Eastern Caribbean Currency Union: Selected Issues

The objective of this paper is to analyze the growth performance of the ECCU countries since independence and the policy challenges they face to ensure sustained growth in the period ahead. Although tourism specialization may bring about higher growth, it could also increase volatility in growth by amplifying the impact of business cycles in source countries on the tourism sector. Low productivity growth is principally the reason for the slowdown in growth. High debt levels have been a major drag on growth.

Abstract

The objective of this paper is to analyze the growth performance of the ECCU countries since independence and the policy challenges they face to ensure sustained growth in the period ahead. Although tourism specialization may bring about higher growth, it could also increase volatility in growth by amplifying the impact of business cycles in source countries on the tourism sector. Low productivity growth is principally the reason for the slowdown in growth. High debt levels have been a major drag on growth.

III. Rationalizing Public Expenditure in the ECCU1

A. Introduction

1. Given the high level of deficits and outstanding public debt in the ECCU,2 fiscal consolidation is paramount (see also Chapter II on public debt). Without sizable adjustments, the present situation and trends in several ECCU member countries are not sustainable. High and growing debt and debt service payments have not only limited the fiscal space for responding to shocks, but also crowded out other priority spending to support growth and poverty reduction. Moreover, the growing financing needs associated with the fiscal deficits risk undermining the stability of the currency union.

2. While there is room for broadening the revenue base in the ECCU, the relatively high level of revenue-to-GDP ratios suggests that there is considerable scope to achieve fiscal consolidation through expenditure rationalization and control. Indeed, insufficiently rigorous budget procedures or controls and difficulties in reining in growth in entitlements have contributed decisively to the increase in deficits. In this context, rationalizing government expenditure would generate fiscal savings as well as enhance the efficiency of government spending. To this end, the ECCU authorities have established a Public Expenditure Commission, supported by technical assistance from the Fund (Fiscal Affairs Department), to provide guidance on best practices and benchmarks and to seek the necessary political support.

3. This chapter discusses selected expenditure issues in the ECCU. Section B briefly discusses the evolution of public finances. Section C reviews government compensation and employment, followed by a discussion on social security (Section D), health (Section E), education (Section F), social assistance (Section G), and spending issues related to parastatal entities (Section H). Given the importance of sound public financial management systems for the implementation of expenditure policies, Section I summarizes key issues in this area. Section J discusses weaknesses in the management of investment projects that have contributed to sharp increases in capital spending and Section K concludes.

B. Evolution of Public Finances

4. Fiscal imbalances widened significantly in the last decade. Average primary fiscal balances have deteriorated during the 2000s in most ECCU countries with the notable exception of Dominica and St. Vincent and the Grenadines (Table 1). In 2009, the average primary fiscal balance declined by about 3½ percentage points of GDP for the ECCU as a whole, reflecting a sharp contraction in economic activity.

Table 1.

ECCU: Selected Economic and Financial Indicators, 1990-20091/

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Sources: Country authorities; and Fund staff estimates.

Includes Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines.

5. Large fiscal imbalances have contributed to a build-up of public sector debt in the ECCU. While government revenue (including grants) increased from about 26 percent of GDP in 1990 to 31 percent of GDP in 2009 (Figure 1), total expenditure increased from 28 percent of GDP to about 39 percent of GDP.3 Capital spending increased the most during this period. Moreover, average central government spending as a share of GDP has increased by about 3 percent of GDP since 2006 (Table 2). The resulting deficits have been financed by borrowing leading to rising interest bills and high public sector debt averaging 108 percent of GDP for the six ECCU countries in 2009.

Figure 1.
Figure 1.

ECCU: Revenue and Expenditure, 1990-2009

(In percent of GDP)

Citation: IMF Staff Country Reports 2011, 032; 10.5089/9781455213894.002.A003

Sources: Country authorities; and Fund staff estimates.
Table 2.

ECCU: Central Government Expenditure, 20006-20101/

(In percent of GDP)

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Sources: Country authorities; and IMF staff estimates.

Weighted average for Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines.

6. Developments in the composition of spending are unsustainable. There have been large increases in non-discretionary transfers (including public pensions and subsidies). In particular, during the period 2006–09, current expenditure increased by about 3½ percentage points of GDP, mainly on account of increases in the wage bill and current transfers. Thus, the increasing weight of non-discretionary recurrent spending has reduced the flexibility of budgets to respond to shocks.

7. To achieve fiscal consolidation, two principles that could guide expenditure rationalization are:

  • Improving the efficiency of spending. Countries should seek to reduce the cost of producing existing public sector outputs. In addition, spending should be allocated to activities that provide the greatest marginal benefits to society as a whole.

  • Ensuring equity. Growth without equity is less durable,4 and so expenditure policy must reflect the need for both intra- and intergenerational equity. Greater targeting of social spending may also be necessary to ensure that the poor are protected as spending levels as a share of GDP are reduced.

C. Government Compensation and Employment

8. The government wage bill constitutes the largest expenditure item in the budgets of ECCU countries. Expenditure on wages and salaries averaged close to a third of total government expenditure (over 11 percent of GDP during 2006–09) and account for a significant share of total revenue (Figure 2). When other elements of the compensation package are included (i.e., other benefits and allowances, employer contributions and civil service pensions), the total compensation costs of civil servants approaches almost two-thirds of budgetary revenue in some countries (e.g. Antigua and Barbuda), raising questions about affordability and sustainability. These figures do not include parastatal entities which tend to have compensation arrangements which are at least as generous as the ones in the civil service (see Section G). Given their large relative size, reducing compensation expenditure will have to be a central element of any expenditure rationalization strategy.

