ST. Lucia: 2018 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for ST. Lucia
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International Monetary Fund. Western Hemisphere Dept.
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Publication Date:
20 Jun 2018
eISBN:
9781484362617
ISBN:
9781484362617
Language:
English
Keywords:
ISCR; CR; investment; expenditure outlay; GDP; tourism sector; staff estimate; time deposit; financing risk; Credit bureaus; Credit; Caribbean
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2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for St. Lucia

Abstract

2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for St. Lucia

Recent Developments and Outlook

A. Context

1. St. Lucia faces challenges common to many small states. Its economy has become increasingly dependent on tourism after the erosion of EU trade preferences led to downsizing banana production in the 1990s. Its narrow economic base, shallow financial system, and almost complete reliance on imported fossil fuel make it particularly vulnerable to external shocks while low productivity, weak institutional capacity, and natural disasters limit its growth potential. Tourism is limited by capacity constraints, including an inadequate road network and an outdated international airport. The Global Financial Crisis (GFC) dealt a severe blow to the economy, reflected in a protracted period of low or negative growth, rising public debt as the government increased the size of the public sector partly to cushion the impact of the crisis, and banks still dealing with legacy NPLs.

2. A particularly important vulnerability arises from the consequences of climate change. As underscored in the CCPA pilot, St. Lucia is one of the countries most exposed to natural disasters, with average annual damages exceeding 1 percent of GDP. More frequent and severe natural disasters would substantially harm long-term growth and fiscal sustainability. In a high CO2 emissions scenario, the average impact of natural disasters would increase from 3½ percent of GDP or more to at least 5 percent of GDP.1 Tax revenues would be negatively affected, and additional expenditure would be needed for immediate relief, social support, infrastructure rehabilitation, and reconstruction.

3. The authorities are taking measures to address these challenges. The government is trying to boost growth and restore fiscal sustainability by enhancing the potential of tourism with stronger marketing and new international hotel operators; reducing some taxes (VAT) while increasing others that the authorities deem more growth friendly (aviation taxes, road fuel tax); fostering revenues through the Citizenship-by-Investment Program (CIP); and improving the efficiency of the public sector. St. Lucia is a regional leader in climate change preparedness, with a balanced mitigation strategy backed by investment plans that have been costed, and a qualitative adaptation strategy with identified priorities. Staff advice has had some traction (Annex I).

B. Current Trends

4. Economic activity remained strong. Real GDP grew by 3 percent in 2017, driven by tourism, construction, and wholesale and retail trade (Figure 1). Stay-over arrivals grew by 11 percent, the fastest in the Caribbean, while the cruise ship segment rebounded from its decline in 2016. Several hotel expansions increased the room stock by about 10 percent and the addition of new flights increased airlift capacity by 5 percent. Conversely, agriculture experienced a contraction owing to the lingering effects of tropical storm Matthew. Backed by strong tourism inflows, the current account balance moved from a deficit of 1.9 percent of GDP in 2016 to an estimated surplus of 1.3 percent of GDP in 2017. Unemployment declined from 21.3 percent in 2016 to 20.2 percent in 2017, but youth unemployment remains high at 38.5 percent and labor force participation has fallen (Figure 5, Table 6). Inflation turned positive again after two years of oil-price related deflation.

Figure 1.
Figure 1.

St. Lucia: Stronger Growth and External Balance on Account of Rising Tourism Inflows

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Figure 2.
Figure 2.

St. Lucia: Persistent Weaknesses in the Financial Sector

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources: Country authorities; and IMF staff estimates.
Figure 3.
Figure 3.

St. Lucia: Baseline and Adjustment Scenarios

(Central Government, percent of GDP)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources: Country authorities; and IMF staff estimates.
Figure 4.
Figure 4.

St. Lucia: External Competitiveness and Structural Weaknesses

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Figure 5.
Figure 5.

St. Lucia: Unemployment

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Table 1.

St. Lucia: Selected Social and Economic Indicators, 2014–2023

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Sources: St. Lucia authorities; ECCB; and Fund staff estimates and projections.

Fiscal year (April–March) basis.

Comprises public sector external debt, foreign liabilities of commercial banks and other private debt.

Table 2a.

St. Lucia: Central Government Operations, 2014–2023 1/ (In millions of EC dollars)

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

Fiscal year (April–March) basis.

Includes revenue from the Airport Development Tax, which is fully transferred to St. Lucia Air and Sea Ports Authority.

Includes transfer to St. Lucia St. Lucia Air and Sea Port Authority corresponding to the Airport Development Tax.

Includes roads rehabilitation in 2018 and 2019, implemented by private Special Purpose Vehicle, financed through a US$50 million from the government of the Taiwan, Province of China.

Natural disaster costs are annualized estimated costs (see Box 1).

Direct debt and debt of the parastatal entities (including debt guaranteed by the central government).

Table 2b.

St. Lucia: Central Government Operations, 2014–2023 1/ (In percent of GDP)

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

Fiscal year (April–March) basis. Figures shown for a given calendar year relate to the fiscal year beginning on April 1 of that year.

Includes revenue from the Airport Development Tax, which is fully transferred to St. Lucia Air and Sea Ports Authority.

Includes transfer to St. Lucia St. Lucia Air and Sea Port Authority corresponding to the Airport Development Tax.

Includes roads rehabilitation in 2018 and 2019, implemented by private Special Purpose Vehicle, financed through a US$50 million from the government of Taiwan, Province of China.

Natural disaster costs are annualized estimated costs (see Box 1).

Direct debt and debt of the parastatal entities guaranteed by the central government.

Table 3.

St. Lucia: Balance of Payments Summary, 2014–2023

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Sources: Ministry of Finance and Planning; ECCB; World Bank, and Fund staff estimates and projections.

Includes largely gross foreign liabilities of commercial banks and other private debt.

Table 4.

St. Lucia: Monetary Survey, 2014–2018

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Sources: St. Lucia authorities; ECCB; and Fund staff estimates and projections.

End-of-period rates.

Table 5.

St. Lucia: Banking System Summary Data, 2010–2017

Table 5. St. Lucia: Banking System Summary Data, 2010–17

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Correspond to indigenous banks only.

Sources: ECCB; and IMF staff estimates.
Table 6.

St. Lucia: Selected Labor Market Indicators, 2010–2017

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Sources: St. Lucia Population and Housing Census and National Insurance Corporation.

5. Based on preliminary data, the fiscal stance deteriorated slightly in FY2017/18, reflecting additional spending. The primary surplus declined, owing to increases in current and capital spending that were only partially offset by higher revenues from airport taxes, road fuel tax, and CIP.2 As a result, the overall fiscal deficit and public debt continued to rise. The authorities have raised fuel prices, which were capped and limited revenues, and outlined intentions that would help strengthen the fiscal position, including that of a new residency program and tax reforms, but no policy decisions have been taken yet. A system of targeted social assistance, expected to be in place by year end, should help protect low-income households when some of the measures are enacted. The authorities have secured concessional financing from Taiwan, Province of China, the terms of which are yet to be finalized, aimed at revamping the airport (US$100 million) and the road network (US$50 million).3

St. Lucia: Banking Sector Soundness Indicators’ Map 1/ 2/

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Source: ECCB and IMF staff calculations.

Red, orange and green cells represent high, medium and low risks, respectively.

The indicators do not reflect the forthcoming prudential regulations or the introduction of IFRS9 and thus the map can potentially understate the provisioning needs and related risks.

Corresponds to indigenous banks only.

6. Banks continued to underperform while the non-bank sector expanded further. NPLs are still hovering at 12.5 percent of total loans, contributing to low profitability and contracting credit to the private sector since 2013 (Figure 2). The Eastern Caribbean Asset Management Company (ECAMC), which is part of the regional strategy to help banks clean their balance sheet, started operating last year, but faces capacity challenges. New insolvency and foreclosure laws, which would help simplify the resolution of NPLs, are still under preparation. Indigenous banks managed to maintain their corresponding bank relationships (CBRs), although at higher costs. Credit unions continued their expansion, with assets and membership growing respectively by 42 and 20 percent since 2014. Total assets of credit unions represented about 15 percent of total assets of banks in 2017.

C. Outlook and Risks

7. The short-term outlook is favorable, but prospects beyond that are sobering. GDP growth is expected to remain buoyant in the near term, supported by large infrastructure investment, tourism-related FDI, and continued tourist inflows driven by the global recovery and increased capacity. However, weaknesses in the banking sector will continue to be a drag on growth. Reflecting the increase in capital spending, the fiscal and external positions will deteriorate. Over the medium term, growth will decline gradually as pipeline projects are completed, and the current account deficit will narrow. In the absence of corrective fiscal measures, public sector wage negotiations and rising interest rates will add to expenditure pressures and government debt.

8. Downside risks dominate (Annex II). Policy uncertainty in major advanced economies and tighter global financing conditions could be a drag on global growth and tourism demand. Tax erosion may occur from concessions to tourism and other sectors and tax revenues earmarked for the repayment of infrastructure loans may fall short, further weakening the fiscal position and increasing the risk of an abrupt fiscal adjustment. Risks related to the assessment of compliance with international tax rules, slow progress in addressing bank weaknesses, and a growing non-bank financial sector could undermine financial stability and growth. Over the medium term, high production costs, low productivity, and a difficult business environment will continue to limit growth potential. The projected rise in the frequency and severity of natural disasters and the impact of climate change cast a shadow on long-term economic prospects.

9. The external position is broadly consistent with fundamentals and desirable policies. The very narrow base of the economy as well as a range of non-price indicators point to competitiveness challenges, with the main impediments stemming from a poor business environment and a large disconnect between wages and productivity (Annex III).

