St. Vincent and the Grenadines: Staff Report for the 2012 Article IV Consultation—Debt Sustainability Analysis
Author: International Monetary Fund. Western Hemisphere Dept.
Publication Date:
21 Aug 2014
eISBN:
9781498308434
Language:
English
Keywords:
ISCR; CR; current account; debt; deficit; real GDP; creating flow; sustainability framework; debt trajectory; debt stock; service-to-revenue ratio; Public and publicly-guaranteed external debt; Fiscal stance; Public sector
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KEY ISSUESBackground: Activity is slowly recovering after a cumulative decline of about 5 percent during 2008–10. Expansionary fiscal policies—largely to counteract the impact of the global slowdown and the two successive natural disasters—led to a deterioration in fiscal balances, with public debt up by about 10½ percent of GDP over this period. The fiscal deficit, however, is expected to narrow this year, largely reflecting cuts in capital spending. In the financial sector, non performing loans remain above prudential guidelines; provisioning and profitability are low; and supervision remains weak.Policy Challenges: Further fiscal consolidation—including by rebalancing government expenditure toward growth and employment generating public sector projects—is required to ensure medium-term sustained growth as well as keep public sector debt on a downward trajectory. In this regard, improving the efficiency of revenue collection and reducing current spending—especially on the wage bill, which is high relative to revenues—will be crucial to allow the government to maneuver fiscal policy. Financial sector weaknesses also need to be addressed, including through strengthening of supervisory and regulatory standards, to promote effective financial intermediation that supports private sector growth. Structural reforms, including infrastructure enhancements and labor market reforms are critical to improve competitiveness andensure medium-term growth and current account sustainability.

Abstract

KEY ISSUESBackground: Activity is slowly recovering after a cumulative decline of about 5 percent during 2008–10. Expansionary fiscal policies—largely to counteract the impact of the global slowdown and the two successive natural disasters—led to a deterioration in fiscal balances, with public debt up by about 10½ percent of GDP over this period. The fiscal deficit, however, is expected to narrow this year, largely reflecting cuts in capital spending. In the financial sector, non performing loans remain above prudential guidelines; provisioning and profitability are low; and supervision remains weak.Policy Challenges: Further fiscal consolidation—including by rebalancing government expenditure toward growth and employment generating public sector projects—is required to ensure medium-term sustained growth as well as keep public sector debt on a downward trajectory. In this regard, improving the efficiency of revenue collection and reducing current spending—especially on the wage bill, which is high relative to revenues—will be crucial to allow the government to maneuver fiscal policy. Financial sector weaknesses also need to be addressed, including through strengthening of supervisory and regulatory standards, to promote effective financial intermediation that supports private sector growth. Structural reforms, including infrastructure enhancements and labor market reforms are critical to improve competitiveness andensure medium-term growth and current account sustainability.

Introduction

1. Slow recovery appears to be underway after three consecutive years of output contraction. Economic activity contracted by about 1.7 percent per annum, on average, during 2008–10, reflecting the impacts of the global slowdown, the international commodity price increases in 2008–09, and draught and Hurricane Tomas in 2010. Another weather shock, torrential rains and floods, in April 2011 derailed the ongoing recovery; as a result, growth remained tepid at around ½ percent last year. Government efforts to counter the impacts of these shocks resulted in a reversal of the 1.1 percent of GDP primary surplus in 2008 to a persistent deficit since then. At the same time, the public sector debt-to-GDP ratio increased by 10½ percentage points to 67.8 percent in 2011. External debt constituted around 63 percent of the public sector debt at end-2011, of which about two-thirds is multilateral debt. The Caribbean Development Bank is the creditor for the bulk of the multilateral debt. The central government owed about 85 percent of the total public sector debt at end-2011, with the rest owed by state-owned enterprises.1

A03ufig01

Public Sector Debt, end-2010

(In percent)

Citation: IMF Staff Country Reports 2014, 251; 10.5089/9781498308434.002.A003

2. The fiscal stance is expected to be tighter this year, reflecting financing shortfalls. Revenue outturns and external disbursements for the first 10 months of the year fell short of expectations. As usual, the brunt of financing shortages falls on capital expenditure, where only a quarter of the planned projects are expected to be executed. The overall deficit is expected to be 2¾ percent of GDP, lower by about a percentage point of GDP compared to last year.

