Dominica: 2021 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Dominica
Author:
International Monetary Fund. Western Hemisphere Dept.
Search for other papers by International Monetary Fund. Western Hemisphere Dept. in
Current site
Google Scholar Close
Publication Date:
14 Feb 2022
eISBN:
9798400202506
Language:
English
Keywords:
government efficiency; economic statistics; government transfer; government deposit; Dominican authorities; Credit bureaus
Download PDF (1.2 MB)

1. TheCovid-19 pandemic continues to hit Dominica hard. After having a minimal number of Covid-19 cases through mid-2021, an outbreak since August is stretching the capacity of the country’s health system. Total infections have surpassed 5 percent of the population-only 40 percent of the population has received two doses—mainly due to vaccine hesitancy; vaccine availability is sufficient to vaccinate a large share of the population.1 Mobility restrictions have been reinstated in response to the outbreak.

Abstract

1. TheCovid-19 pandemic continues to hit Dominica hard. After having a minimal number of Covid-19 cases through mid-2021, an outbreak since August is stretching the capacity of the country’s health system. Total infections have surpassed 5 percent of the population-only 40 percent of the population has received two doses—mainly due to vaccine hesitancy; vaccine availability is sufficient to vaccinate a large share of the population.1 Mobility restrictions have been reinstated in response to the outbreak.

Background

1. TheCovid-19 pandemic continues to hit Dominica hard. After having a minimal number of Covid-19 cases through mid-2021, an outbreak since August is stretching the capacity of the country’s health system. Total infections have surpassed 5 percent of the population-only 40 percent of the population has received two doses—mainly due to vaccine hesitancy; vaccine availability is sufficient to vaccinate a large share of the population.1 Mobility restrictions have been reinstated in response to the outbreak.

uA001fig01

Dominica: Covid Cases and Policy Stringency

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Sources: Johns Hopkins University and University of Oxford.

2. To support the government’s response to the pandemic, in 2020 the Fund disbursed the equivalent of SDR 10.28 million (US$14 million; 89.39 percent of quota) under the Rapid Credit Facility (RCF). The RCF helped Dominica address urgent balance of payments needs, scale up health spending, and catalyze additional concessional financing from the World Bank (WB) and the Caribbean Development Bank (CDB). It was anchored on policy commitments to ensure fiscal and external sustainability, including a phased fiscal consolidation plan of 5.7 percentage points of GDP, to be executed over 5 years. The government has used the resources to increase testing capacity, acquire medical supplies and adapt healthcare facilities, as well as to fund transfer programs to support households and businesses.

Recent Developments

3. Domestic and international movement restrictions to prevent the spread of Covid-19 led to a decline in output estimated at 11 percent in 2020. The pandemic interrupted the recovery from Hurricane Maria in 2017, reversing two years of growth. The most affected sectors have been tourism (due to the international travel restrictions) and wholesale and retail trade, and construction activity (owing to domestic mobility restrictions). Output is estimated to recover partially in 2021 growing 3.7 percent, buoyed by a rebound in construction activity (supported by large public investment and the building of new hotels) and the retail sector.

uA001fig02

2020 Real GDP, Contributions to Percent Change

(Percentage points)

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

4. The government promptly implemented appropriate measures to mitigate the decline in economic activity and to support household income. The measures included an extension for filing personal and corporate taxes and waiving of penalties for late filing. It also provided corporate tax cuts to companies committing to keep employment of at least 80 percent of their staffing. Import duties and VAT were eliminated on cleaning and health products, and funding to the Ministries of Health and Agriculture was increased. Cash transfers were provided to farmers and income support to the unemployed and the elderly. An ECCU-wide moratorium on loan repayments was extended to March 2022 (from September 2021) to contain pressures on households, firms, and banks, while the domestic regulator extended the loan moratorium to credit unions.

5. The sharp decline in economic activity and official borrowing for pandemic-related spending led to an increase of public debt in FY2020/21.The overall fiscal balance showed a large deficit of 7.2 percent of GDP in FY2020/21 underpinned by a decline in tax revenue and the additional spending on health and social transfers. Public investment peaked at 26.5 percent of GDP, an annual increase of over 17 percentage points, mostly allocated to the construction of infrastructure resilient to natural disasters, largely financed with buoyant CBI revenue of 29.5 percent of GDP. Official loans and domestic short-term borrowing with the National Bank of Dominica (NBD), plus the output decline, pushed public debt to 106 percent of GDP at end 2020 (from 94 percent in 2019). Recurrent spending remained contained outside pandemic-related one-off allocations, including a VA percent wage increase agreed with labor unions. Financing included official loans of 4 percent of GDP, aid by debt service relief of 1 percent of GDP (27 percent of the FY2020/21debt service) under the G20’s Debt Service Suspension Initiative (DSSI). The Fund-wide Special Drawing Rights (SDR) allocation provided Dominica with SDR 11 million (US$15.65 million), which has been retained as international reserves.

