ST. Lucia: 2019 Article IV Consultation—Press Release; and Staff Report
Author: International Monetary Fund. Western Hemisphere Dept.
Publication Date:
24 Feb 2020
eISBN:
9781513530963
ISBN:
9781513530963
Language:
English
Keywords:
ISCR; CR; investment; infrastructure investment; cost; CARTAC TA; energy price shock; CARTAC Customs; CARTAC Mac programme; fuel price pressure; Natural disasters; Tax administration core functions; Tourism; Caribbean; Global; public finance; debt target; management framework; rising allocation; time deposit
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2019 Article IV Consultation-Press Release; and Staff Report

Abstract

2019 Article IV Consultation-Press Release; and Staff Report

Recent Developments and Outlook

A. Context

1. The St. Lucia economy is heavily dependent on tourism. A late 2000s investment boom in the tourism sector ended abruptly with the global financial crisis, leading to sizeable banking sector non-performing loans (NPLs) and a heavy public debt burden from the use of fiscal stimulus to cushion the impact of the shock. Despite more favorable external conditions in recent years, including robust growth in the United States which accounts for nearly one half of stayover tourists, St. Lucia’s growth has remained subdued, averaging 0.9 percent in 2008–18 compared to 2.4 percent in the previous decade. Tourism has contributed only one-third of that growth, reflecting strong regional competition and domestic capacity constraints arising from a weak appetite for new private investment in additional hotel capacity.

uA01fig01

Real GDP Growth

(Ten-year average, percent)

Citation: IMF Staff Country Reports 2020, 054; 10.5089/9781513530963.002.A001

Sources: ECCB and national authorities.
uA01fig02

Hotel Sector Development

(2004–2018, in percent)

Citation: IMF Staff Country Reports 2020, 054; 10.5089/9781513530963.002.A001

Sources: Caribbean Tourism Organization (CTO)

2. Domestic vulnerabilities are heightening St. Lucia’s susceptibility to external shocks. Public debt, already high at 64 percent of GDP as of 2018, is expected to rise to 74 percent over the near term as a result of external debt-financed public infrastructure investment.1 As such, this limits the policy space to react to an economic downturn. In addition, weak asset quality weighs on bank balance sheets and there are long-standing structural impediments to efficient financial intermediation which constrains the funding for private sector projects. Finally, St. Lucia is susceptible to disruptions in tourism demand and to large shifts in its terms of trade as the country’s energy needs are almost entirely met through imported fossil fuels.

3. St. Lucia is also among the countries most exposed to climate and natural disaster shocks. As underscored in the 2018 Climate Change Policy Assessment (CCPA), the average annual damage of natural disasters exceeds 1 percent of GDP. More frequent and severe natural disasters due to global warming would substantially harm long-term growth and undermine fiscal sustainability (staff calculations suggest that the average economic impact of natural disasters could increase by 40 percent in a high CO2 emission scenario). Despite being a regional leader in climate change preparedness, St. Lucia has large institutional, financing and capacity gaps in its disaster and climate response strategy.

B. Current Trends

4. Growth slowed in 2018 due to a sharp fall in construction but has picked up in the first three quarters of 2019 based on preliminary quarterly data. Following relatively strong growth in 2016–17, real GDP growth declined to 0.9 percent in 2018 as the completion of the Port Castries expansion project led to a 20 percent contraction in construction (Figure 1). The tourism sector expanded modestly in 2018, with stayover arrivals growing by 2.2 percent (although this is below the average growth of 3 percent for the Caribbean as a whole). While the slump in construction activity continued in early 2019, strong growth in stayover arrivals (7.9 percent y-o-y in the first three quarters of the year) contributed to stronger GDP growth. Unemployment has declined somewhat but remains high at 18 percent as of Q2 of 2019. Inflation picked up to 2.2 percent in 2018, driven by higher food and fuel prices, but has subsequently moderated to 1.6 percent in the first half of 2019.

Figure 1.
Figure 1.