Policy Discussions

A. Attaining Fiscal Sustainability and Resilience to Climate Change and Natural Disasters

10. The deterioration of the fiscal position has its roots in the government’s response to the GFC. An expansion of the public service payroll and wage rises in the middle of the crisis increased the wage bill by 2 percent of GDP from 2007 to 2012 (not including temporary work programs). Staff simulations indicate that, had the wage bill been anchored to nominal GDP, the debt target of 60 percent of GDP would have already been attained. A wage freeze in 2013–16 contained the wage bill, but further efforts are needed to fully reverse its previous expansion. Subsequent attempts to correct the fiscal imbalance have been too timid to stabilize debt.

uA01fig01

Wage Bill Anchor Since 2007

Debt-to-GDP (%)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

* Assumes the wage bill grows in line with nominal GDP.

11. In the absence of a correction, financing pressures will persist and public debt will continue to rise. Despite the recent GDP revision, which led to an improvement in the debt-to-GDP ratio, public debt remains high, with a large short-term component generating significant rollover risks.4 Growing expenditure pressures—related to infrastructure investment, the upcoming negotiation of public employees’ compensation, and rising interest rates—will add further to public debt, which is projected to reach 81.3 percent of GDP in 2023.5 External debt is expected to increase to 74.9 percent of GDP over the same period (Annex IV). Some uncertainty in the projections relates to the degree of transmission of rising global interest rates to domestic rates, which staff assumes is partial based on empirical evidence (Annex V), and the authorities have not fully incorporated in their framework. Nonetheless, even in the absence of passthrough from international to domestic interest rates, the debt trajectory would remain unsustainable.

uA01fig02

Effect of Rising Global Interest Rates on Debt Projections

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

* Rates on external borrowing increase one-on-one with global rates.** Pass-through to local rates is 0.2 for short term debt and 0.1 for medium-to-long term borrowing.

Central Government Cash Flows Under a Baseline Scenario 1/

(Millions of Eastern Caribbean dollars, fiscal years)

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Projections assume no asset transactions and that existing investors roll over maturing debt. Scenario assumes that there are no significant changes in fiscal policy in the future.

12. Building resilience to climate change and natural disasters could help strengthen the fiscal position and reduce macroeconomic volatility. Given the fiscal costs associated with these events, climate change mitigation and adaptation policies, discussed in in the CCPA pilot (SM/18/131), are a key component of a medium-term fiscal strategy. Appropriate plans could help unlock concessional climate finance and undertake the necessary investment in resilience.6 Particularly important, in this regard, is the costing of investment plans in the now completed National Adaptation Plan. The development of renewable energy sources will be crucial to attain the authorities’ emission target under the Paris accord, lower exposure to oil price fluctuations, and reduce high electricity costs. Together with strong fiscal buffers, these policies can have a growth dividend, which would help in the fiscal adjustment effort.7

13. A fiscal adjustment of 2.7 percent of GDP is needed to attain the ECCU debt target of 60 percent of GDP by 2030. The adjustment would be implemented over the next six years to accommodate additional spending for resilience building and the gradual implementation of some revenue and expenditure measures. This approach balances the need to address short-term financing risks and attain the regional debt target with the objective of building resilience to climate change and natural disasters (Figure 3). Elements of such an adjustment include:

  • Reducing the wage bill closer to its pre-crisis level by anchoring it to CPI inflation during the adjustment period. This could be done through a combination of general wage control (using fiscal health parameters in wage negotiations), introduction of performance-based pay, attrition, payroll audits, and private sector participation in the provision of public services (1.2 percent). Once the adjustment is completed, the wage bill could be anchored to nominal GDP (see ¶14).

  • Streamlining exemptions to VAT and zero-rated items to reverse the impact of the recent rate cut (0.6 percent).8

  • Eliminating energy subsidies, allowing fuel prices to move in line with international prices, and introducing a carbon tax to help attain the emission target and speed up the shift to renewable energies (1.1 percent).

  • Phasing out temporary work programs (0.3 percent) while increasing targeted social spending, including to protect low-income households from the impact of the carbon tax (-0.5 percent) in an efficient and cost-effective manner.

  • Building a saving fund for natural disasters of 5 percent of GDP by 2021, financed by CIP revenues, carbon taxation, with a governance framework based on international best practices.9

  • Increasing investment in resilience to climate change and natural disasters.10

Staff Recommended Adjustment Scenarios 1/

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Source: IMF staff calculations

Under the baseline scenario, the government faces an annualized natural disaster cost of 1 percent of GDP, of which 0.66 percent is not covered by insurance. In the adjustment scenario, a saving fund of 5 percent of GDP is built in 2018- 2020, with annual replenishment costs of 0.56 percent of GDP.

Higher GDP growth resulting from the temporary impact of adaptation investment on aggregate demand and the permanent impact of the savings fund and re silient capital. See footnote 12 .

Including 10 percent of carbon tax revenue to offset negative impact on bottom quintile.

Higher growth in the adjustment scenario will come from both temporary and permanent effects of additional investment in resilience and the saving fund.11 Other revenue enhancing measures could be considered, including streamlining of other tax exemptions, or the introduction of other taxes with economic or social rationale, such as sin taxes, which are being considered by other countries in the region given the high prevalence of non-communicable disease.

14. Adopting a fiscal rule would support the adjustment effort, as it did in other ECCU countries. Enshrined in a fiscal responsibility legislation, the fiscal rule would define appropriate institutional arrangements; the coverage of government and fiscal aggregates, with due consideration for capital spending; implementation procedures—including links with the budget process and escape clauses—; automatic correction mechanisms; and sanctions and supporting mechanisms for enhanced fiscal transparency and accountability. The fiscal rule could be based on the ECCU debt target for 2030, and include a cap on the wage bill (in percent of GDP). Such cap has proved useful as a coordination device for public wage negotiations in Grenada. The fiscal rule should accommodate the buildup of a natural disaster fund and its annual replenishment (estimated at 0.6 percent of GDP) and include specific clauses linking disbursements from the fund to natural disasters.

15. Continued efforts in enhancing PFM and public investment management are needed to underpin fiscal consolidation and resilience building while a rationalization of tax incentives will reduce fiscal risks. The 2017 PEFA report shows progress in several areas, reflecting also TA support from CARTAC. Several weaknesses, however, remain in budget implementation, dissemination of fiscal planning documents, financial information on the large parastatal sector, public procurement, payroll, and other payment controls. Key measures recommended in the PEFA action plan include revising the Public Enterprise Monitoring (PEM) Act and the PFM Act to expand coverage of parastatals, clearing the backlog and improving annual financial statements of public institutions, and strengthening procurement planning, operations, and transparency. Resuming the public-sector investment plan (PSIP) and strategies to strengthen appraisal and monitoring would ensure effective implementation.12 Increased transparency on tax expenditures is particularly important to ascertain their real costs and prioritize their use against other government programs, and comprehensive budgeting for these items should be introduced and published regularly. Rationalizing the structure of tax incentives and introducing a rules-based approach to minimize discretion would reduce the risk of base erosion.

B. Strengthening the Financial Sector

16. Progress in lifting obstacles to bank lending remains slow. NPLs have been gradually declining as banks made efforts to remove bad assets from their balance sheets. However, they remain high, reducing banks’ ability and willingness to lend to the private sector. Some progress has been made on new insolvency and foreclosure laws, albeit at slow pace. Capitalization levels are low relative to the rest of the region, and the upcoming implementation of prudential regulations and introduction of IFRS9 could require some banks to increase their capital to reach the regulatory minimum. The implementation of a regional credit bureau is advancing, even though the adoption of the Harmonized Credit Reporting Act is still pending.

uA01fig03

St. Lucia – Credit by Commercial Banks

(EC million)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources: ECCB; and IMF Staff Estimates.
uA01fig04

Real GDP and Financial Intermediation

(Index, 2000=100)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source: ECCB; and IMF Staff Estimates.
uA01fig05

GDP vs. Total Credit from Banking Sector

(Growth rate, percent)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source: ECCB; and IMF Staff Estimates.

St. Lucia vs. ECCU Financial Soundness Indicators (2013–2017)

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a/ Corresponds to indigenous banks only. Source: Eastern Caribbean Central Bank.

17. The ECAMC needs additional resources and a strong commitment by stakeholders to become fully operational. While the ECAMC, which started operating in mid-2017, has showed capacity to act as a receiver for failed banks, its ability to purchase and/or manage NPLs from regional banks is limited.

18. Financial stability risks may arise from credit unions, where potential difficulties stemming from the rapid increase in lending could affect banks via deposits held by credit unions in the banking system. The expansion of credit unions might be driven by tighter bank credit standards, favorable taxation, and a looser regulatory environment, highlighting the need for a stronger regulatory and supervisory framework. To monitor these risks more closely, the Financial Services Regulatory Authority has implemented risk-based supervision and intensified onsite inspections, but new harmonized legislation on credit unions has not been adopted yet.

19. While the loss of CBRs has been limited for indigenous banks, costs have increased significantly. The loss of CBRs has been confined to money service businesses and the offshore sector, with apparently limited impact on the economy and the financial sector.13 Indigenous banks have preserved their CBRs, but are actively looking for new ones to minimize risks in a context characterized by uncertainty and heightened pressure from correspondent banks. Fees for most operations have increased substantially in the last two years (from 50 to 100 percent in some cases), but banks have not passed on the additional cost to customers yet. Banks also reported additional allocation of resources to address AML/CFT requirements and rising cyber security risks. The needed legislative changes to transfer AML/CFT supervisory powers to the ECCB are still pending.

20. Reputational risks arise from the CIP and the international taxation regime. After the changes to the CIP introduced in 2017 (IMF Country Report No. 17/76, Box 3), interest for the program has gradually increased while these programs are under increased international scrutiny for the integrity of the screening process and regional competition has eroded revenues in other countries. St. Lucia has been included by the EU in a “grey list”, which comprises jurisdictions that are not in line with EU standards against tax avoidance, but have committed to adjust their rules and practices.