6. The collapse in tourism exports and the increase in public investment led to record-high external current account deficits of over 30 percent of GDP in 2020 and 2021. The external current account deficits were partially cushioned by a reduction in imports of goods and services associated with the decline in income and aggregate demand. In 2021, tourism receipts are estimated to fall by an additional 0.5 percent of GDP with the spike in contagions and a full-year impact on the sector, while imports of goods and services would increase with the public investment push, causing further widening of the current account deficit.2 External financing needs are projected to be covered by official lending, CBI revenue, and foreign direct investment—no significant decline on imputed net international reserves is expected given the regional currency board arrangement, maintaining high reserve coverage. The real effective exchange rate (REER) depreciated in 2020 and 2021 driven by an increase in foreign inflation in fuel and food items which only moderately affected domestic consumer prices under low domestic demand. Based on 2021 staff estimates, the external position is assessed moderately weaker than the level consistent with medium-term fundamentals and desirable policies, and the REER was estimated to be overvalued by4.1 percent.3

uA001fig03

Flight Activity and Tourist Arrivals

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Sources: FlightRadar and Caribbean Tourism Organization

7. Despite the challenges posed by the pandemic, the government has made progress on the fiscal consolidation measures it has committed to in the RCF disbursement, with some adjustments going forward. Progress includes establishing limits on discretionary tax exemptions on imports; advancing preparations to simplify the income tax by including a presumptive tax (which the government intends to pass in FY2022); enacting a property tax reform to incentivize the use of idle property in prime urban areas; and strengthening the collection of tax arrears with improved auditing capacity and collection effort. These savings, however, have been offset by transitory tax exemptions to support the recovery.4 The government is also set to prepare some of the remaining reforms. These include an updated analysis of pension system sustainability, which is planned by early 2022 (delayed due to covid mobility restrictions) and would trigger parametric adjustments if needed for sustainability.5 It also includes a civil service reform (under preparation with support of CARICAD) to increase the public workforce efficiency and to better retain qualified professionals. However, other remaining measures are being reconsidered. The introduction of a solid waste charge is unlikely to be pursued in light of the low potential revenue and the additional tax administration burden, while a reduction of the preferential rate on diesel would be considered later once the economy has recovered. Based on these revisions and some reassessment of the saving yields, the estimated cumulative savings of the fiscal consolidation plan have declined by 0.6 percent of GDP to 5.1 percent over a five-year period.

uA001fig04

Collection of Tax Arrears

(Millions of EC dollars)

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

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

Dominica: Structural Fiscal Consolidation Plan 1/

article image
Source: Fund staff estimates

In fiscal years (July-June).

Increase in public employment efficiency with category reclasification and rationalization of allowances.

Review of pension formula commensurate with contribution effort.

8. The banking sector remained stable and liquid, supported by the debt service moratorium authorized by the Eastern Caribbean Central Bank (ECCB). Bank deposits remained steady despite the pandemic pressure on household incomes, helping maintain high liquidity in the system. System liquidity was also supported by a loan moratorium to support firms and households in financial distress was complemented by supervisory flexibility, including a temporary classification freeze for loans under moratoria. Bank capitalization increased, but loan loss provisions remain low despite high non-performing loans (NPLs) of 14 percent of total loans as of 2021: Q3. The Eastern Caribbean Central Bank (ECCB) authorized an extension of the loan service moratoria by six months to March 2022 to contain further deterioration of NPLs. However, the bulk of the loan portfolio is no longer under moratorium. The purchase of two foreign banks operating in the region by a consortium of indigenous banks6, of which the Dominica National Bank is a member, has increased its size and systemic importance, concentrating 73 percent of the banks’ loans.

Dominica: Financial Stability Indicators

article image
Source: ECCB.
uA001fig05

Commercial Bank Liquidity Ratios

(Percent)

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Sources: ECCB and Fund staf calculations.
uA001fig06

Commercial Banks: Lending and Asset Quality

(Percent)

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Sources: ECCB and Fund staff calculations.

9. The large credit unions sector also remained stable, but it is undercapitalized. Total credit union assets were 62 percent of GDP as of 2020: Q2, with total deposits at 56 percent of GDP, underscoring the sector’s macro criticality. Their lending plateaued in 2020 and deposits remained steady, following years of strong growth. Some entities in the sector, however, are below the capital adequacy regulatory requirement of 10 percent. NPLs are at 7 percent of total loans, with adequate loan-loss provisioning at 85 percent. The impact of the pandemic is yet to show in the data due to a moratorium granted by the non-bank regulator, which expired in September 2021.

uA001fig07

Credit Unions: Capital Adequacy1

(In percent of assets, June 2020)

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Source: Data from authorities and IMF staff estimates.1 Data for 2020Q2. In percent of total assets. Total institutional capital for credit unions.

10. Dominica has been removed from the list of non-cooperative tax jurisdictions by the European Union, after receiving a “partially compliant” rating from the OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes in February 2021.7

11. Safeguard’s assessment. An updated safeguards assessment of the ECCB, finalized in August 2021, found strong external audit and financial reporting practices that continue to be aligned with international standards, and further improvements in the capacity of the internal audit function. Legal reforms were recommended to further strengthen operational autonomy of the ECCB and align its Agreement Act with leading practices. The issuance of digital currency (DCash) introduces new risks that require additional controls and oversight, and the assessment made recommendations to enhance the related project-governance framework.

