure on the current account balance and undermine growth prospects.

  • Without remedial fiscal action, governments’ payment capacity might be threatened in countries with dire fiscal imbalances adversely affecting liquidity and even solvency in banks with large public sector exposures.

  • Critically, against the backdrop of a slow recovery of the ECCU economy and the lagged impact of the recession, the ECCU banking system is likely to be under stress for some time to come. This could potentially erode confidence in the ECCU banking system and the currency board arrangement.5

  • With heightened vulnerabilities, any new shock could send the region into a downward spiral.

III. Policy Discussions6

14. Policy discussions focused on the consistency (or lack thereof) of policies to support the common currency. In particular, discussions focused on five main themes:

  1. Strengthening the institutional underpinnings of the ECCU;

  2. Restoring fiscal and debt sustainability;

  3. Ensuring the resilience of the financial system, including improving the framework for crisis preparedness and management;

  4. Enhancing external stability, growth and competitiveness; and

  5. Enhancing ECCU and Fund engagement.

A. Strengthening the Institutional Underpinnings of the ECCU

15. The continued success of the currency union and peg to the U.S. dollar needs to be supported by consistent fiscal policies across all member countries, including an appropriate institutional set-up to foster fiscal policy coordination. Fiscal cross-border spillovers from the weakest member, as well as the large exposure of a number of indigenous banks to the public sector could potentially undermine confidence and trigger a full-blown crisis, possibly via the banking system. Despite the fact that the Monetary Council adopted (in July 2006) a debt-to-GDP target of 60 percent for 2020, the measure has largely been ineffective. Staff urged the authorities to develop mechanisms to ensure collective fiscal discipline in the short run, although they may want to consider moving toward a fiscal union in the medium term. As the European Union experience shows, coordination is a difficult challenge and considerable political capital has to be spent to achieve results.

16. Building on the Eight Point Program and this common policies discussion, the authorities agreed on the need to adopt annual fiscal targets. In line with staff’s recommendation, the ECCU authorities agreed to adopt annual primary surplus targets consistent with attaining the medium term debt-to-GDP target. As Dominica’s experience has shown, an annual primary surplus target can be a very effective instrument to shape the debate on the budget.7 The authorities do not intend to present the parameters of national budgets to the Monetary Council nor do they envisage using specific incentives to ensure compliance at this juncture. However, they plan to publish the fiscal targets to increase policy transparency and to enhance the peer review process. Staff indicated that the Fund stands ready to support the authorities’ increased fiscal coordination through analytical background work and technical assistance.

B. Fiscal Consolidation and Debt Sustainability

17. In terms of fiscal targets, the surge in fiscal deficits in 2009/10 put further pressure on public debt sustainability calling for ambitious adjustments to ensure sustainable debt dynamics. The continued viability of the common currency/peg to the U.S. dollar depends critically on a simultaneous implementation of strong policies by all ECCU members. Strong fiscal adjustments would also facilitate a reduction in the external current account deficit.

18. Some countries have already started to implement ambitious measures, with primary surplus targets that are consistent with a debt-to-GDP ratio of 60 percent by 2020. The targeted primary surpluses of about 2 percent of GDP implemented under current policies in Dominica and about 4 percent of GDP envisaged under the current economic programs in Antigua and Barbuda8 and Grenada would put the debt dynamics in these countries on a sustainable path. Staff emphasized that while these measures are necessary and commendable, without concomitant adjustments in the other ECCU countries, the currency union will remain at risk.

uA01fig07

ECCU: Public Debt and Fiscal Adjustments Under Current and Program Policies, 2009-2020

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Primary Balance Target

(In percent of GDP)

article image
Source: Country authorities and Fund staff estimates.

Primary Balance Target

(In percent of GDP)

article image

19. For the other countries, and in line with the recently completed Article IV consultations, staff reiterated the need for fiscal adjustments ranging from about 3 percent of GDP in St. Lucia and St. Vincent and the Grenadines, and close to 10 percent of GDP in the case of St. Kitts and Nevis. In addition to reducing fiscal vulnerabilities, the adjustment would also reduce the current account deficit. For St. Kitts and Nevis, the recently announced fiscal consolidation package includes the introduction of VAT, elimination of tax exemptions, an increase in the social service levy, a freeze in wages and hiring, and greater prioritization of capital spending.9 St. Lucia’s adjustment would also critically depend on the implementation of the VAT. In the case of St. Vincent and the Grenadines, the adjustment would hinge on a mix of revenue and expenditure measures, including improvements in the efficiency of tax collections, reduction of exemptions, and limiting the growth in the wage bill.

uA01fig08

ECCU: Public Debt and Fiscal Adjustments, Active Scenario

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Primary Balance Target

(In percent of GDP)

article image
Source: Country authorities and Fund staff estimates.

The difference of primary balance under active scenario and current policies.

20. Staff welcomed the authorities’ commitment to seek a consensus on the respective fiscal targets at an extraordinary Monetary Council Meeting in September 2010. While the targets still need to be defined, the authorities indicated that they were in broad agreement with the targets presented by staff. In this context, staff also noted that it would be important for the authorities to secure the political consensus for the effective implementation of these fiscal targets in this challenging time.10

21. Measures aimed at containing current expenditure, prioritizing public investment spending, and enhancing expenditure efficiency will have to be critical components of fiscal reform programs. While there is room to increase revenue by eliminating tax exemptions and broadening the tax base, high and rising public expenditure call for a broad public expenditure reform. In this context, staff welcomed the authorities’ establishment of a Public Expenditure Commission, which held its first meeting with Fund participation on September 3. Based on the preliminary findings of a FAD technical assistance report, the focus on any reform needs to center on reducing the wage bill, a rationalization of statutory bodies, pension reform, and measures to strengthen public financial management to minimize fiscal slippages, including off-budget activities (Box 4).11 In particular, wage bill management should be part of a comprehensive civil service reform aimed at reducing the overall size of government and improving efficiency in the delivery of public services.

22. The authorities recognized the benefits in examining the composition and quality of government expenditure. They concurred that reducing the wage bill through attrition would provide significant savings, especially if combined with wage freezes which have been implemented in some countries. A number of the ECCU authorities highlighted that the adoption of a regional approach would facilitate achieving public sector wage reduction and improvements in social safety nets in the context of limited fiscal space. Some ECCU authorities are moving forward with civil service reforms with support from the World Bank. There was also a broad agreement on the need to review the effectiveness of statutory bodies to create fiscal space. The authorities agreed that pension reform was critical in restoring the health of ailing social security systems and looked forward to implementing the recommendations from the Pension Commission.

23. Staff encouraged the authorities to further strengthen the debt management capacity to complement the fiscal consolidation effort. The benefits of having “below-the-line” fiscal improvements, linked to better institutional frameworks and strengthened capacity for debt management, as well as a clear medium-term debt strategy, will help to reduce financial risks and place the debt-to-GDP ratio on a sustainable downward trajectory. In this context, staff welcomed the work by the ECCB through the Debt Management Advisory Service (DMAS) Unit, which is funded by the Canadian International Development Agency (CIDA) (CAD$ 7.2 million), to improve the debt management capacity of ECCU members.12

C. Resilience of the Financial System

Banking sector

24. The exposure of some indigenous banks to highly indebted governments and increasing private sector NPLs are taking a toll on the health of the financial system, if left unchecked, could lead to regional spillovers and undermine the confidence in the currency. Safeguarding financial system stability calls for prompt efforts in addressing the underlying fiscal problems, resolving weak institutions, enhancing crisis preparedness and contingency plans, and strengthening regulation and supervision. While the authorities have been able to avoid a full blown crisis and made progress on some of the critical issues (including by intervening in the Bank of Antigua), decisive policy action is required on a number of fronts. Given the expected slow recovery of the ECCU and the lagged impact of the recession, the banking system will continue to face both credit and liquidity risks during 2010–11 (Box 5).

25. Financial sector stability in the ECCU is intertwined with fiscal and debt sustainability as impairment of a government’s payment capacity could affect banks’ liquidity and solvency. For some indigenous banks, a large share of their assets is related to the government, which entails the risk that a disruption of government’s payment capacity could lead to an adverse downward spiral. In the near term, liquidity risks would remain significant as some governments are facing financing difficulties—as evidenced in some cases through the build up of arrears—and high rollover risk. Given the large exposure of some indigenous banks to the government, a sovereign debt crisis could trigger a banking crisis with potential spillovers across banks and the ECCU via the payment system and a generalized loss of confidence. If not well managed, this in turn could lead to capital flight and undermine the stability of the currency peg. Staff highlighted that fiscal consolidation and a reduction in government exposure is paramount and urged the authorities to change the public sector financing model in those countries that rely mostly on the banking system. The authorities reiterated that they are committed to fiscal adjustments and are seeking ways to either reduce or limit bank exposures to the government.13

26. Staff welcomed the authorities’ intention to engage in a preemptive resolution of weak indigenous banks. Experiences from the global financial crisis highlight that liquidity problems in the banking system are often symptoms of underlying problems, which could quickly become solvency issues.14 In addition, the recent experience with the Bank of Antigua illustrated how quickly confidence can erode. Preemptive actions, including a possible removal of impaired assets from banks’ balance sheets and consolidation of the sector could help to minimize the eventual fiscal cost and reduce vulnerability. In this context, staff welcomed the appointment of the Ministerial Sub-committee on Banking of the Monetary Council to provide strategic guidance and oversight. In addition, the ECCB also established a Recapitalization Committee (RECAP) in 2009 to (i) facilitate the preparation of contingency plans of watch-listed banks and (ii) propose alternatives for a new structure of the banking sector in the ECCU. In addition, it intends to establish a Resolution Trust, which would be registered in St. Kitts with licenses to operate in all the ECCU territories.

