St. Kitts and Nevis: 2015 Article IV Consultation and First Post-Program Monitoring Discussions
Author: International Monetary Fund. Western Hemisphere Dept.
Publication Date:
04 Sep 2015
eISBN:
9781513519470
Language:
English
Keywords:
ISCR; CR; CBI inflow; one-off corporate tax settlement; reform; inflow; CBI program; debt forgiveness; debt service; CBI flow; Public sector; Caribbean; B. managing CBI inflow
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Context and post-program performance: Macroeconomic conditions continued to improve, with the economy recording a second year of strong growth of about 6 percent, significantly higher than envisaged in the 9th Review. The fiscal balance has also been exceptionally strong, reflecting both robust tax revenues and continued strong growth of CBI budgetary fees, while the debt-to-GDP ratio has fallen more rapidly than projected, to 79 percent of GDP. A new government won elections and assumed power in February 2015, which delayed the PPM mission. Article IV: The last Article IV consultation was concluded on March 19, 2014. Current discussions focused on sustaining fiscal prudence, making progress with debt-land swaps, and boosting reform momentum following a further widening of tax exemptions and heightened uncertainty about future CBI inflows. The mission also urged the development of a plan for managing the CBI inflows, support for the regional bank strategy while continuing to strengthen bank oversight, preserving debt sustainability with a strategy for moving forward with the debt-land swap, implementing growth enhancing reforms focusing on strengthening tourism, developing cost-effective energy solutions, and improving the business environment. Post-Program Monitoring: The 36-month SBA for SDR 52.51 million (590 percent of quota) was concluded on July 27, 2014, with total withdrawals of SDR 47.37 million. Following several advance repayments, Fund credit outstanding fell to 298 percent of quota as of end-June 2015, placing St. Kitts and Nevis under Post-Program Monitoring till May 2016, absent additional early repayments.

Abstract

Context and post-program performance: Macroeconomic conditions continued to improve, with the economy recording a second year of strong growth of about 6 percent, significantly higher than envisaged in the 9th Review. The fiscal balance has also been exceptionally strong, reflecting both robust tax revenues and continued strong growth of CBI budgetary fees, while the debt-to-GDP ratio has fallen more rapidly than projected, to 79 percent of GDP. A new government won elections and assumed power in February 2015, which delayed the PPM mission. Article IV: The last Article IV consultation was concluded on March 19, 2014. Current discussions focused on sustaining fiscal prudence, making progress with debt-land swaps, and boosting reform momentum following a further widening of tax exemptions and heightened uncertainty about future CBI inflows. The mission also urged the development of a plan for managing the CBI inflows, support for the regional bank strategy while continuing to strengthen bank oversight, preserving debt sustainability with a strategy for moving forward with the debt-land swap, implementing growth enhancing reforms focusing on strengthening tourism, developing cost-effective energy solutions, and improving the business environment. Post-Program Monitoring: The 36-month SBA for SDR 52.51 million (590 percent of quota) was concluded on July 27, 2014, with total withdrawals of SDR 47.37 million. Following several advance repayments, Fund credit outstanding fell to 298 percent of quota as of end-June 2015, placing St. Kitts and Nevis under Post-Program Monitoring till May 2016, absent additional early repayments.

Context

1. The economic situation has continued to improve with robust growth and a strong fiscal balance. Economic growth for 2013-2014 averaged about 6 percent per year, the fiscal surplus remained high as a result of strong tax revenue, which more than offset higher spending, while the public debt-to-GDP ratio fell faster than anticipated. This follows the successful completion of the 36-month exceptional access SBA, which aimed to restore growth and fiscal and debt sustainability, while preserving financial stability.1 Under the program, St. Kitts and Nevis implemented substantial fiscal consolidation measures, undertook a major debt restructuring exercise, including a debt-land swap, while making substantial progress with key structural reforms. The latter included strengthening tax administration and improving public financial management. There was considerable progress in implementing Fund policy advice from the 2014 Article IV consultation but important issues remain outstanding (Box 1).

2. Recent developments suggest increased risks to the Citizenship-By-Investment (CBI) program, the main driver of the economy’s strong performance. The Canadian imposition of visa requirements on citizens of St. Kitts and Nevis on November 22, 2014 led the government to undertake important reforms to address security concerns. However, the heightened international scrutiny, combined with substantial competition from new CBI programs in the region and globally, raises concerns about the sustainability of these inflows.

3. Recent elections led to a change in administration. Team Unity, a three-party coalition won Parliamentary elections on February 16th, 2015, with Dr. Timothy Harris replacing Dr. Denzil Douglas—the country’s Prime Minister since 1995. The campaign promised strong employment creation, lower taxes, and higher welfare benefits, and opposed the debt-land swaps. The campaign also promised to strengthen the CBI program administration and improve the transparency of the operations of the Sugar Investment Diversification Foundation (SIDF). The new government has already moved by widening tax exemptions introduced by the previous government and stepped up the reform of the CBI program.