C. Removing Structural Obstacles to Growth

21. Limited access to credit, weak contract enforcement, and high electricity and trading costs remain significant bottlenecks. Owing to these factors, St. Lucia’s ranking in the World Bank’s Doing Business, has deteriorated steadily in recent years (Figure 4). Several measures, including the establishment of a commercial court, e-payment for government services, and an online application system for trade licenses have been implemented, but their expected positive economic effects will take time to materialize. The authorities are preparing a national competitiveness strategy in cooperation with Compete Caribbean, which will entail the inclusion of St. Lucia in the World Economic Forum competitiveness indicator. Lower electricity prices will be possible only when a significant portion of renewable sources comes on stream, but removing the existing cap for solar energy production could help reduce business costs in the interim. To further reduce operational costs, lower import duties for raw material could be considered. Reforms to institute a credit bureau and broaden the range of assets to be used as collateral, together with an appropriately-regulated non-bank financial sector, should help improve access to credit.14

22. Labor market and education system reforms are critical to reduce unemployment particularly among the youth. High structural unemployment, relatively high wages, and a disconnect between productivity and wages reflect a poorly functioning labor market and weigh on external competitiveness (Annex IV and Figure 5). Continued revisions to the labor code are necessary to help alleviate some of these rigidities, including a reform of the lengthy and costly redundancy procedures and generous leave practices. Targeted initiatives are also necessary to address high youth unemployment, including by upgrading skills through targeted training programs, promoting apprenticeships, encouraging entrepreneurship, and better aligning the education system with labor market needs.

uA01fig06

Caribbean: Firms with a Loan or Credit Line

(% SMEs)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources: World Bank Enterprise Survey and IMF staff calculations
uA01fig07

Caribbean: Access to Credit as Major Constraint

(% SMEs that responded “yes”)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources: : World Bank Enterprise Survey and IMF staff calculations

23. Expanding the narrow production and export base could help provide buffers against fluctuations caused by external shocks and the seasonal nature of tourism. Backward linkages of tourism, particularly in agriculture, should be strengthened. The authorities’ export strategy identifies activities that can increase diversification and exports, which include industries where economies of scale are less important, like business processing, ICT, creative industries, and spa and wellness. The establishment of OJO Labs—the Caribbean’s first Artificial Intelligence Contact Centre—should encourage further investment in outsourcing. Business incubators should be further used to promote entrepreneurship. In some industries, like agro-processing, greater access to regional markets will be key.

D. The Authorities’ Position

24. The authorities recognized that reaching the ECCU debt target requires corrective measures, which they were considering. The authorities were contemplating revenue-enhancing measures, including streamlining exemptions to VAT, a property tax reform, a reform of taxation of hotel stays, and a new residency program. Some of these measures would be implemented after a new system of targeted social assistance is in place by year end. On spending, the authorities confirmed that continued wage moderation in the public sector is essential. They were considering savings from privatizations, outsourcing of the largest public hospital, closure of some state-owned enterprises, modernization of government services, and pension reform for public employees not covered by the National Insurance Corporation. Their debt management strategy was focused on lengthening maturity and reducing servicing costs.

25. Views differed on the size of the required fiscal adjustment, which the authorities estimated at about 1.5 percent of GDP based on a more optimistic view of interest rates and the non-inclusion of natural disasters costs in their framework. They agreed that a fiscal resilience framework, regardless of whether it includes a savings fund for natural disasters, would help sustain the adjustment effort and were discussing with the World Bank a Development Policy Loan to support work on this issue. On fiscal reforms, they confirmed their commitment to the recently updated PFM action plan, including new legislation on procurement, and plans to strengthen public investment management with capacity building and the revival of the PSIP. They also noted that the epartment of Commerce had started consultations on a more structured and transparent approach to tax concessions for manufacturing.

26. The authorities stressed the urgency of donors’ support of policies to enhance resilience to climate change and natural disasters. With assistance from the World Bank, the authorities were preparing a Disaster Risk Financing Strategy based on several components, including insurance (CCRIF) and contingent financing (CAT-DDO), for which discussions with the World Bank were at an advanced stage. They recognized that the annual flows to the contingency fund included in the draft PFM law (0.5 percent of revenues) may be small to accumulate an adequate fiscal buffer, but noted the challenges in building a savings fund of the size proposed by staff and suggested that the recapitalization of CCRIF supported by donors would be a better option. They noted continued progress on the renewables program and a more active approach to secure concessional financing from climate funds and multilaterals.

27. The authorities concurred on steps to strengthen the financial sector. They noted that new legislation on foreclosure, insolvency, assets to be used as collateral, and credit reporting is expected to be completed during the current fiscal year. They supported the full operationalization of the ECAMC, which could benefit some of the indigenous banks. They also agreed on the importance of measures to further strengthen supervision and minimize CBR-related risks, and noted their commitment to address gaps in compliance with international standards on tax rules by year end.

28. The authorities agreed that structural impediments must be addressed to boost sustainable growth and reduce unemployment. Efforts were underway to improve the business environment, particularly to ease access to credit, and boost productivity, including through greater focus on innovation and implementation of new technologies in the public sector. Programs to enhance education and provide an adequate skill set were expected to improve employability of young people. While the focus remained on expanding the tourism industry, the authorities acknowledged potential gains from greater diversification and identified priority sectors within their new export strategy.

Staff Appraisal

29. Growth prospects remain good in the short term, but the longer-term outlook is challenging. Favorable external conditions and a mild fiscal stimulus sustained growth in 2017. A favorable external environment and major private and public investment projects are expected to provide continued support to growth. However, risks to global growth, natural disasters, and fiscal risks weigh on the outlook. Over the medium term, structural bottlenecks, high production costs, and low productivity will continue to dampen growth prospects.

30. Fiscal adjustment, anchored by the ECCU debt target, should focus on broadening the tax base, controlling expenditure, and improving financing terms. Public debt continues to be unsustainable under current policies and its large short-term component magnifies financing risks. The necessary adjustment should concentrate on streamlining the extensive tax exemptions, which undermine the revenue base and the efficiency of the tax system; and on controlling the government wage bill, inflated by wage and payroll increases during the GFC, through continued wage moderation and public-sector reform. When feasible, targeted social assistance should replace temporary work programs and non-targeted subsidies, which are less efficient and fiscally costlier. Increased reliance on concessional financing and a shift to longer-term instruments should reduce servicing costs and mitigate rollover risks. A fiscal responsibility framework, defining institutional arrangements, coverage of government and fiscal aggregates, implementation procedures, automatic correction mechanisms, and mechanisms for transparency and accountability, would help provide operational targets consistent with the ECCU debt target and the discipline required to attain them.

31. Building needed resilience to climate change and natural disasters is an essential part of the medium-term economic strategy. Investment plans under the National Adaptation Plan should now be costed and fully integrated into development plans and fiscal medium-term frameworks, and a financing strategy, based primarily on grants, prepared. Financial protection against natural disasters requires a layered approach, involving a broad set of tools, including self-insurance, insurance, and financial innovation. However, high public debt and limited risk-transfer instruments suggest that self-insurance has a key role in preparing for natural disasters. Considering the historic cost of disasters and their expected intensification, a savings fund of 5 percent of GDP, with a strong governance framework, would provide the necessary resources for relief and reconstruction without increasing public debt when disasters occur. Revenues from the Citizenship-by-Investment program (CIP) and the new residency program, together with receipts from a carbon tax, could be used to finance this fund. A carbon tax, introduced gradually with appropriate compensation for low-income households, would also reduce risks to attaining emission targets.

32. Continued fiscal reforms should underpin fiscal consolidation and resilience building. Despite progress in several areas, improvements are needed to broaden the coverage of public institutions, enhance timeliness and transparency of financial reporting, and strengthen procurement, in line with the recently updated PFM Action Plan. Reviving the PSIP and further strengthening project appraisal and monitoring will enhance public investment efficiency and adequately support the government strategy to build resilience to climate change and natural disasters. A rationalization of tax expenditures in all economic sectors, based on a transparent rules-based system, is critical to reduce the risk of base erosion and improve revenue predictability.

33. Financial sector policies need to address promptly legacy issues and emerging risks. The rapid approval of new foreclosure and insolvency legislation is needed for the resolution of NPLs and the resumption of bank lending. In addition, the authorities should use their representation powers on the ECCB Monetary Council to ensure that the ECAMC can efficiently collect and dispose of distressed assets. In view of the imminent implementation of IFRS9, and of prudential regulations on provisioning and valuation, indigenous banks’ capitalization must be increased. The rapid rise of lending from credit unions and microfinance companies calls for strengthened monitoring and supervision of these entities and a rapid approval of the regionally harmonized regulation. A swift adoption of the Harmonized Credit Reporting Act and the creation of a credit bureau would help contain future losses from NPLs and facilitate financial intermediation. CBR pressure would be mitigated by sustained efforts in strengthening the AML/CFT regime, including by risk-based supervision; reinforcing governance, transparency, and due diligence procedures of the CIP; addressing gaps in compliance with international tax rules; and deepening collaboration and information sharing between respondent and correspondent banks. In the medium term, transferring AML/CFT supervisory powers to the ECCB would further reduce these risks.

34. Addressing structural impediments and increasing economic diversification would boost sustainable growth and reduce external vulnerabilities. This requires enhancing a weak investment climate and reducing labor market rigidities that delink productivity and wages. Improving access to credit, including by completing the credit bureau, and reducing the comparatively high costs of trading and energy should remain priorities. Training apprenticeship programs and better aligning the education system with labor market needs would help reduce structural unemployment, particularly among the youth. Strengthening tourism backward linkages with agriculture, and developing sectors where economies of scale are less important, including business processing outsourcing, ICT, creative industries, and spa & wellness seem to be promising avenues to increase diversification

35. The 2016 update safeguards assessment found that the ECCB continues to maintain a governance framework that provides for independent oversight. Transparency in financial reporting has been maintained and the external audit mechanism is sound. The ECCB has restructured the internal audit function and established an independent risk management unit in line with leading international practice.