27. Staff highlighted that the size of the capital shortfall could be large and encouraged the authorities to consider seeking equity participation from strong regional/foreign banks. Headline NPLs and capital numbers may not fully reveal the state of the banking system15 and the cost of the resolution could be significantly larger than currently envisaged by the authorities, potentially leading to large government liabilities, and calling into question the authorities’ ability to raise the necessary financing. In this context, staff urged the authorities to perform bank specific diagnostics without delay and consider a resolution strategy that includes burden sharing by all parties and offered technical assistance. The participation of regional or foreign investors in the resolution would also improve the governance in the banking sector through the application of evolving best international practices and facilitate the creation of an arm’s length relationship between the bank and the government. The authorities indicated that they were currently reviewing a number of resolution strategies, including the amalgamation of a number of indigenous banks and would be open to foreign/regional strategic investors, but a final decision had not been made.

28. The authorities and staff agreed that contingency plans need to be enhanced, with clearly defined responsibilities of relevant institutions in the event of a crisis. Crisis management and contingency planning should include specific measures to strengthen the ECCB’s monitoring capacity to ensure early detection of bank stress; and capacity to provide liquidity support with appropriate safeguards to contain a bank run and protect the central bank’s balance sheet. Also, staff urged the authorities to increase the scope and frequency of on-site inspections and enforcing remedial measures on identified weak banks (Box 6). In this context, staff encouraged the authorities to keep the SDR allocations as a shared liquidity buffer, and to consider strengthening this buffer further.16

29. Staff welcomed the important steps taken by the ECCB in closely monitoring banking risks, in particular the liquidity situation in the banking system. The ECCB is conducting bank stress tests17 and has established a Liquidity Watch Group (LWG) to follow liquidity conditions in individual banks based on daily bank-by-bank data. Also, the ECCB has strengthened monitoring and coordination of its own credit facilities available to governments and banks18 and the interbank market.

30. The authorities and staff agreed that a continued review of the bank resolution framework and stepped-up efforts in strengthening banking regulation and supervision are needed. The resolution framework was tested recently during the intervention of the Bank of Antigua. While the ECCB successfully assumed control of the institution, the intervention revealed the need for a review of the respective national laws.19 Also, in line with FSAP recommendations, the authorities need to strengthen consolidated supervision by the ECCB of offshore bank affiliates of some indigenous banks. Also, staff encouraged the ECCB to strengthen the uniform implementation of revised regulatory guidelines on the treatment of nonperforming public sector obligations (i.e., risk-weighted at 20 percent) and for capital adequacy ratios to appropriately reflect risks faced by banks.20 In this context, staff encouraged the ECCB to further enhance risk-based bank supervision. The authorities reassured staff that the revised regulatory guidelines are applied uniformly and the ECCB would continue to move towards the implementation of risk-based bank supervision. In the medium term, regulation and supervision needs to be aligned with emerging international best practice to eliminate incentives for the over-exposure to government.

Non-bank financial sector

31. Although the authorities have adopted a regional strategy toward the resolution of BAICO, progress has been modest and a comprehensive strategy for CLICO still needs to be defined. Staff supported the ECCU authorities’ announced steps toward the resolution of BAICO, including the establishment of a new insurance company, but raised concerns about the ability of the authorities to raise the necessary capital.21 In the case of CLICO, staff urged the authorities to adopt a regional approach, in close coordination with Barbados. In this context, staff welcomed the authorities’ decision to prohibit the writing of new policies and the planned appointment of judicial managers for all the ECCU countries. With a total exposure of the ECCU to the two companies of 17 percent of regional GDP, staff reiterated the need to minimize the fiscal cost, through revision of existing terms, extension of tenor, and possibly conversion of some liabilities into equity. Also, given the potential of write-offs, banks should be required to make appropriate provisions.

32. The need to strengthen non-bank regulation and supervision was underscored by the Stanford-related Ponzi scheme and the collapse of CL Financial. While the ECCB is responsible for banking supervision, licensing of all financial institutions and supervision of nonbank financial institutions remain the domain of national governments. The authorities recognized the urgent need to complete the establishment of independent single regulatory units (SRUs) for the non-bank sector in all ECCU members and enactment of outstanding legislation governing the non-bank sector. Remaining work to be done includes enacting or harmonizing new insurance legislation, as well as the Cooperative Societies Act, and establishing statutory funds for insurance companies to back up local liabilities.22 In this context, staff welcomed the work of the Regional Oversight Committee (ROC), established in 2009 comprising all financial sector regulators in the ECCU, the ECCB, the SRUs, and the Eastern Caribbean Securities Regulatory Commission) as a positive step in providing a framework for discussing financial sector issues and the exchange of information in a comprehensive manner. Staff, however, pointed out that coordination should be institutionalized through the establishment of complete memorandum of understandings (MOUs), and taking further steps to strengthen supervision of nonbank institutions.

33. Staff urged the authorities to ensure the appropriate supervision of systemically important credit unions, to consolidate the sector, and to move non-bank supervision and regulation to the regional level. The large number of non-bank financial institutions, now comprising 58 credit unions and more than 150 insurance companies, renders effective supervision impossible. In the short run, staff recommended that the supervision of systemically important credit unions be transferred to the ECCB. Also, efforts to collect and compile data from non-bank financial institutions need to be strengthened. In the medium term, and given the capacity constraints to effectively supervise the large number of non-banks, staff recommended the merger of smaller institutions,23 the creation of centers of excellence via the pooling of regulatory and supervisory expertise across countries, or possibly the establishment of a regional non-bank regulator/supervisor, that is, the merger of the national SRUs. Since the authorities might not have the necessary resources to assess which of the nonbank institutions are viable, continued technical assistance from IFIs, regional and development partners would be needed. While the authorities agreed that regional cooperation would help to build expertise in critical disciplines and facilitate information sharing and highlighted that some mergers were already taking place, they emphasized the political constraints in both creating a regional non-bank supervisor and transferring large credit unions to the ECCB.

34. The offshore financial sector in the Caribbean region continues to face pressure to comply with international standards aimed at reducing tax and regulatory havens, which could have an adverse impact on FDI inflows. Staff welcomed the recent signing of the necessary twelve Tax Information Exchange Agreements (TIEAs) by all ECCU member countries, allowing them to be removed from the OECD grey list. At the same time, staff urged the authorities to develop the capacity to respond to the forthcoming peer review process. Also, the authorities may want to build on the Ministerial Sub-committee on International Financial Services of the Monetary Council, to address these issues in a regional context. Furthermore, the authorities may want to consider the cost and benefit of the offshore sector and, if the analysis warrants it, consider exiting the sector altogether.

D. External Stability, Growth and Competitiveness

External stabiltiy

35. Although the real effective exchange rate (REER) appears broadly in line with fundamentals, required fiscal adjustments need to be accompanied by REER depreciations in the near future. The equilibrium real exchange rate approach indicates an undervaluation of about 2 percent. Based on the macro balance approach, the estimated current account norm ranges between -17 and -20 percent of GDP, broadly in line with staff projections of a medium-term current account deficit for the ECCU of around 19 percent of GDP. However, apart from the limitations of the assessment methodologies for countries with data deficiencies and hard pegs, large fiscal adjustments are recommended that would go beyond the baseline projections and that would reduce the equilibrium current account deficit (the current account norm) implying a depreciation of the equilibrium REER.24 Given the peg, this will require an adjustment in relative prices to maintain output close to potential (Box 7). To support such a relative price adjustment, staff highlighted the urgent need to moderate real wage growth or even lower wages, especially in the public sector, given the signaling role of public wages in the economy.

Growth and Competitiveness

36. Following the dismantling of trade preferences for agricultural products, growth has slowed significantly since the 1990s, but tourism has helped to offset some of the decline. Staff analysis suggested that prior to the more recent decline growth was primarily driven by capital and productivity gains, but that during the past two decades, the contribution of productivity has fallen significantly (Box 8).

37. Staff indicated that tourism-led growth remains a viable strategy for the ECCU, especially for the countries with lower income per capita that entered the tourism sector more recently. ECCU countries have recently experienced a decline in market share. In some countries, however, lower tourist arrival was offset by higher tourism expenditure suggesting that moving toward high-end tourism is warranted. At the same time, staff highlighted that some countries will have to look at their cost structures (especially wages) to regain competitiveness (Figure 15). Staff cautioned that the authorities should focus on improving the business climate25 rather than picking winners and losers and instead encourage private sector led efforts in accelerating tourism growth.