Figure 2.
Figure 2.

Wage Bill as a Share of Total Revenue, 2009 1/

(In percent)

Citation: IMF Staff Country Reports 2011, 032; 10.5089/9781455213894.002.A003

Sources: Country authorities and Fund staff estimates.1/ The small island economies group includes Bahamas, Barbados, Belize, Brunei, Trinidad and Tobago, Fiji, Jamaica, Kiribati, Maldives, Marshall Islands, Palau, Papua New Guinea, Samoa, Solomon Islands, Sri Lanka, Timor Leste, Tonga, and Vanuatu.

9. Several factors account for the relatively large size of the wage bill in ECCU countries. Small island economies, such as those in the ECCU, tend to have relatively large governments reflecting indivisibilities in the provision of public services. Nevertheless, high government wage bills in these countries also reflect the fact that, with unemployment high in the region,5 governments have acted as “employer of last resort.” This has led to overstaffing typically reflected in a high ratio of government employment as a share of the population and duplications in functions across several government entities. Overstaffing tends to be prevalent at lower levels in the civil service and results in high compensation costs. In addition, collective bargaining agreements have led, in some cases, to a proliferation of allowances and other benefits and large wage increases (e.g., St. Lucia). More generally, a World Bank study concluded that there was evidence of a positive public sector wage premium over the private sector in some countries.6

10. Absenteeism contributes to high compensation costs in some ECCU countries. While statistics on absenteeism are difficult to come by,7 there are indications that this has resulted in high spending on overtime payments in some countries.8

11. The wide-spread use of non-established workers has also undermined control over employment and compensation in ECCU countries. Non-established employees constitute a significant share of total central government employment in ECCU countries—exceeding 50 percent in some cases (e.g. Antigua and Barbuda). The conditions of employment in these positions are determined in contracts negotiated separately with each individual worker and do not necessarily follow established civil service rules. This has led to: (i) important inequities in pay and benefits between established and non established workers; (ii) increased politicization in the appointment of civil servants; and (iii) difficulties in keeping track of the number of non established employees and their compensation arrangements.

12. Insufficient clarity in regulations about severance payments/termination procedures makes rationalizing central government employment costly or difficult. In some cases, the regulations are unclear regarding severance payments for established employees who are declared redundant (e.g., Antigua and Barbuda). In other cases, the termination procedures of established employees specified in the legislations involve numerous stages of appeals which can take several years.

13. A number of countries in the region have implemented reforms to reduce high wage bills. However, these have often not been underpinned by an overall employment and compensation reform strategy. Short-term measures included wage and hiring freezes with different wage definitions and degrees of coverage of the central government. Medium-term measures included voluntary separation packages (e.g., Antigua and Barbuda), outsourcing, and statutorization of government departments (e.g., Grenada and Dominica). The results from these measures have been mixed as illustrated by the increase in the central government wage bill in recent years, following a decline in the early 2000s.

14. Several ECCU countries have begun to implement more comprehensive reforms to streamline government employment and compensation. Antigua and Barbuda, Grenada and St. Lucia are undertaking civil service censuses, payroll audits, and functional reviews of government departments. Results from these exercises will help design a comprehensive employment and compensation reform strategy with proper quantification of its impact on compensation costs. These efforts are being supported by technical and financial assistance from the World Bank.

15. ECCU countries could consider additional measures for reducing employment and compensation costs. In the short term, streamlining and/or tightening eligibility requirements for allowances and benefits, enforcing civil service regulations to reduce absenteeism and overtime, and reducing legal hurdles to public sector downsizing could not only provide some savings, but also facilitate medium term reforms. In the medium term, a review of the role of the government more generally, including parastatal entities, would help identify government units that could be merged, closed or divested. Some countries in the region (e.g., Antigua and Barbuda) have already taken some steps towards this end. Also, as basic distortions in the grading and classification of established personnel are resolved, gradually integrating non-established employees into the establishment would avoid the inequities and adverse consequences created by the two parallel systems.

D. Social Security

16. National social security systems are a key source of fiscal vulnerability in ECCU countries. A rapid demographic transition due to ageing is currently underway in the region which, combined with high emigration, is projected to significantly worsen the dependency ratios of national social security systems. Consequently, while most schemes are currently operating in surplus, available actuarial projections indicate that, under current policies, reserves in St. Vincent and the Grenadines and Antigua and Barbuda’s schemes will be exhausted by 2026 and 2029, respectively.9

17. A number of design features and weaknesses in reserve management have worsened the financial position of these schemes. Contribution rates and retirement ages tend to be low compared to OECD countries in spite of recent decisions to gradually increase the retirement age in some countries in the region (Table 3).10 Moreover, pension benefit calculation formulas are based on front-loaded accrual rates and short earnings averaging periods, which favor workers with short contribution history.11 With respect to reserve management, limited diversification and investment concentration in government instruments and social investments have reduced effective real rates of return on reserves and contributions. High administrative costs, in part due to the small size of most schemes, have also reduced the rate of return on contributions.

Table 3.

Comparison of Key Parameters of Pension Systems Across the Caribbean

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Sources: Pettinato and Cassou, “A Needs Assessment of Pension Systems in the English Speaking Caribbean;” Mitchell and Osborne, “Old Age Pension Reform in the English Speaking Caribbean;” Brunton and Masci, “Workable Pension Systems: Reforms in the Caribbean,” IADB and CDB (2005) and World Bank, “Strengthening Caribbean Pensions: Improving Equity and Sustainability” (2009).