St. Lucia: Recent Developments

Citation: IMF Staff Country Reports 2020, 054; 10.5089/9781513530963.002.A001

5. Prolonged bank de-leveraging remains a significant headwind to private sector activity amidst an increasing fragmentation of the domestic credit market. Total bank credit to the private sector shrank for the sixth consecutive year. The contraction is driven by banks’ more conservative lending practices and their efforts to resolve legacy NPLs (which have more than halved from the 2013-peak to about 9 percent). This has led to greater competition for the higher quality projects, compressing lending margins and increasing banks’ reliance on non-interest income from fees, charges and overseas security investments. Increasingly, borrowers that are unable to access bank credit are turning to non-bank financing, most notably credit unions (where the annual growth of lending is around 10 percent) and the fast-expanding micro-lenders.2

uA01fig03

St. Lucia: Private Sector Credit Growth

(Resident credit, percent)

Citation: IMF Staff Country Reports 2020, 054; 10.5089/9781513530963.002.A001

6. The fiscal position has improved in recent years, reflecting prudent fiscal policies and revenues from the citizenship-by-investment program (CIP). The primary fiscal surplus rose to 2.1 percent of GDP in 2018 and is projected to be broadly balanced in 2019. However, the overall deficit remains large due to interest payments. CIP applications grew strongly in 2018, generating 1.3 percent of GDP in budget revenues, but have declined sharply in 2019. The recently concluded tri-annual wage negotiations between the government and public sector unions have resulted in additional salary expenditures of 0.5 percent of GDP in 2019 due to retroactive wages increases. Under the terms of the agreement, wages for 2020–21 are set to rise only modestly and the public sector wage bill is expected to stabilize around 7¼ percent of GDP, below the average of 9 percent of GDP in 2010–15.

7. Construction of large infrastructure projects is about to commence. At a cost of US$175 million (9 percent of GDP), a new airport terminal will replace the existing outdated facility. The project is funded through government-guaranteed loans from Taiwan Province of China and from local and regional banks. Since January 2018 the government has been collecting a US$35 airport development tax per airport arrival (estimated to yield revenue of 0.7 percent of GDP annually) to repay these loans. Other planned public investment projects include a US$42 million (2.2 percent of GDP) road improvement program and hospital rehabilitations (1.6 percent of GDP), mostly financed by semi-concessional loans.

8. Preliminary data suggest an increase in the current account surplus to 2.3 percent of GDP in 2018 with an increase in tourism receipts more than offsetting higher imports.3 In part, the strength in tourism revenues has reflected St. Lucia’s increased share in the ECCU tourism market as several countries in the currency union were recovering from the 2017 hurricanes. The overall external position in 2018 is assessed to be broadly consistent with the level implied by fundamentals and desirable policies (Annex II). Nonetheless, St. Lucia still has considerable competitiveness challenges, particularly in its non-tourism sector, where the main impediments stem from a poor business environment, skills mismatches in the labor market, and misalignments between wages and labor productivity. Imputed reserves at the Eastern Caribbean Central Bank (ECCB) correspond to 3.4 months of imports in 2018 and is projected to remain above 3 months of imports in 2019.

C. Outlook and Risks

9. The short-term outlook is favorable, but long-run growth continues to be impeded by important structural weaknesses. Growth in 2019 is projected to pick up to 1.5 percent, thanks to strong growth in tourist arrivals. The current account surplus is projected to rise to around 3 percent of GDP. Import-intensive infrastructure projects will provide a substantial boost to growth in 2020–22 but will push public debt to 74 percent of GDP by 2023 and weaken the external position. However, without greater private sector investment into hotel expansions, the additional capacity from the new airport may remain underutilized, diluting the impact of this investment on long-run potential growth.

10. Risks are to the downside (Annex III). External downside risks include sharp rises in global risk premia, higher energy prices and a deeper-than-expected slowdown in major source markets for tourism (the U.S., Canada and the U.K., see Figure 2). A drying up of CIP revenues would pose additional challenges to public finances. There are also macro-financial risks related to weaknesses in the AML/CFT frameworks, compliance with international tax rules, slow progress in addressing financial sector weaknesses, and a further loss of Correspondent Banking Relationships (CBRs). Natural disasters constitute an ever-present risk to both growth and the fiscal outlook. On the other hand, there is an upside that infrastructure investment could catalyze a greater-than-expected expansion of the tourism sector and related activities.

Figure 2.
Figure 2.