Recent Economic Developments

4. The buoyant recovery reflects a surge in construction activity. Growth in 2013 was revised up from 3.8 percent to 6.2 percent and, estimated to have been 6.1 percent in 2014, driven by the surge in CBI-related construction activity, government and Sugar Industry Diversification Foundation (SIDF) investments and spending, including the People Employment Program (PEP), and the ongoing recovery in tourist arrivals.2 Wages and employment in the construction sector were up by 30 and 15 percent, respectively. Inflation remained low at 0.6 percent (y/y) at end-2014, reflecting low commodity prices. The current account deficit has remained lower than its historical average, at around 7.5 percent of GDP, owing to high CBI service receipts. International reserves continued to increase in 2014, with import coverage remaining at about 9 months.

A01ufig1

Contribution to Growth

(In percentage points)

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Sources: Authorities and IMF staff estimates.

5. The fiscal surplus remained high as a result of strong growth in tax revenue, more than offsetting higher spending. Reflecting the strength of the economic activity, tax revenue increased by 1 percentage point from 2013, significantly higher than envisaged in the 9th Review in Eastern Caribbean dollar (EC$) terms. Current spending was also higher than projected (in EC$) in the 9th Review as a result of the 13th-month salary bonus, increased outlays, in part related to CBI program reforms and higher transfers, but continued to decline as a percent of GDP. Meanwhile, CBI budgetary revenues grew to 14.1 percent of GDP from 13 percent in 2013. As a result, the surplus before grants increased to 6.5 percent of GDP, from 5.2 percent in 2013. Significantly lower grants in 2014, including from the SIDF, generated a decline in the headline central government surplus to 9.5 percent of GDP from 12.1 percent in 2013. Netting the impact of grants, CBI flows and SIDF budgetary support, the central government registered an improvement of 1.5 percent of GDP in 2014.3,4 Debt declined faster than anticipated, reflecting higher GDP growth and advance debt repayments, to 79 percent of GDP at end-2014 compared to a projected 86.2 percent, and 100.8 percent at end-2013. In 2015Q1, the fiscal result remained strong.

A01ufig2

Fiscal Indicators

(In percent of GDP)

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Sources: Authorities and IMF staff estimates.
A01ufig3

Public Debt and Interest Payments

(In percent of GDP)

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Sources: Authorities and IMF staff estimates.

Implementation of 2014 Article IV Recommendations1

The authorities undertook the following actions, consistent with the last Article IV recommendations:

  • Completed the second tranche of the debt-land swap agreement for St. Kitts and the first tranche for Nevis.

  • Saved a large portion of CBI budgetary revenues to build further precautionary buffers.

  • Reduced public debt more rapidly using accumulated government deposits.

  • Limited discretionary tax exemptions on new construction projects to about EC$100 million limits.

  • Passed a new Customs Law in November 2014 to facilitate the enforcement of post-clearance audits at the Customs and Excise Department.

  • Further strengthened the tax administration, including greater focus on large tax-payers, representing 80 percent of total tax revenues and broadening the tax base by limiting deductions.

  • Progressed with civil service reform by operationalizing the implementing regulations of the 2011 Civil Service Act, in May 2014, for the effective implementation of the legislation, and began the payroll audit and functional review of selected departments, with the final review due for completion by end-2015.

  • Made important revisions to strengthen the National Energy Policy and Action Plan and made significant progress in negotiations on the geothermal project in Nevis.

Policy action was slow, delayed, or reversed, in the following areas:

  • Introducing new VAT and import duties exemptions that staff estimates will lead to substantial loss of tax revenues absent offsetting measures.

  • Mobilizing land sales by the Special Land Sales Company (St. Kitts).

  • Curtailing tax holidays and centralizing the power to grant and manage tax incentives in the Ministry of Finance and moving from discretionary to a rules-based concessions system.

  • Strengthening oversight of public enterprises and enhancing their reporting requirements.

  • Implementing an action plan to improve the business climate, which was, however, initiated in 2015.

  • Publishing the latest audited financial statements of SIDF.

  • Developing a time-table for implementing parametric reforms proposed in the latest actuarial review of the Social Security Board (SSB).

  • Strengthening statistical capacity.

1 See IMF Country Report No. 14/86. For a review of SBA program implementation see IMF Country Report No. 14/297.

6. The banking system remains stable while credit growth is low. The debt-land swap in July 2013 and August 2014 contributed to increasing indigenous banks’ NPL ratio to 16.8 percent as of 2014Q4, as public sector loans were removed from the balance of total loans.5 Private sector credit recovered modestly by 0.5 percent (y/y) in December 2014, following two years of contraction, reflecting banks’ low risk appetite and the elevated NPL ratio. On other hand, bank liquidity continued to grow, fuelled by strong deposit growth associated with high CBI inflows and government savings.

A01ufig4

Credit to Private Sector

(In EC$ million)

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Sources: Authorities and IMF staff estimates.