Outlook and Risks

12. The economy is projected to recover gradually from the pandemic, but high levels of public debt would remain for the foreseeable future. The recovery is underpinned by the return of tourism, additional hotel capacity, and high public investment in infrastructure resilient to natural disasters. In the baseline, output is projected to return to the 2019 level by 2023. The outlook includes a significant upward revision of CBI revenue compared to the 2020 RCF projection, based on the high levels observed in the past years and a steady stream of applicants. This revenue is projected to finance an increase in public investment of 16 percent of GDP on average through 2022–26, consistent with the government plans. The largest project is the construction of a new international airport at an estimated cost of 65 percent of GDP, which the government plans to execute within the next 3–4 years. Other large projects include roads, housing resilient to natural disasters, a new hospital and health centers, a geothermal electricity plant, a resilient water and sewage network, an industrial park to support the development of agriculture processing, and schools. The baseline assumes an execution over 6 years given capacity constraints and available fiscal space. The public investment plan will have ripple effects in other sectors and aid the pandemic recovery, pushing GDP growth to a 5 percent average in the medium term. Despite the high CBI revenue in the baseline projection, progress on debt reduction remains limited due to the prioritization of public investment, taking 5 years to return to pre-pandemic debt ratio.8 The baseline assumes that the government continues to make progress on the fiscal consolidation plan. The contractionary impact of the fiscal consolidation is expected to be more than compensated by the increase in public investment, with a larger fiscal multiplier.

uA001fig08

Nominal GDP Trajectory

(Current vs. Counterfactuals with no External Shocks and Airport Investment)

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Sources: Fund staff calculations.
uA001fig09

Grant and CBI Revenues

(Percent of GDP)

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Source: Fund staff calculations based on authorities data.

13. The projected recovery of output and tourism exports, underpinned by the assumption of a receding pandemic, would gradually reduce the current account deficit. In 2022, the current account deficit is projected to narrow to 28.7 percent of GDP, and to decline towards 14.7 percent of GDP by 2026. This outlook rests on a recovery of tourism exports to the 2019 level by 2024 and the narrowing fiscal deficits. Imports are projected to increase in line with higher public investment and the recovery of domestic demand.

Dominica: Macroeconomic Outlook

(Percent of GDP)

article image
Sources: Dominican authorities; Eastern Caribbean Central Bank (ECCB); and Fund staff estimates and projections.

At market prices.

Data for fiscal years from July to June.

Includes estimated commitments under the Petrocaribe arrangement with Venezuela.

Annual percent change.

14. Gross financing needs are projected to be covered by multilateral creditors. Following the RCF disbursement, multilateral creditors committed to providing significant financing to Dominica. These commitments are materializing in the form of loan disbursements, which are assumed to continue over the medium term as the government makes progress on the corresponding reform programs. Dominica has no access to international financial markets.

Dominica: Gross Financing Needs of the Central Government

(EC Million)

article image
Source: IMF staff estimates.

15. In a scenario without progress on fiscal consolidation, public debt would exceed 140 percent of GDP by 2035. In the baseline, with implementation of the fiscal consolidation plan, the primary surplus reaches 3.6 percent of GDP by 2029, and public debt trends downward to 60 percent of GDP by 2035. The scenario without fiscal measures assumes that public investment remains at the high baseline level and the fiscal deficit is financed with external public debt.

uA001fig10

Alternative Scenarios — Selected Fiscal Aggregates

(Percent of GDP)

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Source: Fund staff estimates.

16. The main risks to the outlook are a prolonged pandemic with a slower recovery in tourism and a decline in CBI revenue. The recent local outbreak could intensify or last longer than assumed in the baseline, delaying the recovery and requiring additional government spending. Other external risks include additional waves of Covid-19 contagion, a sharp rise in global risk premia which could reduce liquidity and drive savings out of the region in search for yield while also slowing tourism demand; volatility in the oil market; rising protectionism and natural disasters—including of higher severity with climate change which could delay the execution of resilient investments. Lower-than-projected CBI revenue or official financing would reduce the fiscal space for public investment, slowing growth and worsening the debt-to-GDP trajectory. Capacity constraints could delay the fiscal consolidation and investment execution plans. These multiple downside risks could further deteriorate the public debt outlook, which is rated at “high risk of distress” in the baseline scenario.

17. Risks to financial stability remain significant. The large and undercapitalized credit union sector could result in further capital loss if the downside risks materialize and could affect the connected banks. A delayed economic recovery and unwinding of pandemic policies could place additional stress on the financial sector. A worsening of Covid-19 contagion may require the reinstitution of movement restrictions which would slow the recovery, potentially straining financial sector liquidity and eroding asset quality further. Disruption of correspondent bank relationships (CBRs) remains a threat to trade and growth—there was no loss of CBRs in 2020 and 2021. On the positive side, higher CBI revenue could push the economy above the baseline projection especially if used to finance additional public investment, and the recovery of tourism could occur more quickly than projected in the baseline if the Covid-19 pandemic is controlled globally and domestically. The risk of financial instability in a downside scenario, in particular the credit unions and insurance sectors, implies contingent fiscal liabilities, which could increase public debt further, reducing the fiscal space for investment and lowering growth relative to the baseline.

