Eastern Caribbean Currency Union: Staff Report for the 2018 Discussion on Common Policies Of Member Countries
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International Monetary Fund. Western Hemisphere Dept.
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Publication Date:
22 Feb 2019
eISBN:
9781498300056
ISBN:
9781498300056
Language:
English
Keywords:
ISCR; CR; ECCU country; ECCU price aggregate; Cartac; ECCU debt target; ECCU authority; ECCU region; ECCU work program; ECCU aggregate; Natural disasters; Insurance; Nonperforming loans; Credit bureaus; Caribbean; Global; debt target; market share
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December 20, 2018

Abstract

December 20, 2018

Contents

December 20, 2018

Key Issues

The Eastern Caribbean Currency Union (ECCU) is gradually recovering following the catastrophic impact of Hurricanes Irma and Maria in 2017. Tourism is slowly picking up in hurricane-stricken countries and has remained strong elsewhere in the ECCU. Conditions remain favorable to growth, but risks are increasing. The fiscal balance for the region as a whole—which is particularly important in a quasi-currency board arrangement—worsened in 2017, reflecting lower inflows from citizenship-by-investment programs and higher reconstruction and current spending. While public debt has declined, helped by debt relief operations in some countries, the ECCU debt target of 60 percent of GDP by 2030 remains elusive for most countries. Important progress has been made in financial sector reforms, but long-standing weaknesses and emerging risks weigh on growth prospects and may entail fiscal costs. External deficits remain large, highlighting low competitiveness. Natural disasters are becoming more frequent and intense, compounding these vulnerabilities.

Main Policy Recommendations:

  • Shift focus from the current emphasis on recovery from natural disasters to building ex-ante resilience based on: (i) boosting resilient investment and insurance protection to enhance preparedness to natural disasters and climate change; and (ii) a robust fiscal framework that would both support the shift towards building resilience and help anchor the much-needed fiscal adjustment to break the vicious cycle of high debt and low growth.

  • Intensify decisive and timely actions to resolve weaknesses in the financial sector, including longstanding problems in the banking sector and emerging risks in the non-banking sector.

  • Undertake structural reforms to enhance competitiveness and boost growth, focusing on energy policies, the business climate, trade liberalization, public sector efficiency, regional integration, labor market, and education.

Approved By

Krishna Srinivasan (WHD) and Johannes Wiegand (SPR)

Mission Team: Sònia Muñoz (head), Leo Bonato, Alejandro Guerson, Bogdan Lissovolik, Manuk Ghazanchyan (all WHD), and Gayon Hosin (MCM) held policy discussions with the eight ECCU jurisdictions (Anguilla, Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts and Nevis, St. Lucia, and St. Vincent and The Grenadines), the ECCB, the OECS Secretariat, and the CDB. Mike Sylvester (OED) participated in the closing meetings and Ann Marie Wickham (local economist, WHD) joined some meetings in Bridgetown. The team met with the Prime Ministers of five of the eight-member jurisdictions, Financial/Permanent Secretaries of six-member jurisdictions, Financial Services Authorities of the eight member jurisdictions, the ECCB Governor and other senior officials, the Organization of Eastern Caribbean States (OECS), the Caribbean Development Bank (CDB), and a wide range of private sector representatives.

Mission Dates: October 24-November 2 and November 12–20, 2018. Contributors: ECCU team. Additional analytical input was provided by Marika Santoro and Mauricio Vargas. Steve Brito and Vivian Parlak provided research assistance and Malika El Kawkabi provided editorial assistance.

Contents

  • THE RECOVERY IS UNDERWAY, BUT RISKS ARE LOOMING

  • A. Recent Developments

  • B. Outlook and Risks

  • MACROFINANCIAL POLICY DISCUSSIONS

  • A. Robust Frameworks to Support Fiscal Consolidation

  • B. Building Ex-Ante Resilience to Natural Disasters

  • C. Strategy for Stability and Resolving Problems in the Financial Sector

  • D. Competitiveness and Growth

  • AUTHORITIES’ VIEWS

  • STAFF APPRAISAL

  • BOXES

  • 1. Fitting Fiscal Frameworks to Country Characteristics

  • 2. The Benefits of Resilient Investment

  • 3. Natural Disaster Insurance Financing

  • FIGURES

  • 1. Real Sector Developments

  • 2. Tourism Developments

  • 3. Monetary Developments

  • 4. Financial Soundness Indicators

  • 5. Credit Developments

  • 6. Doing Business Indicators

  • TABLES

  • 1. Selected Economic and Financial Indicators, 2014–24

  • 2. Selected Economic Indicators by Country, 2014–24

  • 3. Selected Central Government Fiscal Indicators by Country, 2014–24

  • 4. Selected Public Sector Debt Indicators by Country, 2014–24

  • 5. Monetary Survey, 2014–24

  • 6. Summary Balance of Payments, 2014–24

  • 7. Selected Labor Force Indicators

  • 8. Financial Structure, end-2017

  • 9. Financial Soundness Indicators of the Banking Sector 2010–2018

  • 10. Selected Financial Soundness Indicators by Country, 2010–2018

  • ANNEXES

  • I. Implementation of Previous Staff Advice

  • II. Risk Assessment Matrix

  • III. External Assessment

  • IV. Real and Financial Cycles in the ECCU

  • V. Impact of US Shocks on the ECCU

  • VI. Competitiveness in Tourism Markets

  • VII. United Kingdom Overseas Territories—Anguilla and Montserrat

The Recovery is Underway, but Risks are Looming

A. Recent Developments

1. Growth is gradually recovering in 2018 following the adverse economic impact of natural disasters in 2017. In September 2017, Hurricanes Irma and Maria hit the region with catastrophic effects on some countries, particularly Dominica and Anguilla.1 Tourist arrivals declined in late 2017 in the affected countries, but they remained strong elsewhere in the first half of 2018. Reflecting these events, regional GDP growth fell to 1.4 percent in 2017 from 3.4 percent in 2016. With output still below potential, core inflation remained subdued, but sharp increases in the prices of food and medication were experienced by hurricane-struck countries in the first half of 2018.

ECCU: Real GDP Growth

(In percent)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: World Economic Outlook database.

ECCU: Total Stayover Arrivals (2001–2018)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Sources: ECCB, Caribbean Tourism Organization (CTO), and IMF staff calculations.

2. The fiscal balance deteriorated in 2017 and the first half of 2018, but debt relief in some countries eased the overall region’s public indebtedness. The combined ECCU fiscal surplus declined markedly in 2017, largely reflecting lower inflows from citizenship-by-investment (CBI) programs in Dominica and St. Kitts and Nevis and increases in current expenditure. The fiscal balance is projected to decline further in 2018, while the underlying fiscal deficit (excluding revenues from CBI programs and bank resolution operations) is expected to increase to about 3½ percent of GDP in 2018. Public debt, however, declined by about 1 percent to an estimated 72 percent of GDP in 2017, largely reflecting debt relief in some countries.2

ECCU Overall Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Sources: Country authorities and IMF staff estimates and projections.

ECCU-6: Public Debt, Baseline Scenarios

(In percent of GDP)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: Country authorities and IMF staff estimates and projections.

3. Recovery in credit provided by banks is weak after four consecutive years of decline, and banking sector risks are increasing. While the business cycle turned in 2011, the credit cycle has lagged (Annex IV). Even now, amid signs of recovery, bank credit growth continues to be subdued (0 percent in September 2018) despite ample bank liquidity, due to low levels of bankable loans. Natural disasters and emerging problems in CBI-related loans raised the nonperforming loan (NPL) ratio to 15.2 percent in locally incorporated banks in September 2018—24.8 percent in majority government-owned banks—while provisioning against such impairment remains low. The reclassification of the debt-land-swap from financial to fixed assets— which requires a risk weight of 100 percent—has decreased the capital adequacy ratio of majority government-owned banks in one jurisdiction, but it remains above the regulatory minimum. Differences exist among ECCU countries, with Grenada’s NPL ratio declining rapidly and St. Kitts and Nevis’ increasing.3

Credit to Private Sector

(In percent, year over year growth, monthly)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Sources: ECCB and IMF staff calculations

Nonperforming Loans

(In percent of total loans)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: ECCB and IMF staff calculations.