Underlying Assumptions in the Baseline Scenario

3. The DSA analysis is based on the following macroeconomic framework, assuming that the authorities will implement the policies discussed in baseline scenario of the staff report.

  • Growth and Inflation: Growth is expected to be around ½ percent in 2012 and to increase to 1 percent in 2013. Over the medium term, growth is projected to reach its potential level of 3 percent, reflecting improved employment and consumption conditions in tourism and FDI source countries and the expected completion of the international airport project. End-period inflation is expected to have eased to around ¾ percent in 2012, reflecting declining international food and fuel prices. Over the medium term, inflation is projected to revert to its long-term path of around 2½ percent, anchored by the currency board arrangement.

  • Fiscal Balance: While a small surplus of around ½ percent of GDP is expected for this year, the public sector primary balance is projected to deteriorate significantly next year to a deficit of 3½ percent of GDP due to expected increasing activity at the international airport project financed mainly by borrowing. Over the medium term, however, the primary balance is projected to register surpluses in the range of 2 percent of GDP, mainly reflecting the central government’s commitment to generate primary surpluses in the range of 1 percent of GDP, and the expected completion of the airport project2. Revenue is projected to increase over the medium term, reflecting the authorities’ plan to implement a number of revenue enhancing measures such as implementation of market-based property tax, improvements in compliance and enhancement of tax audits, and streamlining exemptions. External grants, which peaked in 2009, are projected to decline to around 2 percent of GDP over the medium term and further fall to 1½ percent of GDP in the long term. On the other hand, expenditures in percent of GDP are expected to remain high as there is limited appetite for expenditure cutting measures.

  • External Sector: The current account deficit is expected to remain high at around 28 percent of GDP in 2012, but it is projected to narrow continuously to around 18 percent of GDP by 2017. Tourism and FDI are assumed to rebound as economic recovery strengthens in source countries (mainly North America and Europe), over the medium term. The grant element of new external borrowing is projected to fall over the medium to long term, reflecting difficulty of accessing concessional resources as per capita income increases, however, the grant element will continue to remain high in the near to medium term in line with the central government’s commitment not to borrow on non-concessional terms.

Evaluation of Public Sector Debt Sustainability

4. The public sector debt will continue to increase in the near term, but is projected to revert to a downward trajectory over the medium term as long as the authorities generate primary surpluses in the range of 1 percent of GDP. The public sector debt-to-GDP ratio is projected to peak at 74.7 percent by 2014, mainly reflecting borrowing for the International Airport project. However, the debt trajectory is expected to start a downward trend afterwards, reflecting fiscal consolidation measures that the authorities plan to take combined with the projected rebound in economic growth, as discussed in the staff report. The public debt-to-GDP ratio is projected to fall to 59 percent of GDP by 2020, just below the ECCB’s recommended threshold of 60 percent.

5. Sensitivity analysis shows that permanently lower GDP growth is a key vulnerability for St. Vincent and the Grenadine’s debt dynamics. Under a scenario where growth is permanently lower by one standard deviation divided by the square root of the length of the projection period, the Present Value (PV) of debt-to-GDP ratio would reach 71 percent by 2022 and over 97 percent by 2032, compared to the base line levels of 51 percent and 32 percent in 2022 and 2032, respectively (Table 1b, Scenario A2).

Table 1a.

St. Vincent and the Grenadines: Public Sector Debt Sustainability Framework, Baseline Scenario, 2009–32

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Gross public sector external debt (central government and state-owned enterprises).

Also includes contributions from the real exchange rate in the projection period.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Table 1b.

St. Vincent and the Grenadines: Sensitivity Analysis for Key Indicators of Public Debt 2012–32

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Sources: Country authorities; and staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

Evaluation of External Debt Sustainability

6. St. Vincent and the Grenadines’ risk of external debt distress remains moderate. Under the baseline scenario, the PV of public sector external debt is estimated at 39 percent of GDP in 2012 and is projected to decline to 24 percent of GDP by 2022, half of the threshold value of 50 percent3 (Table 2b). The present values of debt and debt service to export and revenue ratios also remain below the respective thresholds under the baseline scenario. Nevertheless, these ratios would permanently exceed the respective prudential thresholds under the ‘Historical’ scenario, where key macroeconomic variables such as real GDP growth, GDP deflator, growth of exports, and non-debt creating flows are assumed to be at their respective averages for the last 10 years.4 This highlights the pressing need for implementing fiscal consolidation and structural reform measures, as discussed in the staff report, to improve competitiveness and jumpstart economic activity.