Risk Assessment Matrix1

article image
1 The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path. The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability betweer 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. The conjunctural shocks and scenario highlight risks that may materialize over a shorter horizon (between 12 and 18 months) given the current baseline. Structural risks are those that are likely to remain salient over a longer horizon.

Policy Discussions

A. Fiscal Policy: Sustaining Investment in Resilience to Natural Disasters

Prudent use of windfall CBI revenue while maintaining progress on institutional fiscal reform would better address the risks to the outlook and support the execution of the government’s development plan to build resilience to natural disasters. This involves (i) increasing the allocation of CBI revenue to disaster insurance and debt service; (ii) maintaining progress on the fiscal consolidation plan with more focus on the expenditure efficiency measures going forward; and (Hi) further developing budgetary and public financial management practices for an effective implementation of the Fiscal Responsibility Act.

18. The risks to the outlook require a rebalancing the allocation of CBI revenue to sustain the execution of the government’s resilient investment plan. Thus far, the authorities have used the majority of CBI revenue to invest in resilient infrastructure. This is understandable considering the exposure to large natural disasters. However, estimates in the national development plan and the Disaster Resilience Strategy (DRS)9 indicate that the total cost of resilience is $2.8 billion, about 5-times Dominica’s GDP. This implies that it will take many years of sustained high investment rates to achieve a critical mass of physical resilience.

19. To strengthen the sustainability of the plan, a share of CBI revenue should be used for financial resilience and debt service. In the near term, government saving in the VRF could provide a buffer against additional health costs in case of recurrent Covid-19 contagion bouts. In addition, given the long horizon needed to build resilience, the use of CBI revenue could be reprioritized with higher allocations to financial resilience and debt service. To strengthen financial resilience, more CBI revenue could be allocated to the Vulnerability and Resiliency Fund (VRF) specifically created to save for natural disasters. The allocation of CBI revenue to the VRF could cover the following priorities: (i) a saving fund for self-insurance against natural disasters (12 percent of the large stock of government deposits from CBI revenue plus 1.5 percent of GDP per year);10 (ii) net public debt repayments for the next budget cycle (while public debt is above the regional ceiling of 60 percent, targeting a level below the ceiling); (iii) investment in resilient infrastructure financed by the CBI revenue remaining after funding for self-insurance and net debt payments. Relative to the baseline and assuming no natural disasters, this allocation of CBI revenue would reduce the fiscal space for public investment, resulting in an estimated reduction in the level of GDP of about 4 percentage points in the medium term. However, it would better support the debt sustainability outlook by reducing the need to borrow after natural disasters while supporting the post-disaster recovery and by accelerating the pace of public debt reduction.

uA001fig11

Public Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Source: Staff calculations based on authorities’ data.1/ Assumes the real location of 2 percent of GDP to saving in the VRF and 1.5 percent of GDP to net debt amortization per year relative to the baseline.

20. Self-insurance in the VRF should be topped up with additional coverage for large and extreme disasters, as part of a layered insurance framework. The first layer in the VRF would cover relatively more recurrent but less damaging disasters. A second layer could include the Caribbean Catastrophe Risk Insurance Facility (CCRIF), which the government is already accessing but with a re-calibration of the triggers to more severe disasters with higher disbursement per event. The government should also consider a third layer using state-contingent debt instruments for extreme events, with due consideration to fiscal constraints given their cost.11

uA001fig12

Dominica: Insurance Layering Framework

(in percent of GDP)

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Source: Dominica authorities and Fund staff calculations.1/ Calibrated to cover 99 percent of estimated fiscal cost of natural disasters.

21. Maintaining progress on the fiscal consolidation plan is important to increase government efficiency and to create additional fiscal space for the disaster resilience plan. The government should prioritize cost-saving expenditure and efficiency measures: the civil service reform; better targeting of social transfers; and a review of pension contributions to ensure the sustainability of the system. Measures could be taken to reduce informality and increase the tax base (Fund staff estimates indicate that 46 percent of the Dominica economy is informal), including by ensuring the registration with the DSS of workers employed in the public investment projects and with the introduction of the presumptive tax.