4. Although relatively small, lending by credit unions has increased rapidly in recent years. Signs of fragility in credit unions and building and loan societies are increasing in some countries that suffer from high NPLs and low capitalization, including in Dominica, where the sector is systemic accounting for assets totaling 55 percent of GDP. Catastrophic events heavily affected the insurance sector, leading to an estimated 90 percent decline in net income in 2017,4 with a domestic company in one jurisdiction being unable to honor many of its obligations after the latest hurricane.

5. The decline of correspondent banking relationships (CBRs) across the region has stabilized, but maintaining CBRs is more challenging and costly. A few banks, with no direct CBRs with the U.S., are transacting through a non-U.S. bank at significantly increased costs—ranging between 40 and 100 percent higher—and no bank has reported a successful application for CBRs with large U.S. banks. Some banks only have one relationship, which exposes them to withdrawal risk. Those that have more relationships are under pressure by correspondent banks to increase the volume of transactions. Non-bank financial institutions, including credit unions, money services business, and off-shore institutions, are also being impacted by domestic banks exiting certain services and/or banking relationships. In several instances, recently approved off-shore and domestic institutions have been unable to commence business after failing to establish banking relationships with overseas and/or domestic banks, because of which some licenses have been revoked.

6. Some foreign banks are retrenching from the Caribbean region. First Caribbean International Bank (of the Canadian Imperial Bank of Commerce group) will close its Anguilla operations as of January 2019, due to lack of viability in terms of profitability and scale. Republic Financial Holdings Limited from Trinidad and Tobago has announced its intention to acquire Bank of Nova Scotia’s operations in seven ECCU jurisdictions, as well as Guyana and St. Maarten. Bank of Nova Scotia indicated that its decision is based on a refocus on markets of size and scale. Additionally, Bank of Nova Scotia’s subsidiaries in Jamaica and Trinidad and Tobago have agreed to sell their insurance operations to Barbados-based Sagicor Financial Corporation Limited, which would be acquired by a Toronto-based special purpose acquisition corporation.

7. Large external imbalances persisted in 2017. The combined current account deficit of the ECCU reached an estimated 8 percent of GDP in 2017, broadly unchanged since 2016.5 In most countries, conditions remained favorable to tourism, owing to supportive economic prospects in source countries, the addition of direct airline routes, and increased capacity.

ECCU: Current Account Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Sources: ECCB and IMF estimates.

B. Outlook and Risks

8. Growth is projected to gain strength in 2018 and 2019. Growth will be supported in the short term by favorable external conditions, recovery from natural disasters, and a gradual resumption of bank lending (Annex IV).6 U.S. policy shocks will have a considerable impact on the ECCU, mostly through the tourism channel (Annex V). The positive effect from the U.S. fiscal impulse will be partially offset by monetary policy normalization and trade policies. Tourist arrivals are expected to remain strong in countries unaffected by hurricanes and gradually pick up in Anguilla and Dominica as the reconstruction advances. Several projects, related to both rebuilding and new tourism-related FDI, are expected to boost construction activity.

9. Fiscal and external vulnerabilities will weigh on longer-term prospects. Growth will converge to its potential of 2 percent. Following the temporary acceleration caused by natural disasters, the expected stabilization of oil and commodity prices will cause inflation to return to low levels, not exceeding 2 percent. In the absence of significant fiscal adjustment, the fiscal balance will deteriorate, reflecting reconstruction-related capital spending in the short term, and lower revenues and higher interest payments in the longer term. Against this background, only Grenada and St. Vincent and the Grenadines are on track to reach the ECCU target of 60 percent by 2030. With higher imports needed for rebuilding and FDI-related hotel construction, the current account deficit is projected to worsen in the next few years before gradually stabilizing at about 7.0 percent of GDP in the medium term, reflecting persistent competitiveness problems. Reserves appear adequate in the context of the quasi-currency board arrangement, even after taking into account the exposure of the region to natural disasters (Annex III).

10. Risks are titled to the downside. Adverse confidence effects from trade disputes and faster-than-expected monetary tightening could make the net growth impact of US policy shocks negative for the ECCU (Annex V). Other risks include global factors, such as security risks, unsustainable macroeconomic policies in systemic countries, cyberattacks and related financial instability (Annex II). Specific risks include natural disasters increasing in frequency and intensity, a further decline of CBRs, and lingering problems in the financial sector, with banks unable to resume lending, stress in the non-bank segment, and contingent fiscal liabilities from the banking sector. Upside fiscal risks stem from Petrocaribe debt restructuring, which could reduce public debt levels. The cost of petroleum imports, a key influence for the ECCU owing to its high dependence on hydrocarbon fuels, could increase with the closure of the Trinidad and Tobago’s Petronin refinery, a supplier to the ECCU.

Macrofinancial Policy Discussions

The ECCU is facing multiple challenges: low growth, weak fiscal performance, a vulnerable financial system, and low competitiveness. This is compounded by insufficient preparedness for natural disasters. Decisive action to durably improve the fiscal position, build resilience to natural disasters, strengthen the financial sector, and address supply bottlenecks is needed to enhance policy credibility, boost regional integration, and attract the necessary support from the international community.

A. Robust Frameworks to Support Fiscal Consolidation

11. ECCU’s fiscal performance has been characterized by high debt and strong pro-cyclicality. Progress in approaching the region’s 60 percent of GDP public debt target has been insufficient, despite debt relief operations and periodic revenue windfalls, particularly from CBI programs. While natural disasters and external economic shocks have played an important role, domestic policies have displayed an expansionary bias, sometimes driven by political cycles, although there is substantial heterogeneity in individual country positions. In the absence of a strong fiscal anchor, clear commitments, and adequate financing, policies have had a strong pro-cyclical bias in most countries. While many ECCU countries have continued to upgrade their medium-term fiscal frameworks,7 they still lack effective operational frameworks and procedures that link short-term and long-term objectives.

Spending Policy Pro-cyclicality in ECCU-6, 1998–2017

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: IMF staff calculations.

ECCU Public Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Sources: Country authorities and IMF staff estimates.1/ Counterfactual scenario assuming absence of historical CBI fiscal inflows that would have required debt issuance in the same amount.

ECCU Countries: Actual vs. Debt Stabilizing Fiscal Balances, 2011–17 Average

(In percent of GDP)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: Country authorities and IMF staff estimates.1/ Overall fiscal balances consistent with long-term debt stabilizing at 60 percent of GDP level using country-specific estimates of long-term potential growth.

12. Fiscal responsibility frameworks can usefully bolster ECCU’s fiscal performance and help reduce debt. Recent evidence indicates that such frameworks (i) can be effective in correcting a deficit bias; (ii) could enhance economic stabilization; and (iii) are proving workable for small countries, including in the Caribbean (e.g., Grenada and Jamaica). Fiscal responsibility frameworks, however, are not a panacea and need to be well-tailored and supported by adequate institutions and specific fiscal consolidation measures. Large shocks and capacity gaps call for robust design and implementation strategies in ECCU countries.

Fitting Fiscal Frameworks to Country Characteristics

Umbrella structure, leaving countries to adapt operational solutions to their circumstances.

Debt anchor. The public debt target of 60 percent of GDP by 2030 provides a reasonable common anchor or ceiling. With only two countries on track to reach the target, convergence would be an overriding goal. For some individual countries, tighter operational debt objectives may be appropriate based on their specific characteristics, including specific buffers against shocks. Staff argues for: (i) calibrating the targets to gross debt; and (ii) using a broad general government definition to limit the scope for loopholes.

Operational targets. An underlying budget balance target could be the main common element, at least through 2030, due to its strong link to debt dynamics. The targets could be set on fiscal balances (either primary or overall balance depending on the country-specific circumstances)1 net of volatile elements such as CBI inflows to be calibrated for each country to achieve the debt ratio of 60 percent of GDP before or in 2030. The option of supplementary expenditure targets would be strongly recommended given the critical need to ensure savings in good times and could potentially replace the budget balance targets beyond 2030 if debt is sufficiently reduced. Finally, special sub-targets could be used for key components of expenditure, to help right-size the wage bill (as in Grenada and Jamaica) and incentivize public investment, particularly for resilience-related projects. Within the above, individual countries need to avoid complexity and limit themselves to a narrow subset of options best suited to their own circumstances.

Counterfactual Simulation of Selected Fiscal Responsibility Frameworks, ECCU-6 1/

(overall balance, percent of GDP)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

1/ Counterfactual scenarios were calibrated for each country based on (i) targeting a prudent overall balance on average; and (ii) capping primary current expenditure growth at levels not exceeding potential growth.Source: IMF staff estimates.