Outlook: Strong but with New Risks

7. Near-term economic growth is set to continue, albeit at a somewhat slower pace. Growth is expected to slow to about 5 percent in 2015 and 3.5 percent in 2016, reflecting some moderation of construction activity; the output gap is estimated to close in 2015. The authorities are more bullish on growth, projecting a 7 percent increase in 2015, reflecting strong first quarter developments. Given considerable uncertainty related to the CBI program following the Canadian action and growing competition, staff is more cautious and assumes a substantial slowdown in the pace of inflows. Inflation is forecast to be negative 2.2 percent in 2015 as a result of the VAT exemptions on food items, which represent 25 percent of the consumer basket, and the decline in global commodity prices.

A01ufig5

SKN: Real GDP and Output Gap

(In 2003 prices, EC$ million)

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Sources: Authorities and IMF staff estimates.
A01ufig6

St. Kitts and Nevis Real GDP Growth (1971-2020)

(In percent)

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Sources: Authoritiesand IMF staff estimates.

8. Over the medium-term, staff projects growth to converge back to the regional average. The normalization of growth over 2017-2020 to 2.5 percent is based on the staff’s assumption of low CBI inflows, a tapering off in CBI-related construction, and moderate growth prospects for key tourism source markets. This implies an average growth of 3.9 percent for 2013-2020, roughly the same as the pre-crisis average of 4 percent over 1991-2008, a period buffeted by negative exogenous shocks, including natural disasters. Risks to the outlook, highlighted in the Risk Assessment Matrix (Annex I), are broadly balanced. These include the potential fallout of the regional financial resolution process, vulnerability to natural disasters, and slower growth in advanced economies. On the upside, CBI and FDI inflows could be more buoyant than anticipated in the baseline.

9. The external sustainability analysis suggests that the current account deficit is larger than implied by fundamentals, while the exchange rate is somewhat overvalued.6 The current account deficit is expected to deteriorate by about 5 percentage points to 12.6 percent in 2015 reflecting the staff’s cautious projection for CBI inflows for the rest of the year. Excluding CBI receipts, the current account balance remains broadly stable as higher good imports are offset by lower energy cost. Reserves are projected to fall reflecting planned debt repayment, but remain adequate, covering 8 months of imports in 2015.7 Competitiveness indicators - including the investment climate and tourism performance - suggest ongoing challenges (Annex II). The capacity to repay has substantially improved reflecting higher growth and advance repayments to the Fund, with outstanding Fund credit projected at end-2015 to be about 14 percent of imputed reserves compared to projection of 21 percent at the last review.

St. Kitts and Nevis: Medium-Term Outlook

article image
Sources: St. Kitts and Nevis authorities, ECCB and IMF staff estimates and projections.

Includes capital grants and investment proceeds to government.

Reflects debt-land swap equivalent to EC$565 million in 2013 and EC$202 million in 2014.

Policy Discussions

Discussions during the Article IV consultation focused on (i) securing fiscal sustainability following a widening of tax exemptions and greater uncertainty regarding future CBI inflows; (ii) strengthening the management of the CBI program and associated inflows; (iii) preserving financial stability following the debt-land swap and high liquidity; and (iv) implementing policies aimed at enhancing growth. These were also critical issues for the PPM review.

A. Safeguarding Fiscal Sustainability

10. The new VAT exemptions, combined with a weakening of the outlook for CBI inflows, increase fiscal vulnerabilities and raise new challenges to sustainability. The VAT and customs exemptions are estimated to lead to a direct loss of revenues of over 2 percent of GDP in 2015, relative to what they would have been, and a larger amount in 2016, when the full year impact will be realized.8 The projected weakening in the fiscal outlook, if not addressed, could quickly undo much of the gains achieved under the program. The fiscal balance (net of CBI) is projected to be in deficit by 5.3 percent of GDP in 2020, with a primary deficit (net of CBI) of 3.4 percent, compared to an overall deficit of 1.7 percent and a small primary surplus of 0.3 percent at the last review. Moreover, any slowdown in CBI inflows could further erode the tax base resulting in a higher shortfall than that implied from the direct loss in CBI revenues. The weaker fiscal outlook, combined with scheduled debt repayment, could substantially reduce accumulated fiscal buffers, and could trigger a renewed upturn in the debt-to-GDP ratio in case of an exogenous shock.

Impact of Recent VAT and Import Duties Exemptions on Fiscal Accounts

article image
Source: Authorities and IMF staff estimates
A01ufig7

Fiscal Balances

(in percent of GDP)

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Sources: Authorities and IMF staff estimates.
A01ufig8

Fiscal Balances - With Recommended Measures

(in percent of GDP)

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Sources: Authorities and IMF staff estimates.