In these cases, the retirement age is gradually being increased to 65 years. In Jamaica, the retirement ages of men and women will be equalized by 2015 at 65 years of age.

Increasing to 15 years after 2012.

Average for 2006–09 for Antigua and Barbuda and 2006-08 for St. Lucia.

18. Countries in the region also have separate, non-contributory, civil service pension schemes. In some cases, such as in Antigua and Barbuda and Saint Vincent and the Grenadines, these schemes pay retired civil servants additional pension benefits, over and above those paid by the national social security system. Civil service pension spending currently range between 1 and 2 percentage points of GDP in ECCU countries for which information is available. In some cases, civil servants can draw more than one pension, which when combined with the pension from the national scheme, provide replacement rates which exceed 100 percent.

19. Generous civil service pension schemes can also create adverse labor market incentives and complicate public employment and compensation reform. The drawbacks include: (i) reduced labor mobility between public and private sector through long vesting periods and a “golden handcuff effect” by severely penalizing early retirement and limiting pension portability; (ii) reduced credibility of the compensation package given that it is concentrated in future benefits; (iii) costly separation of inefficient workers, which reduces the net fiscal gains from privatization, divestment, or downsizing; and (iv) increased administrative costs needed to administer multiple pension schemes.12 The latter issue is especially important in the region, given the high administrative costs that arise from relatively small systems.

20. Some ECCU countries are implementing parametric reforms to restore the sustainability of their national social security schemes. St. Lucia and Dominica are raising the retirement age, increasing contribution rates, and reducing the generosity of the formula for calculating social security benefits. Other countries in the region also need to move in this direction. Further efforts are needed in all countries for changing pension calculation formulae and reducing front-loaded accrual rates. In addition, investment policies should be strengthened to increase portfolio diversification and the rate of return.

21. Similar reforms should also be implemented for the civil service pension schemes. Capping the civil service replacement rate to ensure that the combined replacement rate is below 100 percent and making the civil service pension scheme a contributory system would be good first steps. These measures would contribute towards leveling the playing field with the private sector and reducing the net fiscal cost of the schemes. Over the medium term, civil service pension schemes should be phased out. This can be achieved by eliminating eligibility for new civil servants to the scheme, which has been the approach taken by Dominica and St. Lucia. If a supplementary pension scheme for civil servants is still viewed as needed, an alternative approach is to create a new voluntary defined contribution scheme for civil servants. The defined contribution nature would ensure that benefits and contributions are appropriately aligned, and that benefits are portable, and thus remove some of the disincentives for mobility between the public and private sectors. Such a system would be best created at a regional level to reduce administrative costs and with strong governance arrangements.

22. There may also be scope for enhanced regional coordination in the social security area. Important areas of coordination would include greater harmonization of pension benefits and a review of current arrangements regarding portability of pension rights to ensure that no portability gains or losses arise due to labor mobility across the region by workers. Sharing of administrative structures could also help exploit economies of scale and lower administrative costs.

E. Health

23. Public provision and public financing dominate health care systems in the ECCU. As a share of GDP, average government spending on health is about 3 percent. Government expenditure on health constitutes more than half of total health spending in these countries, but could be as high as two-thirds in some countries.13 Private health insurance currently plays a very limited role in most ECCU countries, but is most prevalent in Antigua and Barbuda and St. Lucia. In some countries, health financing is facing strong budgetary pressures in light of the fiscal crisis. At the same time, the ageing of the population and the trend towards non-communicable chronic diseases will put strong upward pressure on health spending in the region.14

24. Almost all public spending in health is financed by general revenue. Only in Antigua and Barbuda is there a mix of general revenue and a separate payroll tax to finance health care. User fees for public health facilities do exist, but they are not a significant source of financing. According to World Bank public expenditure reviews, health indicators are generally good with respect to countries’ income levels.15 In addition, they tend to compare favorably with other small island economies (Table 4).

Table 4.

Health Outcomes and Spending across the ECCU and in Small Island Economies1/

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Source: World Health Organization.

Data used are for latest year available. For most countries this is year 2007 for life expectancy, 2004 for standardized death rates.

25. Primary care facilities are underutilized due to two factors. First, there are concerns regarding quality of care due to physician absenteeism in some countries which discourages patients from going to these centers. Quality of care problems also arise when patients are referred by hospitals to primary care facilities, since physicians are often unavailable to ensure continuity of care. Second, user fees for hospitals (which exists in all ECCU countries except Antigua and Barbuda) tend to be low and not reflective of costs. As a result, many patients seek primary care at more costly but better staffed and equipped emergency hospital facilities.

26. Low user fees have also contributed to increased demand for pharmaceuticals and medical supplies. Spending on medical supplies and pharmaceuticals are among the main cost drivers for public health expenditure in some ECCU countries. Low or no copayments for drugs also discourages greater use of generic substitutes contributing to higher pharmaceutical costs. There is also scope for reducing pharmaceutical costs by rationalizing procurement systems and public health campaigns to reduce the incidence of certain diseases.16

27. The use and maintenance of hospital infrastructure is suboptimal in some countries. For example, in St. Lucia, hospital occupancy rates are low by international standards, generating high and unnecessary operational costs. Also, health facilities are insufficiently maintained, requiring costly rebuilding or repairs.