Counterfactual Simulation of Fiscal Responsibility Frameworks, ECCU-6 1/

(public debt, percent of GDP)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

1/ Counterfactual scenarios were calibrated for each country based on (i) targeting a prudent overall balance on average; and (ii) capping primary current expenditure growth at levels not exceeding potential growth.Source: IMF staff estimates.

Fiscal buffers. The targets will need to be calibrated on a country-specific basis to achieve both the optimal buffer coverage (including insurance against natural disasters, as discussed in Box 3) and the 60 percent of GDP debt by 2030. Due to mutually reinforcing benefits of reducing debt and increasing buffers, these would need to proceed in parallel. Based on the assessment of the appropriate size of the buffers and debt target, staff has identified the financing gap that could be bridged by concessional financing (see next sub-section).

Flexibility to shocks and “tail events.” Mechanisms could be included to provide flexibility while preserving the credibility of the framework, including: (i) precise escape clauses with verifiable triggers and corrective mechanisms in the event of truly large shocks (for which the envisioned buffers do not provide sufficient protection); (ii) allowances for relief/reconstruction spending financed with fiscal buffers; and (iii) hurricane clauses allowing cash flow relief as per recent experiences in Grenada and Barbados.

Supporting institutions. Priority areas include: (i) robust accounting procedures (for debt, deficits, CBI inflows, and full recording of non-guaranteed public debt and contingent liabilities); (ii) improved fiscal projections, particularly by including the average cost of natural disasters; and (iii) effective independent fiscal oversight and accountability procedures, such as Grenada’s new fiscal responsibility oversight committee that is unconnected to the government.

1 An overall balance-based rule (used in Jamaica) has the advantage of a closer link to debt sustainability and more control over financing, while a primary balance-based rule (used in Grenada) should better facilitate compliance with the rule. In the ECCU, the difference between the two options would not be large in ECCU countries given the limited volatility of the interest cost of debt.

13. Fiscal frameworks need to be tailored to specific country characteristics, with a few common elements across the region (Box 1). The frameworks would be (i) consistent with the ECCU’s debt target of 60 percent of GDP by 2030; (ii) based on a tailored operational target as a medium-term compass; (iii) supportive of the need to build resilience to natural disasters; and (iv) compatible with the institutional capacity of ECCU countries. Strong and broad-based political commitment would be essential to underpin those efforts.

14. Staff analysis suggests that the proposed framework would contribute to better fiscal outcomes. Counterfactual simulations and scenario analysis suggest that the implementation of the new framework would: (i) substantially improve debt sustainability; (ii) reduce policy pro-cyclicality; and (iii) create fiscal space to build resilience (see next sub-section) and bolster potential growth. The proposed institutional improvements would be highly beneficial regardless of whether formal fiscal responsibility frameworks were adopted, as they would enhance the efficiency of public services, improve public investment outcomes, and contribute to a better and more broad-based public debate on fiscal policy issues. Finally, by enhancing transparency and predictability of fiscal policy, the framework can gradually facilitate union-level coordination and improve the region’s clout in securing donor funding, including from climate funds.

B. Building Ex-Ante Resilience to Natural Disasters

Shifting the Paradigm: Preparing Ex-Ante for Natural Disasters and Climate Change

15. Natural disasters recurrently affect the ECCU, resulting in human loss, destruction of infrastructure, and large fiscal costs. Natural disasters put pressure on government’s finances in the near and long term. In the near term, pressures arise from unanticipated needs for immediate social protection and rehabilitation expenditures, at a time when revenues typically decline. In the long term, the costs of natural disasters contribute to the increase of public debt. The ECCU is subject to larger and more frequent disasters that affect the entire economy. With climate change, the intensity and frequency of disasters is expected to increase.

Damage and frequency of natural disasters in the ECCU

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Sources: Staff calculations based on EM-DAT and authorities data.Note: EM-DAT contains essential core data on the occurrence and effects of over 22,000 mass disasters in the world from 1900 to the present day.

16. The ECCU currently invests little in resilience-building and relies heavily on ex-post recovery efforts. Limited global financing that falls well short of adaptation needs and inadequate capacity to meet the complex access requirements of climate funds are key obstacles to investing in resilient structures or setting aside dedicated funds. Insurance uptake is also low, for both public and private sectors. The Caribbean Catastrophe Risk Insurance Facility (CCRIF), to which all ECCU countries have access, has been a valuable instrument, but most countries’ risk ceding remains below needs, mainly because of the perceived high cost, concerns that significant damages may not trigger payouts, and competing developmental needs. Innovative risk-sharing tools such as cat-bonds have not been issued by the ECCU jurisdictions reflecting their complexity, high setup costs, and capacity/regulatory constraints.

17. Building ex-ante resilience to natural disasters and climate change should be a key policy priority. Staff recommends a paradigm shift from post-disaster recovery to building ex-ante resilience. A framework to support fiscal sustainability is a necessary precondition for a shift in strategy. Sustainable improvements in the fiscal position are necessary to create fiscal space and enhance opportunities to access concessional finance for resilience building.

The Benefits of Resilient Investment

Staff simulations are based on a dynamic general equilibrium model calibrated to all ECCU countries. Expected losses from natural disasters are estimated based on historical data for various types of disasters. The model assumes that resilient infrastructure (such as durable roads, bridges, and sea walls) is a perfect substitute for standard infrastructure but is 25 percent more expensive. Keeping the physical amount of public investment unchanged, countries are assumed to allocate 80 percent of investment in resilient capital, thereby gradually increasing the stock of resilient public capital until it reaches 80 percent. The outcome in terms of output and fiscal performance is then compared with a situation where no resilient capital is in place.

Potential GDP with increase in resilience to 30 percent

(percent change relative to no resilience)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: Model simulations on authorities’ data.

Under these assumptions on resilient public investment, potential output increases by about 3–11 percent in ECCU countries. This implies 0.1–0.4 percent higher GDP growth per year in ECCU countries. Additional annual savings of 0.7–2.7 percent of GDP come from reduced damages and losses from natural disasters.

Fiscal performance also is strengthened in the long term. Higher tax revenues more-than-offset the higher cost of resilient investment, improving the overall fiscal balance by 0- 3 percent of GDP. In the near term, however, the transition from standard to resilient capital has upfront fiscal costs, with returns materializing only at a later stage. Fiscal consolidation is already required in most ECCU countries to reach the regional debt target of 60 percent of GDP by 2030 (see previous sub-section). Assuming countries undertake sufficient fiscal adjustment aimed at meeting the debt target, simulations indicate that public debt would exceed its target by 4–20 percentage points of GDP in 2030 owing to the higher cost of resilient capital (only about half of the public capital stock would be resilient by 2030 at the current investment rates), without concessional financing.

Public Debt with Resilient Investment

(ratio of GDP)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: Model simulations based on authorities’ data.

18. Resilient investment for natural disasters can enhance long-term macroeconomic performance. The shift to resilient public infrastructure reduces expected losses from natural disasters and raises returns to private investment, employment, and output. Resilient public capital reduces private investors’ output losses in the event of a natural disaster, therefore expected returns to private investment are higher relative to non-resilient investment. Higher capital also increases returns to labor and wages, increasing domestic employment, and reducing outward migration, which is generally high in countries prone to natural disasters.8 Staff simulations indicate that the effects of resilient investment on potential output and fiscal performance would be significant (Box 2), with GDP growth higher by 0.1–0.4 percent per year in ECCU countries.

Transitional Increase in Output Growth with Resilience Investment

(Average increase in annual growth, in percent)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: Staff calculations based on Authorities’ data. Assumes public investment in resilience increases to 80 percent.

19. The additional near-term fiscal costs would open a transitional financing gap. The additional costs of resilient investment would make it difficult to attain the ECCU debt target of 60 percent of GDP by 2030. On top of an accumulated fiscal adjustment of 0–7 percent by ECCU countries to meet the debt target, staff’s illustrative simulations show that resilience costs would create financing gaps of 0.4–1.5 percent of GDP or about US$60 million for the ECCU annually (blue bar in text chart) to enable countries adhere to the debt target. However, these estimated financing gaps for resilient investment should be interpreted as a minimum.9 To close the financing gap, concessional financing from the international community, including climate funds, could play a key role.