11. Staff strongly recommended corrective action to safeguard fiscal and debt sustainability. The need for this is underscored by the country’s high vulnerability to external shocks (including natural disasters), the still high debt-to-GDP ratio, and heightened uncertainty regarding the sustainability of CBI inflows. Reversing the VAT exemptions and using the social safety net to more effectively target assistance to the poorer segments of the population is the optimal strategy. This would also reduce the pro-cyclicality of fiscal policy. Staff also presented alternative measures given the political difficulty of reversing recently granted VAT exemptions in the short run. These would bring back the fiscal path over the next 3 years to that envisaged in the 9th review. These measures include further reducing tax exemptions for construction projects, since the sector needs no further incentives given the CBI program, enhancing other tax measures, in particular, property tax, and slowing the pace of the already high level of capital spending. Moving forward with land sales would also lower expenditure by reducing dividend payments to banks. In addition, staff emphasized the need to continue implementing structural reforms, mainly continued strengthening of the tax administration, PFM reform, civil service reform, and improved targeting of social support, while containing expenditures and transfers. The proposed illustrative package would secure fiscal and debt sustainability over the medium term and place the authorities in a stronger position to deal with exogenous shocks.

12. The rest of the public sector must also play its part in maintaining a sound financial position. Continued monitoring and strict oversight of public sector activity must be a priority. In particular, the absence of financial statements for the electricity company, SKELEC, since its incorporation makes concrete assessments of its financial position difficult. Although SKELEC has improved its billing and metering, the company continues to face challenges, including in collecting overdue bills. Additionally, the recent government action to write off residential customer arrears of EC$21 million will need to be offset by some other asset or a reduction in liabilities. Staff stressed the need to devise a strategy to ensure the medium-term viability of SKELEC. Staff also noted that reforms to the Social Security Board will be needed, as outlays are expected to overtake total income by 2024, based on the 2013 actuarial review (Box 2).

Proposed Adjustments to Close the Primary Balance Gap by 2017

(in Percent of GDP)

article image

Net of changes in SIDF funding to the budget

  • Authorities’ views: The authorities broadly agreed that additional measures will be needed to preserve fiscal sustainability, but they stressed the importance of more widely sharing the benefits of the improved public finances. Exempting food and other basic necessities was a quick and direct way to deliver these benefits. They are looking to raise additional revenue by broadening the tax base, especially by reducing discretionary tax incentives and seek to optimize the benefits already provided to ensure that new construction projects contribute more to the economy (Box 3). They also plan to complete the ongoing work to revise the investment code to increase transparency and reduce discretion. They will look to update the valuation of properties to ensure that property tax collection is in line with recent market developments. They agreed with the need to continue public sector reforms, including strengthening the oversight of public enterprises, although they noted that reforming SKELEC will take time.

13. Substantial progress has been made in reducing public debt, although the debt-to-GDP ratio remains high and continues to be vulnerable to adverse shocks. Public debt declined to 79 percent of GDP at end-2014, and is half of that in 2010, reflecting further debt-land swaps, advance repayments, and economic growth. However, at nearly 80 percent of GDP, the debt remains high, and risks to debt sustainability over the medium term are elevated given plausible shocks (Annex III). Staff welcomed plans to further accelerate repayments, which are estimated to reduce debt to 66.3 percent of GDP at end-2015 compared to 73 percent if debt is paid as scheduled. The gross debt-to-GDP ratio is projected to fall to 52.1 percent by 2020, but in the absence of strengthening fiscal policy, accumulated government deposits will be depleted. Staff also recommended lengthening the tenor of debt instruments, which are mostly in the form of 91-day T-bills, while continuing to reduce borrowing costs as the government is now in a strong position to obtain better terms.

  • Authorities’ views: The authorities pointed to the substantial progress and further plans for advance debt repayment, including to the IMF. They have also agreed on a new repayment schedule with one non-Paris Club creditor, will repay another, and plan to finalize debt restructuring negotiations with other non-Paris Club creditors. They continue to work towards reducing borrowing cost on remaining outstanding obligations, and have had some success, including reducing the interest on new T-bills to rates ranging from 4.75 percent to 5.0 percent. However, lengthening the tenor of T-bills may be more challenging given the limited market appetite for longer maturities. NIA noted that they were facing challenges in raising funding.

B. Managing CBI Inflows and Improving the Accountability of the Sugar Industry Diversification Foundation

14. The reform of the CBI program to improve its operations and strengthen the due diligence framework will improve the program’s sustainability. The reforms being implemented include using a minimum of three due diligence companies to leverage their different strengths, incorporating a risk matrix to the reports, increasing CBI Unit staffing and upgrading IT to improve efficiency and reporting capacity. Steps taken to improve transparency of the operations and increasing collaboration with other programs in the region are also important for ensuring high standards for due diligence. Staff urged the government to quickly complete the reforms to the CBI Unit, while continuing to strengthen its oversight. Reforms will also be needed to enhance supervision and monitoring of real estate developments and ensure that the pipeline of CBI-related condominium developments be consistent with the tourism master plan.