Figure 15.
Figure 15.

ECCU: External Competitiveness, 1990–2009

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: ECCB; Caribbean Tourism Organization; Country authorities; World Travel and Tourism Council; and Fund staff estimates.Note: Antigua and Barbuda (ATG), Barbados (BRB), Belize (BLZ), Dominica (DMA), Dominican Republic (DOM), Grenada (GRD), Jamaica (JAM), St. Kitts and Nevis (KNA), St. Lucia (LCA), and St. Vincent and the Grenadines (VCT).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/ A value below 1 indicates that the country’s tourism sector is less productive than that of The Bahamas.
Figure 16.
Figure 16.

ECCU: Doing Business Indicators, 2009 1/

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: World Bank (2009), 2010 Doing Business Indicators; and Fund staff calculations.1/ Smaller numbers represent greater ease in doing business. The 2009 rankings are across 183 countries, covering the period June 2008 through May 2009. The sample size is 178 and 181 for 2007 and 2008, respectively.Note: Antigua and Barbuda (ATG), Dominica (DMA), Grenada (GRD), St. Kitts and Nevis (KNA), St. Lucia (LCA), St. Vincent and the Grenadines (VCT), and Latin America and Caribbean (LAC).
uA01fig09

ECCU: Contributions to Growth, 1970–2007

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Source: Heston, Summers and Aten (2009). Fund staff calculations.
uA01fig10

Caribbean: Tourism and Growth, 1981-2007

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Exlcuding The Bahamas and BermudaSource: World Bank; WTO; Heston, Summers and Aten (2009).

38. Staff also highlighted that available empirical evidence suggests that countries with high public debt-to-GDP ratios grow slower than their peers.26 Reducing high fiscal deficits and public levels will therefore not only reduce vulnerabilities but also be critical to foster growth.

39. Output volatility. Despite the sharp decline in output reflecting the close economic linkages to the United States, staff emphasized that an active regional diversification strategy is not called for given the historically low output volatility of large and diversified advanced economies such as the United States. Staff analysis also indicates that despite frequent natural disasters, the ECCU’s output volatility is not greater than in other low income member countries eligible for Fund’s concessional financing.

40. There was a broad consensus among the authorities that one of the key challenges of the region is how to boost economic growth. Affirming that tourism will continue to be the main driver of growth, some ECCU governments emphasized that in addition to developing niche strategies to seek high end tourism, reducing wage costs, especially in the public sector, would be a critical factor in making the region’s tourism more competitive. The authorities recognized that high debt levels are a hindrance to growth and that government expenditure need to be constrained to reduce debt. However, they noted the difficulties of achieving this given the large role the government plays in the economy through pursuing growth-enhancing capital spending due to the lack of a vigorous private sector. The authorities also underscored that the recent signing of the new OECS Treaty opened new opportunities for a regional marketing strategy offering multi-country destinations to attract more tourists, especially from fast growing non-traditional markets.

E. Enhancing ECCU and Fund Engagement

41. Given intensified vulnerabilities, the Fund is further enhancing its engagement with the ECCU. Responding to the global financial crisis and idiosyncratic shocks, during 2009/10, the Fund provided financing to all of the six ECCU Fund members beyond the SDR allocations. The Fund will continue to offer significant technical assistance to the region either directly from HQ or through CARTAC to foster the institutional capacity for policy analysis and implementation and to further improve the collection and dissemination of statistical data (Box 9). The region faces challenges posed by administrative capacity constraints which are hampering implementation and progress of the necessary reforms and of the ongoing Fund-support programs. With significant support from CARTAC, the authorities have, for example, rebased the GDP series and revised the CPI, both of which are expected to be released in October 2010 (Box 10). The newly established regional resident representative office should also further strengthen the dialogue between the authorities and the Fund in the region. In addition, the Fund stands ready to step-up both bilateral and regional surveillance, provide assistance in fostering policy coordination among ECCU members, and provide additional financing in support of strong adjustment programs.

ECCU: Recent Use of IMF Lending Facilities, 2006-2010

article image

ECF: Extended Credit Facility; ENDA: Emergency Assistance for Natural Disaster; ESF-RAC: Exogenous Shocks Facility (Rapid Access Component); and SBA: Stand-By Arrangement.

The ECF arrangement in an amount equivalent to 90 percent of quota was approved in April 2006. The first ECF augmentation (12 percent of quota) was approved in July 2008 and the second augmentation (38 percent of quota) was approved in June 2009.

42. In response to the authorities’ inquiry, staff stressed that lending into a regional pool is not an option at this juncture27—i.e. programs would continue to take place on a country-by-country basis—but coordination among programs is possible.28 In this context, Fund’s lending to all ECCU countries concurrently would help fostering policy coordination and strengthen the currency union. Given the unique challenges of the ECCU, staff mentioned that there are ways to coordinate country specific measures that are part of Fund programs with the resolution of matters that have a regional dimension. In particular, this could include—and in addition to country specific budget support—the use of Fund financing of country programs for strengthening the lender-of-last resort capacity of the ECCB29, and facilitating a joint bank resolution strategy for some indigenous banks.30

uA01fig11

Country specific and regional dimensions of Fund financial assistance to ECCU countries

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

43. Against the backdrop of the economic crisis, the authorities noted that the ECCU members and the Fund have an opportunity to develop a creative partnership appropriate to both the individual country’s circumstances and issues confronting the currency union. They agreed to continue discussing with the Fund the potential need for balance of payments support and thought it would be best to take into account the regional dimension of the ECCU into possible future Fund arrangements. They also stressed the importance of continued cooperation with the Fund and other international financial institutions to support policy adjustment in the region. The authorities asked the Fund to assist them in accessing TA and financial resources from other IFIs and donors.

IV. Staff Appraisal

44. The ECCU is at crossroads. While the currency board arrangement has provided a strong anchor and continues to be an appropriate exchange rate regime, the global financial and economic crisis has brought to the fore pockets of significant weaknesses. Surging fiscal deficits, the lack of institutional arrangements for fiscal consolidation, unsustainable debt levels, and stress in the financial sector are threatening the underpinnings of the currency union and the currency board. Despite the implementation of reforms by a number of countries, decisive policy action on a number of fronts is urgently needed to ensure the viability of the currency union.

45. The ECCU region has been hard hit by the global economic downturn and is faced with a protracted recovery. Real regional GDP contracted by 6.2 percent in 2009, reflecting a collapse in tourist arrivals and FDI-financed construction activity. Continued weakness in private consumption and high rates of unemployment in the advanced economies has dampened prospects of a rapid recovery and 2011 is likely to remain a very challenging year. In addition, risks to the outlook continue to be on the downside.

46. The main challenge is fiscal consolidation. The currency union needs to be supported by consistent fiscal policies across all member countries. Reducing high fiscal deficits and public debt levels are critical for fostering growth. The authorities’ decision to translate the current debt target of 60 percent of GDP by 2020 into annual primary surplus targets is an important step in the right direction, but the challenge will be both to ensure implementation and compliance. In this context, political consensus to promote fiscal discipline in the region and efforts to further strengthen the fiscal governance system and debt management capacity are needed to secure fiscal consolidation. To put debt on a sustainable downward trajectory, most countries require a primary surplus of 2 to 4 percent of GDP over the next few years depending on initial conditions. In the case of St. Kitts and Nevis, the primary surplus target needs to be significantly larger given the more adverse initial conditions.

47. Rationalizing public expenditure will have to be an important element in addressing fiscal weaknesses and improving the efficiency and effectiveness of public spending. The establishment of the Public Expenditure Commission is an important first step in formulating the actions needed to rationalize public expenditure in the ECCU. Key actions would include comprehensive civil service reform aimed at reducing the overall size of government and improving efficiency in the delivery of public services; the rationalization of statutory bodies; pension reform; and the strengthening public financial management. These reforms would also help to create some fiscal space to pursue growth-enhancing capital spending.

48. Fiscal and debt sustainability in turn are intertwined with the stability of the ECCU banking system and the confidence in the currency peg. As a result of large government exposures, some banks are facing significant challenges including tightening of liquidity. The possible impairment of government’s payment capacity would not only create further liquidity problems, but also lead to solvency issues. While some governments have started with fiscal consolidation and are seeking ways to reduce banks’ exposure to governments, others need to follow suit and the authorities need to change the public sector financing model in those countries that rely mostly on the banking system

49. Safeguarding financial system stability calls for crisis preparedness and prompt actions including a preemptive resolution of weak banks. Given the expected slow recovery of the ECCU economy and the lagged impact of the recession on loan quality, the banking system is likely to continue facing high liquidity and credit risk. The authorities are monitoring the liquidity conditions of banks closely and have strengthened the framework for contingency and crisis management and are reviewing options of a preemptive resolution of weak banks. However, there are concerns that headline NPLs and capital adequacy ratios may not fully reflect the state of the banking system. The cost of the resolution could therefore be significantly higher than currently envisaged by the authorities. The situation calls for bank specific diagnostics without delay. Any resolution strategy should minimize the fiscal cost through burden sharing and consider involving strong regional/international strategic partners.