22. The increase in government efficiency would accelerate growth with more fiscal space for resilient investment and better protection against natural disasters, especially the poor who are disproportionately affected. Staff analysis with a fiscal policy model calibrated to the Dominica economy indicates that fiscal consolidation to create fiscal space for investment in resilient infrastructure would increase output and employment if it relies on saving from recurrent spending.12 Combined with better targeting of social transfers, the model also suggests that a fiscal consolidation of this nature would also reduce income inequality—including by improving social resilience given that the poorest members of society are also the most exposed to the adverse effects of natural disasters. This implies that the expenditure measures in the fiscal consolidation plan (civil service reform and efficiency of social transfers) plus further reduction of tax expenditures on import duties should be prepared as soon as feasible. To increase the efficiency of social transfers, the government should create a database of beneficiaries with eligibility criteria. Model simulations indicate that a natural disaster hitting Dominica after 10 years of resilient investment would contain output loss and income inequality if the fiscal consolidation prioritizes the efficiency of transfers and contains public wage spending with a civil service reform. These benefits are expected to be larger with the increase in intensity and frequency of natural disasters under climate change.

uA001fig13

Growth and Income Distribution Impact of Alternative Fiscal Consolidation Instruments to Finance Investment in Resilient Infrastructure with a Natural Disaster Shock

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Source: Staff calculations based on a general equilibrium model calibrated to the Dominica economy.Note: VAT refers to the Value Added Tax; WIT is labor tax; G-wage is government expenditure in wages and salaries; Transfer is government transfers to households.

23. Maintaining progress on institutional fiscal reforms will support debt sustainability and increase efficiency. The approval of the fiscal rule in December 2021 is an important step. It includes a ceiling on the primary fiscal balance13, a public debt target consistent with the regional commitment, and escape clauses including for natural disasters and pandemics.14 The rule adds credibility to the achievement of the debt target, especially with the introduction of the primary fiscal balance as operational target. The baseline projection, however, indicates that meeting the fiscal balance targets may require additional saving, and can lead to procyclical spending. The effective implementation of the rule would benefit from strengthening Public Financial Management, including budget planning and preparation,15 enhancing fiscal reporting, and improving internal auditing and treasury operations (including bank account reconciliation and payments’ digitalization). The fiscal rule could be further strengthened by establishing mechanisms to monitor implementation—including more specificity on correction mechanisms for deviations from targets and an independent fiscal council to monitor compliance which could be established at a regional level to pool scarce resources. The publication of fiscal data would strengthen the transparency and accountability of its implementation.

24. Other ongoing reforms support the application of the rule. These include a new Public Procurement and Disposal of Public Property Act already submitted to the Cabinet and a framework to monitor state-owned enterprises, important to identify contingent liabilities and fiscal planning. The budget process should be improved to ensure a realistic projection of revenue, spending and financing sources that are consistent with the achievement of the targets in the fiscal rule. Further progress on ongoing revenue administration reforms would broaden the tax base and can increase revenue without increasing tax rates, which could be important for competitiveness.16

Authorities’ Views

25. The government agreed with the advice to prioritize expenditure efficiency measures and noted their intention to increase tax revenue without weakening the business environment. They are committed to prepare the civil service reform and agreed on the objective to increase the efficiency of social transfers with better targeting and design to avoid duplication and abuse. They confirmed the intention to review pension contributions and benefits if needed to ensure the long-term sustainability of the system after the completion of the actuarial review planned in 2022. On the revenue side, the government intends to improve revenue collection by expanding the tax base and intend to avoid the introduction new taxes to favor the business environment. They are committed to improving tax compliance by strengthening the collection of tax arrears and the tax administration to ensure accurate reporting and to improve auditing.17

26. The government also agreed with the recommendation to reserve part of buoyant CBI revenue for self-insurance against natural disasters and debt repayment. They indicated plans to move in this direction once the economic and fiscal pressures posed by the pandemic abate. They intend to increase contributions to the Vulnerability and Resilience Fund for self-insurance against natural disasters, and to avoid the use of CBI revenue on recurrent spending—which was not feasible in the pandemic. They remarked that some of the CBI revenue has already been used in the past to service public debt.

uA001fig14

Loan Loss Provisioning Requirement

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Source: Fund staff estimates based on ECCB data.

B. Strengthening the Financial Sector to Support Pandemic Recovery and Disaster Resilience

A plan for domestic banks’ capitalization is needed to cushion the provisioning targets set by the ECCB, and in the large credit unions sector. Long-standing plans to modernize the regulation of credit unions should be advanced in the near term. Legacy weaknesses in the insurance sector should be addressed without fiscal cost.

27. The domestic banking sector should prepare a plan to strengthen capital buffers in 2022–24, including to meet increasing loan-loss provisioning requirements. The ECCB announced the requirement of 60 percent NPLs provisioning in 2022 and of 100 percent by 2024. Based on 2021: Q2 data with an NPL ratio of 14.2 percent, domestic banks would have to increase provisioning by 55 percent in 2022 (an amount equivalent to 1.6 percent of GDP and near 20 percent of capital) and by 160 percent by 2024 (3 percent of GDP and near 60 percent of capital) relative to the 2021: Q2 value. The possible increase in NPLs with the expiration of the loan moratorium would add to this need. The capitalization plan should consider a wide menu of options and a prioritized timetable, including loan-by-loan workouts for targeted debt service normalization and capital calls—which would imply a fiscal cost for institutions with public ownership of up to about 2.5 percent of GDP. This is feasible if supported by profits’ retention through no distribution of dividends18 and complemented by the capital calls as needed. The authorities should closely monitor the risks associated with the recent acquisition of Royal Bank of Canada’s local branch by the NBD, which increased its market share to 73 percent of total loans.