The Social Security Board

The Social Security Board (SSB) is in a stable financial position with substantial investment funds. The SSB is currently in surplus, averaging 3.8 percent of GDP per year over 2009-2013, with a reserve-expenditure ratio of 20 years.1 Reserves have been increasing steadily reaching around 65 percent of GDP in 2013, the highest in the ECCU. The scheme is also the most liquid, with more than 60 percent of its assets in bank deposits, comprising 17 percent of total banking system deposits. Investments in the public sector, including in public sector enterprises, represented around 20 percent of the investment portfolio as of end-2014, while real estate investments comprised at least 7 percent.

A01ufig9

NIS Investments by Asset Class, 2014

(In percent of total)

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Source: Authorities and IMF staff estimates

The ageing population dynamics are expected to negatively impact the long-run sustainability of the SSB. Based on the 9th actuarial review, the dependency ratio of pensioners to working age persons is expected to more than double from 0.15 to 0.33 by 2035, and to triple to 0.44 by 2055. The 10th review indicates that the SSB will start running down resources between 2024-2030, and exhaust reserves between 2038 and 2044.2 Nonetheless, strong employment growth in the past two years has led to a significant increase in contributions, with benefit expenditure currently standing at 72 percent of contribution income.

Reform of the pension scheme should be a policy priority. The 9th actuarial review recommended reforms including: increasing the minimum retirement age for full pension entitlement from 62 to 65; raising contribution rates; increasing the period over which insurable earnings are averaged to calculate benefits; and indexing annual adjustments of pension payments to actual inflation. The investment portfolio of the SSB also needs to be diversified since the current asset mix is significantly exposed to the government and statutory bodies, including state-owned indigenous banks.

A01ufig10

St. Kitts and Nevis: NIS Financial Position

(in EC$ million)

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Source: Social Security Board and IMF staff estimates.
1 Reserve-expenditure ratio measures number of years of payments the fund could make if no future contributions or interest were received and no additional benefits were awarded.2 The 9th actuarial review was completed in 2010 and the 10th actuarial review in 2013.

Tax Incentives in St. Kitts and Nevis

More effort is needed to contain the magnitude of tax exemptions. Total exemptions granted in 2014 exceeded the EC$100 million cap introduced in the 2014 budget by EC$3 million.1 As a ratio to GDP, revenue forgone from tax incentives has remained stable since 2011. Additional exemptions were granted in late 2014 and April 2015, on food and other items, which will increase foregone revenue by about 2.5 percent of GDP.

The granting of tax exemptions involves considerable discretion. Several laws guide the granting of tax concessions, including the Fiscal Incentives Act, the Small Business Development Act, the Income Tax Act, the Stamp Act for Special Development Areas, the Special Resort Development Act, the VAT Act, the Hotels Aid Act, and the Duty Free Shop Act. However, Cabinet has the authority to grant concessions, and in practice, has discretion in almost all aspects of the decision, including the terms of the concessions. This results in many concessions being provided on a case-by-case basis, based on special Cabinet decisions.

A01ufig11

Tax Incentives: By Tax Type

(Revenue forgone in percent of GDP)

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Sources: Authorities and IMF staff estimates.

The tourism sector share of foregone revenue has declined.2 As with other ECCU countries, the main argument for granting concessions is to encourage investment in tourism. However, it appears that other factors are becoming increasingly important drivers of tax incentives as the share of revenue forgone from tourism has shrunk over time.

The authorities are considering strategies to improving the process of granting exemptions. In addition to maintaining the $100 million cap on discretionary exemptions, they indicated that the VAT and the Customs Service Charge will be excluded from negotiations pertaining to exemptions. The improved monitoring of exemptions granted, with monthly revenue-loss reports, may also aid in containing new exemptions. Staff encouraged the authorities to publish these reports to increase scrutiny of the benefits received by projects that are accorded incentives. Staff also suggested centralizing the power to grant and manage tax incentives at the Ministry of Finance as a move towards a more rules-based concessions system.

A01ufig12

Tax Incentives: By Activity

(Revenue forgone in percent of GDP)

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Sources: Authorities and IMF staff estimates.
1The cap and estimates exclude corporate income tax since the authorities do not have a reliable methodology to estimate forgone revenue from these sources. The FAD report “Tax Incentives and Property Taxation in the ECCU”, by Norregaard, J., E. Crivelli, R. Franzsen, and R. Krelove, IMF (2015), estimate these at 1 percent of GDP.2These estimates are about half of the estimates of tourism-related exemptions in the abovementioned study, so this may also reflect classification issues.

