Abstract
IMF research summaries on Latin America’s external linkages (by Shaun Roache) and on reaping the benefits of structural reforms (by Stephen Tokarick); regional study on the Eastern Caribbean Currency Union (by Paul Cashin and Evridiki Tsounta); listing of visiting scholars at the IMF during March–April 2008; listing of contents of Vol. 55 No. 2 of IMF Staff Papers; listing of recent IMF Working Papers; listing of recent external publications by IMF staff; and a call for papers for the Jacques Polak Ninth Annual Research Conference.
Paul Cashin and Evridiki Tsounta
After gaining their political independence from the United Kingdom in the 1970s and early 1980s, the Eastern Caribbean Currency Union (ECCU) countries prospered initially because of preferential access to European markets for sugar and bananas and later due to tourism development. The ECCU’s longstanding currency board arrangement has also facilitated a sustained period of price and exchange rate stability. However, during the past two decades these small and open island economies have been buffeted by numerous external shocks, including the erosion of trade preferences, a decline in official foreign assistance, the effects of the September 11th terrorist attacks, and frequent natural disasters. The relaxation of fiscal stances, partly reflecting accommodation to these shocks, led to a rapid build-up of public debt, now standing at over 100 percent of regional GDP. IMF staff analysis has focused on these vulnerabilities and the need to enhance the region’s growth prospects, maintain competitiveness, and ensure a sound financial system.
The economies of the Eastern Caribbean Currency Union—which is comprised of six IMF member countries (Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines) and two United Kingdom territories (Anguilla and Montserrat)—share a common currency, the Eastern Caribbean dollar, which has been pegged to the U.S. dollar (at the same rate) since 1976. Sun and Duttagupta (2008) show that the peg and U.S. price stability have helped anchor ECCU prices. Duttagupta and Tolosa (2006) examine the relationship between national fiscal policies and the currency board arrangement and find evidence of increasing free-riding opportunities—member countries transfer the cost of fiscal slippages (the inflation tax) across time and countries. Dehesa and Druck (forthcoming) argue for the need for strong national fiscal positions to sustain the exchange rate peg, since under the Eastern Caribbean Central Bank’s institutional arrangements, its role as a lender of last resort is very limited.
Enhancing the ECCU’s growth potential is the region’s overarching challenge. In recent years, growth has halved from its 1980s level, partly reflecting the erosion in trade preferences and declining development assistance (Mlachila and Cashin, 2007). Given the declining agriculture sector, policymakers have emphasized tourism development, and attempted to support the tourism sector by granting substantial tax concessions (especially tax holidays). Chai and Goyal (2006) find that between 10 and 16 percent of ECCU GDP is forgone annually due to these concessions, while Roache (2006) finds that reducing capital costs, rather than extending tax concessions, would be more effective at raising foreign direct investment. Sosa (2006) and Nassar (2008) argue that discretionary tax holidays can engender the misallocation of resources, erode the tax base, and lower the effectiveness of tax policy initiatives. Relatedly, Vuletin (2008) measures the large size of the informal sector in the Caribbean, arguing for the need to broaden the tax base.
Maintaining competitiveness is pivotal for tourism sector development. Mwase (2008) and Tsounta (forthcoming) find that tourism flows in the ECCU are sensitive to real exchange movements, hotel capacity, crime, and adverse exogenous shocks, including those emanating from tourism-originating countries. Randall (2006) finds that the region has experienced an erosion of price and nonprice competitiveness in recent years, which could be important in explaining the ECCU’s declining share of world tourism. Cashin, Njoroge, and Rodriguez (2004) and Pineda and Cashin (forthcoming) analyze the fundamental determinants of the ECCU equilibrium real exchange rate, finding that there is little evidence of overvaluation of the Eastern Caribbean dollar.
The emergence of tourism in the region, while facilitating economic growth, creates new vulnerabilities to global shocks. While the ECCU’s output volatility is lower than in other middle-income countries, it is still high (Rasmussen and Tolosa, 2006). In studying the pattern of ECCU economic activity, Cashin (2006) finds common comovement of output in the Eastern Caribbean and a strong association with fluctuations in developed countries. In addition, Sosa and Cashin (forthcoming) argue that external shocks (particularly oil prices, external demand, and climate shocks) account for more than half of the fluctuations in ECCU real output.