Financing Gaps from Resilient Investment and Insurance Costs 1/

(Annual flows, percent of GDP)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

1/ Capital spending to maintain observed public investment rates with costlier resilient structures.2/ Calculated to achieve neutral fiscal impact (equivalence between insurance cost and expected payouts).Source: IMF staff calculations based on authorities’ data.

20. ECCU countries should also develop a comprehensive insurance strategy against natural disasters, which would add to the financing gap. Resilient structures mitigate destruction and losses from natural disasters, but do not eliminate them. To ensure liquidity for relief and reconstruction while protecting public finances, a comprehensive disaster risk financing strategy should be prepared. Insurance layering can be engineered to cover most natural disasters’ fiscal costs, but near-term fiscal costs would be significant (Box 3). However, the immediate availability of financing for relief and reconstruction would have significant output payoffs.10 Based on staff’s simulations, reducing annual insurance costs to the value of expected payouts would create an additional fiscal gap of at least 0.2–1.1 percent of GDP or US$40 million for the region annually (orange bar in the text chart above). In the long term as structures become more resilient, insurance needs and fiscal costs would decline significantly. Simulations indicate that insurance requirements for same coverage could decline to about 1/4 of the current needs.

Natural Disaster Insurance Financing

Appropriate size and costs of the three insurance layers is calculated using a stochastic model that replicates output and fiscal performance observed in the historical data after natural disaster shocks. Variables included are tax revenues, expenditures, and grants. Capacity and financing constraints, and re- prioritization of expenditures (reconstruction largely replaces pre-existing projects) are considered. The simulations assume that ECCU countries adopt a three-layer strategy1/ as follows: (i) establishing a saving fund as self-insurance of 6–12 percent of GDP sufficient to cover 90–95 percent of disasters’ fiscal costs (small and medium-sized natural disasters),2/ with CBI resources financing startup costs where available; (ii) purchasing maximum access under CCRIF, with estimated expected coverage of 2–17 percent of GDP (larger disasters); and (iii) issuing CAT bonds, a state-contingent debt instrument, with debt service relief of 2- 5 percent of GDP (extreme events).3/ The insurance instruments are layered according to their incremental costs.

Natural Disaster Insurance Layering

(percent of GDP)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: IMF staff calculations based on CCRIF and authorities’ data.

The results indicate that, to cover 99 percent of the fiscal costs related to natural disasters, ECCU countries would need coverage in the amount of 15–30 percent of GDP. This coverage would imply annual fiscal costs in the range of 0.5–1.8 percent of GDP. At least part of these costs could be covered by donors to make insurance more affordable.

1/ The World Bank has developed a risk-layered framework for optimizing disaster risk financing, which has been applied to some ECCU countries. See World Bank, “Advancing Disaster Risk Finance in Saint Lucia”, 2018; World Bank, “Advancing Disaster Risk Finance in Grenada”, 2018. 2/ A saving fund would need to be supported by a strong institutional framework, establishing annual saving contributions and clear verifiable criteria for disbursements after natural disasters. 3/ IMF and World Bank staff is working on two options for further developing state-contingent debt instruments that could help countries better manage their debt-service payments at times of natural disasters. The first relates to sovereign insurance against natural disasters, where insurance is purchased to cover a specified amount of debt service payments following catastrophic disasters. The second option broadens the concept of “hurricane clauses” already used in two debt restructurings (Grenada and Barbados), where state-contingent features built into the debt contract allow for maturity extensions following disasters.

Fiscally Sustainable Strategy to Build Ex-Ante Resilience to Natural Disasters

21. Full integration of fiscal responsibility frameworks with resilient investment and insurance mechanisms would help the ECCU achieve a sustainable fiscal position while improving resilience to natural disasters, provided there is sufficient external support and strong policy implementation. The country-specific frameworks need to be based on a holistic diagnostic. The Climate Change Policy Assessment (CCPA) has been a valuable tool for St. Lucia to identify the needs and costs of building resilience.11 Staff scenario analysis suggests that if ECCU countries undertake fiscal adjustment and phase in resilient investment and insurance buffers with support with the international community, the ECCU’s public debt trajectory would decline at a faster pace than in a pure fiscal consolidation scenario without building resilience. The benefits would be further amplified beyond 2030, as the growth and fiscal benefits would continue while the costs of building resilience would decline. Ongoing initiatives to pool resources in regional institutions with accreditation to access climate funds should be supported and pursued in the near term. As mentioned above, staff simulations indicate that the additional costs of resilient investment and actuarially-fair insurance would create a financing gap of about US$100 million per year for the region,12 with concessional financing, including from climate funds, being a key option.

ECCU-6 Public Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

1/ Fiscal adjustment is to be supported by a fiscal responsibility frameworkand calibrated to achieve 60 percent of GDP target by 2030.2/ It is assumed that external concessional funding covers all resilience and insurance related costs, except that there is a delay in the provision of 50 percent of concessional funding by 2 years.

22. Countries should also continue advancing institutional fiscal reforms that would help with due diligence requirements of donor funds. This will require:

  • Addressing information, legislation gaps, and small economies of scale. An assessment of general preparedness is necessary to identify priorities, including legislation and processes, such as budgeting and public investment management. Costed investment projects and risk financing plans are needed for an assessment of the overall financing needs. Regional coordination would help accelerate the process by setting standards, facilitate peer review, and create economies of scale.

  • Integrating resilience building with macroeconomic planning. Expected costs of natural disasters should be included in macroeconomic frameworks, as well as costs and benefits of the resilience strategy, to evaluate the fiscal space needed for the implementation. Developing strategies to enhance access to donor grants will be crucial to making ex-ante resilience building sustainable.

  • Coordination of resilience building with fiscal responsibility legislation. Fiscal responsibility legislation would underpin the necessary fiscal adjustment to ensure a credible overall strategy, fill financing gaps, and ensure the long-term sustainability of resilience financing. Public investment projects at risk of natural disasters should be resilient and appropriately designed and costed. Upon achieving the 60 percent anchor, it could be reviewed and tightened in line with minimizing a probability of exceeding the 60 percent of GDP ceiling given the expected fiscal costs of natural disasters. Fiscal responsibility could also incorporate minimum insurance coverage, effectively helping internalize expected fiscal costs of future disasters, and annual saving needs for the sustainability of the saving funds.

Public Investment Management Heatmap1/
Countries Planning Allocating Implementing Average
Anguilla
Antigua & Barbuda
Dominica
Grenada
Montserrat
St. Kitts & Nevis
St. Lucia
St. Vincent & the Grenadines
ECCU Average
Jamaica
Barbados
Source: Country Authorities and IMF Staff Assessments
1 The scoring system reflects the alignment with good Public Investment Management practices. The assessment is based on the IMF’s 2015 Public Investment Management Assessment template for assessing infrastructure governance over the invesment cycle.
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Legend Low Medium Good

C. Strategy for Stability and Resolving Problems in the Financial Sector

23. There has been important progress on the regional financial sector reform agenda. This includes: (i) initial capitalization of the Eastern Caribbean Asset Management Company (ECAMC) as part of the ECCU’s financial stability strategy for reducing high NPLs; (ii) issuance and implementation of the collateral valuation standard; (iii) implementation of risk-based supervision (RBS); and (iv) completion of on-site examinations of all banks within the three-year cycle established in the Banking Act 2015. In addition, the law to establish a credit bureau framework was passed in four member countries13 and an operator was selected for licensing, the ECCB published the first Financial Stability Report, and an MOU was signed for a blockchain technology project which is targeted to, among other things, alleviate the risks of CBR withdrawal. A consultative paper on the consolidation of indigenous banks has been issued, the transfer of AML/CFT supervision for banks to the ECCB has been initiated, and the Monetary Council has considered a paper on the establishment of a Deposit Insurance Fund.

Nonperforming Loans to Total Gross Loans

(In percent)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: ECCB.

24. However, unresolved weaknesses in the banking sector magnify vulnerabilities. Despite recent progress in resolving banks,14 outstanding problems are becoming more acute. Capitalization is above the regulatory standards, but provisioning by indigenous banks against legacy NPLs (as old as 15 years) is not adequate. The impending implementation of IFRS 9 and the new ECCB prudential standards on valuation of collateral and treatment of impaired loans will likely result in larger provisioning requirements that may require major capital augmentation and/or resolution measures, with possible fiscal costs. The replacement of global CBRs with a few, smaller correspondent banks suggest increased counterparty and concentration risks for banks in the region. The pending exit of foreign banks might heighten vulnerability of the affected countries in terms of CBR access and costs. It may also increase withdrawal risks in some jurisdictions, while the related mergers could raise concentration risks in some member jurisdictions. Reportedly, some banks are also actively exploring opportunities for improved earnings from overseas placements and/or investments.