15. In light of the uncertainty surrounding future CBI inflows, careful management of the stock of accumulated savings should be a priority. Staff urged the authorities to create a comprehensive and transparent CBI management framework, build precautionary balances to address exogenous shocks, stabilize economic activity, and prepay debt. Indeed, the return on government deposits is likely to fall short of the cost of debt. CBI resources could also be used for investment in high-priority public projects, subject to a rigorous cost-benefit analysis. While such a framework may take some time to establish, the government should proceed with interim plans to invest these savings abroad, to reduce the pressure on banks’ profitability (see below).9

14. Strengthening of SIDF management and its integration with the government accounts should be a high priority. The SIDF has been increasingly involved in quasi-fiscal activities, including substantial expenditure under PEP (see below). A clear operational framework limiting these operations is needed. Transfers from the SIDF to the budget should also be limited, and be subject to clear rules, to ensure that the government operates with a clearly defined budget constraint. The selection of SIDF investment projects needs to be transparent and based on sound economic returns, while SIDF financial statements should be audited and released to the public on a timely basis.10 Over the medium term, staff recommends establishing an overarching framework to integrate saving and investment activities of the SIDF with the government under a SWF structure, with strong accountability and governance frameworks to preserve accumulated savings and allow for the sustainable use of the resources to face exogenous shocks and promote long-term development (Annex IV).

15. The operation and costs of PEP need to be streamlined. Around 3,300 persons were employed under the program as of end-March 2015, with a cost of about 3 percent of GDP for 2014. Although PEP supported employment when the economy was operating with considerable excess capacity, it needs to be downsized and refocused on skills development in line with labor market needs. Restructuring the program should include establishing a strict budget for its operations, limiting enrollment periods, and lowering the stipend below the minimum wage. Incentives should be put in place to ensure both applicants and participating employers treat it as a training opportunity rather than a permanent subsidy. Plans will need to be made to redeploy the majority of participants working at the public sector since these cannot be absorbed by the civil service, if fiscal discipline is to be sustained.

  • Authorities’ views: Substantial progress has already been made in reforming CBI operations and strengthening security. Government’s effort to coordinate with other programs in the region will help maintain high standards. Notwithstanding, the implementation of reforms must not be rushed, but given adequate time to implement the necessary changes to ensure a stronger and more credible program. The authorities plan to strengthen outreach to clarify the reforms and reduce adverse impressions that the program has stalled. They agreed that construction projects under the CBI program need greater scrutiny and are looking at options to maintain the value of real estate projects. They plan to reform the SIDF and are beginning to examine alternatives, and are eager to improve the transparency and accountability of its operations. They are keenly aware of the need to limit and reform PEP to move it to a sustainable path, but they will need to move gradually in light of the large number of participants.

C. Preserving Financial Stability

16. While the financial system has been stable, safeguards need to be strengthened. Financial soundness indicators have suffered due to the prolonged recession and the debt restructuring. The significant growth in deposits, reflecting government savings from CBI inflows, has also increased pressure on bank profitability. Going forward, banks need to reduce the NPL ratio and revisit their business model to improve credit growth and profitability while exercising caution with new lending to safeguard their asset quality. In particular, exposure to the long pipeline of CBI-financed real estate projects should be carefully considered, to ensure that the projects can be brought to closure. Meanwhile, the government needs to consider an alternative investment vehicle for government deposits to help alleviate excess liquidity.

St. Kitts and Nevis: Selected Financial Indicators, 2010-2014

article image
Source: ECCB
A01ufig13

St. Kitts and Nevis Banking System Liquidity

(In EC$ millions)

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Sources: St. Kitts and Nevis authorities and IMF staff estimates.

17. The regional banking resolution is progressing. The authorities should continue to consult with the ECCB on addressing regional financial sector issues following the completion of the asset quality reviews. We commend the authorities for ratifying the new banking law which will facilitate the implementation of the regional financial resolution plans.11 The government should continue to exercise caution and due diligence in assessing plans for regional financial integration to safeguard St. Kitts and Nevis’ banking system and ensure its viability and efficiency going forward.

18. Moving forward with the land sales will consolidate the progress with debt restructuring. Unwinding the debt-land swap would jeopardize the hard earned gains in fiscal and debt sustainability.12 An extension of the dividend agreement—a three year agreement to pay banks a dividend of 3.5 percent per annum on the stock of land held by the Special Land Sales Company (SLSC)—would provide time to consider options. The SLSC’s executive board should be reappointed and authorized to develop long-term strategies that would benefit the country. Moving forward with land sales will help enhance potential growth through the wider deployment of otherwise idle land assets. It will promote the development of a stronger middle class, stimulate construction by domestic developers for local consumption, and contribute to supporting other sectors, including medical schools, agricultural projects, as well as tourism.

19. Expansion of the offshore financial sector needs to follow best practices. New legislation passed in June 2015 in Nevis facilitates the establishment of offshore banks. Staff cautioned that offshore banks should comply with global AML/CFT regulations and enhanced reporting requirements for tax compliance (e.g. FATCA), and will require direct oversight and strict monitoring by the Financial Services Regulatory Commission (FSRC). It would also be important to consider ramifications on the onshore banking system, and potential loss of correspondent banking relations of indigenous banks.13 Additionally, any perception of an offshore banking jurisdiction as being a tax haven can negatively impact the image of the CBI program, leading to increased pressure by the international community through greater travel restrictions, undermining the sustainability of the CBI program.