St. Lucia: External Sector Developments

Citation: IMF Staff Country Reports 2020, 054; 10.5089/9781513530963.002.A001

Authorities’ Views

11. The authorities broadly agreed with staff’s growth outlook and risk assessment. They anticipate growth to average around 3 percent over 2020–22, driven by major public investment projects, and inflation to rise modestly. Whereas activity in the construction sector is to pick up sharply, growth in the hospitality sector is expected to moderate due to capacity constraints. They believed that the airport and road renovation projects, once completed, would lead to further expansion of the hospitality sector and catalyze other domestic private investment. While the current account surplus is expected to remain strong in 2019, the authorities acknowledged that the current account balance will decline over the medium term as construction-related imports pick up. While agreeing with the thrust of staff’s risk assessment, the authorities stressed that a further slowdown in advanced economies would have limited impact on St. Lucia’s tourism industry as it serves a very resilient segment of the market, namely upscale and romance tourism.

Policy Discussions

A. Rebuilding Policy Space

12. A coherent and credible medium-term adjustment strategy is needed to rebuild policy space and ensure that debt declines smoothly to the regional target of 60 percent of GDP by 2030. Notwithstanding the projected growth benefits from infrastructure investment, debt vulnerabilities are elevated and under current policies public debt does not stabilize in the near term (Annex IV). Moreover, the elevated level of public debt limits the policy space to react to adverse shocks. Finally, the need to build ex-ante resilience to natural disasters further exacerbates public finance pressures.

13. A medium-term adjustment strategy should be built around three main pillars. First, the government should maximize the revenue potential of planned reforms and develop new revenue sources. Second, public spending on resilience should be increased, financed by additional revenue sources and/or grant financing. Third, a clear institutional fiscal responsibility framework, including a fiscal rule, should be adopted to guide the pace and composition of the needed medium-term fiscal adjustment.

14. Revenue-enhancing measures should be a key focus in the near term. The government’s planned reforms to the personal income tax (PIT) and the residential property tax are expected to be largely revenue neutral in the near term (Box 1). The government also plans to introduce a hotel accommodation fee (estimated to generate annual income of 0.7 percent of GDP) to fund tourism marketing and promotion. However, this fee would be matched by a lower VAT on the hospitality sector to limit the impact on tourist expenses. Staff analysis suggests that even if the fee is fully passed on to tourists, it is unlikely to change St. Lucia’s regional ranking on tourist expenses or have a material impact on the number of arrivals given the estimated low-price elasticity of tourists to the region (see Annex V). As such, revenue gains from the hotel accommodation fee should be preserved and not offset with an expansion of VAT preferences. Additional revenue could also be mobilized by eliminating other VAT exemptions (while minimizing the impact on poor and vulnerable households) and by harmonizing tax incentives through regional coordination (see 2019 ECCU Discussion of Common Policies). Restraining current spending, especially on the public sector wage bill, remains a key priority. The plan to introduce the National Health Insurance (NHI) system to provide coverage of basic medical services is in the early stage and needs to be implemented in a fiscally responsible manner.

uA01fig04

Week at the Beach plus Airfare (in US$)

Citation: IMF Staff Country Reports 2020, 054; 10.5089/9781513530963.002.A001

Source:IMF-W@tB Index (WP/14/229), IMF staff calculations.

Fiscal: Major Tax Measures

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15. Introducing a carbon tax would help achieve debt sustainability and provide critical support for St. Lucia’s mitigation efforts. Staff analysis suggests that a carbon tax of US$50 per ton of CO2 (EC$135) would raise revenues of around 1 percent of GDP and, together with other adjustment measures, help bring debt to 60 percent of GDP by 2030 (Box 2). By strengthening incentives to shift to renewables, reducing energy consumption, and improving energy efficiency, the tax would also help St. Lucia attain its emission reduction targets under the Paris Agreement (provided that the carbon tax is complemented with renewed efforts to expand renewables which could also help reduce energy costs, see Annex VI). The carbon tax would be moderately regressive and should be introduced in parallel with targeted assistance to offset the impact on poorer households.4

Fiscal: Baseline and Adjustment Scenarios

article image
Source: IMF staff calculations.

Annualized cost of natural disasters of 0.66 percent of GDP.

Assumes that 10 percent of carbon tax revenues are used to offset negative impact on bottom quintile of households.

It is assumed that grants of 1 percent of GDP received FY2020-FY2024 is used to capitalize self-insurance saving fund.