25. The region’s strategy to address the chronic NPL situation within the rapidly closing timeline is at risk. The ECAMC, set up in July 2017 with the dual mandate to acquire bad assets from banks and other approved financial institutions (AFIs), and to act as the receiver of failed financial institutions, is operating, but progress towards acquisition of a critical mass of NPLs by the statutory July 2019 timeline has been slow. As of November 2018, no NPLs have been purchased and funding modalities are yet to be finalized.15 The pace has improved materially with the ECAMC’s recent hiring of an expert consultant and other capacity augmentation measures, as well as with the ECCB’s instrumentality in following up with banks in sharing information with the ECAMC. The ECAMC has received information of a prospective portfolio of commercial NPLs to acquire of EC$400 million or 29 percent of total NPLs. However, the timeline is very tight and the risk of slippage is real.

26. The rapid increase of credit union lending and natural disasters has increased risks in the non-bank financial sector. While credit union assets represent only 9 percent of financial assets (Table 8), their lending growth has increased in recent years. Additionally, some credit unions have been de-risked by banks that apply know your customer’s customer (KYCC) practices.16 Their market share is significant in Dominica and large in Grenada, St Vincent and the Grenadines, and St. Lucia. The insurance sector, which is also relatively small (7 percent of financial assets) in a region exposed to catastrophic events, was hit hard by the 2017 hurricanes. The sector is also exposed to concentration risk—with two financial conglomerates representing almost half of the total insurance assets in the Caribbean.17 Spillovers to banks through credit unions’ and insurance companies’ bank deposits and credit exposures are also a concern with potential sources of fiscal liability.

Table 1.

ECCU: Selected Economic and Financial Indicators, 2014–24 1/

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

Includes all eight ECCU members unless otherwise noted. ECCU price aggregates are calculated as weighted averages of individual country data. Other ECCU aggregates are calculated by adding individual country data.

Debt relief has been accorded to: (i) Grenada under the ECF-supported program in 2017; and (ii) St. Vincent and the Grenadines in 2017 and Antigua and Barbud in 2018 under the Petrocaribe arrangement.

Table 2.

ECCU: Selected Economic Indicators by Country, 2014–24

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

ECCU: Selected Central Government Fiscal Indicators by Country, 2014–24 1/

(In percent of GDP)

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

Fiscal years for Dominica, Montserrat (since 2010) and St. Lucia.

Includes imputed natural disaster costs.

Table 4.

ECCU: Selected Public Sector Debt Indicators by Country, 2014–24 1/

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

Fiscal years for Dominica, Montserrat (since 2010) and St. Lucia.

Debt relief has been accorded to: (i) Grenada under the ECF-supported program in 2017; (ii) St. Vincent and the Grenadines in 2017 and and Antigua and Barbuda in 2018 under the Petrocaribe arrangement.

Table 5.

ECCU: Monetary Survey, 2014–24

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Sources: ECCB; and Fund staff estimates and projections.
Table 6.

ECCU: Summary Balance of Payments, 2014–24 1/

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Sources: Country authorities; and Fund staff estimates and projections.
Table 7.

ECCU: Selected Labor Force Indicators

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Sources: WEO, World Bank, WDI, National Authorities (censuses and poverty assessments); and IMF staff calculations.

2013

2014

2016

2017

Table 8.

ECCU: Financial Structure, end-2017

(In millions of EC dollars; unless noted otherwise)

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Sources: National Authorities, Eastern Caribbean Central Bank, Caribbean Confederation of Credit Unions, and IMF staff calculations.

Insurance data for Anguilla, Dominica, and St Lucia as at end of period 2016.

ECCU: Private Credit Growth

(percent, year over year)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Sources: Country Authorities; ECCB; and IMF staff calculations.1 Total loans for ECCU countries with the exception of Anguilla which has no credit unions.

ECCU Credit Stock

(In percent of GDP)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Sources: Country Authorities, ECCB, and IMF staff calculations.1 Total loans for ECCU countries with the exception of Anguilla which has no credit unions.

27. Weak supervision and oversight of the non-bank financial sector increases financial system risks. Regulatory oversight and supervision of credit unions, insurance companies, building and loan societies, offshore bank and non-bank financial institutions, and a wide span of other non- bank financial institutions is undertaken by national authorities, who have acknowledged deficiencies in terms of fragmented supervisory frameworks, inadequate resources given the scope of oversight responsibilities, weak enforcement powers, and data gaps. A healthy private insurance sector is critical in the region to support risk sharing for natural disasters.

28. Intensified efforts are necessary to fully operationalize the ECAMC’s mandates. The acquisition of a critical mass of commercial NPLs at realizable market values should be completed by the July 2019 deadline. While non-government sources of financing are being sought, funding for the acquisitions of NPLs may have fiscal implications to the extent that government guarantees may be required.18 Consistent with IMF technical assistance, staff recommends that, absent adequate progress to meeting the deadline, ECAMC’s operations should be promptly downscaled to receivership or wound up—with the receivership operations returned to individual receivers. Completing urgently the modernization of the insolvency and foreclosure laws and easing restrictions on non-citizen property ownerships will help maximize NPL recovery and minimize potential fiscal costs.

29. Further timely actions are needed to address current and emerging risks. The ECCB should: (i) establish and enforce a realistic plan for banks to reduce NPLs to no more than 10 percent by end-2019 and attain the 5-percent benchmark for NPLs by end-2023; (ii) require banks to submit credible, time-bound action plans to improve provisioning and resolve NPLs, especially large CBI- related NPLs in one territory, and dispose of non-core assets within statutory timelines;19 (iii) promptly issue and implement its prudential standards on the treatment of impaired assets; (iv) closely monitor banks’ progress to plans and appropriately utilize statutory powers to ensure that banks adhere to their NPL resolution plans, fully comply with prudential standards on collateral valuation and provisioning, enhance risk management and strengthen capital; and (v) accelerate the consolidation of indigenous banks to attain sustainable critical mass and act quickly with any undercapitalized banks. The ECCB should also focus on assessing and mitigating risks that may arise from institutions seeking better returns overseas.

30. Plans for the resolution of weak non-bank institutions need to be established and implemented by country authorities, in collaboration with the ECCB. These plans need to be supported by effective coordination among the relevant agencies and governments and appropriate crisis management and resolution measures, including for effective (i) intervention of problem entities, (ii) management of system impact (e.g. liquidity), and (iii) communications. Moreover, the large impact of natural disasters on the financial position of insurance firms suggests that specific focus must be placed on establishing and enforcing appropriate risk mitigation standards and practices (e.g. minimum investment criteria and reinsurance standards).

31. Strategies to minimize the risk of a potential decline in CBRs and related increased costs, de-risking of downstream financial institutions by banks, and exit of foreign banks should be finalized and implemented. This should include: (i) specific monitoring of banks’ CBRs, considering the reporting template developed by the IMF ; (ii) intensified information sharing and relationship building with current and prospective correspondent banks and their oversight authorities, including involvement of the ECCB at appropriate levels; (iii) strengthening and harmonization of the regulatory and AML/CFT oversight framework for banks and non-bank financial institutions, including urgent passage and implementation of legislation designating the ECCB as Supervisory Authority for AML/CFT for banks by all remaining territories;20 (iv) timely completion of national risk assessments; and (v) enhanced governance, qualifying criteria, transparency, due diligence and penalties/sanctions relating to any abuse of CBI programs. Strategies should also address the issue of banks’ size and scale to maintain CBR minimum transaction thresholds.

32. Prompt completion of the financial sector reform agenda is critical to preserve financial stability. A prompt finalization of the harmonized, strengthened laws on credit unions (and building and loan institutions) and the insurance, pension, and securities subsectors is needed to improve the regulatory framework for non-banks.21 Effective consolidation of regional financial sector oversight, with the ECCB having supervisory responsibility for all deposit taking institutions and another agency mandated to supervise the non-deposit taking financial sector will maximize cohesive coverage and mitigate resource and skills constraints.22 In line with previous ECCU consultation’s advice, the ECCU minimum saving deposit rate should be eliminated, or at least gradually phased out, given its distortionary nature.23

33. The last update of the safeguards assessment of the ECCB, completed in 2016, concluded that governance arrangements are sound. Recommendations of the assessment have since been implemented, and the annual financial statements continue to be prepared and audited in accordance with international practices.