  • Authorities’ views: They were mindful of risks related to the regional financial resolution and the high NPL ratio. On the challenges created by the debt-land swap, they noted that preserving public land is of special significance to the nation. Their first priority is to introduce transparency to the process, while considering the merits of individual transactions, ensuring that they are consistent with the government’s overall vision for the country. They will consider options for addressing the debt-land swap while developing a long-term strategy for land use that would be consistent with supporting strong economic growth. They assured staff that any new offshore bank would need to meet criteria established under the country’s Anti-Money Laundering legislation.

D. Stepping Up Growth-oriented Reforms

20. Reforms to support sustainable private sector development could reduce growth volatility and make the economic recovery underway more durable. The priorities are:

  • Enhance tourism’s contribution to the economy. Steadfast implementation of the new tourism master strategy will help diversify source markets, raise the value-added of tourism through upgrading hotel and infrastructure, develop niche markets and increase backward linkages to other economic sectors. Initiatives to enhance the quality of tourism service provision, including the center of excellence for human resource training, could provide much-needed skills to boost high-end tourism services.

  • Continue efforts to improve the investment climate. The development and implementation of a strategic plan to improve processes for registering property, securing credit, enforcing contracts and resolving insolvencies remain critical. Expeditious implementation of the new Bankruptcy and Insolvency Bill would help foster domestic credit growth.

  • Reduce dependence on fossil fuels. High energy cost is an important factor behind the high cost of doing business. Implementing the national energy initiative and identifying adjustments to the regulatory and institutional environment of the energy sector is crucial for the country’s energy independence. To that end, recent sharp declines in fuel prices heighten the need for cost analysis of energy-related initiatives (Annex V).

  • Improve statistical capabilities. Significant data gaps exist in the Balance of Payments and National Accounts and Fiscal statistics, hampering economic assessment and policy prescription. This reflects methodological challenges in estimating value added in various sectors, and the absence of data, including, for example, on the impact of the large number of medical school students on the economy. Harnessing technical assistance and accelerating institutional reforms, in particular through increased staffing and training, is critical to identifying and closing data gaps (Informational Annex).

  • Authorities’ views: The authorities agreed with these priorities and noted that substantive work has already taken place in this regard. The challenge is implementing these plans in a cost effective manner given capacity constraints in nearly all areas of government.

Staff Appraisal

21. Economic performance since the completion of the three-year Fund arrangement has been impressive. The economy continued to expand at a rapid pace, averaging just above 6 percent in both 2013 and 2014. Public finances remained on a very strong footing, notwithstanding the run up to the elections in early 2015, while the debt-to GDP ratio has fallen much faster than anticipated. The strong economic activity reflects primarily a construction boom fueled by inflows under the CBI program, government and SIDF investment and expenditure, including on PEP, and a continued recovery in tourist arrivals.

22. The outlook for 2015-2016 is positive, although the pace of expansion is expected to somewhat moderate and the economy remains vulnerable to changes in CBI flow. Over the medium term, staff projects a return to more moderate growth rates, as construction projects conclude and the tourism sector continues to expand. However, new developments with the CBI program, mainly loss of visa free access to Canada and considerable increase in competition from new programs in the region and globally, raise new concerns about the sustainability of the CBI inflows, which have played such a crucial role in turning around the economy.

23. The strong 2014 fiscal outturn was supported by robust tax revenues. Growth in tax revenues more than offset higher-than-planned expenditures, including the 13th-month wage bonus. CBI revenues to the budget increased to about 14 percent of GDP, also higher than in 2013. The strong fiscal outcome, combined with additional progress with the debt-land swaps and advance debt repayment, led to a further decline in public debt to 79 percent of GDP at end-2014, compared to 100.8 percent at end-2013, and 159.3 percent in 2010. St. Kitts and Nevis’ debt-to-GDP ratio is now below the ECCU average.

24. Recent policy changes will need to be addressed to safeguard the substantial achievements in fiscal and debt sustainability. The widening of the VAT and customs exemptions could lead to a growing fiscal imbalance that could quickly deplete the country’s accumulated savings, and lead to a reversal in the downward trend of the debt-to-GDP ratio, particularly if the country experiences an exogenous shock. Corrective measures are needed to prevent the adverse impact on government finances, including substantially reducing tax exemptions, while continuing to implement other structural reforms that are already in train, mainly further strengthening tax administration, implementing the civil service reform, and improving public financial management. Strengthening the performance of public enterprises, and moving forward with reforms of the social security system are also important.