50. While some progress has been made in the resolution of BAICO, the risk of rising fiscal costs and a possible fallout from CLICO calls for a more decisive and stepped-up regional approach. The authorities have defined a resolution strategy for BAICO, but there are concerns about the ability to raise the necessary capital; in the case of CLICO, a resolution strategy still needs to be defined. In both cases, the fiscal costs should be minimized and a closer coordination with Trinidad and Tobago and Barbados (the home supervisory authorities of BAICO and CLICO, respectively) is warranted.

51. Regulation and supervision of the nonbank financial sector needs to be stepped up. Despite progresses made so far, urgent priorities would include: completing the establishment of SRUs in the remaining countries; making further progress in enacting or harmonizing financial sector legislation covering insurance, credit union and money services; transferring supervisory responsibility systematically important credit unions to the ECCB, and strengthening the information exchange and collaboration between the ECCB, SRUs and other regulators. In the medium term, consideration should be given to the creation of a regional non-bank supervisory institution and in consolidating the number of smaller nonbank institutions.

52. The REER appears broadly in line with current fundamentals, but the necessary fiscal adjustments will imply equilibrium REER depreciations in the near term. Despite the fact that the REER is broadly in line with current fundamentals (based on standard CGER methodologies), the implementation of large fiscal adjustments going forward will require a REER depreciation. In light of the peg, this implies adjustments in relative prices and calls for constraints in real wage growth or even a reduction in nominal wages to facilitate the adjustment. Given the signaling effect, public sector wages should take the lead.

53. Tourism remains a viable growth sector for the ECCU, but cost reductions are critical to ensure competitiveness. Following the dismantling of trade preferences for agricultural products, growth has slowed significantly, but tourism has offset some of the decline and has been a key driver of growth. In addition to moving toward high-end tourism, the ECCU economies need to significantly reduce their cost structures to regain competitiveness. Although the ECCU has been hit hard by the recession in the United States, an active regional diversification strategy is not called for given the historically low output volatility of large and diversified advanced economies such as the United States.

54. Further progress in capacity building is needed to improve policy analysis and implementation of necessary structural reforms. This will require continued sizable support through technical assistance from IFIs, regional as well as development partners.

55. It is proposed that the next discussion on ECCU common policies takes place in 12 months.

Public Debt in ECCU Countries

ECCU countries are among the most highly indebted in the world. All of the six independent ECCU countries rank within the 15 most indebted emerging markets and developing countries, of which three (Antigua and Barbuda, Grenada and St. Kitts and Nevis) have a public debt-to-GDP ratio of over 100 percent and all of the countries currently exceed the ECCU’s 2020 target of 60 percent of GDP.

uA01fig12

Public Sector Debt in Selected Emerging Markets/Developing countries, end-2009

(In percent of GDP)

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: IMF, World Economic Outlook; and Fund staff calculations.1/ emerging and developing economices.

Roughly half of the regional debt is owed to external creditors (of which 19 percent is multilateral debt). Reliance on domestic sources is high, particularly in Antigua and Barbuda (63 percent of total public debt) and St. Kitts and Nevis (66 percent). St. Vincent and the Grenadines’ share of domestic debt in total debt is in line with the regional average of about 50 percent.

The aggregate public debt increased sharply in 1998–2004 and peaked at 112 percent of GDP in 2004. Central government primary deficits (excluding grants) played a major role in the rise in the debt ratio in ECCU countries, accounting for over half of the total increase during that period. Significant contributions from the residual term, “other factors”, suggest that the public sector deficit is underestimated. This may reflect data limitation related to non government public sector operations (including off budget), and contingent liabilities such as the granting of guarantees to public corporation debt. Although debt-to-GDP ratios declined during 2005–08, there has been a significant surge in debt more recently. During 2005–08, the debt to GDP ratio declined by 17 percentage points. High growth and grants explain the result as primary deficits maintained a large contribution to debt and the residual “other factors” contribution was close to nil thanks to debt restructuring in Dominica and Grenada. With the global economic slowdown, fiscal balances deteriorated sharply in 2009, contributing to an increase in the debt ratios.

uA01fig13

ECCU 6: Composition of Public Debt

(percent of total, end-2009)

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Source: Country authorities and IMF staff calculations
uA01fig14

ECCU 6: Contribution to changes in public debt per year

(in percent of GDP)

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Collapse of the CL Financial Group

The collapse of the Trinidad and Tobago-based CL Financial Group in January 2009 represents a major challenge to financial system stability in the ECCU. Two insurance subsidiaries of the Group—CLICO International Life Insurance Limited (CLICO), based in Barbados, and British American Insurance Company (BAICO), based in The Bahamas—had been selling deposit-like investment instruments throughout the ECCU in addition to traditional insurance products.

Both companies are financially stressed. Given the problems of BAICO, its operations in ECCU jurisdictions were placed under the control of judicial managers in July-August 2009. Their report, completed in October 2009, determined that BAICO is insolvent. CLICO is not current with payments on deposit-like instruments and on policy claims in some countries. Information on the state of CLICO’s parent company in Barbados is still very limited, but the company has been seeking to divest assets to address its liquidity problems and urged investors not to cancel policies and withdraw their funds. In addition, the Barbadian authorities have prohibited the company from writing new policies, which prompted the ECCU authorities to follow suit.

The exposure of ECCU policy and deposit holders to the two companies amounts to about EC$2 billion (17 percent of ECCU GDP). Commercial banks and related offshore banks account for EC$127 million of this exposure or equivalent to about 8 percent of commercial banks’ total capital, with exposure in a few commercial banks equivalent to a large share of their respective capital. The exposure of credit unions is EC$84 million, and for some institutions is sufficiently large to threaten their solvency. State pension schemes have claims of EC$140 million, less than 3 percent of their total assets, although in St. Vincent and the Grenadines the exposure is nearly one fifth of assets.

The ECCU governments have announced a regional strategy aimed at keeping BAICO as a going concern, while avoiding systemic risk and protecting as far as practicable the interest of depositors and investors. Governments plan to establish a new company to take over the ECCU operations of BAICO as recommended by the judicial managers (including the deposit-like liabilities and the traditional insurance business); to transfer the property insurance portfolio to an existing insurance company; and to establish a Medical Claims Support Fund. Discussions on establishing the new company are under way between potential strategic private investors and a Ministerial Subcommittee for Insurance. CARTAC is providing TA related to the creation of this new company.

Fund staff have recommend that the resolution of BAICO adhere to three principles: (i) limiting the risk of systemic spillovers; (ii) minimizing the fiscal costs to the extent possible, particularly given the region’s high debt levels and related vulnerabilities; and (iii) ensuring equitable treatment of claimants, including giving priority to all claims up to a low threshold to protect vulnerable groups for equity considerations and for administrative simplicity. Finding sufficient funds to capitalize the new company will be a challenge. While it is almost certain that ECCU governments will need to inject capital, notwithstanding a US$50 million contribution from Trinidad and Tobago’s Petroleum Fund, fiscal costs should be limited through revision of existing terms, including lowering of interest rates, extension of tenor, and possible conversion of some liabilities into equity. The financial difficulties of CLICO Barbados are a significant concern, and staff has recommended that the authorities continue to monitor developments closely.

This experience with CL Financial has prompted ECCU authorities to accelerate their plans to strengthen supervision of the nonbank financial sector. Country experience shows that good supervision matters: the stronger framework Jamaica put in place after the crisis in the 1990s successfully insulated the country from the CL Financial crisis. Priority measures being taken in the ECCU include:

  • Establishing single regulatory units (SRUs) for the nonbank financial sector with supporting legislation, adequate staffing, and capacity building. So far SRUs are only operational in Dominica and Grenada while legal frameworks exist or draft legislation has been prepared in most other ECCU jurisdictions.

  • Enacting a new harmonized Insurance Act. New Insurance Acts have been passed in Antigua and Barbuda, Grenada, and St. Kitts and Nevis, and—in its first reading in St. Lucia—although amendments will be required to harmonize these.

  • Requiring insurance companies to create statutory funds with sufficient assets under trusteeship to cover local insurance liabilities.

  • Establishing a regional regulatory and supervisory institutional structure, with a College of Regulators to oversee regional financial institutions that span multiple jurisdictions. Also, the core technical committee, created to deal with the fallout from CL Financial could be converted into a permanent regional forum to deal with ECCU non-banking sector issues.

Estimated Exposure to CLICO and BAICO

article image
Source: Data provided by country authorities.

As of end-2008, except for Dominica, which is as of March 2010.

As of end-June 2009, according to the November 2009 judicial managers’ report.

Includes Clico Investment Bank, CMMB, and the CL Financial Group.

GDP estimates for 2009.