16. Building ex-ante resilience to natural disasters would enhance St. Lucia’s long-term macroeconomic performance. Phasing in resilience building investments could raise near-term growth by 0.2–0.3 percent (for details see 2018 St. Lucia Article IV report). Garnering donor grants, including climate funds, for such investments will be crucial to preserve a downward path for public debt. In addition, building sufficiently large ex-ante financing instruments, including a dedicated self-insurance saving fund (that would be invested in liquid, highly rated, international assets)5, risk-sharing mechanisms such as insurance products, and pre-arranged credit lines with international financial institutions (IFIs), can help St. Lucia cover the ex-post fiscal costs of natural disasters. Given the large infrastructure spending pressure in the next three years, the self-insurance fund can be built over the medium term and possibly financed by greater access to donor grants and/or over-performance of CIP revenues.

17. Adopting a fiscal responsibility framework (FRF) including a fiscal rule would couch the needed consolidation in a clear, medium-term institutional framework. The government plans to link the growth of primary current spending to the debt-to-GDP ratio, anchored by the 60 percent of GDP debt target.6 A credible and enforceable fiscal rule would help strengthen budget discipline and signal the government’s commitment to sound public finances. To be effective, the rule should encompass a comprehensive definition of fiscal activities, including the annual fiscal cost of natural disasters and the lumpy expenditure associated with infrastructure investment. The fiscal framework should also create incentives both to credibly meet the 2030 debt target and to undertake much-needed investments to build resilience.

18. Appropriate institutional and governance arrangements are needed to ensure the flexibility and enforceability of the FRF. Key elements should include:

  • Credible escape clauses (in the event of extremely large shocks) and corrective mechanisms defined in the relevant legislation.

  • Clear transition provisions that would anchor expenditures even after the debt target has been reached (to avoid a sudden relaxation of the budget constraint once debt is below 60 percent of GDP).

  • Supporting institution and governance arrangements that include: (i) robust accounting procedures (for debt, deficits, CIP inflows) and a full recording of public debt and contingent liabilities; (ii) improved fiscal projections; and (iii) effective independent fiscal oversight and accountability (one model could be Grenada’s fiscal responsibility oversight committee).

19. Efforts are needed to further strengthen public financial management (PFM). The draft PFM Bill includes comprehensive measures aimed to enhance PFM transparency and accountability, such as strengthening public asset management, setting annual ceilings for public guarantees and government borrowing (including by parastatals), consolidating legislation on public debt, improving financial statements of public institutions, and introducing enforcement mechanisms. There is also a scope to improve the public investment management framework by better aligning public investment to the budget cycle, enhancing project appraisal, and strengthening procurement planning, operations and transparency.

Authorities’ Views

20. The authorities noted that the ongoing tax reforms could be revenue enhancing in the long run. The reformed PIT and the new property tax would be easier to administer and could yield efficiency gains over time, while the hotel accommodation fee has the potential to mobilize revenue from the alternative accommodation sector such as Airbnb, which has grown substantially in St. Lucia in recent years without contributing directly to government revenues. The authorities were of the view that a VAT reduction for the hotel industry would be needed to offset the adverse impact on competitiveness. The authorities reaffirmed their commitment to eliminate VAT exemptions and zero-ratings once the social safety system has been reformed. While recently concluded negotiations on retroactive pay will increase the public sector wage bill for the current fiscal year, the authorities emphasized their commitment to restraint on current spending. On carbon taxation, while the authorities recognized its potential benefits for containing carbon emission and raising revenue and they welcomed staff’s analysis on the distributional impact, they cautioned that the tax could lead to further increases in the already-high energy costs in St. Lucia. The authorities recognized that the planned NHI system needs to be implemented in a fiscally responsible manner. As such, the authorities are considering a phased approach under which the services included in the NHI package will be contingent on the financing that can be made available.

21. The authorities are actively considering the introduction of a fiscal rule to guide public expenditure in pursuance of the 60 percent debt-to-GDP target. They emphasized that the fiscal rule should allow for a smooth expenditure path and avoid sharp adjustments to spending. They acknowledged the need to embed the fiscal rule into a broader fiscal responsibility framework, including escape clauses and a strong PFM framework. They also expressed hope that the fiscal rule will signal the government’s commitment to fiscal responsibility and therefore could reduce government borrowing costs. On climate financing, the authorities reported continuing challenges in accessing climate funds, and indicated that they would like to explore alternative financing mechanisms such as a dedicated infrastructure investment foundation with contributions from donors and the private sector. The authorities noted that that the primary purpose of the planned National Economic Fund, which is to be funded from CIP revenues, would be investment into development projects, with a small share potentially serving as a self-insurance fund against natural disasters. The authorities remained committed to fiscal structural reforms including further improving public investment management framework and introducing a new PFM Bill aimed to enhance transparency, accountability and efficiency of public financial management.