25. The implementation of substantive measures to strengthen the administration and the security of the CBI program should improve its sustainability. We commended the authorities for their commitment to and progress with reforming the CBI program and their leadership in enhancing cooperation with neighboring islands. Increased risk to CBI inflows underscores the importance of careful use and preservation of the stock of accumulated savings. Staff urges establishing an effective and transparent framework to manage the CBI inflows and savings in the banking system, as well as more stringent oversight of development projects. The SIDF operations should also be reviewed, and its audited accounts should be made available to the public, with a view to its gradual integration with the budget. Moreover, the strong economic environment provides an opportunity to streamline PEP’s operations and reinforce the temporary nature of its program.

26. Financial stability has been preserved notwithstanding debt restructuring that has impacted financial soundness indicators. The resulting high NPL ratio may be inhibiting new lending, and efforts to bring it down rapidly together with continued vigilance to ensure that the high level of liquidity does not weaken credit practices will be needed. Moving forward with land sales would strengthen banks’ balance sheets, while securing the gains from debt restructuring and spurring growth. The dividend agreement with banks should be extended to allow more time to develop a comprehensive plan that would support long-term growth through the wider deployment of otherwise idle lands, while progress is made on a case by case basis.

27. Implementing growth enhancing measures is key to sustaining high growth over the medium-term. The current strength of the economic recovery provides an opportunity to undertake important reforms, including implementing the tourism master plan to enhance its value added, taking concrete measures to improve the business climate, and investing in alternative energy sources to reduce long-term energy costs.

28. Weak data quality is of increasing concern. Accelerating efforts to improve economic data is crucial to providing a better basis for policy decisions.

29. It is proposed that the next Article IV consultation be held on a standard 12-month cycle. The PPM framework will continue until outstanding Fund credit falls below 200 percent of quota, expected by May 2016, absent early repayment.

Figure 1.
Figure 1.

St. Kitts and Nevis in the Regional Context

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Sources: ECCB, authorities and IMF staff estimates.
Figure 2.
Figure 2.

St. Kitts and Nevis: Real Sector Developments

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Source: ECCB, authorities and IMF staff estimates.
Figure 3.
Figure 3.

St. Kitts and Nevis: Fiscal Sector Developments

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Sources: ECCB, authorities and IMF staff estimates.
Figure 4.
Figure 4.

St. Kitts and Nevis: External Sector Developments

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Sources: ECCB, authorities and IMF staff estimates.
Figure 5.
Figure 5.

St. Kitts and Nevis: Monetary Developments

Citation: IMF Staff Country Reports 2015, 248; 10.5089/9781513519470.002.A001

Sources: ECCB, authorities and IMF staff estimates.
Table 1.

St. Kitts and Nevis: Basic Data

article image
Sources: St. Kitts and Nevis authorities; ECCB; UNDP; World Bank; and Fund staff estimates and projections.

IMF Country Report No. 14/297.

GDP growth in 2013 has been revised upwards following technical assitance by CARTAC.

In relation to broad money at the beginning of the period.

Central government unless otherwise noted. Primary and overall balances are based on above-the-line data.

Decline in goods and services expenditure in 2012 reflects the corporatization of the Electricity Department from August 2011.

2012 disbursement includes financing to regularize the external arrears related to fuel purchases.

Reflects operations linked to the restructuring of public debt.

Reflects the debt-land swap equivalent to EC$565 million in 2013 and EC$231 million in 2014.

Table 2.

St. Kitts and Nevis: Central Government Fiscal Operations, 2010–20 1/

(In millions of Eastern Caribbean dollars)

article image
Sources: St Kitts and Nevis authorities; and Fund staff estimates.

Combined accounts of the Federal Government of St. Kitts and Nevis and the Nevis Island Administration.

IMF Country Report No. 14/297.

The sharp drop in international taxes and concurrent rise in taxes on domestic goods and services reflect the introduction of VAT in November 2010.

Data from August 2011 exculdes the electricity department following its corporatization.

Includes a 3.5 percent dividend payment on unsold lands held by the Special Land Sales Company (St. Kitts) Limited and the Land Sales Company in Nevis, that were transferred, as part of the debt-land swap agreement.

2012 disbursement includes financing to regularize the external arrears related to fuel purchases.

Estimated from below the line based on the monetary survey and public sector debt data. May differ from actual operating balance.

Table 3.

St. Kitts and Nevis: Central Government Fiscal Operations, 2010–20 1/

(In percent of GDP)

article image
Sources: St. Kitts and Nevis authorities; and Fund staff estimates.

Combined accounts of the Federal Government of St. Kitts and Nevis and the Nevis Island Administration.

IMF Country Report No. 14/297.

The sharp drop in international taxes and concurrent rise in taxes on domestic goods and services reflect the introduction of VAT in November 2010.

Data from August 2011 exculdes the electricity department following its corporatization.

Includes a 3.5 percent dividend payment on unsold lands held by the Special Land Sales Company (St. Kitts) Limited and the Land Sales Company in Nevis, that were transferred, as part of the debt-land swap agreement.

2012 disbursement includes financing to regularize the external arrears related to fuel purchases.

Estimated from below the line based on the monetary survey and public sector debt data. May differ from actual operating balance.