28. Cost controls are weak. Costing of health services and drugs provided in the public benefit package is weak and formal processes for examining their cost-effectiveness are deficient. Information on cost of treating specific diseases tends not to be available at health facilities. Health information systems are also not sufficiently developed to allow the recording of all health expenditure related to providing treatment to patients. This has led to situations where decisions to expand the benefit package have been taken without clarity about cost implications leading to arrears and overruns.

29. ECCU countries can take a number of measures to enhance the efficiency of health spending over the short and medium term. In the short term, there may be scope for:

  • Increasing revenue through user fees, while ensuring that user fees: (i) exclude only the poor and those with chronic conditions who cannot afford to pay the fees; (ii) exempt services that treat infectious diseases due to externalities; (iii) are not covered by private insurance, since this weakens the incentives for efficient utilization; and (iv) are fully collected from those required to pay.

  • Strengthening monitoring and enforcement to ensure services are delivered as contracted. Physicians and other health workers should be monitored to verify that they report to work and perform as intended. An optimal strategy might be to implement a random checking system as is being done in St. Lucia. Penalties should be set appropriately based on the number of infractions, large enough to change behavior, and enforced to instill credibility.

  • Ensuring proper maintenance of hospital infrastructure. This will avoid the need for costly rebuilding or repairs in the medium term.

  • Undertaking cost audits and installing appropriate health information technology to be able to track costs. This will also provide critical information to further revise the schedule of user fees and to prepare the ground for medium term reforms discussed below. Appropriate health information technology to support the reforms is paramount.

In the medium term, consideration could be given to:

  • Reviewing public benefits packages taking into account budget constraints. Given the strong medium-term pressures resulting from demographic and epidemiological transitions, a review of the current health benefits packages is needed to ensure that appropriate prioritization and cost control decisions are taken to maintain their affordability.

  • Greater regional cooperation to reap benefits from economies of scale. ECCU countries are already benefiting from regional procurement of pharmaceuticals. This could be expanded to include other medical supplies. Since establishing a formal regional cost-effectiveness agency could be challenging and expensive, one strategy would be to base the pharmaceutical list and reimbursement decisions on the evaluations of agencies from other countries, such as the National Institute of Clinical Excellence in England and Wales.

  • Rationalizing the use of hospital infrastructure. Given the relatively low occupancy rates in hospitals in some countries, there is scope for rationalizing the number and distribution of hospital beds. This could lead to more efficient utilization of hospital resources.

  • Basing some portion of hospital reimbursement on prospective methods, such as diagnosis-related groups (DRGs). DRGs pay hospitals a fixed amount to treat a patient based on diagnosis at admission. Since these payment methods put part of the provider’s income at risk, he or she is likely to be more attentive to the costs and benefits of treatment decisions and has an incentive to minimize costs. However, DRGs also incentivize providers to increase admissions and to reduce non-observable quality so that it is necessary to monitor admissions, treatment patterns, and adherence to standard protocols to ensure appropriate delivery of care and that budgets are adhered to.

F. Education

30. At about 6½ percent of GDP, government spending on education in ECCU countries is relatively high with respect to comparator countries (Table 5). Education outcomes have improved over the last two decades. Access to both primary and secondary education and enrollment rates for secondary education have improved markedly over the past decades. Most ECCU countries have achieved the Millennium Development Goal (MDG) of universal primary education.

Table 5.

Education Expenditure in ECCU Countries1/

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Sources: Country authorities and Fund staff estimates based.

Figures for each country correspond to latest year available.

31. High spending levels are due in good part to the fact that education systems have yet to adjust to demographic changes. Total number of students enrolled has been declining steadily with the fall in birth rates. However, this does not seem to have been reflected in the net hiring of teachers as illustrated by Figure 3 below for the case of St. Lucia. This reflects an inertial input-based approach to budgeting, which is based on historical spending and does not allow adjustments in the number of teachers and schools in response to demographic developments.

Figure 3.
Figure 3.

St. Lucia. Number of Students and Teachers in Primary and Secondary Education

Citation: IMF Staff Country Reports 2011, 032; 10.5089/9781455213894.002.A003

Sources: St. Lucia’s Budget Estimates 2010/11 and Statistical Digest 2009 Ministry of Education and Culture.

32. The demographic changes are resulting in low and decreasing student teacher ratios (STR) for primary and secondary education. The student-teacher ratios for primary education and secondary education have declined to about 20 or below in most ECCU countries. They are lower than in other Caribbean and Latin American countries and below international standards. The World Bank recommends student teacher ratios of 25 and 30 for primary and secondary education, respectively given that internationally there is empirical evidence that increasing student teacher ratios to those levels would not harm outcomes.17 18

33. The relatively high spending on wages and salaries is crowding out important recurrent spending. Salaries in some countries consume over 90 percent of current outlays leaving few resources for supplies and materials, operating and maintenance services, and teacher training. Under-provision of these inputs can have a detrimental impact on the quality of education.

34. Cost recovery in tertiary education is low in most countries. Typically, tuition and fees cover only a small portion of total cost in tertiary education. In fact, cost recovery of tertiary education spending is considerably higher in Latin America and North America than in the ECCU. In some countries, the benefits of subsidized fees in tertiary education accrue mostly to the non-poor. For example, household survey data indicates that in St. Lucia, only 11.4 percent of the students in tertiary education come from poor households. Greater effort could also be placed on means testing scholarships that would allow more needy individuals to attend universities while retaining funding for top performing students.