Moving Forward with the Establishment of an Economic and Monetary Union

While economic integration in the Eastern Caribbean has taken place on a number of different levels, the model of integration in the ECCU is determined by the region’s common currency and quasi currency board. In addition to multilateral trade liberalization under the guidance of the WTO, significant strides have been made at the regional level, both in the context of CARICOM’s Single Market and Economy Initiatives and efforts by the Organization of Eastern Caribbean States (OECS). The implementation of the revised Treaty of Basseterre, signed in June 2010 and to be ratified by the respective national Parliaments by January 2011—is the region’s latest effort to foster the creation of a full-fledged Eastern Caribbean economic and monetary union. Among others, the Treaty transfers legislative authority in economic and financial matters to the OECS Authority, comprising Heads of government. The greatest benefits from economic integration in the Eastern Caribbean will come from economies of scale (rather than intraregional trade), risk sharing, rationalizing the provision of public services, eliminating duplication of administrative structures, and the ability to better represent the region in international fora. The Union Treaty covers the following areas: (i) common market, including customs union; (ii) monetary policy, (iii) trade policy; (iv) maritime jurisdiction and maritime boundaries; and (v) civil aviation. In particular, the new treaty requires that member states delegate legislative competence in these areas over member states’ law. Still, the success of the common currency will critically depend on the region’s ability to deepen regional frameworks to enforce fiscal discipline and to harmonize financial sector regulation and supervision. In this respect, integration differs from that of CARICOM in that it has to be deeper and faster.

Level of integration. In addition to the monetary union and a regional central bank (ECCB), the Eastern Caribbean is a free trade area, but still an incomplete customs union and common market. While the region is committed to a system of common external tariffs (CET), full harmonization has not taken place, given that this depends critically on alternative sources of revenue, including the implementation of a value-added tax. With an open financial account and the right of establishment for companies and financial institutions, capital markets and the financial sector are highly integrated. However, the free movement of labor (pursued at the CARCIOM level) has been limited to university trained persons and the informal sector.

uA01fig15

Eastern Caribbean Economic and Monetary Union: Progress of Integration

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Source: Fund staff.1/ The level of integration is classified as “committed” (white), “some” (light gray), and “high” (dark blue).
uA01fig16

Eastern Caribbean Economic and Monetary Union: Institutional Structure 1/

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Source: Fund staff.1/ This figure is illustrative and does not necessarily reflect the formal legal structure.

Improving the Efficiency of Public Expenditure in the ECCU

Given the region’s relatively high revenue-to-GDP ratios, efforts to create fiscal space would have to focus more on the expenditure side. Rationalizing government expenditures would not only generate fiscal savings, but also enhance the efficiency of government spending. The authorities have established a Public Expenditure Commission, supported by technical assistance from the Fiscal Affairs Department, to provide guidance on best practices and benchmarks and to seek the necessary political support. The following discusses selected expenditure issues in the region.

Government compensation and employment. On average, total compensation costs of civil servants account for about two-thirds of budgetary revenue in the ECCU countries. Given their relative size, reducing compensation expenditures will have to be a central element of the expenditure rationalization strategy. Some countries have imposed temporary wage and hiring freeze and outsourced certain functions to contain the wage bill in the short term. Over the medium-term, this issue needs to be addressed through a comprehensive civil service reform. Ongoing civil service censuses, payroll audits, and functional reviews of government departments across the region will help formulate such a reform strategy.

Capital spending. Over the last two decades, capital spending has seen the highest growth in the ECCU because entities involved in investment planning are not given clear budget constraints. This has led to an unfinanced list of projects and inefficient prioritization at the execution stage. Poor monitoring and insufficient ex-post evaluation has also undermined the efficiency of capital spending. These issues can be addressed by: defining and strictly enforcing selection criteria for investment projects, developing capacity for cost benefit analysis at the regional level, and strengthening and enforcing project monitoring procedures.

Social security. While most schemes in the region are currently operating in surplus, with an ageing population, most will begin to incur cash flow deficits and eventually exhaust reserves in the medium term. Low contribution rates and retirement ages, front loaded accrual rates, as well as limited diversification in reserve management, have contributed to a weakening of the financial position of these schemes. Some countries (Dominica, St. Lucia and St. Vincent and the Grenadines) have implemented parametric reforms to address the financial sustainability of these schemes. Others also need to move in this direction. The report of the Pension Commission will provide important guidance in this regard. There is also a need to reform the non-contributory civil service pension schemes.

Health and education spending. Although health spending currently accounts for about 3 percent of total government spending, population ageing and non-communicable chronic diseases are expected to put strong upward pressure on health spending in the medium term. In this context, cost controls need to be strengthened, including reviews of cost effectiveness, cost recovery and benefit packages. The education system has not yet adjusted to demographic changes and declining student-teacher ratios. This has resulted in high spending on wages, crowding out other important recurrent spending. Rationalizing the education workforce, reallocating spending more toward non-salary components and better targeting of subsidized educational programs could simultaneously contain costs and improve education outcomes.

Social assistance programs. The large number of uncoordinated programs implemented through different government agencies result in high start-up and administrative costs. Weak targeting and monitoring has also resulted in leakage to non-poor groups and undermined the efficiency of these programs. Reform options in this area include improving targeting mechanisms, strengthening monitoring and conditioning social assistance to actions that promote human capital development. Some countries have made progress in this area.

Statutory bodies. These entities are executing an increasing amount of spending in some countries, creating potential fiscal risk for the central government. Monitoring of their operations is weak, partly due to capacity constraints. Financial reporting by these entities is also deficient.

Public financial management (PFM). Effective expenditure rationalization will also require strengthening PFM systems. Recent diagnostic assessments have pointed to a number of weaknesses in budget formulation, execution and reporting. Key reforms include formalizing the budget preparation process to support a proper medium-term fiscal framework, centralizing all government resources in a single treasury account, and strengthening internal control.

ECCU Banking Sector Sensitivity Analysis

While headlines numbers suggest that the ECCU banking system appears to be well capitalized, they are likely not to fully reflect potential risks. Banks’ capital adequacy ratio (CAR) stood at 22 percent at end-2009, far exceeding the ECCB’s 8 percent prudential requirement. However, there are concerns about potential under-provisioning, given banks’ relatively low provisioning-to-NPL ratio, weak accounting practices by some banks, which could lead to understatements of the level of reported NPLs.

Liquidity indicators have deteriorated. As of end-2009, banks had net liquid assets equivalent to 20 percent of deposits, in line with the ECCB’s 20–25 percent prudential requirement. However, this represents a 1.7 percentage points decline compared to end-2008.

On the basis of official data, staffs’ analysis on banks reveal the need to address vulnerabilities relating to liquid and credit risks, as well as to manage foreign exchange risks.

Despite limited direct linkages across countries, there are significant risks of potential spillovers. Should an individual bank become insolvent, this could create difficulties in the payment system and deposits run leading to a loss of confidence in the banking system.

ECCU Banking System: Crisis Preparedness and Management

It is possible to think of a number of events that would stress the banking system. A sovereign debt crisis triggered by the impact of a natural disaster on economic activity, a government default, or an overly aggressive sovereign debt restructuring could have an adverse impact on the banking system. Bank operational failure in itself could also quickly evolve into a systematic banking crisis as would contagion. Despite limited direct linkages among indigenous banks, spillovers in the ECCU could take place via a failure in the payments system, interbank exposure, and a general erosion of confidence. The possibility of easily switching deposits from indigenous banks to foreign banks can facilitate a deposit run. A widespread financial crisis in turn could lead to capital flight and threaten the exchange rate peg to the U.S. dollar.

The ECCB is in the process of strengthening its framework for contingency and crisis management. It has established a group to develop a contingency plan for troubled banks. However, it will be important to clearly establish and formalize powers and responsibilities of governments and various agencies (ECCB, Single Regulatory Units (SRU), Eastern Caribbean Securities Regulatory Commission (ECSRC) during a crisis through MOUs and legislation. An MOU executed by members of the Regulatory Oversight Committee establishes information exchange rules and responsibilities for ongoing monitoring. Previous interventions (Bank of Montserrat, 1991; and most recently the Bank of Antigua, 2009) have shown the ability of the authorities to intervene effectively within the existing bank resolution framework set out in Part IIA of the Eastern Caribbean Central Bank Agreement 1983 (as amended).

Further enhance contingency planning frameworks is needed by strengthening the monitoring capacity for early detection and prevention of bank stress. Based on best international practice, the ECCU should:

  • Adopt a comprehensive response. International experiences widely show that piecemeal responses tend to fuel panic and—underestimating the size of problem—may increase eventual costs.

  • Secure liquidity support. As a first pass, the 2009 IMF SDR allocations should be held as an additional and shared liquidity buffer. In addition, consider seeking official or private arrangements in advance for liquidity support from abroad (for example, Canadian or regional banks, other central banks, and IFIs).

  • Continue to garner political support. Secure a quick consensus and effective cooperation among the ECCU authorities. The availability of modern technology has enabled the Monetary Council to convene at short notice. This is particularly crucial as an ECCB intervention requires directives from the ECCB Monetary Council, comprised of eight finance ministers from the participating governments.

  • Ensure an adequate communication policy. A good communication strategy with sufficient information disclosure and the announcement of a comprehensive strategy is critical. Since time is of essence and a crisis puts significant strain on resources, it is prudent to have draft announcements ready to be adopted in the event of a crisis.