D. Competitiveness and Growth

34. The external position of the ECCU in 2017 was weaker than implied by medium-term fundamentals and desirable policies. The external sector assessment indicates that the real effective exchange rate (REER) in 2017 was overvalued by about 5.9 percent on average.24 Despite the REER depreciation of 4.2 percent in 2017 on account of a weakening U.S. dollar, the REER model also shows an overvaluation in 2017 (Annex III). Since then, the REER appreciated slightly through November 2018. The weak external position partly reflects fiscal imbalances.

Real Effective Exchange Rate

(Index: 2010=100; the increase represents an appreciation)

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: IMF, International Financial Statistics (IFS).

35. Large current account deficits and high unemployment indicate low competitiveness. The region faces formidable structural constraints, including high costs of electricity, trading, and unit labor; labor skill mismatches; an unfavorable business climate, particularly for the difficulties in resolving insolvencies and getting credit; and public-sector inefficiencies. Despite some efforts to alleviate these constraints in recent years, progress has been slow (Figure 6).

Figure 1.
Figure 1.

ECCU: Real Sector Developments

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: Country authorities, ECCB and Fund staff calculation.
Figure 2.
Figure 2.

ECCU: Tourism Developments

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Sources: ECCB, CTO and Fund staff calculations.
Figure 3.
Figure 3.

ECCU: Monetary Developments

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: ECCB
Figure 4.
Figure 4.

ECCU: Financial Soundness Indicators

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: ECCB and Fund staff calculations
Figure 5.
Figure 5.

ECCU: Credit Developments

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: Country Authorities; ECCB; and IMF Staff Calculation
Figure 6.
Figure 6.

ECCU: Doing Business Indicators 1/

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Sources: World Bank 2018 Doing Business Indicators; and Fund staff calculations.1/ Distance to frontier (DTF) score measures the deviation of a country from the best perfomer, 0 representing the worst performer and 100 the fontier.2/ Smaller numbers represent greater ease in doing business. 2018 Doing Business rankings a across 190 countries. Annual rankings are rebased to adjust for different sample sizes. These indicators should be interprete with caution due to a limited number of respondents, a limited geographical coverage, and standardized assumptions on business constraints and information availability.

36. Notwithstanding the advantage of proximity to North-American markets, ECCU tourism has seen its global market share decline, partly reflecting lack of competitiveness. Staff analysis shows that the ECCU enjoys a competitive advantage for its proximity to North-American tourist market (Annex VI). However, despite the reputation of ECCU countries as high-end tourist destinations, tourist inflows to these countries are price sensitive, and the product offered is relatively expensive when compared with other tourist destinations globally. This may reflect supply-side constraints, and particularly high electricity costs and tariffs. Staff analysis shows that relaxing these constraints could increase the ECCU market share by 40 percent.

Week at the Beach Index

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Source: IMF staff estimates.Note: Week at the Beach Index(W@TB)" measures the average cost of a 7-day trip in a country's beach destinations. The Index is a composition of an average hotel price (3 to 4 'bubble' rating) from TripAdvisor and over 80 million corwd sourced data on meals, taxi fares, coffee and beer. The database covers 155 beach destinations from 56 countries.

37. Structural reforms are needed to improve the external position and boost competitiveness and growth. Priority areas include the business climate, tariffs and regional integration, labor markets and education, and public-sector efficiency.25 Faster progress of new legislation on foreclosure, insolvency and credit bureaus is key to address the ease of getting credit, the most critical areas of business climate according to Doing Business Indicators and other business surveys. To lower electricity costs and attain their emission targets under the Paris accord, countries should accelerate implementation of their investment strategies in renewable energies while actively engaging the private sector. Tariff cuts under the CARICOM regime would help enhance competition and reduce high import prices, while further regional integration is necessary to address the small size of internal markets and high costs. On labor markets and education, the comprehensive technical and vocational skills program, adopted for instance by Grenada, promises to better align the supply of skills to the broader needs of the economy. The introduction of new technologies in the public sector have the potential to significantly enhance its efficiency. Finally, as discussed above, the implementation of a strategy to build resilience to climate change and natural disasters would have positive spillovers on competitiveness and growth.

Imports: Shipping Costs and Tariffs (2014)1

Citation: IMF Staff Country Reports 2019, 062; 10.5089/9781498300056.002.A002

Sources: World Bank, Doing Business 2014 and WDI.1 Tariffs for Dominica, Grenada, and St. Vincent and the Grenadines correspond to 2015.Note: Excludes three countries with shipping costs above $6,000/container.

Authorities’ Views

38. The authorities broadly agreed with staff’s assessment of the economic outlook and risks. They saw however more upside to near-term economic momentum, estimating growth around 3.0 percent in 2018 and 2019. They also emphasized that the continuing multi-year decline in the public debt ratio is a positive signal, notwithstanding the contribution of temporary factors, in some countries, to the dynamics. They noted that banking sector metrics were also gradually improving, as reflected in a positive rate of growth of bank credit to the private sector as of mid-2018, driven by solid loan growth to private businesses.

39. The authorities agreed with the primacy of the 2030 debt target and strategies to achieve it. They indicated that medium-term fiscal frameworks consistent with reaching the 60 percent of GDP target had been prepared in the six ECCU countries. Some of the countries had already tabled those frameworks in parliament, while in others, the process was ongoing. The medium-term plans provide for fiscal adjustment measures and medium-term deficit targets as well as interim public debt targets for 2020 and 2025. The authorities agreed with the need for a prudent fiscal stance that would address fiscal risks going forward, including in countries that are already close to achieving the 60 percent of GDP debt target.

40. At the same time, views were mixed on the need for legally-binding fiscal responsibility frameworks. Most countries were weighing the merits of adopting formal fiscal responsibility legislation (FRL) to solidify progress and build fiscal resilience. With this in mind, they were also consulting with the Grenadian authorities and other stakeholders to assess their experience with the implementation of FRL’s provisions, including with independent oversight arrangements such as the Fiscal Responsibility Oversight Committee in Grenada. In this context, a key takeaway highlighted by the Grenadian authorities in the success of the FRL was its broad political backing through a social compact. One country authority considered that, in the absence of extensive punitive sanctions for non-compliance in most existing FRLs, these were not suitable for codification in legal norms but rather could be adopted as government or parliamentary declarations of fiscal responsibility. Several country authorities stressed the need for FRLs to be compatible with promoting growth opportunities in the region and expressed some concern that their implementation could de-facto constrain public investment.

41. The authorities expressed broad agreement on the need for resilient investment and higher insurance coverage. They explained that fiscal sustainability and competing developmental needs imply significant opportunity costs. In some countries, staff estimates for self-insurance was deemed insufficient given the increasing frequency of non-catastrophic events due to climate change. Furthermore, though highly supportive of CCRIF and appreciative of the immediate liquidity it offers for catastrophic events, countries did recognize the imperfect nature of parametric instruments.

42. They highlighted the high costs of an ex-ante resilience strategy, especially in light of competing development needs and fiscal challenges. They agreed on the importance of developing integrated national resilience strategies including detailed projects, execution timeline, and costing. They explained that although such strategies were not fully developed within a unified framework, their public investment plans included specific resilient investment projects, while budgets included CCRIF insurance costs, although insurance coverage was below the desired level. The authorities agreed that insurance expense supports fiscal sustainability by de-facto internalizing natural disasters’ expected losses and cost recovery in the form of insurance payouts. However, they noted CCRIF and market insurance instruments are expensive. Most authorities were supportive of the creation of saving funds for natural disasters, but were concerned about the size needed to insure against large and recurrent disasters. Most authorities also noted that CBI programs, a potential source of financing for resilience building, are being undermined by their inclusion in the OECD published list of schemes susceptible to facilitating tax evasion and illicit financial flows. All authorities called on the international community to provide more financial assistance for the implementation of these ex-ante resilience strategies.

43. Governments noted the onerous requirements of grant and climate fund financing. They explained that administrative requirements for application and disbursement from climate funds are complicated, not always commensurate with human resource and capacity constraints of small states, and that the neglect of vulnerability as a criterion for ODA accessibility penalizes middle-income Caribbean states. They expressed understanding of donor funding’s due diligence requirements and asked for technical assistance to address any reasonable gaps. They urged the international financial community to collaborate in support of the simplification of grant financing administrative burden and disbursement process and for the inclusion of vulnerability among the criteria eligibility for concessional financing.