36. Statistics are broadly adequate for surveillance. However, the lack of historical data on the external sector based on BPM6 hampers the assessment of the external position.

37. Staff recommends that the next Article IV Consultation for St. Lucia take place on the standard 12-month cycle.

Annex I. Implementation of Previous Staff Advice

Progress on 2017 Article IV Policy Recommendations

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Annex II. Risk Assessment Matrix1

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Annex III. External Sector Assessment

Driven by strong performance of tourism, St. Lucia’s largest export sector, the external position has improved since last year and is assessed as broadly in line with fundamentals and recommended policies. However, high structural unemployment, a disconnect between wages and productivity, high costs of energy and trading, and poor access to credit, limit non-tourism related exports and point to the need for structural reforms to improve competitiveness and strengthen the external position further.

Balance of Payments – Background and Outlook

1. The shift to BPM6 data dramatically improves 2014–2016 current account (CA) balances. In July 2017 the ECCB published the estimates of the 2014–2016 Balance of Payments (BOP) data for ECCU countries and discontinued compilation of BPM5 data. With the shift to the new methodology, St. Lucia’s current account improved markedly, moving from large deficits to large surpluses in 2014 and 2015. The bulk of this adjustment is explained by the balance of services, in which travel expenditures are now based on updated tourist expenditure surveys and include students at offshore universities. The balances on trade and net income have worsened with the move to the new classification, but not sufficiently to offset the improvement in services. However, a recent CARTAC mission has indicated that further adjustment to the historical data is expected due to incorrect estimates of re-exports and possible double-counting of exports of alcoholic beverages. The correction will amount to a reduction in the current account balance of about 2.2 to 3.1 percent of GDP.

uA01fig08

Current Account Balance (BPM6)

(In pecent of GDP)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources: Country Authorities; and IMF Staff Estimates.
uA01fig09

BPM6 VS BPM5 2016

(in percent of GDP)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

2. St. Lucia’s external position improved markedly in 2017 because of a strong tourism performance. After a deficit of -1.9 percent in 2016, St. Lucia’s current account has improved significantly. The ECCB has not yet published the 2017 BOP data, but based on preliminary figures on tourism and trade, staff is projecting a current account surplus of 1.3 percent of GDP. After a disappointing performance in 2016, St. Lucia’s tourism sector experienced a very strong year, increasing its market share among its ECCU competitors. The sector benefitted from: (i) a 10-percent expansion of hotel room stock, owing to the completion of the 470-room Royalton hotel and several hotel renovation and expansion projects; (ii) the addition of four direct flight routes, expanding the seat capacity by 5 percent; and (iii) the recovery of the cruise ship segment, which grew by 14 percent after a large drop in 2016. The increase in aviation taxes did not apparently affect arrivals, with all foreign markets showing significant growth. The United States remained the most important market with about half of total arrivals, while arrivals from Europe experienced the strongest growth. Due to expansion in duty-free shopping of cruise-ship passengers and imports of food and hotel supplies, strong tourism translated also into larger exports and imports of goods, but the trade deficit was roughly stable at about 25.2 percent of GDP.

3. In the medium-term, tourism is expected to remain strong, but the external position is expected to worsen due to investment related imports. Due to a pipeline of major hotel investment projects and the completion of a berth allowing docking of quantum vessel of up to 5000 passengers, strong tourism performance is expected to continue in the medium-term, despite further increase of aviation taxes in 2018. Trade balance will worsen significantly due to an anticipated pick-up in imports related to the planned infrastructure and hotel investment projects. Combined with slight worsening of net income balances and steady net current transfers, a significantly negative current account balance is expected for the upcoming years, before returning closer to balance in 2021, when most of the investment projects are expected to be completed. The outlook for the external sector is subject to risks, including some of the hotel investment not materializing, lower than expected growth in major tourist source markets, and natural disasters.

uA01fig10

Stay-Over Tourist Arrivals

(% of ECCU total)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

uA01fig11

Stay-Over arrivals BY Market

(Number of Persons)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Exchange Rate Developments

4. The real effective exchange rate (REER) continued to depreciate in 2017. The REER had been steadily appreciating since 2011, mostly reflecting the nominal appreciation of the U.S. dollar to which the E.C. dollar is pegged. The REER started to gradually depreciate in 2015 and this trend persisted into 2017, driven mostly by the US dollar depreciation, boosting St. Lucia’s competitiveness.

uA01fig12

REER Appreciation

(In percent, year-on-year contribution to growth)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources; INS Database; and IMF Staff Estimates.
uA01fig13

Effective Exchange Rate Indexes

(2012=100)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources: INS Database; and IMF Staff Estimates.

EBA-lite results

5. The EBA-lite results do not point to an exchange rate misalignment. The CA-regression approach of the EBA-lite methodology yields a CA norm of -3.0 percent of GDP. Applying an adjustment of 2.7 percent of GDP–about the midpoint of the expected statistical adjustments to exports–to the cyclically adjusted actual current account balance of 2.2 percent of GDP, this implies a current account gap of 2.5 percent and a real exchange rate undervaluation of 5.6 percent. The external sustainability approach of the EBA-lite methodology leads to a similar finding. Given the current net IIP of -46.3 percent of GDP and the targeted reduction of public external debt to 29.4 percent of GDP by 2030, the net IIP target was set at-41 per cent in 13 years yielding a CA norm of -3.7 percent, and pointing to an undervaluation of 7.2 percent. On the other hand, the results of the REER model point to an overvaluation of 5 percent.

uA01fig14

CA: Actual, Fitted, and Norm

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

St. Lucia External Sector Assessment EBA-lite Model Estimates (2017 in percent)

article image
Source: IMF staff estimates and calculations.

Positive number indicates overvaluation.

Includes statistical adjustment related to expected export data correction

Non-Price Competitiveness Indicators

6. Non-price indicators clearly point at a weak competitive position. A narrow exports base, high unemployment, and low output growth in sectors unrelated to tourism or construction seem to indicate low competitiveness. The latest World Bank Doing Business Indicators show that the country’s overall ranking has continued to fall from 86 in 2017 to 91 in 2018. St. Lucia scores particularly poorly on indicators related to the financial sector, like getting credit and insolvency and trading across borders, which reflects the high costs of port operations. Despite some improvement in 2017, high unit labor costs and a marked disconnect between wages and productivity—partly reflecting the large share of public sector employment and strong unions—are further weighing on St. Lucia’s external competitiveness.

uA01fig15

St. Lucia: Key Doing Business Rankings (2017 vs. 2018)

(Position in sample of 190 economies, higher = worse ranking)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source: World Bank, Doing Business Indicators.
uA01fig16

Productivity and Unit Labor Cost

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source: St. Lucia authorities

Reserves

7. Imputed net international reserves held at the ECCB remain above the reserve adequacy thresholds. As a member of the ECCU, reserve adequacy is assessed based on the net imputed reserves held at the ECCB. The reserve coverage of about 17 percent of GDP in 2017 corresponds to about 3.8 months of imports and 25 percent of broad money, exceeding the benchmarks of 3 months and 20 percent, respectively. The decline in import coverage from 5.1 in 2016 is driven by the switch to BPM6 data, particularly the about twice as large services imports compared to BPM5 data.

uA01fig17

Foreign Currency Reserves and Adequacy Thresholds

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources: Country Authorities; and IMF Staff Estimates.

Annex IV. Debt Sustainability Analysis1

St. Lucia’s public debt continues to be unsustainable under current policies with external debt following a similar upward trajectory. Public debt is projected to rise gradually throughout the medium term to reach 81.3 percent of GDP by 2023, largely reflecting primary deficits and positive interest-growth differentials, while external debt will increase by about 5 percentages points to 74.3 percent of GDP. The financing needs generated under current policies are projected to double over the next 5 years. The baseline debt path is vulnerable to unfavorable shocks from real interest rates, real GDP growth, the primary balance, and natural disasters.

A. Background and Recent Developments

1. St. Lucia’s public-sector debt has risen three-fold since the early 1990s. Gross public debt increased from 19.6 percent of GDP in 1990 reaching 70.7 percent of GDP in 2017 (Figure 1). Deteriorating fiscal balances were the main drivers of debt up to 2014 (Figure 2). Since 2001, St. Lucia recorded primary deficits every year, except during 2008–09 period and more recently in the last few years, which has contributed to a dramatic rise in debt. During 2006–2017, debt climbed by 14.2 percent of GDP, of which 8.7 percentage points were due to worsening primary balances. In the years following the GFC, St. Lucia’s primary deficit deteriorated significantly, leading to a sizeable increase in the debt-to-GDP ratio of 7 percentage points.

Figure 1:
Figure 1:

Public Debt and Primary Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources: St. Lucia Authorities and IMF Staff calculations
Figure 2:
Figure 2:

Contributions to Change in Public Debt

(in percent of GDP)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources: St. Lucia Authorities and IMF Staff calculations

2. Over the past decade, the government has increased its reliance on domestic financing. Consequently, the share of domestic debt doubled from 29 percent of total debt in 2005 to 57 percent in 2017 (Figure 3). Non-bank financial institutions, including the national insurance scheme, and commercial banks are the largest holders of domestic debt. Short-term debt has increased substantially, accounting for 17 percent (less than one year) and 57.5 percent (less than five years) of total debt.

Figure 3:
Figure 3:

2006 vs. 2017 Public Sector Debt Decompostion

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources: St. Lucia Authorities and IMF Staff calculations

3. A comparison with the previous DSA (2017 Article IV) shows improved debt ratios as a result of revisions to the national accounts series (Figure 4). Following the revision, the debt-to-GDP ratio fell by some 10 percentage points (see footnote 4 in the main text).