28. National regulatory authorities should stress test credit unions and insurance companies in light of the risks to the outlook. While loan moratorium and restructuring has helped maintain financial stability during the pandemic, a plan for their normalization should be prepared on a loan-by-loan basis. To support banks and credit unions, foreclosure legislation should be reviewed to facilitate the resolution of new and longstanding NPLs, to become effective once the economy recovers from the pandemic, while ensuring the National Bank continues engaging with the Eastern Caribbean Asset Management Corporation to dispose NPLs. Loan loss provisioning should internalize a slow recovery and the risks to the outlook.

29. The regulator should enforce a plan to bring all credit unions’ capital above the regulatory minimum and prepare other structural reforms to support financial stability. In light of the risks to non-bank financial institutions (NBFIs), the authorities should evaluate options to provide liquidity assistance to the sector. This is critical considering their size and macro criticality— assets of credit unions and insurance companies exceed 75 percent of GDP, and credit unions deposit their liquid assets at the National Bank. The non-bank regulator should be endowed with additional human and financial resources, and a structure independent of the Ministry of Finance to strengthen supervision effectiveness and help accelerate compliance. The capitalization of credit unions and progress on regulatory reform are critical to support private sector growth, while reducing the risk of government support after a shock, thereby improving the public debt outlook.

30. Continued progress in strengthening the AML/CFT framework is important to minimize risks to correspondent banking relationships. Dominica completed its third-round mutual evaluation process with the Caribbean Financial Action Task Force during 2008–14 and has since addressed most identified deficiencies.19 With the passage of legislative amendments in 2020, Dominica designated the ECCB as the competent authority for the AML/CFT regulation and supervision of the banking sector. Strengthening of resources and independence of the national regulator will help address weaknesses in the oversight of NBFIs and non-financial businesses, especially risk assessment capacity. Meeting the RCF commitment to Maintain high due-diligence standards of the CBI program will also strengthen the integrity of the AML/CFT framework. These commitments are critically important considering the significant contribution the program makes to government revenues and concerns about the vulnerability of CBRs. Dominica plans to adopt the digital currency launched by the ECCB in 2020. As the DCash platform is owned by the ECCB and transactions will be limited to registered participants who have acquired a Dwallet, there is potential to reduce ML/TF vulnerability. However, this potential is unlikely to materialize, until use of DCash is relatively widespread, which could help strengthen AML/CFT compliance.

Authorities’ Views

31. The authorities agreed on the need to closely monitor risks to financial sector stability and interconnectedness of financial institutions. They reiterated their commitment to work closely with ECCB to analyze risks associated with the acquisition of Royal Bank of Canada’s local branch by the NBD). Given that NBD is the repository of all the deposits of the credit union sector, they also noted the risk arising from interconnectedness of the bank and non-bank financial sector.

32. The authorities stressed the de-facto independence of the financial regulator. The government noted that they have never interfered with the workings of the financial regulator, which is therefore operating independently despite being housed inside the Ministry of Finance.

C. Addressing Economic Informality

33. The economic impact of the pandemic and natural disasters underscores the importance of addressing economic informality. Estimates indicate that about 46 percent of the economy is informal, on the high end of the ECCU.20This has been a challenge in designing social policies during the pandemic and after natural disasters because informal workers are often not registered in government systems, complicating the targeting and effectiveness of social assistance.21 To strengthen social resilience, the government should incentivize the formalization of workers and small businesses. Some policy options include: (i) a reduction in the cost of land registration to formalize ownership; (ii) digitalization of government services to facilitate registration in government systems; (iii) improve access to online services. Updating the population database would help targeting and efficiency of social assistance. These reforms would also pay dividends in terms of enhancing private sector efficiency and supporting investment, including by facilitating access to credit with proof of collateral and income, while strengthening fiscal performance by broadening the tax base.

uA001fig15

MIMIC Model Estimates for Size of Shadow Economy

(Percent of total economic activity, average 2011–19)

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Sources: Fund staff estimates.

Authorities’ Views

34. The authorities agreed that the size of economic informality in some sectors is considerable. They highlighted that most of the agricultural sector is informal, and not accounted properly in the economic statistics. A similar situation is observed in the sector that provide ancillary services for tourism and has been significantly affected by the pandemic. They expect that the presumptive tax and the 2022 census will help to improve registration and provide data to address informality.

D. Economic Statistics

35. Improvement of statistics is a priority to improve surveillance and economic management. This is especially the case for national accounts and the balance of payments. Main areas in need for improvement are the enforcement of data submission deadlines, training, and additional resources to the statistics office.

Authorities’ Views

36. The authorities concurred with the importance of enhancing economic statistics and requested Fund technical support. They valued the significant technical assistance program from CARTAC on economic statistics and are seeking additional resources to improve the quality and reduce the data publication lags, which have been negatively affected by the mobility and lockdown restrictions during the pandemic.