Exchange Rate Assessment

The ECCU real exchange rate appears broadly aligned with fundamentals, but required fiscal adjustments need to be accompanied by REER depreciations in the near future.

The real effective exchange rate (REER) has appreciated since 2007, but remains slightly below its equilibrium level under current fundamentals. The recent appreciation reflects a stronger US dollar and higher relative inflation rates following the 2008 spike in food and oil prices. Despite the recent appreciation, estimates of the equilibrium real exchange rate (ERER) approach—which takes into account productivity differentials, terms of trade shocks, government consumption, and net foreign assets—indicate that the EC dollar is about 2 percent below its fundamentals-based equilibrium value. However, going forward, both fiscal adjustments and lower NFA will have an impact on the ERER. A decline of government consumption by 1 percent of GDP would reduce the ERER by 0.4 percentage points, while reductions in NFA are less pronounced. Taking required future policies into consideration, the ERER will therefore depreciate.

uA01fig17

ECCU: Actual and Equilibrium REER, 1979–2009 1/

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: IMF, Information Notice System; and Pineda and Cashin, “Assessing Exchange Rate Competitiveness in the ECCU,” forthcoming IMF Working Paper.1/ The dotted lines around the equilibrium exchange rate represent 90 percent confidence intervals of the prediction.

While projections of the ECCU’s medium-term current account deficit are within 3 percentage points of GDP from the estimated current account norm, Fund recommended fiscal adjustment would suggest a larger deviation. The assessment is based on the macro balance approach, which contrasts a regression-based estimate of the current account norm with staff projections based on ECCU’s current policies.1/2/ Depending on the sample size, the estimated norm ranges between -17 and -20 percent of GDP. Meanwhile, staff projects a medium-term current account deficit for the ECCU around 19 percent of GDP. With the additional fiscal adjustment suggested by staff, the equilibrium current account deficit (norm) would be lower implying a depreciation of the equilibrium REER and—in light of the peg—requiring an adjustment in relative prices. Due to the signaling effect of public wages in the ECCU, staff urged the authorities to moderate real wage growth or even consider lowering nominal wages.

uA01fig18

ECCU: Current Account Deficit, Actual and Estimated Norms 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: Fund staff estimates and projections.1/ In computing the norms, medium-term values of the fiscal balance, oil-balance, output growth, and relative income are drawn from staff projections. Band is ±1 standard error of the prediction. CARICOM sample includes ECCU countries and The Bahamas, Barbados, Belize, and Jamaica. Full sample includes 24 tourism-dependent economies as defined by Bayoumi and others (2005).2/ Based on Fund staff estimates. Medium-term is 2014.
1/Details on the econometric approaches and sample coverage can be found on Pineda, Cashin, and Sun (2009), “Assessing Exchange Rate Competitiveness in the Eastern Caribbean Currency Union,” IMF WP/09/78. 2/Given data deficiencies, the external sustainability approach is not applied.

Growth in the ECCU

Growth in the ECCU countries has been on a declining trend since the 1990s, with the current global slowdown exacerbating this trend. The ECCU region has been buffeted by a series of adverse exogenous shocks over time, including the erosion of trade preferences; the decline in official foreign assistance; periodic recessions in the developed countries, the main source of tourism and FDI for the region; and frequent natural disasters. The recent global slowdown has exacerbated the already declining trend in growth. At the same time, relaxation of the fiscal stance, partly reflecting accommodation to these shocks, has led to a rapid build-up of public debt in the region. The main results of the study are:

  • Low factor productivity has been the main factor dragging growth down. Following strong productivity growth in the 1970s and 1980s, TFP growth declined leading to a decline in growth despite strong capital accumulation. While difficult to point to specific factors, the decline in TFP could reflect a drop in efficiency with which others factors of production are being used perhaps due to lack of complimentary structural framework, weak institutions and lack of technological innovation.

  • Tourism has contributed positively to economic growth. Panel regressions using an augmented growth equation that includes tourism in addition to the standard growth determinants such as education, health, openness of the economy and prudential fiscal policy indicate that tourism has been a significant factor in long-term growth in the ECCU countries.

  • Improvements in competitiveness could further enhance the contribution of the tourism sector. ECCU countries appear to have lost some market share in tourism. The share of stay-over arrivals in the Caribbean (as percent of total visitors in the world) fell from 2.7 percent during 1990–95 to 2.2 percent during 2005–08. Moreover, ECCU countries’ share within the Caribbean fell from 5.7 percent to 5.1 percent over the same period, in particular because of the decline in shares by Antigua and Barbuda and Grenada. The rest of the ECCU countries have either gained by small margins or maintained their shares.

  • High debt has reduced growth in the ECCU. Empirical evidence for the ECCU countries suggests that during periods of declining debt (even though debt levels were high) average growth rates almost doubled compared to periods when debt was high and rising, suggesting ‘that debt crowds out of private investment, and acts as a tax on future investment.

uA01fig19

ECCU: Relative Performance vis-à-vis the World

(In percent)

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

ECCU: Average Market Shares in Stay-over Arrivals

article image
Source: World Travel and Tourism Council; and Fund staff calculations

ECCU: Technical Assistance from the Fund in 2009 and 2010

The ECCU has been an intensive user of CARTAC (backstopped by the Fund) and Fund technical assistance (TA). The following major support has been provided or is envisioned in 2009–10:

Tax and customs reform: Post value-added tax (VAT) support in Antigua and Barbuda, Dominica, Grenada, and St. Vincent and the Grenadines to strengthen VAT implementation and assistance with near-term implementation of VAT in St. Kitts and Nevis, and St. Lucia (CARTAC, FAD, LEG). A comprehensive revenue mobilization TA to Antigua and Barbuda; assistance with custom reforms and modernization in all ECCU countries; and strengthening tax administration training provided to Grenada, St. Kitts and Nevis, and St. Vincent and the Grenadines (all CARTAC).

Macro-Fiscal: assistance to ECCU members to establish macro-fiscal policy units to house the financial programming exercise; support for public sector pension plan reform in Montserrat; and public pension reform conference delivered jointly with the ECCB in June 2009 (all CARTAC).

Public expenditure: TA on options for public expenditure rationalization completed in St. Lucia and Antigua and Barbuda and to be implemented in all ECCU countries by end 2010, recommendations would be key inputs for the ECCU Public Expenditure Commission (FAD).

Public debt management: Assistance to strengthen debt management capacity and develop medium-term debt strategy has been provided to St. Lucia and St. Kitts and Nevis in 2008, Dominica in 2009, and Grenada in 2010 (MCM).

Public finance management: PEFA assessment finalized in Montserrat and delivered in Antigua and Barbuda; PFM reform action plan updated in Dominica, Grenada and St. Lucia, and implemented in St. Vincent and the Grenadines (all CARTAC). Extensive implementation of TA to Antigua and Barbuda (CARTAC and DFID). Strategic budgeting to Cabinet and Permanent Secretaries in Antigua and Barbuda (CARTAC, CARICAD, and Financial Secretary of Dominica)

Regional financial and capital market: Assistance to facilitate the establishment of an overnight repo facility and the functioning of the interbank market; payments and settlements (both MCM); assistance for review and preparation of new securities regulations (CARTAC).

Financial sector supervision: Ongoing assistance (since 2003) to ECCU member countries in the development of Single Regulatory Units (SRUs) based on the specific needs of each SRU; nonbank regulatory reporting forms created and nonbanks are to begin reporting on these forms quarterly in September 2010; revision of insurance laws and designing of regulatory insurance reporting forms; development of law, and training for the supervision of credit unions; development of credit bureaus in the region; on-site examination and development of capital requirement for international banks in St. Vincent and the Grenadines; on-site examination of insurance companies in Anguilla; first College of Regulators held for two large regional insurance companies; and assistance in the restructuring of BAICO in the ECCU (all CARTAC). Ongoing development of a regional financial stability framework (CCMF/CARICOM/CARTAC).

Economic and financial statistics: Ongoing assistance in rebasing national accounts (completed in most ECCU countries); compiling supply and use tables; rebasing and revising consumer price index based on the recent Household Expenditure Surveys; and developing export-import price indexes in all ECCU countries (all CARTAC); assistance in the development of tourism satellite accounts (CARTAC; CARICOM Secretariat; CDB; and OECS Secretariat); provided monetary and financial statistics (MFS) TA to the ECCB and assistance in the development of a regional statistics network (STA).

Balance of payments statistics: Ongoing assistance in revising forms for compiling external sector statistics, in particular to implement the Balance of Payments and Investment Position Manual (BPM6) in 2009 (CARTAC; OECS Secretariat; STA).

Features of the Rebased GDP and Revised CPI

The national accounts series of the ECCU member states have been rebased to base year 2006 from base year 1990.1 The rebasing has improved the current and constant price GDP series by using a wider range of data sources (including economic surveys and administrative data), applying improved methodology, and better extrapolation and deflation techniques for the GDP constant price series. The rebased GDP series reflect the inclusion of financial intermediation services indirectly measured, activities of offshore universities, and the output of owner-occupied housing.