Figure 4:
Figure 4:

Comparison of Changes to Public Debt

(in percent of GDP)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources: St. Lucia Authorities and IMF Staff calculations

B. Public Sector Debt Sustainability Analysis

4. The baseline scenario is built on the following assumptions:

  • Growth and Inflation: Real economic activity is projected to grow by 3.5 percent in 2018 and 3.7 percent in 2019, and to gradually decline before reaching its potential rate of 1.5 percent in 2023. Inflation is projected to converge to 1.5 percent over the medium term, reflecting changes in the terms of trade.

  • Primary Balance: The primary balance is expected to deteriorate from a surplus of 0.6 percent of GDP in 2017 to a deficit of 1 percent of GDP in 2018 (including estimated uninsured costs of natural disasters of 0.7 percent of GDP) and remain close to that level in the medium term.

5. The baseline debt path is unsustainable (Figure A3-A5). Under the baseline assumptions public debt rises throughout the medium term to reach 81.4 percent of GDP by 2023, largely reflecting primary deficits from 2018 onwards and positive interest rate-growth differentials. The primary deficits over the projection period averages 0.5 percent of GDP, while the debt-stabilizing primary surplus is 2.1 percent.

Figure A1.
Figure A1.

St. Lucia: Public DSA Risk Assessment

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source: IMF staff.1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are: 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.4/ EMBIG, an average over the last 3 months, 27-Mar-17 through 25-Jun-17.5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.
Figure A2.
Figure A2.
Figure A2.

St. Lucia: Public DSA – Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source : IMF Staff.1/ Plotted distribution includes all countries, percentile rank refers to all countries.2/ Projections made in the spring WEO vintage of the preceding year.3/ Not applicable for St. Lucia, as it meets neither the positive output gap criterion nor the private credit growth criterion.4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.Source: IMF Staff1/ Data cover annual observations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP, Percent of sample on vertical axis.
Figure A3.
Figure A3.

St. Lucia: Public Sector Debt Sustainability Analysis (DSA) – Baseline Scenario

(In percent of GDP, fiscal-year basis, unless otherwise indicated)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source: IMF staff.1/ Public sector is defined as central government and includes public guarantees, defined as .2/ Based on available data.3/ EMBIG.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r – π(1+g) – g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r – π (1+g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).8/ Includes changes in the stock of guarantees, asset changes, and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
Figure A4.
Figure A4.

St. Lucia: Public DSA-Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source: IMF staff.
Figure A5.
Figure A5.

St. Lucia: Public DSA-Stress Tests

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source: IMF staff.

6. The heat map and fan charts highlight significant risks to debt sustainability (Figure A1). Both debt level and gross financing needs exceed the benchmark for emerging market economies. Moreover, the debt profile is also subject to high risks due to the high share of public debt held by non-residents. The fan charts show the possible evolution of the debt-to-GDP ratio over the medium term, based on both a symmetric and an asymmetric distribution of risks. The asymmetric fan chart (where negative shocks to growth, the real interest rate, and the primary balance are considered) shows that debt would reach almost 100 percent of GDP by 2023 if economic conditions were to deteriorate.

7. The projection bias evident in the baseline macro assumptions can be explained by the revision to the GDP series (Figure A2). The revised GDP show a much slower growth rate of economic activity for 2012 than previously estimated, generating a large forecast error. The significant forecast errors for the primary balance in 2014–2016 are also explained by the GDP revision. The inflation forecast errors are comparable with those of other countries.

8. Shocks and Stress Tests (Figure A4 and A5)

Under DSA adverse shock scenarios, the baseline debt path worsens, with the most significant impact in a combined shock scenario.

  • Growth shock- Under a growth shock, output is reduced by 1.8 percentage points in 2019 and 2020 (1 standard deviation of growth over the past 10 years) relative to the baseline projections and inflation declines by 0.4 percentage points each year in 2019–20. Specifically, debt would peak at 86.1 percent in 2023, which is 5.5 points higher than in the baseline. Concurrently, the impact on gross financing needs would result in an increase on average, over the medium-term, of 1.6 percentage points higher than the baseline projections.

  • Primary balance shock – The primary balance shock of 1.2 percentage points over 2019–20 (½ standard deviations of the historical 10-year average) results in the debt-to-GDP ratio of 83.5 percent of GDP by 2023 (2.9 percentage points higher relative to the baseline).

  • Interest rate shock – A sustained interest rate shock of 633 basis points (difference between the maximum and average rates over the last 10 years), starting in 2019 to the end of the projection period, would result in an increase in the debt ratio to 88.9 percent of GDP by 2023 (8.3 percentage points higher than the baseline).

  • Combined macro-fiscal shock -Combining all previous shocks would lead to debt exceeding 100 percent of GDP over the medium term and increasing gross financing needs as a percent of GDP by 8.7 percentage points by 2023 compared to the baseline scenario.

  • Natural disaster shock – A natural disaster occurring in 2019 comparable to the damage caused by Hurricane Tomas in 2010 would lead to a contraction of real GDP growth of 5, 3 and 2 percent in 2019, 2020 and 2021, and a deterioration in the primary balance of the same amount, increasing the debt-to-GDP ratio to 89.2 percent by 2023, 8.6 points above the baseline.

  • Adjustment Scenario – Under the staff proposed adjustment policies, assuming lower growth but improved primary balance, debt to GDP would gradually decline to 66.9 percent of GDP in 2023, 13.7 percentage points lower than the baseline scenario and closer to the regional debt target of 60 percent of GDP by 2030. This scenario also results in a reduction of gross financing needs by 8 percentage points by 2023 to reach 10.5 percent of GDP.

  • Contingent liability shock – Under this scenario, government assumes 10 percent of banking sector’s total assets and a 1 standard deviation shock to real GDP growth. This would increase the debt-to-GDP ratio by 16.2 percentage points in 2023, while the gross financing needs-to-GDP ratio would rise to 22.8 percent by 2023 (4.3 points higher than the baseline).

C. External Debt Sustainability Analysis

9. St. Lucia external public debt is projected to steadily increase over the medium term, from 66.9 percent of GDP in 2017 to 73.2 percent of GDP in 2023 (Table A1). The increase in external debt reflects the projected rise in public sector debt. Gross external financing needs are projected to increase from less than 0 percent of GDP in 2017 to an average of 2.7 percent over the medium term.

Table A1.

St. Lucia: External Debt Sustainability Framework, 2013–2023

(In percent of GDP, unless otherwise indicated)

article image

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

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

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

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

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

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

10. Under the baseline scenario, the external debt path remains highly vulnerable to potential adverse shocks, including from a growth shock, a current account shock, combined scenarios, and a real exchange rate depreciation shock, but is less sensitive to an interest rate shock (Figure A6). Under a growth shock, external debt is projected to increase marginally by 5 percentage points in 2023, reaching 79 percent of GDP, while under the current account shock, external debt is projected to increase to 99 percent of GDP. The combined shock, which incorporates the real interest rate, growth, and current account scenarios, pushes external debt to 89 percent of GDP. The most adverse shock to external debt is the real depreciation shock, which increase the debt-to-GDP ratio to 109 percent in 2023 (34 percentage points higher than the baseline). The vulnerability suggested by this scenario is mitigated by the currency-board arrangement.2

Figure A6.
Figure A6.

St. Lucia: External Debt Sustainability: Bound Tests 2/ 2/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs in 2010.

Annex V. Sensitivity of Public Debt Profile to Changes in International Interest Rates1

St. Lucia’s public debt dynamics are exposed to changes in international interest rates, particularly U.S. interest rates. While the pass-through effect is only partial, its impact can be substantial. A sound debt strategy for St. Lucia must consider the implications of changes in international interest rates, particularly in view of its relatively high levels of outstanding debt.

A. Recent Trends of Interest Rates and Public Debt

1. International interest rates, driven by tighter U.S. monetary policy, are expected to rise over the medium term. As a response to the financial crisis, the Federal Reserve kept its policy rate target between zero and 25bp in the period from end-2008 to end-2015. Owing to improved economic conditions, this policy has been officially reversed since 2016, and U.S. interest rates are expected to increase by about 200 bps over the next four years. Depending on the debt composition, this trend could impact the servicing of St. Lucia’s public debt, with loans contracted in foreign currency or instruments issued in external markets more likely to be affected by changes in international interest rates. Moreover, interest rates of domestic instruments might also be affected by changes in external rates if interest rate parity holds.

2. St. Lucia’s public debt composition suggests that its debt profile might be sensitive to international interest rates. Public debt as a percent of GDP has steadily risen over the past 10 years, and—unless a tighter fiscal envelope is adopted—is projected to follow an upward trend over the medium term. As of 2017, domestic and external debt represent 46 and 54 percent of total public debt of the central government, respectively. Sovereign guaranteed instruments, namely—bonds, treasury notes and treasury bills—are the bulk of total public debt, representing 71 percent of the total; of them, 32pp is contracted externally and 30pp is traded in the Regional Governments Securities Market (RGSM), which is a regional market for trading debt instruments of member states of the Eastern Caribbean Currency Union (ECCU). Multilateral and bilateral external loans represent about 22 percent of total public debt.

uA01fig19

Central Government Public Debt

(percent of GDP)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources: Ministry of Finance; and Fund staff estimates and projections.
uA01fig20

Central Government Domestic and External Debt

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source: IMF staff calculations based on authorities’ data.

3. Multilateral and bilateral debt terms, especially interest rates, in some cases adjust and follow international market trends. However, most of St. Lucia’s debt is contracted at fixed rates. Although this type of credit might in some cases be established at variable rates, reflecting the opportunity cost of the funds, with the interest rate based on international benchmarks (e.g. LIBOR), most of St. Lucia’s debt is at fixed interest rates. Caribbean Development Bank and World Bank’s loans account for 96 percent of multilateral outstanding debt. The bulk of World Bank’s loans contracted by St. Lucia are concessional under the International Development Association (IDA) facility; IDA interest rates are fixed for their whole maturity period.

uA01fig21

World Bank Outstanding Debt

(end 2017)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source: WB Group Finances.