Staff Appraisal

37. TheCovid-19 pandemic took a heavy toll on the Dominican economy. GDP is estimated to have contracted by 11 percent in 2020 and is expected to post a modest recovery of 3.7 percent in 2021 underpinned by a sharp reduction in tourism and related sectors, worsened by the Covid-19 outbreak that forced a lockdown in August. The output decline was contained by strong growth in the construction sector due to the large public investment program in housing and infrastructure resilient to natural disasters, financed with record-high CBI revenue of 30 percent of GDP. Sharp declines in tax revenue and increases in spending in health and social transfers led to significant fiscal deficits in 2020 and 2021 and to a peak of public debt at 106 percent of GDP in 2020 with higher official borrowing, despite large CBI revenue. In this context, the current account deficit remained abnormally high in 2020 at 30 percent of GDP and is estimated to reach 31.4 percent of GDP in 2021. The loss of tourism exports, increase in imports related the public investment, and increase in commodity prices—albeit contained by a decline in private demand for imports— prevented the current account from returning to pre-hurricane ranges.

38. The financial sector has remained liquid and stable during the pandemic, but NPLs are above prudential benchmarks. The loan service moratoria authorized by the regulators of banks and credit unions helped support firms and households affected by loss of income, helping contain a deterioration in portfolio performance. Despite an improvement relative to 2020, NPLs remain high, in the range of 11–14 percent of loans for banks and 10–17 percent for credit unions (the prudential benchmark is 5 percent in both sectors). To comply with the ECCB requirement, banks have prepared plans to increase provisioning to 100 percent of NPLs by 2024—pre-Covid precautionary increase in provisions with adoption of IFRS9 standards in 2018 is facilitating this process. Most loans under moratoria have normalized. The financial sector remains liquid with an increase in deposits underpinned by prudent private spending, government transfers, the loan moratoria, and increase in foreign remittances.

39. In the near term, containing the pandemic and supporting the recovery remain the key policy priorities. Continuing public communication and education campaigns to address vaccine hesitancy and building additional health care centers could prove critical in possible additional contagion outbreaks.

40. The growth outlook is promising, supported by the large public investment program and the projected gradual recovery in tourism with added hotel capacity. The government plans to maintain high levels of public investment into the medium term financed mainly by CBI revenue. Key projects include a new international airport, housing resilient to natural disasters, roads, a resilient water and sewage network, increase in the hospital capacity (including a new hospital financed by the People’s Republic of China), an industrial park to support the development of agriculture processing, and a geothermal electricity plant. These projects will accelerate growth in the near term during the construction phase and will also increase potential output in the long term—including spillovers in tourism and reduction of fossil fuel dependency, all of which improve Dominica’s external sustainability and competitiveness.

41. Saving a portion of CBI revenue would help better balance public investment needs with fiscal resilience and debt sustainability goals, reducing policy procyclicality and output volatility. Thus far, the authorities have used the majority of CBI revenue to invest in infrastructure resilient to natural disasters. This is understandable considering Dominica’s significant exposure and important to boost potential output. However, Dominica’s high exposure to natural disasters, rising fiscal vulnerabilities, and significant risks to the outlook justify the allocation of a larger share of CBI revenue to the VRF for self-insurance against natural disasters and to public debt reduction once output recovers. This would increase fiscal buffers, speed up post-disaster recovery, and create space to access external financing in the event of a large natural disaster or additional pandemic bouts. Self-insurance in the VRF should be topped up with additional coverage for large and extreme disasters, as part of a layered insurance framework. The recent Parliament approval of a fiscal rule will strengthen debt sustainability and support the achievement of the regional public debt ceiling of 60 percent of GDP by 2035. The fiscal rule has potential to play an important role in reducing procyclicality of fiscal policy and increasing its credibility.

42. Sustained progress on the fiscal consolidation plan is important to reduce debt, improve government efficiency and expand space for the disaster resilience plan. Thus far the government established limits on discretional tax exemptions; advanced preparations of an income tax reform including a presumptive tax; and is studying a property tax reform to incentivize the use of idle property in prime urban areas. Beyond this, the government’s intention to avoid additional new taxes or charges is welcome, consistent with the objective of creating a favorable environment for private investment while minimizing the burden on tax administration, which is affected by limited capacity. The actuarial analysis of the pension system by the Dominica Social Security (DSS) planed by early 2022 (delayed due to covid mobility restrictions) could trigger parametric amendments if needed for sustainability. These measures improve allocational efficiency while addressing long-term contingent liabilities. On the other hand, the introduction of a solid waste charge could be delayed or reconsidered, in light of the low potential revenue and the additional tax administration burden, while a reduction of the preferential rate on diesel to reduce its distortionary impact could become effective once the economy has recovered.