44. The authorities broadly agreed on the principal areas of risk to financial sector stability. These center largely on (i) slow resolution of high NPLs and insufficient provisioning, particularly in indigenous banks; (ii) de-risking pressures and lack of access to replacement global CBRs, which appear to be linked to the lack of “critical mass” to meet minimum transaction thresholds; and (iii) emerging risks and vulnerabilities in the near-bank and non-bank financial sector (inclusive of the credit union and insurance sectors) where oversight arrangements have not kept pace with the rapid growth of near-bank institutions. The authorities emphasized the need for urgent collaboration for realistic solutions to de-risking to be agreed to and supported by all international stakeholders.

45. The authorities acknowledged the importance of implementation of IFRS 9 and the new prudential standards to incentivize banks to clean up their books. They also noted the potential fiscal implications regarding banks making the requisite adjustments. The ECCB indicated that it would take supervisory steps to address these issues. While the mandate and success of the ECAMC as a strategy to effectively reducing system NPLs is fully supported by the authorities, funding for NPL acquisitions should be premised predominantly on private sector options as issuance of government guarantees is inconsistent with the debt target.

46. The authorities expressed commitment to the acceleration of key reforms to upgrade and strengthen the financial sector regional oversight framework. The ECCB indicated that indigenous banks are being encouraged to implement functional cooperation including sharing services and costs, as a first step for more consolidation. While most country authorities expressed general agreement on consolidating the regional financial sector oversight framework (the plan currently contemplates three regional agencies), concerns were raised on ensuring adequate funding and staff resources. The ECCB was viewed by some as the only agency in the region with the necessary skills, resources, infrastructure and capacity to effectively undertake the responsibility, while concerns were raised about the risk to effectiveness that will arise with lack of on-the-ground regular contact/follow-up and in-depth knowledge of institutions. The ECCB concurred that there is sound basis for re-looking the plans to ensure effective, coordinated oversight, including strengthened AML/CFT supervision, and broaden its supervisory parameter consistent with its financial stability mandate. The ECCB also shared its focus on Fintech and the issuance of digital fiat currency given their potential for growth, financial inclusion, competitiveness, and mitigating AML and governance issues.

47. The authorities agreed on the need to bolster competitiveness in the context of the quasi-currency board arrangement. The authorities expressed the view that high prices of ECCU tourism reflect quality considerations, but they agreed that the cost structure in the region is relatively high compared with other tourist destinations, which might help explain the declining share of the ECCU in global tourism. On structural bottlenecks, the authorities pointed to the ECCB’s efforts in helping improve the ECCU countries’ ranking in the Ease of Doing Business Index with the aspiration to break into the top fifty in the next three years. The authorities stressed the importance of enhancing connectivity, a regional credit bureau, modern land and property registries and harmonized border regulations to create a more efficient regional market for all factors of production and enhanced tourism accessibility. They also stressed that innovative solutions, including opportunities provided by Fintech to reduce the use of cash, have the potential to reduce transaction costs while hardening the financial system against crime.

Staff Appraisal

48. Growth is gradually recovering in 2018 following the adverse economic impact of natural disasters in 2017. Growth declined substantially in 2017 mainly owing to Hurricanes Irma and Maria. The growth outlook is favorable in the near term, but it is subject to increasing risks. Natural disasters are becoming more frequent and intense, compounding these vulnerabilities.

49. A paradigm shift from post-disaster recovery to building ex-ante resilience to natural disasters should be a key policy priority. The growing recurrence and intensity of natural disasters and the gradual effects of climate change require a comprehensive ex-ante resilience strategy, including by scaling up resilient investment and insurance cover against natural disasters. Fiscal sustainability is a necessary precondition for such a shift in strategy.

50. Robust fiscal responsibility frameworks are needed to underpin the region’s debt target, while improving economic performance and enabling resilience building. Based on current policies, public debt in most countries is on an upward trend, diverging from the ECCU target of 60 percent of GDP by 2030. Well-designed country-specific frameworks will help reverse debt dynamics, create fiscal space, and enable fiscal policy to become more counter-cyclical.

51. The frameworks should be anchored by the ECCU public debt target of 60 percent of GDP by 2030. Within this common umbrella, each country could have the flexibility to select operational and institutional elements that best fit its conditions, to be codified in national norms. A credible focus on the debt objective would entail some form of a medium-term fiscal balance target, which should exclude volatile items such as CBI inflows. Precise escape clauses will also be needed to allow flexibility while preserving credibility. Simple medium-term expenditure targets could play a useful complementary role to contain pro-cyclicality. Key supporting institutions and strong and broad-based political commitment would be essential to underpin those efforts.

52. Investment in resilient public capital would have a significant impact on economic growth. Staff estimates suggests that resilient infrastructure would raise potential output by 3– 11 percent, with an annual growth-dividend of 0.1–0.4 percent in ECCU countries. This is because resilient public capital reduces damages from natural disasters and increases expected returns to private investment and output. Resilient investment would have further durable expansionary effects through an increase in employment and wages and a decline in out-migration.

53. To ensure liquidity for relief and reconstruction while protecting public finances, increased insurance coverage should be considered within a layering framework. This could include: (a) creating saving funds for self-insurance as soon as feasible–with CBI resources financing startup costs where available; (b) maximizing CCRIF coverage; and (c) considering state-contingent sovereign debt for extreme disasters. As structures become more resilient, insurance needs would decline in the long-term to about 1/4 of the current level.

54. Resilient investment and insurance are costly, requiring additional resources in an initial phase before payoffs from resilience building materialize. Upfront costs of resilient infrastructure would make it difficult to attain the ECCU debt target of 60 percent of GDP by 2030. Assuming that countries undertake the much-needed fiscal adjustment to meet the debt target, staff analysis indicates that investment in resilience would create a substantial financing gap for the countries, with concessional financing from the international community, including climate funds, being a key option that enables countries to improve resilience to natural disasters while adhering to the debt target.

55. Despite important progress on the regional financial sector reform agenda, further timely actions are needed to address current and emerging risks. The ECCB should: (i) establish and enforce a realistic plan for banks to reduce NPLs—especially large CBI-related NPLs—and dispose of non-core assets within statutory timelines; (ii) promptly issue its prudential standards on the treatment of impaired assets; and (iii) use ECCB’s statutory powers to ensure that banks adhere to mandated prudential standards and enhance risk management, including requiring them to take measures to strengthen capital. The ECCB should also focus on assessing and mitigating risks that may arise from institutions seeking better returns overseas. Strategies to minimize the risk of a potential decline in CBRs and related increased costs, de-risking of downstream financial institutions by banks, and exit of foreign banks should be finalized and implemented.

56. Intensified efforts are necessary to operationalize the ECAMC’s mandate. The acquisition of a critical mass of commercial NPLs at realizable market values should be completed by the July 2019 deadline. Absent adequate progress, ECAMC’s operations should be promptly downscaled to receivership or wound up. Completing urgently the modernization of the insolvency and foreclosure laws and easing restrictions on non-citizen property ownerships will help maximize NPL recovery and minimize potential fiscal costs.

57. Prompt completion of the financial sector reform agenda is critical to preserve financial stability. Plans for the resolution of weak non-bank institutions need to be established and implemented by country authorities, A prompt finalization of the harmonized laws on credit unions (and savings and building institutions) and the insurance, pension, and securities subsectors is needed to improve the regulatory framework for non-banks. An effective consolidation of regional financial sector oversight for banking and non-banking financial sectors will maximize cohesive coverage and resource and skills constraints. The ECCU minimum saving deposit rate should be eliminated, or at least gradually phased out, given its distortionary nature.

58. In addition to fiscal consolidation, injecting new vigor into the structural policy agenda will help enhance competitiveness and make growth more inclusive. The external position is weaker than implied by medium-term fundamentals and desirable policies. Fiscal consolidation will help address the real exchange rate overvaluation in the context of the quasi-currency board. Long- term and consistent commitment to implementing structural reforms in investment and business climate, public sector efficiency, reducing energy and transportation costs and tariffs, labor market reforms, and regional integration will be instrumental in enhancing the region’s competitiveness.

59. The discussion with the ECCU authorities will be on the 12-month cycle in accordance with Decision No. 13655-(06/1), as amended.

Table 9.