B. Some Stylized Facts on External and Internal Interest Rates

4. The yields on St. Lucia’s short-term instruments issued through the RGSM are positively correlated with U.S. instruments. An important part of St. Lucia’s treasury bills, treasury notes, and bonds of different maturities are traded in the RGSM. Evidence from comparing short-term instruments suggests a positive association of RGSM’s yields with U.S. interest rates.

uA01fig22

RGSM’s T-bill Interest Rates for St. Lucia and its Correlation with Equivalent U.S. Instruments

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Sources: ECCB on RGSM data and Haver.

5. The response of bond yields, however, is more difficult to predict. First, owing to the low frequency of issuance of long-term maturity instruments on the RGMS, an association with U.S. interest is more difficult to detect. Second, while U.S. short-term treasury instruments have responded immediately to changes in the Fed funds rate, the response of U.S. long-term instruments is not clear. This result suggests that a transmission mechanism from international rates to St. Lucia’s long-term instruments (i.e. bonds), which represent 40 percent of total outstanding debt of the country, is not warranted.

uA01fig23

U.S. Treasury Yields and Federal Fund Rate

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source: U.S. Department of Treasury

6. Commercial banks’ banks’ lending rates and U.S. rates are highly correlated, but only for loans issued in foreign currency2. Commercial bank loans represent just 6 percent of total central government debt, of which just 1.1 pp were loans contracted in foreign currency. The apparent lack of a strong association between lending rates in local currency and external rates might in part be driven by distortions, such as the minimum savings deposit rate established at the regional level by the Eastern Caribbean Central Bank (ECCB). The rate artificially pushes active rates in local currency higher than in a market without frictions, resulting in higher levels of liquidity and nonperforming loans in the regional commercial banking system.

uA01fig24

Commercial Banks’ Interest Rates and US Bank Prime Rate

(Percent)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source: ECCB and Board of Governors of the Federal Reserve System (US).

C. Measuring the Pass-Through from External to Internal Interest Rates

Measuring pass-through from external to internal interest rates would help to effectively manage St. Lucia’s growing public debt

Methodology and Data

7. To capture the pass-through effect between external and internal interest rates, we estimate a VAR model. This allows us to measure the dynamic of interest rates controlling by effects of other endogenous and exogenous variables. The benchmark specification setup is:

y t = ν + A 1 y t − 1 + ... + A p y t − p + u t , t = 0 , 1 , 2... ,

Where yt=(it−billUS,ilendLCA,ideposit−savLCA,πUS,πLCA),it−billUS is the US 3-month T-bill yield, ideposit−savLCA is St. Lucia’s savings deposit rate, π stands for inflation rate and ilendLCA stands for two alternative definitions of St. Lucia’s commercial banks’ lending rates: in local and foreign currency. Finally, ν is a vector of intercept terms allowing for the possibility of a nonzero mean, Ai are coefficient matrices and ut, is a multi-dimensional white noise process.

8. Given the nature of financial flows, we base our analysis on monthly data. The main drawback of this approach is that some potential control variables, such as economic activity indicators, had to be excluded from the analysis.

Results

9. Econometric evidence confirms that interest rates of debt issued in local currency are less sensitive to international interest rates changes. Using banking system lending rates as a proxy for domestic interest rates, we estimate that US short-term interest rates would have a full pass-through effect to St. Lucia’s foreign-currency lending interest rates, but only a partial pass- through effect to instruments issued in local currency.

uA01fig25

Impulse Response Function due total percent increase in US T-Bill (in percent)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source: IMF staff calculations.
uA01fig26

Impulse Response Function due total percent increase in US T-Bill (in percent)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source: IMF staff calculations.

D. Public Debt Implications

10. St. Lucia’s debt is likely to respond to changes in U.S. interest rates. We calculated the stock of debt of the country in 2030 under two extreme scenarios, full and null pass-through from international interest rates to public debt instruments. Our results show that the stock of debt would reach 101.3 percent of GDP when international interest rates are fully transmitted to debt instruments, and 88.4 percent of GDP when the opposite happens (null transmission of international interest rates to public debt instruments). That represents a difference of 13 pp of GDP between both scenarios.

uA01fig27

St. Lucia – Debt Path under Stochastic Simulation of Interest Rates

(in percent of GDP)

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Source: IMF staff calculations.

11. The results of a simulation show that the actual impact on debt is likely to be between these extremes. Our baseline scenario considers St. Lucia’s debt structure and conditions to project a debt path for the country. The debt path reflects a partial pass-through from the expected rise in U.S. interest rates over the next few years. Based on the results from previous sections, we assume that short-term instruments in foreign currency will face a larger pass-through, while interest rates associated with multilateral/bilateral, local currency, and long-term debt will see only marginal changes. We then run a Montecarlo simulation constraining interest rate movements to the same volatility observed in historical data. The results suggest that by 2030 the stock of debt would reach between 93.9 and 97.8 percent of GDP, with a 95 percent confidence interval.

12. Given St. Lucia’s current unsustainable debt path, international interest rates developments should be cautiously considered when implementing a debt strategy to put the country back on track to reach the ECCU regional debt target of 60 percent of GDP by 2030.

References

Myrvoda, A. and J. Reynaud, 2018, “Monetary Policy Transmission in the Eastern Caribbean Currency Union”, IMF-WP 18/70.

Annex VI. Policy Trade-Offs in Building Resilience to Natural Disasters1

Resilience to climate change and natural disasters hinges on two fundamental elements: financial protection, provided by insurance and self-insurance, and structural protection, which requires investment in resilient infrastructure and adaptation to climate change. Using DIGNAD, an extension of the DIG model calibrated to the St. Lucia’s economy, this paper studies the conditions under which each of the two strategies provides the best protection against climate change and natural disasters. While structural protection normally delivers a larger output payoff because of its direct dampening effect on the cost of disasters, financial protection is superior when liquidity constraints limit the ability of the government to rebuild public capital promptly. The estimated trade-off is very sensitive to the efficiency of public investment.

A. Introduction

1. Building resilience to climate change and natural disasters is a key priority for St. Lucia. A small island in the Atlantic hurricane belt, St. Lucia is very vulnerable to natural disasters and climate change (see IMF-WB, 2018). Besides significant human and social costs, extreme weather and other catastrophic events have major macroeconomic and fiscal implications, with an average annual cost estimated at 1.5 percent of GDP, of which 1 percent is borne by the government.2 Despite the surge in donors’ assistance that follows these events, disasters leave deep scars in the fiscal position, with public debt increasing and little fiscal space left for government programs, including climate-related ones. Building resilience is therefore necessary not only to reduce the human, social, and economic costs associated with climate and natural disasters, it is also a way to exit the vicious circle of natural disasters/high public debt that St. Lucia has experienced with many other countries in the region.

2. Financial protection and structural protection are key elements of a two-pronged strategy to build resilience. Financial protection is a combination of self-insurance, risk-transfer instruments, and other financial tools that provide the government with the necessary liquidity immediately after the event for relief purposes as well as resources to finance promptly the reconstruction. For a country like St. Lucia, which needs fiscal adjustment to attain debt sustainability, non-debt-creating instruments like insurance and self-insurance are most important. Financial protection has the additional benefit of reducing the government’s contingent liabilities and building buffers that improve sustainability and reduce the risk premium on public debt. Structural protection is a series of actions that facilitate adaptation to climate change and minimize the impact of natural disasters. These include investment in resilient infrastructure and roadways, water supply systems, land use planning and management, and agriculture (see IMF-WB, 2018). The additional advantage of structural protection is a more resilient capital stock, which reduces the cost of capital and stimulates private investment.

3. This paper uses a dynamic general equilibrium model (DIGNAD) to evaluate the trade-offs between financial protection and structural protection. Knowing these trade-offs is particularly important to find the optimal combination of policies when resources are severely constrained. We build on the work by Marto, Papageorgiou, and Klyuev (2017), who extend the DIG model (Buffie and others, 2012) to incorporate natural disasters. The model is modified to reflect features specific to St. Lucia and this exercise, and calibrated to the St. Lucian economy. Section B presents the model; section C provides some detail on calibration; Section D reports the results of the simulations; and Section E concludes.

B. The Debt-Investment-Growth (DIG) Model: Incorporating Natural Disasters and Fiscal Constraints

4. The use of a general equilibrium model allows us to analyze the macroeconomic effects of natural disasters jointly with the policy responses. The model used is built on Marto, Papageorgiou, and Klyuev (2017), who extend the DIG model to simulate the impact that cyclone Pam had on Vanuatu in 2015, and study how the country could have built resilience to cope with it. DIG is a real, dynamic, open economy model in which public capital is used as an input of production. The government has access to external and domestic debt while fiscal instruments ensure debt sustainability. Its extension incorporating natural disasters (DIGNAD, henceforth) allows the government to invest in both standard infrastructure and adaptation capital, as well as in a savings fund. Adaptation capital is more resilient to climate change and natural disasters and help preserve standard infrastructure and dampen the damages inflicted to the economy. A savings fund immediately provides the necessary liquidity to start the reconstruction in the aftermath of the natural disaster.3 Natural disasters affect the economy by damaging both public and private capital and by reducing total factor productivity. To study the policy trade-offs in building resilience to natural disasters, we extend the DIGNAD model further along four dimensions.

5. First, natural disasters are modeled as continuous shocks rather than one-time events. The economy is hit by a continuum of natural disasters of average magnitude with a permanent effect on GDP. This eliminates issues related with the specific timing of the event and simplifies the comparison between policies, making the exercise more relevant for the analysis of frequent average intensity disasters.