B. Strengthening Financial Sector Balance Sheets and Financial Intermediation

22. Legacy asset quality weaknesses continue to weigh on bank balance sheets. NPLs remain well above the ECCB’s 5 percent benchmark and comprise largely of long overdue exposures that are likely to be challenging to recover. Loan portfolios remain sensitive to renewed stress (the stock of impaired loans in indigenous banks’ audited financial statements are nearly twice their NPLs). Banks’ efforts to strengthen their balance sheets should therefore continue, including resolving NPLs through sales of troubled assets to the Eastern Caribbean Asset Management Company (ECAMC) or fully provisioning as required by regulation. The pending introduction of the new ECCB prudential standard on provisioning should give further impetus to loss recognition, although would likely reverse the recent improvement in indigenous banks’ capital adequacy ratios (Figure 4).7

Figure 3.
Figure 3.

St. Lucia: Fiscal Sector Developments

Citation: IMF Staff Country Reports 2020, 054; 10.5089/9781513530963.002.A001

Figure 4.
Figure 4.

St. Lucia: Banking System Developments

Citation: IMF Staff Country Reports 2020, 054; 10.5089/9781513530963.002.A001

Sources: Financial Stability Indicators, ECCB Monetary Surveys, IMF staff calculations.

23. Indigenous banks’ risk profiles are changing as they increase their exposure to foreign investments. The banking system benefits from an abundant but relatively costly local deposit base (about 43 percent of the value of deposits is subject to the minimum saving deposit rate, or MSR). Faced with limited local investment opportunities, indigenous banks have increased their overseas security exposures, particularly through investments in corporate debt. Such investments now account for about one quarter of total assets and more than twice total regulatory capital. This leaves the local banks exposed to mark-to-market losses (e.g. if global market conditions deteriorate and risk premia rise). The 2019 ECCU Discussion of Common Policies discusses the need to strengthen supervision of market risk, including attuning bank stress testing exercises to mark-to-market losses on overseas investments.

uA01fig05

Bank Credit, Investment and Liquid Claims

(Indigenous banks, in EC$ millions)

Citation: IMF Staff Country Reports 2020, 054; 10.5089/9781513530963.002.A001

24. Long-standing structural impediments contribute to a sustained weakness in private business credit growth. St. Lucia’s private sector comprises mostly small businesses with limited access to bank loans or lines of credit. Anecdotal information suggests that many have turned to alternative, often less affordable, non-bank financing sources. The inability of these smaller borrowers to access traditional bank financing has been exacerbated by structural credit market rigidities that include:

  • Outdated foreclosure and insolvency legislation that increase banks’ risk aversion and lead to strict loan approval requirements.8

  • Banks’ ongoing efforts to mitigate and resolve NPLs;

  • The absence of a credit bureau and registry, which creates information asymmetries about borrower risk that are exacerbated by lack of information sharing across lending institutions;

  • A shortage of acceptable collateral that is largely limited to fixed assets (real estate or land);

  • The regional MSR (currently set at 2 percent) that distorts the cost of local funding and contributes to an uneven competitive playing field between indigenous and foreign banks.

uA01fig06

Caribbean: Access to Credit as Major Constraint

(Percent of firms, 2010)

Citation: IMF Staff Country Reports 2020, 054; 10.5089/9781513530963.002.A001

Source: 2017 World Bank Entreprise Survey and staff calculations.

25. Improving the efficiency of financial intermediation would have an important positive effect on private investment and growth. The authorities are at an advanced stage toward adopting the harmonized legislation to support establishment of the regional credit bureau and registry. Supported by technical assistance from development partners, they are also making progress on modernizing the insolvency legislation and introducing a new legal framework and online registry to facilitate the use of movable property as loan collateral. Renewed focus is needed to move forward with legislative changes to address weaknesses in the current court-driven and costly foreclosure process. The 2019 ECCU Discussion of Common Policies called for phasing out the MSR and address its social function through fiscal policies.

