ST. LUCIA: Staff Concluding Statement of the Mission for the 2018 Article IV Consultation

May 16, 2018

An IMF mission visited St. Lucia during April 23-May 4, 2018, for the annual Article IV consultation [1] discussions on economic developments and macroeconomic policies. At the end of the discussions, the mission issued the following statement: [2]

“Favorable external conditions and a mild fiscal stimulus sustained growth in 2017. The outlook remains benign, but is subject to significant downside risks. The fiscal position weakened, underscoring the need for corrective policies. Policies to enhance resilience to climate change and natural disasters should be fully integrated into a fiscal adjustment program consistent with attaining the 2030 regional debt target of 60 percent of GDP. Continued progress in financial sector policies and structural reforms is necessary to support economic activity and enhance sustainable growth. ”

1. Favorable external conditions and a mild fiscal stimulus sustained growth in 2017. Continued strong demand from major source markets, the opening of a large new hotel and additional airlift lifted the tourism sector, which experienced the fastest growth in stay-over tourist arrivals in the Caribbean, and benefited from a recovery of cruise-ship visitors. Tourism-related FDI and public investment supported strong activity in construction. Growth was relatively broad-based, with wholesale and retail and transport contributing positively, but agriculture production declined, owing to the lingering impact of Hurricane Matthew. Overall unemployment continued to decline, but youth unemployment remains high. On the back of the good tourism season, the current account balance moved into surplus. Higher oil prices led to inflation turning positive.

2. Growth prospects remain good, but risks are tilted to the downside. Tourism-related FDI and public investment are expected to provide continued support, but weaknesses in the banking sector will continue to be a drag on growth. After a temporary slow-down in 2018 following the completion of major projects, construction activity should pick up again driven by private hotel investment and government infrastructure spending. Tourism should benefit from favorable external conditions and expanded supply, with major investment projects scheduled to be completed by 2020, but will be limited by capacity constraints, including an inadequate road network and an outdated international airport, which the authorities intend to address. Risks to global growth, natural disasters, and fiscal risks weigh on the outlook. Over the medium term, growth prospects are limited by structural bottlenecks, high production costs, and low productivity.

3. The fiscal position weakened in FY2017/18, underscoring the need for corrective policies. The primary surplus declined slightly, reflecting higher current and capital spending. As a result, public debt rose to 70.5 percent of GDP and is expected to increase further based on current policies. The authorities have raised fuel prices, which were capped and limited revenues in 2017/18, and outlined intentions that would help strengthen the fiscal position, including that of a new residency program, but no policy decisions have been taken yet. The plan to develop a system of targeted social assistance will be key to achieve significant fiscal savings while protecting those most in need. To reduce the high cost of servicing public debt, the authorities have secured significant concessional borrowing from Taiwan, Province of China. These loans will finance the revamping of the road network and the airport, the latter of which will be repaid with extra budgetary revenues (the Airport Development Charge).

4. Fiscal adjustment, anchored by the Eastern Caribbean Currency Union debt target, should focus on broadening the tax base, controlling expenditure, and improving financing terms. The upward revision to GDP released in 2017 reduced the debt ratio by almost 13 percentage points to 69.2 percent of GDP, bringing it closer to the 2030 debt target of 60 percent of GDP. However, with public debt now just over 70 percent of GDP and rising, it is necessary to capitalize on the growing economy to reverse this trend. The adjustment should concentrate on streamlining the extensive tax exemptions, which undermine the revenue base and the efficiency of the tax system; and on controlling the government wage bill, inflated by wage increases during the recession, through continued wage moderation and public-sector reform. When feasible, targeted social assistance should replace temporary work programs and non-targeted subsidies. A fiscal responsibility framework would help provide operational targets consistent with the final objective and the discipline required to attain them.

5. Building resilience to climate change and natural disasters is an essential part of the medium-term economic strategy. Leading the region in this effort, St. Lucia is the first Caribbean nation to complete a pilot Climate Change Policy Assessment and has just finalized a comprehensive National Adaptation Plan. Investment plans should now be costed and fully integrated into development plans and fiscal medium-term frameworks, and a financing strategy, based primarily on grants, prepared. Private participation is needed for the implementation of the renewables strategy, which is essential to attaining the emission targets under the Paris accord, lessening reliance on fossil fuels, and reducing high electricity costs. A more resilient economy, with adequate financial buffers, would dampen the human, social, and economic costs of climate change and natural disasters, and contribute to the attainment of fiscal targets.

6. Financial protection against natural disasters requires a layered approach, involving a broad set of tools, including self-insurance, risk transfer, and financial innovation. High public debt and limited risk transfer instruments suggest that self-insurance has a key role in preparing for natural disasters. Considering the historic cost of disasters and their expected intensification, a savings fund of 5 percent of GDP, with a strong governance framework, would provide the necessary resources for relief and reconstruction without increasing public debt. Revenues from the Citizenship-by-Investment program (CIP) and the new residency program, together with receipts from a carbon tax, could be used to finance this fund. The latter, to be introduced gradually with appropriate compensation for low-income households, would also reduce risks to attaining emission targets.

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

8. Financial sector policies need to address promptly legacy issues and emerging risks. Despite a slight decline in nonperforming loans (NPLs) and an uptick in profitability, bank credit to businesses continued to decline. NPL resolution requires rapid approval of new foreclosure and insolvency legislation, which is currently being prepared. Regional and national authorities should create the conditions for the Eastern Caribbean Asset Management Company, which started operating in mid-2017, to efficiently collect and dispose of distressed assets. While bank credit to the private sector has contracted since 2013, lending from credit unions and microfinance companies has increased rapidly, calling for strengthened supervision of these entities and a rapid approval of the regionally harmonized regulation. The ongoing regional initiative to create a credit bureau will help contain future losses from NPLs and facilitate financial intermediation. While the loss of correspondent bank relationships (CBR) has been limited, costs for indigenous banks have increased significantly. CBR-related risks would be further reduced by transferring AML/CFT supervisory powers to the ECCB, further strengthening governance and procedures of the CIP, and establishing a plan to meet international standards on tax rules.

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