6. Second, the government replenishes the savings fund regularly. After withdrawing the necessary resources to start the reconstruction without issuing new debt, the government replenishes the savings fund to keep the liquidity buffers needed to withstand future natural disasters. We thus allow for endogenous dynamics of the savings fund as follows:

s t = ( 1 + r f ) s t − 1 + s t i n − s t o u t , ( 1 )

where rf is a risk-free real interest rate earned on the stock of resources held in the previous period, while stinandstout are money injections and withdrawals, respectively. While money withdrawals equal the investment needed to reconstruct public capital, money injections are such that the government endogenously restores the savings fund up to the initial level, that is:

s t i n = φ s ( s t − 1 − s 0 ) , ( 2 )

where φs > 1 is a parameter governing the speed at which money is injected in response to the deviations of the stock of financial resources from the initial level s0.

7. Third, the reconstruction of public capital is endogenous and limited by financial constraints. While Marto, Papageorgiou, and Klyuev (2017) define an exogenous path of public investment in response to the natural disaster, we let the government reconstruct the destroyed public capital within the year according to a reaction function. Investment in public standard and adaptation capital follow respectively:

i z i , t = φ z [ z 0 i − ( 1 − δ z i ) z t − 1 i ] , ( 3 )
i z a , t = φ z [ z 0 a − ( 1 − δ z a ) z t − 1 a ] . ( 4 )

In both cases, whenever the stock of the non-depreciated capital is lower than the initial stock, the government increases investment to restore it Parameter φz ∈ [0,1] measures financial constraints and determines the capacity of the government to reconstruct the destroyed capital, i.e. φZ = 1 implies full reconstruction while for φZ < 1 the government can reconstruct only a fraction of the missing capital stock.

8. Finally, we impose a specific fiscal reaction function. We assume that the consumption tax will be adjusted as needed to attain the ECCU debt target of 60 percent of GDP by 2030. To illustrate this point, equation (6) shows a simplified version of the law of motion of government debt in real terms where the only expenditure is for standard public investment and the only source of revenue is a consumption tax:

B t + 1 = ( 1 + r t ) B t + i z , t − τ t c c t , ( 6 )

where rt is the real rate of interest on government bonds, Bt; τtc is the consumption tax rate; ct is private consumption so that τtcct represents total tax revenues.

C. Calibration

9. The model is parameterized to fit a “typical” LIC when country specific information is not available. In the absence of specific information, we used the parameters of the average LIC in the DIG model, most of which were also used in calibrating the DIGNAD model for the case of Vanuatu. Country-specific initial values were used for public infrastructure investment, public debt and its composition, grants, private external debt, real interest rate on public debt. Country-specific parameters were used for the trend per capita growth rate, imports, and value-added of the non-tradeable sector.

10. Parameters that determine the impact of natural disasters are broadly in line with Marto, Papageorgiou, and Klyuev (2017). Adaptation capital better withstands natural disasters than standard infrastructure, hence the former depreciates at a lower annual rate than the latter, i.e. δza = 3% while δzi = 6%. We calibrate the parameter φs such that the savings fund is replenished at the initial level anytime it is used, i.e. st = s0, ∀t. On average, each year St. Lucia suffers a loss of public and private capital of 1 percent and 0.5 percent of GDP, respectively, due to natural disasters. We therefore calibrate a continuum of natural disaster shocks that generate the observed yearly losses of public and private capital.

D. Simulation and Findings

Simulations Set-up

11. We design alternative policies to build resilience to natural disasters.

  • Policy 1: Do nothing. As a baseline policy, we simply assume that, despite natural disasters hitting the economy, the government does not revise its plans for public investment, which is kept at the initial level. In this case, there is no reconstruction of lost public capital. This serves as a baseline scenario against which we compare the other two.

  • Policy 2: Financial protection. In year t-1, the government receives a grant of 8 percent of initial GDP that is spent to build a natural savings fund.4 The fund is then used exclusively to finance the reconstruction of public capital without issuing new debt. We assume that when the natural savings fund is active, the government has the necessary liquidity to rebuild the destroyed public capital, i.e. φz = 1 in equations (3) and (4). Moreover, the immediate availability of funds reduces the sovereign risk premium. We thus assume that the annual interest rate paid on public debt is 50 basis points lower than under the alternative policies.

  • Policy 3: Structural protection. In year t-1, the government receives a grant of 8 percent of initial GDP that is used to invest in adaptation capital, thus improving resilience to natural disasters.5 In other words, the entity of all damages is dampened, although the stock of public capital is not entirely reconstructed, due to continuous shocks hitting the economy and absence of liquidity. We therefore calibrate φz < 1.

12. The government should be able to rebuild 85 percent of the destroyed capital to be indifferent between policy 2 and policy 3. Given that, when the savings fund is active, the government can rebuild the entire stock of public standard capital destroyed, we first calculate the fraction of destroyed public capital (standard and adaptation) the government should reconstruct in the case of adaptation capital to reach the same level of output after 15 years. We find that the government should be able to rebuild 85 percent of the destroyed stock of standard and adaptation capital (i.e. φZ = 0.85) to reach the same level of GDP after 15 years as in policy 2.

Simulation Results

13. Scenario 1: investing in adaptation capital is preferable if the government can rebuild more than 85 percent of the destroyed capital. We assume that, under the option of building adaptation capital, the amount of public capital that can be reconstructed is 10 percent higher than the threshold of 85 percent (i.e. φz = 0.95). Figure 1 shows that not engaging in public capital reconstruction (blue line) is very harmful for the economy, with a loss of GDP of more than 3 percent after 15 years. Moreover, tax revenues to GDP increase by almost 13 percent to reach the public debt target. Conversely, when the savings fund is active (red line) the government has the necessary liquidity to promptly reconstruct the destroyed public capital.6 Indeed, GDP is about 1.5 percent lower than the initial year while tax revenues increase by 10 percent of GDP. The lower increase in tax revenues stems from the joint effect of the reconstruction of public capital financed by the savings fund, the lower loss in GDP and the lower sovereign risk premium. Finally, investing in adaptation capital (yellow line) when the government can reconstruct above the calculated threshold leads to the lowest output loss among the three policies. It also follows that the required increase in tax revenues to GDP is below 10 percent. Indeed, the lower depreciation and higher return of adaptation capital coupled with its intrinsic effect of dampening the damages of natural disasters outweigh the advantages in terms of liquidity and lower sovereign risk premium provided by the savings fund. To sum up, this will hold if φz ∈ (0.85,1], that is, at least 85 percent of the destroyed capital can be reconstructed.

14. Scenario 2: investing in adaptation capital is less preferable if the government reconstructs less than 85 percent of the destroyed capital. We now assume that the government’s ability to reconstruct public capital under policy 3 is 10 percent lower than the threshold of 85 percent (i.e. φz = 0.75). Figure 2 plots the same paths under policy 1 (blue line) and policy 2 (red line) as in Figure 1. The tighter constraint on the government’s ability to reconstruct public capital under policy 3 (yellow line) leads to a lower GDP level than under policy 2, with a loss of nearly 2 percent after 15 years. Despite the lower damages suffered by the economy due to the stock of adaptation capital, the constraints on public capital reconstruction make building the savings fund a preferable policy. In this scenario, investing in public adaptation capital entails a lower increase in tax revenues due to the lower public investment during the reconstruction. To sum up, this will hold for φz ∈ [0,0.85), that is less than 85 percent of the destroyed capital can be reconstructed.

Sensitivity of the Threshold of Reconstruction to Alternative Calibrations.

15. The same sovereign risk premium across the two alternative policies lowers the threshold to 83.5 percent. Assuming that building a savings fund does not lower the sovereign risk premium by 50 annual basis points implies that, when investing in adaptation capital, the government should be able to reconstruct 83.5 percent of the destroyed public capital to make the two policies equivalent. Intuitively, removing one of the advantages of the savings fund being in place implies that a lower fraction of public capital needs to be reconstructed to make investing in adaptation capital reach the same output after 15 years.

16. Lower public investment efficiency under the investment in adaptation capital policy substantially increases the threshold. We assume that when the government invests in adaptation capital, public investment efficiency is 2.5 percent lower than when it invests in the disaster fund. Indeed, the lack of available liquidity may make the process of rebuilding the public capital stock slower and less efficient. The implied threshold increases from 85 to 96 percent, so that the government should can rebuild a substantial higher fraction of the destroyed public capital to be indifferent between policies 2 and 3.

17. Increasing the depreciation rate of adaptation capital slightly increases the threshold. We assume that public standard and adaptation capital display the same annual depreciation rate of 6 percent. Each year, the fraction of adaptation capital that needs to be replaced for reasons other than natural disasters is higher. It follows that, with respect to the baseline calibration, an additional fraction of capital needs to be reconstructed following a natural disaster, hence the calculated threshold increases to 87 percent.

E. Conclusions

18. Building resilience is key to cope with natural disasters. Whether the government builds a disaster fund or invests in adaptation capital, building resilience is key to cope with natural disasters. The do-nothing policy delivers dramatic negative outcomes in the economy, with large permanent losses of capital, output, and growth and a much larger increase in taxes needed to attain the fiscal target.

19. Simulations highlight non-trivial trade-offs in building resilience to natural disasters. Financial protection provides resources for immediate relief and reconstruction after a natural disaster and improves the net asset position of the government. Structural protection and resilient public capital soften the impact of natural disasters on the economy and reduce the cost of capital to the private sector. For the case of St. Lucia, structural protection is the preferred policy if the government can reconstruct at least 85 percent of the destroyed public capital stock before the next disaster hits. Should the government’s ability to reconstruct public capital be lower, the financial protection policy would lead to a lower output loss. Moreover, low efficiency of public investment would further reinforce the advantage of financial protection. This conclusion can be generalized to countries where financial constraints are prevalent and efficiency in public investment procedures is low. While the paper analyzes two stylized policies, these policies are complementary and both required for an optimal strategy for building resilience.

Figure 1.
Figure 1.

St. Lucia: Above-Threshold Public Capital Reconstruction

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

Figure 2.
Figure 2.