35. Administrative expenses are relatively high due to the small size of the countries, while some subsidized programs are not well-targeted. Larger countries spend roughly half of the amount ECCU countries spend on administration. The fixed costs of developing curriculum, information systems, and guidelines for the education sector drive this difference. Inefficient targeting of some programs such as school feeding, subsidies for tuition and textbooks also raise equity concerns.

36. Enhancing the efficiency of education spending could lead to better outcomes while also generating some cost savings for the budget.

  • Measures in the short term could include: (i) increasing student-teacher ratios through attrition; (ii) reallocating existing spending more towards non-salary components; (iii) better targeting of subsidized educational programs; and, (iv) introducing/raising user fees at the tertiary level.

  • In the medium term, reforms could include:

    • Reforming the financing and organization of primary and secondary education to better match resources to demographic changes. Establishing a system that bases funding on the number of students in school would automatically adjust financing so that spending on teachers declines as fewer are needed. Some countries (e.g., St. Lucia) have introduced multi-grade teaching in response to declining student population. At some point, merging schools may be required to achieve higher student-teacher ratios. However, this would likely engender higher public spending on transportation as well as higher private costs. For that reason, careful monitoring is needed to ensure that educational outcomes do not suffer.

    • Achieving economies of scale through greater regional cooperation. Improved coordination among ECCU countries could help reduce administrative costs without sacrificing quality of education. At the primary and secondary levels, economies of scale could be achieved in areas such as curriculum development. This could also be relevant at the tertiary level and include specialization in particular fields with different countries specializing in different areas.

G. Social Assistance

37. ECCU countries implement a wide array of social assistance programs to provide income support and access to basic services to the poor and the vulnerable. These include transfers (both cash and in-kind), labor-market programs (including public works and training programs), welfare programs based on education or health, programs for the disabled, and housing programs.

38. Spending on social assistance programs has increased steadily in almost all countries in the region over the last few years. Spending on such programs varies across countries—ranging from less than 1 percent of GDP in Antigua and Barbuda to over 3 percent of GDP in Grenada.19 This compares with spending of 1.4 percent of GDP in Latin America and the Caribbean countries.20

39. Poverty assessment reports point to limited coverage of the most vulnerable by these programs. For example, public assistance programs covered less than 20 percent of the poor and indigent in Dominica, 25 percent of the elderly in Grenada, and 9 percent of the poor in St. Lucia. This is due to low spending on these programs as well as inadequate targeting.

40. Social assistance programs are implemented by different government agencies with little or no coordination. Large number of programs, each with its own administrative system and procedures, stretches the capacity of staff and results in high start-up and administrative costs.

41. Targeting, accountability and monitoring mechanisms are weak. Weak targeting of some programs has resulted in considerable leakage to non-poor groups. For example, children from both highest and lowest quintiles appear to benefit almost equally from school feeding programs in St. Lucia, while close to half of the benefits of the welfare assistance program accrues to the non-poor. There is also a lack of effective monitoring and evaluation of programs due to weak accountability and monitoring mechanisms.

42. Programs lack flexibility to respond to shocks. Financial crisis, price shocks, and natural disasters can all have an adverse impact on the poor and the vulnerable. Protecting the population from shocks require that programs be expanded or contracted as appropriate, both in terms of beneficiaries as well as benefit levels. Lack of effective planning and possible financing constraints may have contributed to the lack of flexibility of programs.

43. There is scope for improving the efficiency of social assistance programs in ECCU countries.

Short term options include:

  • Introducing objective and transparent targeting mechanisms. In the first instance, targeting mechanisms in existing programs should be evaluated and all non-transparent methods replaced with explicit and verifiable methods. Household survey data provides important information for the construction of poverty maps and collection of other relevant information for targeting.

  • Establishing a central beneficiary system for all programs. Such a system would provide important monitoring and planning information. It would also streamline the application procedure and reduce administrative costs for targeting and approval. Since the programs cover only a small number of beneficiaries, this could be done rather quickly.

Medium term options include:

  • Rationalizing social assistance programs on the basis of a coherent social protection strategy. The strategy should specify objectives, core programs with fiscal allocations that match these priorities, implementation arrangements, accountability and control mechanisms, and monitoring and evaluation plans. One set of programs could focus on addressing key dimensions of extreme poverty and intergenerational transmission of poverty, covering also the elderly and the disabled who are not covered by the social security scheme. Small labor-intensive public works type of programs could form a second group which can be scaled up or down in response to economic shocks. A third group could concentrate on skills training and development.

  • Linking social assistance programs to actions that promote human capital development. Conditioning social assistance on regular visits to health clinics or attendance and progression of children in schools can be an effective method of breaking intergenerational transmission of poverty. However, these programs require more sophisticated administrative and institutional frameworks. Governments have attempted to overcome these constraints by rolling these programs out gradually over time.

  • Strengthening information management systems. Computerization would enhance the ability of the governments to monitor and evaluate programs and also reduce administrative costs. Programs and beneficiaries can be tracked over time and evaluated with respect to inputs and outcomes. This is an area where a regional approach might be explored with the goal of improving cost-effectiveness and overcoming capacity constraints.

H. Parastatal Entities

44. Parastatal entities are government units that operate separately from the budget. In ECCU countries, a variety of entities operate as parastatal entities including public enterprises, government corporations, regulatory commissions, extra-budgetary funds, and government agencies. Many of these entities perform non-commercial functions that are normally carried out by government departments. In some countries, the number of such bodies has increased steadily over the years and currently account for a significant share of public employment and spending. For example, in Antigua and Barbuda, these entities account for more than 40 percent of public employment, while budgetary transfers to them amount to more than 2 percent of GDP. Similarly, in St. Lucia the most recent information available indicates that transfers to parastatals accounted for about 1¾ percent of GDP.