26. The rapidly increasing size of the credit union sector warrants a more assertive approach to regulation and supervision. The locally supervised sector has, on aggregate, sizeable capital and liquidity buffers. However, the prolonged rapid credit growth, looser lending standards and persistently high loan delinquencies increase its vulnerability to shocks, while intensifying competition is beginning to weigh on profitability (see Annex VII). The operating environment is becoming increasingly challenging for smaller credit unions with existing prudential weaknesses and capacity limitations in meeting evolving compliance and accounting requirements. Direct cross-exposures between credit unions and the rest of the financial sector appear limited, but the sector’s macro-financial significance is increasing, and disruptive shocks could have confidence effects. Modernizing the national regulatory framework through adoption of the regionally harmonized CoOperative Societies Bill remains a legislative priority. There is also a need to strengthen the sector’s prudential oversight including through regular stress-testing, timely enforcement of prudential standards, resolution frameworks and crisis management processes. It is important that the capacity of the national supervisor (Financial Services Regulatory Authority, or FSRA) keeps apace with the sector’s rising importance, as well as developments of other nonbank financial institutions including micro-lenders and broker dealers.

27. Indigenous banks have avoided major CBR disruptions, but the risks remain significant. The associated cost pressures from international banks exiting the correspondent banking business in the region have stabilized following a sizeable increase in fees in prior years. However, some banks remain hindered in offering certain client services and the active correspondents remain relatively thin and concentrated in a few institutions, underscoring the banking system’s reliance on few foreign institutions’ willingness to maintain their exposure to the region.9 Even as AML/CFT supervision of commercial banks is transferred to the ECCB, it will be key for St. Lucia to remain compliant with international standards, including by strengthening the overall AML/CFT supervisory framework and enhancing the respondent institutions’ capacity to effectively manage risks. The authorities are in the midst of the Caribbean Financial Action Task Force mutual evaluation, with a final report expected in May 2020.

Authorities’ Views

28. The authorities broadly shared staff’s assessment of the legacy and the emerging financial sector risks. They noted the tightening competitive environment in the domestic banking sector, and the need to monitor risks associated with banks’ rising overseas exposures as well as rapid non-bank domestic credit growth. They remained committed to completing the legislative initiatives to address credit market rigidities, where delays largely reflected thorough stakeholder consultations and capacity constraints. They were also mindful of rising risks in the non-bank financial sector, including pressures on smaller credit unions’ capacity to keep up with the evolving competitive landscape and regulatory requirements. The expected adoption of the harmonized Cooperative Societies Bill should help ensure adequacy of prudential buffers, but the authorities acknowledged this should be accompanied by further strengthening of FSRA’s supervisory capacity. While the imminent threat to indigenous banks’ CBRs has eased, the authorities saw a need for a more sustainable longer-term solution to mitigate the associated risks, which could involve a regional function to strengthen AML/CFT compliance and reduce compliance costs. They also noted their continued commitment to meet the relevant international standards, including on taxation rules and practices.

C. Supporting Resilient, Sustainable Growth

29. St. Lucia is committed to further enhancing resilience to climate change and natural disasters. Commendable progress has been made in implementing the recommendations of the 2018 CCPA, particularly in the areas of updating the national and sectoral adaptation plans, formulating a climate financing strategy and mobilizing resources from the global climate funds (Annex VIII). To address the remaining gaps in the climate adaptation and mitigation strategy, further efforts are needed in the active costing of climate projects, improving public financial management of climate financing and outlays, and mobilizing private investment for mitigation and adaptation. The ongoing PFM reforms should be accompanied by capacity development to ensure that climate-related investments can be systematically identified, costed, procured and evaluated.

30. Targeted reforms are needed to address supply-side impediments to private investment. According to the 2020 Doing Business indicators, St. Lucia ranks relatively low on the availability of credit, the ability to resolve insolvency, and on registering property. The country’s overall ranking has deteriorated since 2016. Implementation of new technologies can help address these challenges by modernizing land registry operations and facilitating greater online delivery of government services. An accelerated transition to renewable energy will help reduce the high electricity costs and the country’s vulnerability to oil price shocks. Achieving greater investment in renewables would require putting in place a more favorable regulatory framework (including by relaxing the existing cap on solar energy production).

31. A persistent skills gap argues for reforms to the education system. Skill mismatches in the labor market, especially in the tourism sector which accounts for nearly one half of employment, have been a long-standing impediment to labor productivity growth. Increasing enrollment in technical and vocational education and training (TVET) could help address this challenge. A more timely assessment of labor market needs would help guide TVET offerings. In addition, containing public sector wage growth will be key to narrowing the misalignment between wages and labor productivity since the public sector wage-setting process has an important effect on private sector wages.