43. The government should now prioritize the cost-saving expenditure efficiency measures in the plan. These include a civil service reform including a review of allowances, and better targeting of social transfers (the national census needed to update the Ministry of Social Services’ database is planned in 2022). Measures could be taken to reduce informality and increase the tax base (Fund staff estimates indicate that 46 percent of the Dominica economy is informal), including by ensuring the registration with the DSS of workers employed in the public investment projects and with the introduction of the presumptive tax. Further steps in improving public investment efficiency and procurement would also be welcome.

44. The financial sector weathered the pandemic without disruptions, but long-standing vulnerabilities require decisive policy action. The banks’ plans to strengthen capital buffers in 2022–24 to meet increasing loan-loss provisioning requirements set by the ECCB would strengthen the financial stability outlook but it will require immediate action including limits on dividend distribution and capital calls, as needed. In the credit union sector, the regulator should enforce a plan to bring all credit unions’ capital above the regulatory minimum and prepare other structural reforms to support financial stability, including to provide liquidity assistance to the sector which includes large systemic institutions connected with banks. While the loan moratorium and restructuring has helped maintain financial stability during the pandemic, credit unions should prepare a plan to reduce NPLs. The modernization of foreclosure legislation could facilitate seizing collateral and aid NPLs’resolution. Long-standing plans to modernize the regulation of credit unions aligned with the regional harmonization strategy should be advanced in the near term. Additional human and financial resources, and independence from the Ministry of Finance, would strengthen supervision effectiveness and accelerate compliance. The capitalization of financial institutions and progress on regulatory reform are critical to support private sector growth, while reducing the need of government support after a shock, thereby improving the public debt outlook. Maintaining progress on strengthening the AML/CFT framework is important to minimize risk to correspondent banking relationships.

45. In 2021, the estimated external position was estimated to be moderately weaker than the level consistent with medium-term fundamentals and desirable policy settings. Although the deterioration in tourism after the Covid-19 pandemic was severe, the current account deterioration was not as severe as the one experienced in 2018–19 after Hurricane Maria due to high Citizenship-by-investment (CBI) receipts and lower imports. While the current account is expected to adjust in the medium term as the economy recovers, external sustainability depends on the successful implementation of structural reforms that boost competitiveness and resilient infrastructure; and fiscal consolidation supported by windfall CBI revenue for debt reduction, whilst remaining at risk of recurrent natural disasters and CBI revenue volatility.

46. It is recommended that the next Article IV consultation takes place on the standard 12-months cycle.

Figure 1.
Figure 1.

Dominica: Economic Performance

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Figure 2.
Figure 2.

Dominica: External Sector

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Figure 3.
Figure 3.

Dominica: Fiscal Sector

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Figure 4.
Figure 4.

Dominica: Monetary Sector

Citation: IMF Staff Country Reports 2022, 040; 10.5089/9798400202506.002.A001

Source: Country authorities, ECCB and IMF staff calculations.
Table 1.

Dominica: Selected Social and Economic Indicators, 2016–26

article image
Sources: Dominican authorities; Eastern Caribbean Central Bank (ECCB); and Fund staff estimates and projections.

At market prices.

Data for fiscal years from July to June.

Does not include grants received but not spent.

Includes estimated commitments under the Petrocaribe arrangement with Venezuela.

Includes public capital expenditure induced imports from 2019 onwards to account for possible mitigation of natural disasters.

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

Table 2a.

Dominica: Central Government Operations, 2016–26 1/2/

(In millions of EC dollars)

article image
Sources: Dominican authorities; and Fund staff estimates and projections.

The GFSM 2001 format presentation is an approximation, and is based on the GFS 1986 format data.

Fiscal year (July-June) basis. Figures shown for a given year relate to the fiscal year beginning on July 1 of that year.

Does not include grants that were received but not spent.

Natural disaster costs are annualised estimated costs for reconstruction expenditures. It is calculated based on a Monte-Carlo experiment that simulates natural disaster shocks and their impact on output and government finances.

The underlying primary balance is calculated as the primary balance excluding CBI revenues, one-off collection of tax arrears, temporary storm-related reconstruction and social assistance spending, and the transitory increase in grants projected after tropical storms Erika (2015) and Maria (2017).

Includes debt of SOEs guaranteed by the central government, and commitments under the Petrocaribe arrangement with Venezuela.

Table 2b.

Dominica: Central Government Operations, 2016–261/2/

(In percent of GDP)

article image
Sources: Dominican authorities; and Fund staff estimates and projections.

The GFSM 2001 format presentation is an approximation, and is based on the GFS 1986 format data.

Fiscal year (July-June) basis. Figures shown for a given year relate to the fiscal year beginning on July 1 of that year.

Does not include grants that were received but not spent.

Natural disaster costs are annualised estimated costs for reconstruction expenditures. It is calculated based on a Monte-Carlo experiment that simulates natural disaster shocks and their impact on output and government finances.

The underlying primary balance is calculated as the primary balance excluding CBI revenues, one-off collection of tax arrears, temporary storm-related reconstruction and social assistance spending, and the transitory increase in grants projected after tropical storms Erika (2015) and Maria (2017).

Includes debt of SOEs guaranteed by the central government, and commitments under the Petrocaribe arrangement with Venezuela.