45. Parastatal entities do not fully comply with the legal reporting and auditing requirements. In some countries of the ECCU, established legislation specify governance arrangement and reporting requirement for parastatal entities. However, compliance with the law is very weak. Moreover, available financial information is often incomplete and not sufficiently reliable to evaluate their financial condition. In most countries, there is no dedicated unit or body monitoring the operations of these entities. Even in countries where there is one, such as in St. Lucia, monitoring is weak due to capacity constraints.

46. The proliferation of parastatal entities combined with insufficient oversight and limited information on their financial operations is a source of concern. Country experiences have shown that establishing new parastatal entities can create inefficiencies and loss of fiscal control, if appropriate governance arrangements and reporting requirements are not in place. In particular, this can lead to:

  • A multiplicity of institutions with related responsibilities, but no mechanism to prioritize and avoid duplications. This can generate high overhead costs and waste limited public resources;

  • A reduction in budget discipline. Statutory bodies may be used to circumvent regular budget procedures and the checks and balances implied by them resulting in reduced transparency, a loss of control over spending, and the potential creation of significant contingent liabilities; and

  • Reduced credibility to meet deficit and debt targets. When entities do not have the financial capability to cover their spending needs or service their debt, the government may need to intervene in ways that move them away from the debt target, by issuing supplementary budgets, or assuming off-budget debt.

47. Reform options in the short term to address these issues include:

  • Enforcing existing legislation on reporting requirements and strengthening sanctions for non-compliance. Deadlines for submitting audited financial statements need to be clarified and penalties for non-compliance increased. Such penalties could include the withholding of transfers and the rejection of any loan approval if the information on their finances is not submitted on time and in line with the regulations and international accounting standards

  • Ensuring that sufficient and reliable information is available to determine the financial condition of the entities and that it is presented in a way that facilitates analysis. Compiling the information in line with international government finance statistics standards such as in the Government Financial Statistics Manual (GFSM2001) could help significantly in achieving that objective. Bridge tables could then be prepared from the financial statements of the statutory bodies into the GFS2001 methodology to prepare the information for analysis.

  • Strengthening the oversight of parastatal entities. With increased and improved information on statutory body finances, the focus should first be in ascertaining the financial situation of the largest statutory bodies and the factors underlying their financial position since those are the ones which could impact the budget most with contingent liabilities. This will allow the government to identify measures that will enable them to strengthen their financial condition, minimize their reliance on transfers, and thus save resources for the budget. Moreover, the ministries of finance should play an important role in approving investment projects (see Section J) and controlling borrowing by parastatal entities.

  • Increasing the level of scrutiny to justify the creation of new parastatal entities and periodically assessing whether their objectives remain relevant. The first objective could be attained by requiring an independent assessment of the business case for the establishment of a parastatal entity by showing that objectives would be met at a lower cost than with other alternatives, including through existing government departments. The second objective could be met by introducing automatic sunset clauses for some institutions in the relevant acts and requiring periodic reviews of their performance with respect to the objectives for which they were created.

48. A review of the functions and rationale of the existing statutory bodies should be undertaken over the medium term. This could be done in the context of the review of the role of government discussed above. The review will help identify areas of duplication, if any, which could create rationalization opportunities and savings for the budget. It would also help decide which entities should continue to operate, be merged, divested or closed down.

I. Public Financial Management21

49. Successful expenditure rationalization will also require reforms in broader public financial management (PFM). Diagnostic assessments and technical assistance undertaken during the period 2006–09, have pointed to a number of weaknesses in budget formulation, execution, accounting, recording, and reporting. These include:

  • Budget formulation: ECCU countries continued to be heavily reliant on supplementary warrants, suggesting that their original budgets were not comprehensively formulated. The fiscal crisis in 2009 also demonstrated fragility in budget processes, particularly in relation to the absence of clear processes. Policy based budgeting is underdeveloped, as is the linkage between the budget and the overall policy objectives of the government. Formal multi-year fiscal frameworks are either absent or limited. The recurrent and development budgets are also not well integrated.

  • Budget execution: Predictability and control in budget execution in the region remains weak. Discipline, particularly in relation to commitments, is not always achieved, requiring a large volume of virements and frequent use of supplementary warrants. A significant growth in arrears was also seen in 2009, in part due to the absence of commitment control. In general, the performance of the Accountant General’s operations is below the level required to provide quality financial information for decision making. This is in part due to the fragmented nature of government finances.

  • Accounting, recording and reporting: While detailed budget documentation is available in most cases, there is an overall lack of regular consolidation of economic and financial information on externally financed projects, limited information on the macroeconomic framework/fiscal risks (including debt and pensions), and poor reporting by, and oversight of, statutory bodies and state owned enterprises. Most governments experience bank reconciliation challenges, delayed in-year budget reports and annual financial statements, and deficiencies in terms of the quality of auditable information. In terms of transparency, countries release only limited information for public scrutiny, and external scrutiny and audit is seen as the weakest area. Delays in producing financial statements undermine the capacity of both the external auditor and the Public Accounts Committees (PACs) to properly perform their roles.