32. Greater diversification can play an important role in providing buffers against external shocks and the seasonal nature of tourism. St. Lucia’s exports as a share of GDP have been declining steadily since 2010, and the country ranks among the least diversified in the region. Further diversifying the economy toward higher-value exports such as business ICT, agro-processing and creative industries would require better education and improved transportation infrastructure. Greater diversification within the tourism sector (including by increasing local content in the tourism supply chain and re-pivoting the country’s package-based tourism market to more diversified products such as wellness tourism, ecotourism and city tours for cruise passengers) could also help boost growth.

33. Continued efforts are needed to improve data quality. While data provision is broadly adequate for surveillance, the lack of historical data on the external sector based on BPM6 and frequent revisions to the historical data pose challenges to macroeconomic analysis and need to be addressed with continued technical assistance from development partners and more resources for capacity development.

Authorities’ Views

34. The authorities remained committed to implementing the national Climate Change Adaption Policy. Resilience to natural disasters is an important aspect of public investment and is embedded in the planned infrastructure projects. Progress has been made to update the national and sectoral adaptation plans, prepare a climate finance strategy to match investment priorities to potential funding sources, and formulate a country program with the Green Climate Fund to unlock financing. They also underscored the importance of continued donor support including technical assistance on capacity development and access to concessional financing.

35. The authorities agreed that structural reforms are needed to boost St. Lucia’s productivity and competitiveness. Efforts to improve the business environment for private initiatives are under way, including through greater use of online delivery of government services and implementation of new technologies. The ongoing labor market assessment will help the formulation of a strategy to address skill mismatches and youth unemployment. In this regard, greater intra-regional labor mobility can also help reduce labor market rigidities. The authorities recognized that energy costs are high in St. Lucia but removing the cap on solar electricity production would require legislative changes.

36. The authorities acknowledged the benefits from greater economic diversification including in the tourism sector. Implementation of the Village Tourism program would spur the local economy while preserving St. Lucia’s high-end destination quality, and re-development of the Castries downtown area can help transform the area into a tourist attraction. Further development of wellness tourism and ecotourism also has the potential to increase local content in the tourism supply chain. In addition, the authorities saw potential to expand the ICT and agro-processing sectors to meet the demand of a growing tourism sector. On the other hand, some fiscal subsidies are needed to support the development of the manufacturing sector and SMEs given their competitiveness challenges.

Staff Appraisal

37. St. Lucia’s near-term growth prospects are favorable, but policy adjustments will be needed to strengthen longer-term growth. The commencement of large public infrastructure projects is expected to substantially boost growth in 2020–22 but will raise public debt and weaken the external position. However, a deeper-than-expected slowdown in major source markets for tourism, energy price shocks, disruptions to global financial markets, and loss of CBR all represent downside risks. St. Lucia’s high vulnerability to natural disasters constitutes an ever-present risk to both growth and the fiscal outlook. Longer-term growth continues to be impeded by the high public debt, lingering vulnerabilities in the financial system, and structural impediments to private investment. On the other hand, there is an upside that infrastructure investment could catalyze a greater-than-expected expansion of the tourism sector and related activities. While the overall external position is assessed to be broadly consistent with the level implied by fundamentals and desirable policies, St. Lucia still has considerable competitiveness challenges, particularly in its non-tourism sector, that need to be addressed.

38. Fiscal policies should be geared toward rebuilding policy space and ensuring public debt converges to the regional target of 60 percent of GDP by 2030. The debt-financed infrastructure investments, despite being on semi-concessional terms with long-run repayment largely covered by dedicated revenue streams, will move public debt further away from the regional target. The need to invest in climate resilience and the uncertainty over future CIP revenues pose additional challenges to public finances. Without policy adjustments, debt vulnerabilities are elevated, and public debt does not stabilize over the near term.

39. The government’s near-term focus should be on revenue-enhancing measures and investments that build resilience to climate related shocks. In addition to limiting current spending growth (particularly the public wage bill), additional revenues should be mobilized from the proposed hotel accommodation fee, the introduction of a carbon tax, and reducing the scope of VAT exemptions. Since some of these measures will likely be regressive, they should be introduced in parallel with targeted transfers that offset the impact on poor and vulnerable households. The National Health Insurance system should also be introduced in a fiscally responsible manner. Concerted efforts are also needed to mobilize donor grants to fund investments in climate resilience. If there is over-performance of the CIP, or of other revenue sources, it should be directed toward financing a self-insurance fund to bolster the economy’s resilience against natural disasters.