To enhance growth and income equality, policymakers have also placed increasing emphasis on trade and regional integration. Despite being among the most open in the world, the ECCU economies fall short of being fully integrated in the global economy (Mlachila, Samuel, and Njoroge, 2006). Moreover, Suss and others (2004) note that the increased integration obtained through the Caribbean Community’s common market has not significantly increased trade within the ECCU.
Despite being exposed to numerous external shocks, the ECCU has never experienced a systemic banking crisis. Chai (2006) finds that the banking system is well capitalized but is burdened by the high level of nonperforming loans and its large exposure to government. In a later study, Duttagupta and Cashin (2008) examine the resiliency of the ECCU banking system to external shocks, finding that such resiliency derives in large part from the macroeconomic stability provided by the region’s currency board arrangement.
Other challenges facing the ECCU include its exposure to natural disasters, high emigration rates, population aging, and burdensome public debt. Rasmussen (2006) finds that the region is among the most disaster-prone in the world, and argues that Caribbean natural disasters are contemporaneously associated with output contraction and the deterioration of fiscal and external balances. The ECCU experiences one of the highest emigration rates in the world, and Mishra (2006) finds evidence of a “brain drain” in the Caribbean. Roache (2007a) and Monroe (2008) argue that high emigration imposes escalating demographic pressures on the sustainability of ECCU pension schemes. Population aging will also affect the ECCU’s health system, with important policy implications for those countries considering introduction of universal health care (Tsounta, 2008). Finally, Sahay (2006) and Roache (2007b) argue that the accumulation of ECCU debt in the last decade can be explained partly by increasing expenditure in response to external shocks and partly due to policy slippages—fiscal consolidation is needed to raise the efficiency of public investment, maintain external stability, and enhance the sustainability of the currency board arrangement. Over the medium term, a key priority for the countries of the ECCU is to enhance policies that will accelerate GDP growth through greater regional integration, a more competitive business environment, and the maintenance of a strong financial system.
References
Cashin, P., 2006, “Key Features of Caribbean Business Cycles,” in The Caribbean: From Vulnerability to Sustained Growth, ed. by R. Sahay, D.O. Robinson, and P. Cashin (Washington: International Monetary Fund).
Cashin, P., P. Njoroge, and P. Rodriguez, 2004, “Competitiveness in the ECCU: Measures of the Real Exchange Rate,” in ECCU: Selected Issues, IMF Country Report 04/335.
Chai, J., 2006, “The Eastern Caribbean Currency Union Banking System in a Time of Fiscal Challenge,” in The Caribbean: From Vulnerability to Sustained Growth, ed. by R. Sahay, D.O. Robinson, and P. Cashin (Washington: International Monetary Fund).
Chai, J., and R. Goyal, 2006, “Tax Concessions and Foreign Direct Investment in the Eastern Caribbean Currency Union,” in The Caribbean: From Vulnerability to Sustained Growth, ed. by R. Sahay, D.O. Robinson, and P. Cashin (Washington: International Monetary Fund).
Dehesa, M., and P. Druck, forthcoming, “The ECCB: Challenges to an Effective Lender of Last Resort,” IMF Working Paper.
Duttagupta, R., and P. Cashin, 2008, “The Anatomy of Banking Crises,” IMF Working Paper 08/93.
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Mishra, P., 2006, “Emigration and Brain Drain from the Caribbean,” in The Caribbean: From Vulnerability to Sustained Growth, ed. by R. Sahay, D.O. Robinson, and P. Cashin (Washington: International Monetary Fund).
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Sosa, S., 2006, “Tax Incentives and Investment in the Eastern Caribbean,” IMF Working Paper 06/23.
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Tsounta, E., 2008, “Financing Universal Health Care: Lessons for the Eastern Caribbean and Beyond,” ECCU: Selected Issues, IMF Country Report 08/96.
Tsounta, E., forthcoming, “What Attracts Tourists to Paradise?” IMF Working Paper.
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