  • Information Technology (IT) systems: Countries continue to struggle to maintain these systems and are not realizing their full potential. While a number of issues could be traced to the level of support made available by software providers, countries themselves continue to allocate insufficiently skilled human resources to the proper maintenance of these mission critical systems. It is also clear that not enough attention is given to the reengineering of business processes to gain maximum benefits from these systems, with many countries continuing with their pre-system manual processes, often duplicating these functions within the new systems.22

50. ECCU countries are in the process of formulating PFM action plans to address these issues. Six of the eight ECCU members have undertaken a Public Expenditure and Financial Assessment (PEFA) in the last 12 months; and seven will have completed PFM reform action plans by the end of the year. This will assist authorities to identify short and medium-term reform priorities and to seek coordinated support from development partners. Importantly, countries are likely to identify similar areas of need and this presents an opportunity to jointly undertake reforms and to provide peer support.

51. Key short-term reform measures include:

  • Strengthening the budget preparation process. This area of reform needs to focus on all aspects of public spending and revenue and must ensure full consolidation of the budget process. This will also support the preparation of a proper medium-term fiscal framework (MTFF). A formal mid-year budget review should also become a standard feature on the budget calendar for each country.23

  • Increasing predictability and control in budget execution. This can be achieved by (i) ensuring that all government spending and receipts are within the control of the Accountant General’s Department and within the government Financial Management Information System (FMIS), and (ii) centralizing the management of government’s resources within a treasury single account system. The experience of CARTAC technical assistance suggests the need to focus work on fundamental processes, such as bank reconciliations, accounting, cash management, commitment recording, chart of accounts redesign and timely reporting.

  • Strengthening internal control. Reengineering processes to better utilize available technology would realize major benefits, including improving controls and greater efficiency. Investing in capacity building programs to ensure that financial actors understand their roles will also improve the quality of financial processing—particularly as many countries have enacted new laws and regulations in recent years and changed certain PFM processes, but have not adequately raised the level of awareness of these changes among relevant players.

52. Key medium term reform measures include:

  • Examining regional solutions to retaining skills in the region. In order to avoid the inhibitive costs often associated with an individual approach among small economies, ECCU countries need to pursue opportunities for collaboration, such as in the development of laws, policies, and procedures, and IT systems, or by sharing skilled people and training programs. External audit represents another area where expertise could be shared across the region.

  • Exploiting opportunities to promote regional collaboration in capacity building initiatives and building a common program of development activities. CaPFA/CARTAC’s one-week PFM workshop has been successfully implemented in six countries in the region over the past 12 months, and was developed in the region and delivered by regional presenters. The pool of regional experts to deliver this and future training initiatives should also be expanded.

  • Reviewing business processes to streamline workloads. Efforts to reduce or even eliminate both cheque payments and receipts would significantly reduce workloads. The new Support for Economic Management in the Caribbean (SEMCAR) program, financed by the Canadian Development Agency (CIDA), should also provide a strong basis for upgrading existing IT systems and creating a regional focus in the medium and longer term.

J. Capital Spending24

53. Capital spending has been the area of largest expenditure growth in the ECCU. As illustrated in Figure 1, capital spending hovered around 6 percent of GDP in the 1990s. Since then, it has grown considerably, exceeding 10 percent of GDP in 2006.25 Only since 2006 have capital spending levels started to come down and further adjustments are expected in 2010 as the region adjusts to the fiscal impact of the global economic and financial crisis.

54. The process underlying capital spending decisions has contributed significantly to expenditure growth. While some countries were hit by natural disasters (especially hurricanes), which triggered large reconstruction needs, World Bank public expenditure reviews (PERs) for several countries in the region have also flagged weaknesses in the planning, execution and monitoring of public sector investment programs (PSIPs) that have contributed to high and inefficient investment spending. These include:

  • Dual budgeting. This refers to the practices where de jure or de facto recurrent and capital expenditure are budgeted separately. These practices have typically led to underestimation of the recurrent cost implications of capital projects since these are normally not included in the public sector investment programs. This also leads to serious inefficiencies, since under-budgeting of maintenance and operations spending can reduce the rate of return of capital projects.

  • Lack of a clear budget constraint for capital. Entities involved in investment planning are not given a clear budget envelope. This has resulted in an unfinanced list of projects commonly referred to as a “wish list” and does not force prioritization at the budget stage. It leads to inefficient prioritization at the execution stage where projects are arbitrarily matched with available resources.

  • Lack of project selection criteria and link to the countries’ medium term economic strategies. Projects are approved and included in the budget without the necessary information to carry out feasibility studies and cost benefit analysis, without them being fully financed, or without being consistent with the relevant sectoral strategies. In addition to increasing the risk of approving projects with low or negative rate of return, it makes budgeting unrealistic and may lead to spending overruns, forcing revisions in budget appropriations during the year, as discussed in Section H.

  • Limited coverage. Projects carried out by statutory bodies, state enterprises or financed using special arrangements (such as public-private partnerships or projects executed by private companies financed by guaranteed loans) are not included in the PSIPs subverting the prioritization process.

  • Poor monitoring and insufficient ex-post project evaluation. Detailed project execution report requirements are not adhered to on a regular basis by the entities with reporting responsibilities. In addition, capital expenditure disbursed directly by donors are unlikely to be recorded and reported in the budget. Ex-post project evaluation is only carried out for externally funded projects where it is required by the financing institution.

55. ECCU countries can take a number of measures to rationalize capital spending and enhance its efficiency in the short and medium term:

In the short term, there may be scope for:

  • Giving the ministry of finance a greater gateway role. This can be achieved by requiring that all investment projects above a certain threshold should be screened by the ministry of finance (MOF). The MOF would have to give a go-ahead on the basis of the financial viability of the project and an assessment of the risks to the budget.