Table 2a.

External Debt Sustainability Framework, Baseline Scenario, 2009–321/

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Table 2b.

St. Vincent and the Grenadines: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2012–32

(In percent)

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Sources: Country authorities; and staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

7. Sensitivity analysis shows that St. Vincent and the Grenadines’ external debt dynamics is vulnerable to changes in non-debt creating flows and the nominal exchange rate. The stress test assuming that net non-debt creating flows are at historical average minus one standard deviation in 2013-2014 shows that the PV of external debt-to-GDP ratio would jump to 52 percent in 2013, breaching the country-specific threshold of 50 percent, and will remain above 50 until 2019. Similarly, the PV of external debt-to-GDP ratio would jump to 56 percent in 2013 and remain above 50 percent until 2016 under the scenario of a one-time 30 percent nominal depreciation relative to the baseline in 2013 (Table 2b, Scenario B6).

Active Scenario: Higher Capital Spending and No Commercial Borrowing for the Airport

8. Re-orientation of central government spending into infrastructure and avoiding commercial borrowing for the airport would reduce the public sector debt to a more desirable level. Additional investment in infrastructure, financed through savings from current expenditure, would increase medium-term growth by about ½ a percentage point. This would help reduce the public sector debt in percent of GDP. Further reduction in public sector debt would be achieved if the government continues to rely on external grants, land sales and some concessional resources for the airport project, avoiding the planned commercial borrowing assumed in the baseline. Under this scenario, the public sector debt would fall to 52½ percent of GDP by 2020. While the external debt distress still remains in the moderate range, the PV of public sector external debt would be at 38 percent of GDP in 2013 and is projected to decline to 25 percent of GDP by 2022, well below the threshold value of 50 percent (Figure 3).

Figure 1.
Figure 1.

St. Vincent and the Grenadines: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2012–321/

Citation: IMF Staff Country Reports 2014, 251; 10.5089/9781498308434.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2022. In figure b. it corresponds to a Non-debt flows shock; in c. to a Combination shock; in d. to a Non-debt flows shock; in e. to a Combination shock and in figure f. to a Non-debt flows shock
Figure 2.
Figure 2.

St. Vincent and the Grenadines: Indicators of Public Debt Under Alternative Scenarios, 2012–321/

Citation: IMF Staff Country Reports 2014, 251; 10.5089/9781498308434.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2022.2/ Revenues are defined inclusive of grants.
Figure 3.
Figure 3.

St. Vincent and the Grenadines: Indicators of Public and Publicly Guaranteed External Debt under the Active Scenario, 2012–321/

Citation: IMF Staff Country Reports 2014, 251; 10.5089/9781498308434.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2022. In figure b. it corresponds to a Non-debt flows shock; in c. to a Combination shock; in d. to a Non-debt flows shock; in e. to a Combination shock and in figure f. to a Non-debt flows shock.

Conclusion

9. St. Vincent and the Grenadines’ public debt is projected to revert to a sustainable trajectory over the medium term and the external debt distress remains moderate. While the fiscal situation has been deteriorating in recent years, the authorities are committed to fiscal consolidation measures, in particular on the revenue side. These, along with projected improvements in economic prospects, are expected to improve the fiscal situation and ensure debt sustainability over the medium term. Reorientation of spending into capital projects would improve the medium-term growth prospects and bring down public sector debt to a more desirable level.

1

See Appendix III of the Staff Report for further discussion of the financial performance of state-owned enterprises.

2

The SOE’s projected primary deficit in the coming two years is primarily due to the international airport project, which is managed by a state-owned enterprise (the International Airport Development Corporation). After the completion of the project in 2014, the SOEs combined are expected to generate primary surpluses in the range of 1 percent of GDP.

3

The DSA uses policy-dependent external debt burden indicators. Policy performance is measured by the Country Policy and Institutional Assessment Index (CPIA), compiled annually by the World Bank, categorizing countries into three groups based on the quality of their macroeconomic policies (strong, medium, and poor). St. Vincent and the Grenadines is classified as a strong performer, with the thresholds on PV of debt-to-GDP, debt-to-exports, and debt-to-revenue of 50, 200 and 300 percent, respectively.

4

The historical scenario for this year’s DSA differs significantly from that of last year’s DSA because the 10-year historical averages for this year drops one ‘good’ year (2000) and includes one ‘bad’ year (2011) for key macroeconomic variables.

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