St. Lucia: Below-Threshold Public Capital Reconstruction

Citation: IMF Staff Country Reports 2018, 179; 10.5089/9781484362617.002.A001

References

  • Buffie, E., Berg, A., Pattillo, C., Portillo, R., and L.F. Zanna, 2012, “Public Investment, Growth, and Debt Sustainability: Putting Together the Pieces”, IMF Working Paper 12/144.

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  • Guerson, A., 2016, “Assessment of Government Self-Insurance Needs Against Natural Disasters: An Application to the ECCU”, Eastern Caribbean Currency Union, 2016 Discussion of Common policies of Member Countries, Annex VIII, IMF Country Report No. 16/333.

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  • IMF, 2017, “St. Lucia—Staff Report for the 2017 Article IV Consultation”, SM/17/41.

  • IMF-WB, 2018, “St. Lucia: Climate Change Policy Assessment—Pilot”, IMF Country Report No. 17/76.

  • Marto, R., Papageorgiou, C., and V. Klyuev, 2017, “Building Resilience to Natural Disasters: An Application to Small Developing States”, IMF Working Paper 17/223.

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1

According to staff simulations in the CCPA pilot for St. Lucia (SM/18/131), based on the Representative Concentration Pathways scenario RCP8.5 of the 2014 report of the Intergovernmental Panel on Climate Change.

2

The government increased the airport tax on non-CARICOM travel from US$25 to US$63 and introduced an airport development tax of US$35, effective January 2018. The airport tax was then reduced to US$53 in January 2018. The excise tax on gasoline and diesel for road use was increased by EC$1.5 per gallon, but its revenue impact was limited by the imposition of a ceiling on fuel prices at EC$12.75, which by March 12, 2018 restricted the tax increase to EC$0.7 per gallon for gasoline and to EC$1.1 per gallon for diesel.

3

Public debt will increase only by the amount of the road network loan. The airport loan will be contracted by SLASPA (the port and airport authority), a non-financial public corporation, and repaid with the proceeds of the Airport Development Tax of US$35 per departing visitor levied as of January 1st, 2018. The road network loan will be contracted by a private non-resident Special Purpose Vehicle, which the government will repay with part of the proceeds of the road fuel tax. As the owner of the road network, the central government will be ultimately responsible for this obligation.

4

GDP was revised in 2017 to include commercial property rental activities, introduce the 2008 SNA calculation of Financial Intermediation Services Indirectly Measured, and to better align the coverage in owner-occupied and rented dwelling with the results of the 2010 census. As a result, 2016 nominal GDP increased by 19 percent and the public debt ratio fell from 82 percent of GDP to 69.2 percent of GDP (on a fiscal year basis).

5

Any wage increases would apply retroactively to the period 2016–18 and would likely take place in FY2019/20.

6

Access to concessional climate financing is limited by the lack of defined plans on climate change adaptation, the unsustainable fiscal stance, and institutional capacity, which is a challenge in most small island developing states.

7

Staff estimates that, in a scenario where the CCPA policies were implemented, GDP growth could be permanently higher by 0.3 percent reflecting the impact of adequate fiscal buffers and resilient infrastructure (Annex VI). The adjustment scenario assumes that this change occurs gradually as resilient infrastructure is built. An additional 0.3 percent would come from the temporary impact on demand of investment in climate change adaptation of 0.5 percent of GDP.

8

Priorities include exemptions on transportation, residential property sales, betting and gaming, and zero-rating on foodstuff and fuel.

9

Staff estimates that a savings fund of 8 percent of GDP, replenished on a rolling basis, would be sufficient to cover fiscal costs of natural disasters without incurring additional debt with 95-percent probability (SM/18/131). This estimate does not consider the insurance coverage already provided by the Caribbean Catastrophe Insurance Facility (CCRIF) and private insurance, which can be approximated at some 3 percent of GDP.

10

The additional investment (0.5 percent of GDP) would be financed by grants from climate funds that the implementation of the CCPA recommendations would help unlock by establishing a comprehensive plan to effectively address climate change. Concessional funds would also be more readily available following the implementation of an adjustment program that strengthens fiscal sustainability.

11

See footnote 7. Fiscal multipliers are negligible in small island economies with high imports and high public debt. Empirical estimates for the ECCU find that only public investment has a multiplier (0.6) different than zero (Gonzalez- Garcia, Lemus and Mrkaic “Fiscal Multipliers in the ECCU”, IMF WP/13/117).

13

The number of application for new licenses has declined in these sectors, reflecting also more stringent regulatory requirements.

14

Li and Wong, “Financial Development and Inclusion in the Caribbean”, IMF WP/18/53, based on the 2010 World Bank Enterprise Survey for St. Lucia, identifies this country as one with the weakest access to credit indicators in the region.

1

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term” (ST) and “medium term” (MT) are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

1

Prepared by Anne Marie Wickham. The analysis of public debt sustainability is based on the framework developed for market access countries. See Staff Guidance Note for Public Debt Sustainability Analysis in Market Access Countries, IMF, May 2013.

2

Under the ECCB Act (1983), external reserves must be held at not less than 60 percent of demand liabilities, but under current practice they exceed 90 percent of demand liabilities, making the ECCU a currency board.

1

Prepared by Mauricio Vargas and Steve Brito.

2

For an extensive and complementary analysis of the pass through of U.S. interest rates at regional level for the ECCU, see Myrvoda and Reynaud (2018).

1

Prepared by Leo Bonato, Alessandro Cantelmo, Giovanni Melina, and Gonzalo Salinas. Mauricio Vargas helped in the model calibration.

2

See IMF (2017), Box 1, p.11.

3

For simplicity, we assume that the only financial protection is provided by the savings fund.

4

Guerson (2016) estimates that a savings fund capitalized at 8 percent of GDP and replenished annually with 0.9 percent of GDP would have a 95 percent chance of non-depletion.

5

This implies that, in year t-1, the share of adaptation capital in the total stock of public capital is 23.5 percent.

6

Note that the stock of public standard capital stabilizes at a lower level due to the continuous shocks hitting the economy. In practice, the government replaces the destroyed capital but, at the end of the same period, a new shock hits hence the stock of public standard capital stabilizes at a lower level.

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Cover IMF Staff Country Reports
St. Lucia: 2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for St. Lucia
Author:
International Monetary Fund. Western Hemisphere Dept.
Volume/Issue:
Volume 2018: Issue 179
Publisher:
International Monetary Fund
ISBN:
9781484362617
ISSN:
1934-7685
Pages:
86
DOI:
https://doi.org/10.5089/9781484362617.002
Figure 1.

St. Lucia: Stronger Growth and External Balance on Account of Rising Tourism Inflows
Figure 2.

St. Lucia: Persistent Weaknesses in the Financial Sector
Figure 3.

St. Lucia: Baseline and Adjustment Scenarios

(Central Government, percent of GDP)
Figure 4.

St. Lucia: External Competitiveness and Structural Weaknesses
Figure 5.

St. Lucia: Unemployment

Wage Bill Anchor Since 2007

Debt-to-GDP (%)

Effect of Rising Global Interest Rates on Debt Projections

(Percent of GDP)

St. Lucia – Credit by Commercial Banks

(EC million)

Real GDP and Financial Intermediation

(Index, 2000=100)

GDP vs. Total Credit from Banking Sector

(Growth rate, percent)

Caribbean: Firms with a Loan or Credit Line

(% SMEs)

Caribbean: Access to Credit as Major Constraint

(% SMEs that responded “yes”)

Current Account Balance (BPM6)

(In pecent of GDP)

BPM6 VS BPM5 2016

(in percent of GDP)

Stay-Over Tourist Arrivals

(% of ECCU total)

Stay-Over arrivals BY Market

(Number of Persons)

REER Appreciation

(In percent, year-on-year contribution to growth)

Effective Exchange Rate Indexes

(2012=100)

CA: Actual, Fitted, and Norm

St. Lucia: Key Doing Business Rankings (2017 vs. 2018)

(Position in sample of 190 economies, higher = worse ranking)

Productivity and Unit Labor Cost

Foreign Currency Reserves and Adequacy Thresholds

(Percent of GDP)
Figure 1:

Public Debt and Primary Balance

(In percent of GDP)
Figure 2:

Contributions to Change in Public Debt

(in percent of GDP)
Figure 3:

2006 vs. 2017 Public Sector Debt Decompostion
Figure 4:

Comparison of Changes to Public Debt

(in percent of GDP)
Figure A1.

St. Lucia: Public DSA Risk Assessment
Figure A2.

St. Lucia: Public DSA – Realism of Baseline Assumptions
Figure A2.

St. Lucia: Public DSA – Realism of Baseline Assumptions
Figure A3.

St. Lucia: Public Sector Debt Sustainability Analysis (DSA) – Baseline Scenario

(In percent of GDP, fiscal-year basis, unless otherwise indicated)
Figure A4.

St. Lucia: Public DSA-Composition of Public Debt and Alternative Scenarios
Figure A5.

St. Lucia: Public DSA-Stress Tests
Figure A6.

St. Lucia: External Debt Sustainability: Bound Tests 2/ 2/

(External debt in percent of GDP)

Central Government Public Debt

(percent of GDP)

Central Government Domestic and External Debt

World Bank Outstanding Debt

(end 2017)

RGSM’s T-bill Interest Rates for St. Lucia and its Correlation with Equivalent U.S. Instruments

U.S. Treasury Yields and Federal Fund Rate

Commercial Banks’ Interest Rates and US Bank Prime Rate

(Percent)

Impulse Response Function due total percent increase in US T-Bill (in percent)

Impulse Response Function due total percent increase in US T-Bill (in percent)

St. Lucia – Debt Path under Stochastic Simulation of Interest Rates

(in percent of GDP)
Figure 1.

St. Lucia: Above-Threshold Public Capital Reconstruction
Figure 2.

St. Lucia: Below-Threshold Public Capital Reconstruction