  • Defining and strictly enforcing simple selection criteria for screening investment projects. For example, investment projects considered for inclusion in the budget or the PSIP should: (i) be submitted with all the information needed to evaluate them (including information on their recurrent spending implications); (ii) have gone through appropriate feasibility studies/cost benefit analysis, especially for large projects; and (iii) be fully financed, consistent with sectoral priorities and spending envelopes provided by the MOF to the requesting entity. The criteria should apply to all public investment projects independently of the way they are financed and without any exceptions.

  • Strengthening and enforcing monitoring procedures. In particular, monthly monitoring of capital spending execution should be required and credible penalties should be applied to non-compliant institutions.

In the medium term, consideration could be given to:

  • Developing capacity for cost benefit analysis at the regional level. While in the short term feasibility/cost benefit analysis studies can be contracted out due to capacity constraints, steps should be taken to develop such capacity over the medium term. Standard manual on ex ante and ex post evaluation of projects could be developed to guide this process. A regional approach could be considered to take advantage of scale economies not only in the development of the manuals but also in training of government officials.

  • Carrying out systematically ex-post cost benefit analysis of large investment projects. Information on what went right and what went wrong with projects is very valuable to refine the project selection criteria to limit the losses from projects with low or negative rates of return.

K. Conclusion

56. Fiscal consolidation efforts in the ECCU need to focus on the expenditure side of the budget. The surge in fiscal deficits and the associated increase in debt have raised concerns regarding fiscal and debt sustainability. This has also constrained the fiscal space needed to respond to shocks and expand social and poverty-reducing spending. Given extremely high revenue-to-GDP ratios in the region, expenditure rationalization efforts will be key to successful fiscal consolidation. These efforts should be guided by two principles: equity and efficiency.

57. The government wage bill and social security schemes are two priority areas for expenditure rationalization. Given that the wage bill constitutes the biggest expenditure item in the ECCU, any meaningful rationalization effort would have to address this issue. Some countries have implemented short-term measures to contain the growth of the wage bill. These need to be complemented with more medium-term measures. Social security systems also are a key source of fiscal vulnerability over the medium-term. Parametric reforms are needed to restore the financial sustainability of these schemes. Dominica and St. Lucia have been leaders in this area of reform, but other countries need to follow suit. There is also scope for efficiency enhancing reforms in other expenditure areas.

58. Successful expenditure rationalization will also require strengthening PFM systems. ECCU countries are in the process of formulating reform action plans to strengthen these systems. Implementing these plans would require continued financial and technical assistance from donors, including CARTAC and the IMF.

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1

Prepared by Shamsuddin Tareq, Alejandro Simone, Koffie Nassar and Anna Viseth.

2

ECCU countries covered are: Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines.

3

These figures exclude spending by parastatal entities as well as investments financed through special financing arrangements. There is not sufficient cross country information available to attempt a correction.

5

For example, labor survey information available for St. Lucia suggests that unemployment has exceeded 14 percent during most of the last 15 years.

6

According to World Bank (2005a), in most countries the expectation in terms of wage premium is for it to be negative. Wages in the government sector tend to be lower as employees typically have greater job security and enjoy a number of other pecuniary and non-pecuniary benefits.

7

There are two types of government employees in ECCU countries—established and non-established. Employees appointed by the Public Service Commissions are referred to as established employees and cover all types of government employees, including teachers, health workers, the police, and the military. The prevalence of manual processing of human resource information for established workers and the existence of significant non established employment have led to the limited availability of information.

8

For example, in Antigua and Barbuda, physician absenteeism is reportedly common in public health care facilities.

9

See Monroe, H. (2009) and Roache, S. and Rasmussen, T. (2007) for additional discussion.

11

In some cases, such as in Antigua and Barbuda, pension parameters are especially generous for certain groups of workers including parliamentarians, teachers, and police.

14

According to a World Bank study (2010), demographic changes alone will increase total health spending needs in Latin America and the Caribbean region by 47 percent over the next 20 years.

15

See World Bank (2005a, 2005b, 2005c, and 2005d).

16

In Antigua and Barbuda, there are three different procurement systems for pharmaceutical products in public health facilities reducing the potential for savings from centralized procurement. In St. Lucia, there is a shared perception among several health professionals that certain diseases that lead to high drug consumption could be most cost effective if addressed by public health campaigns to inform the population of the risk factors and how to prevent them. Widely cited cases are diabetes and hypertension.

17

See World Bank (2005a, 2005b, 2005c and 2005d).

19

However, comparison of spending figures across countries can be misleading because of different definition and coverage of such programs.

21

This section is based on contribution by Marc Silins of the Caribbean Regional Technical Assistance Center (CARTAC).

22

Based on a CARTAC regional IT Study (which included ECCU countries) focusing on the three major PFM IT systems: tax, customs and treasury undertaken over 2008-10.

23

Note that Grenada is successfully implementing quarterly reviews.

24

This section draws on various public expenditure reviews undertaken by the World Bank.

25

These figures do not include capital spending by parastatals or financed under special arrangements (e.g., public-private partnerships) thereby understating capital spending. On the other hand, all foreign financed capital projects are automatically included as capital expenditure in most, if not all, countries in the region. These project expenditure also include some current spending so that this practice results in inflating capital spending.

Eastern Caribbean Currency Union: Selected Issues
Author: International Monetary Fund