ECCU: Financial Soundness Indicators of the Banking Sector 2010–2018

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Correspond to locally incorporated banks only.

Weighted average lending rates less weighted average deposit rates.

Sources: Eastern Caribbean Central Bank (ECCB); and IMF staff
Table 10.

ECCU: Selected Financial Soundness Indicators by Country, 2010–2018

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Correspond to locally incorporated banks only.

Sources: Eastern Caribbean Central Bank (ECCB); and IMF staff calculations.
1

On September 5, Irma, a category 5 hurricane, hit Anguilla, Barbuda, and St. Kitts and Nevis. On September 19, Maria, also a category 5 hurricane, hit Dominica and St. Kitts and Nevis. Estimated damages range from 226 percent of GDP (Dominica) and 103 percent of GDP (Anguilla) to 9.8 percent of GDP (Antigua and Barbuda) and 3.3 percent of GPD (St. Kitts and Nevis). While 95 percent of buildings were destroyed in Barbuda, Antigua—a much larger economy—was not significantly damaged.

2

Including the final haircut under the ECF-supported program in Grenada and the restructuring of Petrocaribe debt in St. Vincent and the Grenadines.

3

Grenada has a more agile court process for collateral recovery than other member jurisdictions.

4

Best’s Special Report – Trend Review June 14, 2018.

5

The current account deficits are however lower than those reported during the 2017 ECCU consultation, owing to the shift to the BPM-6 methodology that generally improved the external balances. Staff estimates differ slightly from the ones released by the ECCB in September 2018, owing to the reclassification of insurance payouts in Dominica. Staff is discussing the appropriate classification with STA, CARTAC, and the ECCB. New estimates will be released by the ECCB in March 2019.

6

As per guidance for small states, the baseline scenario incorporates an imputed fiscal cost of natural disasters, ranging from 0.2 to 1.4 percent of GDP.

7

Initial drafts of medium-term fiscal frameworks aiming at achieving the 60 percent of GDP target were being prepared in six ECCU countries (excluding British Overseas Territories) at the time of the mission, but were not yet available for assessment.

8

Average out-migration rates (e.g., proportion of labor force working abroad) are about 40 percent on average in the ECCU, and nearly 80 percent for high-skilled workers, as reported by the United Nations (http://data.un.org/).

9

The financing gaps are calculated as the savings required after fiscal adjustment to reach the regional debt target and cover with the additional costs of resilient investment and after fiscal adjustment. Public investment may need to be upscaled to accelerate resilience building, especially where public investment is low (Antigua and Barbuda and Saint Vincent and the Grenadines) or where reconstruction is underway after major natural disasters (Dominica).

10

Cantelmo, A., Bonato, L., Melina, G. and G. Salinas, “Policy Trade-Offs in Building Resilience to Natural Disasters and Climate Change”, IMF WP (forthcoming) estimate that these effects could be comparable to or greater than those of investing in resilience.

11

In the ECCU, one pilot for this exercise—conducted by the IMF in cooperation with the World Bank—has been completed for St. Lucia (IMF Country Report No. 18/181) and another will soon be undertaken for Grenada.

12

The financing gap of US$100 should be considered as a lower bound estimate. Staff estimates indicate that the cost of all resilient projects and the full insurance would be about US$350 million per year for the region. This would imply a financing gap in the range of US$100–350 per year for the region. In the absence of enough support from the international community, resilience building would need to be scaled back and recalibrated to avoid un-anchoring the fiscal framework, which by itself would jeopardize resilience-building going forward.

13

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

14

The resolution of the two banks in Anguilla that were intervened in 2016 is nearing conclusion with the July 2018 signing of the put-back agreement for the transfer of nonperforming loans between the receiverships and the bridge bank, National Commercial Bank of Anguilla (NCBA). This step unblocked loan proceeds from the Caribbean Development Bank to fund the EC$59 million capital injection into NCBA. A committee has been established to deal with the sale of that bank to the private sector. The receiverships will be transferred to the ECAMC on completion of the independent valuation of disputed NPLs under the put-back transaction.

15

The ECAMC Board approved the NPL Acquisition Proposal on November 29, 2018.

16

Although FATF confirms that KYCC is not a requirement, this approach continues to be taken by some banks to mitigate risk of loss of CBRs.

17

There is also concern for deepening concentration in certain member jurisdictions with pending sales of a large insurer’s portfolios to a smaller operator.

18

The ECAMC Act contemplates that government guaranteed bonds would be used to fund the acquisition of NPLs.

19

The ECCB has required the reclassification of the 2015 debt-land-swap from financial to fixed assets in the balance sheet of banks. This will require that the land be sold within a timeframe of 5 years, consistent with ECCB regulation (Section 55(3) of the Banking Act for the ECCU).

20

To date only three-member countries have enabling legislation in place and named the ECCB as AML/CFT Supervisor.

21

While a Harmonized Co-operative Societies Act was enacted between 2010 and 2012 by all but two countries, implementation—including for credit unions—remains outstanding as regulations to govern implementation of the Act continue to be subject to ongoing consultation and revisions among national regulators.

22

There is also an immediate need for country financial regulatory authorities to be adequately resourced to allow for effective non-bank financial sector oversight in the interim, while the harmonized laws are finalized and implemented and until the consolidated regional architecture is established.

23

The MSR increases lending rates and reduces banks’ profitability, slowing capitalization and NPL reduction prospects. The authorities have argued that the MSR was set for a social objective to stimulate savings and provide additional income to households.

24

The external assessment also shows that the REER overvaluation would increase to 14.6 percent if CBI flows were excluded.

25

As part of its 2017–21 strategic plan, the ECCB has committed to support member countries to achieve a top-50 ranking on the World Bank’s Doing Business Index in the next three years. This will include policy advice and quarterly consultations to reform processes and support specific initiatives, including the establishment of a modern land registry.

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Cover IMF Staff Country Reports
Eastern Caribbean Currency Union: 2018 Discussion on Common Policies of Member Countries-Press Release; Staff Report; and Statement by the Executive Director for the Eastern Caribbean Currency Union
Author:
International Monetary Fund. Western Hemisphere Dept.
Volume/Issue:
Volume 2019: Issue 062
Publisher:
International Monetary Fund
ISBN:
9781498300056
ISSN:
1934-7685
Pages:
82
DOI:
https://doi.org/10.5089/9781498300056.002

ECCU: Real GDP Growth

(In percent)

ECCU: Total Stayover Arrivals (2001–2018)

ECCU Overall Balance

(In percent of GDP)

ECCU-6: Public Debt, Baseline Scenarios

(In percent of GDP)

Credit to Private Sector

(In percent, year over year growth, monthly)

Nonperforming Loans

(In percent of total loans)

ECCU: Current Account Balance

(In percent of GDP)

Spending Policy Pro-cyclicality in ECCU-6, 1998–2017

ECCU Public Debt

(In percent of GDP)

ECCU Countries: Actual vs. Debt Stabilizing Fiscal Balances, 2011–17 Average

(In percent of GDP)

Counterfactual Simulation of Selected Fiscal Responsibility Frameworks, ECCU-6 1/

(overall balance, percent of GDP)

Counterfactual Simulation of Fiscal Responsibility Frameworks, ECCU-6 1/

(public debt, percent of GDP)

Damage and frequency of natural disasters in the ECCU

Potential GDP with increase in resilience to 30 percent

(percent change relative to no resilience)

Public Debt with Resilient Investment

(ratio of GDP)

Transitional Increase in Output Growth with Resilience Investment

(Average increase in annual growth, in percent)

Financing Gaps from Resilient Investment and Insurance Costs 1/

(Annual flows, percent of GDP)

Natural Disaster Insurance Layering

(percent of GDP)

ECCU-6 Public Debt

(In percent of GDP)

Nonperforming Loans to Total Gross Loans

(In percent)

ECCU: Private Credit Growth

(percent, year over year)

ECCU Credit Stock

(In percent of GDP)

Real Effective Exchange Rate

(Index: 2010=100; the increase represents an appreciation)
Figure 1.

ECCU: Real Sector Developments
Figure 2.

ECCU: Tourism Developments
Figure 3.

ECCU: Monetary Developments
Figure 4.

ECCU: Financial Soundness Indicators
Figure 5.

ECCU: Credit Developments
Figure 6.

ECCU: Doing Business Indicators 1/

Week at the Beach Index

Imports: Shipping Costs and Tariffs (2014)1