Based on the data available, the rebased current and constant price GDP series in the ECCU are expected to be appreciably larger than their old counterparts. For countries for which the exercise has been completed, preliminary data suggest increases in nominal GDP series of between [20 and 35 percent]. For example, the current price annual GDP in Dominica over the period 2000–2008 has been revised up by 32.6 percent. In constant prices, the average annual GDP revision is 2.9 percent (2001–2008) with the new base year, and 1.0 percent under the 1990 base year. The rebased GDP values will alter key ratios, e.g. the public debt-to-GDP ratios and the gross external debt-to-GDP ratios in the ECCU economies, with nontrivial implications for economic policies. In this context, on the current debt target of 60 percent of GDP by 2020, while it is sufficiently ambitious given the high debt levels, the mission recommended the authorities to consider moving towards a debt ratio of 25–40 percent of GDP that is more commensurate for emerging markets and counties with a hard peg in the medium term. In addition to the aggregate series, the relative contributions of industries in the rebased GDP will also change. Real estate, renting, and business activities will likely record the largest revisions due to the incorporation of estimates for owner owned housing.

Using the results from Household Income and Expenditure Surveys, the ECCU member states have updated the market basket for the CPI. They have also improved the classification structure, methods, and procedures used to compile the CPI in line with the CPI Manual, 2004. The revised CPIs will make the measurement of inflation more accurate and allow for greater comparability across the region.

Due to expanded geographic coverage, the revised CPI is more representative of the entire counties, not just the capital city areas. Adding college tuition, cell phones, MP3 players, computers, and health and auto insurance to the CPI basket reflects both updated spending patterns and newly introduced products. Old regional classification structures have been replaced by adopting the Classification of Individual Consumption by Purpose, the international standard recommended in the CPI Manual, 2004. The revised CPI has been made conceptually consistent with the System of National Accounts by incorporating the owner’s equivalent rent. To reduce the biases that result from arithmetic averages of prices and arithmetic averages of price relative biases, the revised CPI is compiled using geometric rather than arithmetic averaging. In addition, missing prices are now imputed by using the price changes of related products and not by carrying forward the last reported prices, as in the old index.

Both the rebased GDP and CPI series are expected to be announced simultaneously in all of the ECCU countries via a comprehensive outreach strategy in October 2010. The ECCU members have received substantial technical assistance from CARTAC in the process of the GDP and CPI revisions. CARTAC helped each country develop their market basket and introduce the Price Index Processor System software that will enable the statistical offices to implement the improved methods described in the CPI Manual.

Table 1.

ECCU: Selected Economic and Financial Indicators, 2005–11 1/

article image
Sources: Country authorities; and Fund staff estimates and projections.

Includes all eight ECCU members unless otherwise noted. ECCU price aggregates are calculated as weighted averages of individual country data. Other ECCU aggregates are calculated as sum of individual country data; ratios to GDP are then calculated by dividing this sum by the aggregated GDP.

Excludes Anguilla and Montserrat.

Includes errors and omissions.

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

SDR allocation of US$ 93.7 million (SDR 59.9 million) implemented in 2009.

Table 2.

ECCU: Selected Economic Indicators by Country, 2005–15

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Sources: Country authorities; and Fund staff estimates.
Table 3.

ECCU: Selected Central Government Fiscal Indicators by Country, 2005–15 1/

(In percent of GDP)

article image
Sources: Country authorities; and Fund staff estimates.

Fiscal years for Dominica and St. Lucia.

Table 4.

ECCU: Selected Public Sector Debt Indicators by Country, 2005–15 1/

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Sources: Country authorities; and Fund staff estimates.

Fiscal years for Dominica and St. Lucia.

The decline of public debt in 2008 reflects debt write-down by the Banco do Brazil and two statutory bodies.

Includes external arrears.

Interest payments from 2009 are on accrual basis.

The increase (decrease) in implicit domestic (external) interest rate in 2010 is due to the projected repayment of domestic debt financed by external borrowing, resulting in a large decline (increase) in year-end domestic (external) debt outstanding.

Table 5.

ECCU: Monetary Survey, 2005–11

(In millions of Eastern Caribbean dollars)

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Sources: ECCB; and Fund staff estimates.

Includes the national insurance schemes.

Table 6.

ECCU: Summary Balance of Payments, 2005–15

article image
Sources: ECCB; and Fund staff estimates and projections.

Includes errors and omissions.

SDR allocation of US$ 93.7 million (SDR 59.9 million) implemented in 2009.

Table 7.

ECCU: Selected Vulnerability Indicators, 2005–11

article image

Sources: Country authorities; and Fund staff estimates and projections.

Excludes Anguilla and Montserrat.

Defined as external current account deficit plus external amortization.

Foreign assets as a percentage of demand liabilities.

Table 8.

ECCU: Creditor Composition of Public Debt at End-2009 1/

(In percent of total)

article image
Sources: National authorities; and Fund staff estimates.

Figures for Dominica are as of end-June 2009.

Arrears to a bilateral creditor.

Arrears are largely to social security fund, medical benefit scheme and supplier credits.

Unpaid invoices.

Appendix Table 1.

ECCU: External Debt Sustainability Framework, 2005–15

(In percent of GDP, unless otherwise indicated)

article image

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Defined as gross debt of nonfinancial public sector. Information on private sector external borrowing is not available.

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Natural disaster impacting half of the ECCU countries, increasing the regional CA deficit by 4 percent of GDP in 20011–13, and reducing growth by an average of 1.6 percentage points for the same period. These parameters are taken from the median impact of 12 large natural disasters in the ECCU (Rasmussen, WP/04/224).

Appendix Table 2.

ECCU: Public Sector Debt Sustainability Framework, 2005–15

(In percent of GDP, unless otherwise indicated)

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Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Defined as gross debt of nonfinancial public sector. Information on private sector external borrowing is not available.

Derived as [(r - π(1+g) - g + αε(1+r)]/(1 + g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and ε = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 3/ as r - π (1 + g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 3/ as αε(1 + r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Assuming that a hurricane hits half of ECCU countries, increasing their primary deficit by three percent of GDP for 20011-13 and reducing growth to zero.

Derived as nominal interest expenditure divided by previous period debt stock.

Appendix Figure 1.
Appendix Figure 1.

ECCU: External Debt Sustainability: Bound Tests 1/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: International Monetary Fund, Country desk data, and 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 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.3/ One-time real depreciation of 30 percentoccurs in 2010.
Appendix Figure 2.
Appendix Figure 2.

ECCU: Public Debt Sustain ability: Bound Tests 1/

(Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2011, 030; 10.5089/9781455213900.002.A001

Sources: International Monetary Fund, country desk data, and 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 1/4 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 2010, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).
1

The Eastern Caribbean Currency Union (ECCU) comprises six Fund members: Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines; and two territories of the United Kingdom, Anguilla and Montserrat. The ECCU is a currency union in which members pool their foreign reserves, and its exchange rate has been pegged at EC$2.7 to US$1 since 1976.

2

The reserve coverage ratio remains above the mandatory and operational targets. The ECCB’s reserve coverage does not include SDR holdings of ECCU Fund members. The adjusted reserve coverage including SDR holdings would amount to about 104 percent of demand liabilities as of end-June 2010.

3

The OECS was established on June 18, 1981 on the signing of the Treaty of Basseterre. The OECS comprises Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines, with the British Virgin Islands (joined in 1984) and Anguilla (joined in 1995) as associate members. The British Overseas Territory of Montserrat is expected to sign the new Treaty shortly, after receiving permission from the U.K. government; while associate members Anguilla and the British Virgin Islands will not be members at this juncture. The new Treaty was signed by participating governments on June 18, 2010.

4

These five areas are related to the common market and customs union, monetary policy, trade policy, maritime jurisdiction and maritime boundaries, and civil aviation.

5

Although the statutory requirement for foreign reserves is 60 percent of ECCB’s demand liabilities, the ECCB has functioned as a full-fledged currency board during the last decade, involving minimal lending to governments and banks while achieving a currency backing ratio of about 100 percent.

6

This report covers regional topics, highlighting the common policy and cross-border issues of members of the currency union, and provides a regional perspective on economic policies relevant for Fund surveillance for which responsibility lies at the national level. Analysis of the developments and prospects of individual ECCU countries, with a focus on national fiscal and structural policies, can be found in bilateral Article IV staff reports.

7

Dominica adopted a primary surplus target during the period of a Fund program, and this continues to be an effective anchor.

8

In the case of Antigua and Barbuda, the authorities intend to support the large fiscal adjustment by seeking a comprehensive public debt restructuring.

9

Theses measures are not reflected in the baseline projections. The authorities announced their policy priorities at the National Consultation Day on September 2, 2010. Even with this large fiscal adjustment, St. Kitts and Nevis still has a residual financing gap, which grows larger in the medium term (averaging close to 4 percent of GDP in 2011-15), and debt remains too high. To close the financing gaps staff recommended that the authorities seek financial support from international financial institutions, including the Fund, to underpin the home-grown adjustment program, and design further medium-term fiscal measures.