40. A fiscal rule would help anchor fiscal policy over the medium term and support consolidation efforts. To be effective, the fiscal rule should encompass a comprehensive definition of fiscal activities, including the fiscal costs of natural disasters and the lumpy expenditure associated with infrastructure investment, and should be part of a broader fiscal responsibility framework that embeds appropriate institutional and governance arrangements to ensure both the appropriate degree of flexibility as well as enforceability of the fiscal rule. The fiscal rule will also need to be carefully calibrated to strike the balance between credibly meeting the debt target over the medium-term and providing space for much-needed spending to build resilience.

41. To support private sector investment, measures are needed to address constraints on financial intermediation. There is scope to improve credit market efficiency by modernizing foreclosure and insolvency legislation, establishing a regional credit bureau and registry, and taking steps to allow for the greater use of movable property as loan collateral.

42. Emerging financial sector risks warrant a more assertive approach to regulation and supervision. The banks’ rising allocation of their assets to overseas debt securities has supported bank profitability but may also expose the sector to losses if global financial market conditions deteriorate or risk premia rise. The rapid expansion of credit unions has increased the sector’s macro-financial significance that warrants stronger oversight. The swift adoption of the Harmonized Co-operative Societies Act, combined with a strengthening of supervisory oversight of the non-bank financial sector, remain key policy priorities. In addition, continued efforts are needed to satisfy international taxation and AML/CFT standards.

43. Efforts are needed to further enhance resilience to climate change and natural disasters. Progress has been made in implementing recommendations of the CCPA. Key measures to address the remaining institutional, financing and capacity gaps include the active costing of climate projects, improving public financial management of climate financing and outlays, mobilizing private investment in mitigation and adaptation and strengthening capacity in managing climate-related investments.

44. Decisive and targeted reforms are needed to address supply-side impediments to long-term growth. Enhancing productivity will require a better alignment of the education system with labor market needs. There is scope to improve the business environment by enhancing access to credit and reducing electricity costs, further diversifying the economy toward higher-value exports, and increasing local content in the tourism supply chain.

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

Figure 5.
Figure 5.

St. Lucia: Credit Union Sector Developments

Citation: IMF Staff Country Reports 2020, 054; 10.5089/9781513530963.002.A001

Sources: St. Lucia FSRA, ECCB Monetary Surveys, IMF staff calculations.
Figure 6.
Figure 6.

St. Lucia: External Competitiveness and Structural Weaknesses

Citation: IMF Staff Country Reports 2020, 054; 10.5089/9781513530963.002.A001

Table 1.

St. Lucia: Selected Social and Economic Indicators, 2015–24

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

Fiscal year (April–March) basis. Fiscal balances do not include the airport project, which is implemented by a public corporation.

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

Comprises investment by the central government and construction expenditures of public corporations, incl. the US$175 million airport project.

Table 2a.

St. Lucia: Central Government Operations, 2015–24 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 (SLASPA).

Includes transfer to SLASPA corresponding to the Airport Development Tax.

Includes roads rehabilitation in 2019–21 financed through a US$50 million from the government of the Taiwan, Province of China.

Natural disaster costs are annualized estimated costs of 0.7 percent of GDP (for details see 2018 Article IV report).

Includes a government guarantee for a US$75 million syndicated loan from private banks to SLASPA for the redevelopment of Hewanorra airport.

Includes a government guarantee for a US$100 million loan from the government of the Taiwan, Province of China, to SLASPA for the redevelopment of Hewanorra airport.

Table 2b.

St. Lucia: Central Government Operations, 2015–24 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 (SLASPA).

Includes transfer to SLASPA corresponding to the Airport Development Tax.

Includes roads rehabilitation in 2019–21 financed through a US$50 million from the government of the Taiwan, Province of China.

Natural disaster costs are annualized estimated costs of 0.7 percent of GDP (for details see 2018 Article IV report).

Includes a government guarantee for a US$75 million syndicated loan from private banks to SLASPA for the redevelopment of Hewanorra airport.

Includes a government guarantee for a US$100 million loan from the government of the Taiwan, Province of China, to SLASPA for the redevelopment of Hewanorra airport.

Table 3.

St. Lucia: Balance of Payments Summary, 2015–24

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

Includes collections from the Airport Development tax.

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