10

St. Vincent and the Grenadines has to call general elections by March, 2011, and St. Lucia’s elections are due in December 2011.

11

Public expenditure TA provided by FAD to Antigua and Barbuda and St. Lucia would be extended to other Fund members of the ECCU, and the output of these TA will form part of the report to the Public Expenditure Commission.

12

Activities to be undertaken by the project include the preparation of national debt strategies to guide the acquisition of debt; the provision of support to efforts aimed at expanding the use of the Regional Government Securities Market (RGSM) to improve cash flow and debt management; and the strengthening of the capacity in member countries to manage debt.

13

The government of St. Vincent and the Grenadines, for example, plans to use a Caribbean Development Bank (CDB) loan to reduce the National Bank’s exposure to the government.

14

As of end March 2010, the net liquid asset-to-deposit ratio showed that some indigenous banks fell below the ECCB’s minimum prudential requirement of 20–25 percent.

15

A pre-emptive restructuring of loans by banks could, for example, mask the underlying deterioration in loan quality.

16

While St. Vincent and the Grenadines has drawn some 90 percent of its SDR allocations, Dominica, Grenada, and St. Lucia have indicated they would keep the SDR allocations as a liquidity buffer. At the same time, the authorities are currently considering using part of the SDR allocations for the capitalization of BAICO and/or to provide capital to newly created resolution trust.

17

As a result of the stress tests, some indigenous banks have been put on a watch list.

18

The ECCB operates under a statutory requirement to maintain at least 60 percent of its monetary liabilities backed by reserve assets. The residual 40 percent could in principle be used for discretionary lending operations to governments and banks. In the beginning of each fiscal year (April 1), the ECCB determines global limits of its lending based on an operational target of 20 percent of average demand liabilities during the previous year, of which 60 percent is for member governments (allocated in proportion of each government’s share of total regional recurrent revenue less all outstanding balances and arrears) and 40 percent to financial institutions (no distribution of limits to individual banks or other credit institutions).

19

The Bank of Antigua suffered a bank run in the week beginning February 16, 2009 precipitated by the publication of negative statements regarding its shareholder, Allen Stanford. The failure of the Bank of Antigua could have destabilized the banking and financial system in Antigua and Barbuda, and potentially led to spillovers to other ECCU territories via its participation in the clearing and settlement system. To avoid a financial crisis, the ECCB, on the direction of the Monetary Council and in accordance with its Emergency Powers, conferred on it by the ECCB Agreement 1983, assumed control of the Bank of Antigua on February 20, 2009. A management company, Eastern Caribbean Amalgamated Financial Company Ltd was appointed to manage the Bank of Antigua on behalf of the Central Bank to return it to normalcy. The intervention, however, showed, for example, that the amendment to the ECCB Agreement Act that provides for emergency powers passed in Antigua and Barbuda was not identical with the regional uniform amendment, due to transcription error.

20

Banking regulation was passed in all ECCU territories, except Antigua and Barbuda and St. Kitts and Nevis, stipulating a higher level of capital based on bank’s risk profile. The ECCB is also revising its capital computation to include elements of market risks.

21

BAICO’s current resolution strategy is, for example, predicated on the ability of the ECCU countries to receive US$100 million from Trinidad and Tobago.

22

Both pieces of legislation benefited from CARTAC TA. While legal frameworks for SRUs exist in Anguilla, Dominica, Grenada, Montserrat, and St. Kitts and Nevis, so far SRUs are only operational in Grenada and Dominica. New insurance laws have been enacted in Antigua and Barbuda, Grenada, St. Kitts and Nevis, and St. Lucia.

23

The Roseau Cooperative Credit Union, the largest in the ECCU, has recently announced its plan to merge with four other credit unions in Dominica.

24

The additional fiscal adjustment would imply a lower equilibrium current account deficit, even though FDI would be higher.

25

Empirical analysis suggests that there is positive relationship between business-friendly regulation and economic growth (see Djankov, Simeon, Caralee McLiesh and Rita Maria Ramalho, 2006, “Regulation and Growth,” Economics Letters, Vol. 92, pp. 395—401). As revealed by the Ease of Doing Business indicator, in the ECCU emphasis should be placed on improving contract enforcement and reducing difficulties in registering property (Figure 16).

26

See for instance, IMF, 2010, Fiscal Monitor (Washington: International Monetary Fund) and Reinhart, Carmen and Kenneth Rogoff, 2010, “Growth in a Time of Debt,” American Economic Review, Vol. 100(2) (May), pp. 573-78.

27

A change in the Articles of Agreement would be needed for the Fund to be able to lend into a regional pool.

28

The Fund’s financial assistance to Euro zone members, for example, takes place on a country-by-country basis using existing lending instruments. The activation of the European Stabilization Mechanism (ESM) is subject to strong conditionality in the context of a joint EU-IMF support. While coordinated, IMF conditionality is separate from conditionality under the EU arrangement.

29

A number of metrics could be used to determine the optimal level of reserves. A common central bank practice is to have a reserve coverage of about 10–15 percent of deposits. Given the ECCB’s operational target of at least 80 percent of demand liabilities and the weakness of some of the indigenous banks, this would imply maintaining international reserve coverage slightly above 100 percent of demand liabilities as of end 2009. Such a liquidity buffer would also be consistent with meeting deposits withdrawal in an extreme deposit run on some indigenous banks in one large ECCU country.

30

Staff emphasized that Fund financial support would be based on members’ balance-of-payments needs.

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Cover IMF Staff Country Reports
Eastern Caribbean Currency Union: 2010 Discussion on Common Policies of Members Countries—Staff Report; Informational Annex, and the Public Information Notice on the Executive Board Discussion
Author:
International Monetary Fund
Volume/Issue:
Volume 2011: Issue 030
Publisher:
International Monetary Fund
ISBN:
9781455213900
ISSN:
1934-7685
Pages:
90
DOI:
https://doi.org/10.5089/9781455213900.002
Figure 1.

ECCU: Overview
Figure 2.

ECCU: External Environment, 1995–2009

ECCU: Stayover Arrivals, 2006-10Q1

(Annual percentage change)
Figure 3.

ECCU: Fiscal Revenue, 1997–2009

(In percent of GDP)
Figure 4.

ECCU: Fiscal Expenditure, 1997–2009
Figure 5.

ECCU: Monetary Developments, 2001–June 2010
Figure 6.

ECCU: Private Sector Credit Growth, 2004–June 2010
Figure 7.

ECCU: Bank Liquidity, January 2008–June 2010
Figure 8.

ECCU: Banking System’s Gross Exposure to the Public Sector, 2003–09
Figure 9.

ECCU: Decomposition of Commercial Banks’ Gross Exposure to the Public Sector, 2004–2009

(In percent of public sector exposure)
Figure 10.

ECCU: Banking System Vulnerabilities, 2004–June 2010 1/

ECCU: Net Liquid Assets to Deposits Ratio of Indigenous Banks, 2008-09

(ln percent)

ECCU: Total Deposits by Origin of Banks, March 2008-June 2010

(In millions of EC dollars)

ECCU: Gross International Reserve’s Coverage of Demand Liabilities, 2008-10

(In percent)

Change in NPL to total loans ratio between December 2008 and June 2010 1/

(In percentage points)

ECCU: Commercial Banks’ Gross Public Sector Exposure
Figure 11.

ECCU: Regional Government Securities Market (RGSM), 2002–10
Figure 12.

Eastern Caribbean Securities Exchange
Figure 13.

ECCU: External Sector Developments, 1997–2009 1/
Figure 14.

ECCU: Stayover Arrivals, 2006–10

(Annual percentage change)

ECCU: Public Debt and Fiscal Adjustments Under Current and Program Policies, 2009-2020

ECCU: Public Debt and Fiscal Adjustments, Active Scenario
Figure 15.

ECCU: External Competitiveness, 1990–2009
Figure 16.

ECCU: Doing Business Indicators, 2009 1/

ECCU: Contributions to Growth, 1970–2007

Caribbean: Tourism and Growth, 1981-2007

Country specific and regional dimensions of Fund financial assistance to ECCU countries

Public Sector Debt in Selected Emerging Markets/Developing countries, end-2009

(In percent of GDP)

ECCU 6: Composition of Public Debt

(percent of total, end-2009)

ECCU 6: Contribution to changes in public debt per year

(in percent of GDP)

Eastern Caribbean Economic and Monetary Union: Progress of Integration

Eastern Caribbean Economic and Monetary Union: Institutional Structure 1/

ECCU: Actual and Equilibrium REER, 1979–2009 1/

ECCU: Current Account Deficit, Actual and Estimated Norms 1/

(In percent of GDP)

ECCU: Relative Performance vis-à-vis the World

(In percent)
Appendix Figure 1.

ECCU: External Debt Sustainability: Bound Tests 1/

(External debt in percent of GDP)
Appendix Figure 2.

ECCU: Public Debt Sustain ability: Bound Tests 1/

(Public debt in percent of GDP)