Mission Concluding Statement 

St. Lucia: Staff Concluding Statement of the 2017 Article IV Mission

February 6, 2017

An IMF mission visited St. Lucia during January 16-27, 2017, for the annual Article IV consultation discussions on economic developments and macroeconomic policies. [1]

Despite weak tourism activity, unemployment continued to fall in 2016 and the economy is expected to experience positive albeit moderate growth in 2017. The authorities are designing a bold program of economic reforms which they intend to outline in the forthcoming budget . A credible medium-term fiscal consolidation plan and a rapid implementation of the reform agenda are needed to reduce policy uncertainty and ensure the success of the authorities’ economic program.

1. Weakness in tourism activity continues to dampen growth. Strong employment growth in agriculture and construction led to a significant reduction in unemployment in the first three quarters of 2016. Nonetheless, weak activity in tourism, transport, and manufacturing hampered GDP growth, which is estimated to have reached 0.8 percent in 2016. Declining exports are widening the current account deficit after improvements in recent years mainly owing to lower oil prices.

2. The short-term outlook is mildly positive, but presents some risks. Moderate growth is expected in 2017, primarily on account of continued strong performance in construction and agriculture. The overall outlook appears uncertain as positive developments in tourism—the expected increase in the number of hotel rooms and the opening of new direct flights from the U.S.— may be stifled by the impact of the new airport tax.

3. The medium-term outlook remains subdued as structural weaknesses impinge on competitiveness and potential growth . Risks are tilted to the downside, as low global growth would negatively affect tourism inflows; U.S. dollar appreciation would reduce competitiveness, and tighter global financial conditions could compress fiscal space by increasing interest costs on the high public debt. Upside risks are related to stronger-than-projected foreign direct investment inflows, especially if the authorities are successful in implementing economic reforms that address structural vulnerabilities.

4. The new administration is launching an ambitious program of economic reforms, but key policies are still being shaped ahead of the forthcoming budget . The broad pro-growth reform agenda is focused on lowering the tax burden, enhancing the efficiency of the tax system, and reducing tax compliance costs; reorganizing the public sector to rationalize functions and increase efficiencies; reviewing the Citizenship by Investment Program (CIP) to make it more competitive; and enacting structural reforms to improve the business climate and encourage foreign direct investment. This program addresses many areas that are critical to strengthening St. Lucia’s growth potential, but details of the policies are still pending and many of the reforms will take time to yield results. In the meantime, the fiscal package announced by the government under the “Five to Stay Alive” initiative, which includes a reduction of the VAT rate from 15 percent to 12.5 percent, will weaken the fiscal position unless measures are taken to mitigate its impact; and, by shifting the tax burden onto the tourism sector, risks having undesirable effects on competitiveness and growth.

5. A multi-year fiscal consolidation plan is necessary to stabilize the projected debt dynamics and attain the 2030 debt target of 60 percent of GDP. The high public debt — currently exceeding 82 percent of GDP— and a delicate fiscal situation need to be addressed promptly. A fiscal consolidation plan would help the authorities clarify their intentions, confirm their commitment to fiscal responsibility, and reduce risks while the economic program is being defined. By mapping the path to the debt target, the authorities would minimize the risk of sudden corrections, which typically involve cuts to capital projects, thereby gaining control over expenditure composition while improving its quality. The plan should be adopted as soon as possible and measures should be included in the FY2017/18 budget currently being prepared.

6. The adjustment effort should focus on broadening the tax base, controlling expenditure, and improving financing terms. Further cuts in tax rates should be preceded by a reduction of the extensive exemptions that undermine the efficiency of the tax system. Consideration should also be given to reducing the very high taxes and charges on imports, which are particularly harmful to external competitiveness. In view of the importance of the public sector wage bill, continued control of wage dynamics and intensified attrition in the context of a functional assessment of employment needs are key. Social spending should be preserved and gradually refocused from temporary work programs and non-targeted subsidies to targeted social assistance. Much needed investment in infrastructure, renewable energy, and natural disaster resilience should be financed with concessional lending rather than costly bond issuance, and partnerships with the private sector should be used when feasible.

7. The consolidation plan should address the need to prepare for the inevitable recurrence of natural disasters. St. Lucia, like other countries in the region, is extremely vulnerable to natural disasters, which entails significant costs in terms of lower investment, lower GDP, higher poverty, and a more volatile revenue base. Costs can be significantly reduced by preparing for these events with adequate domestic policies aimed at increasing resilience and reducing risks. These policies should be integrated into investment, debt, and public financial management frameworks. Financing should be arranged ahead of time through a combination of fiscal buffers, contingent financing plans, and risk transfer arrangements.

8. The implementation of the medium-term fiscal framework could be supported by an appropriate fiscal rule. Enshrined in a fiscal responsibility legislation, the fiscal rule would define appropriate institutional arrangements; the coverage of government and fiscal aggregates, with due consideration for capital spending; implementation procedures —including links with the budget process and escape clauses—; automatic correction mechanisms; and sanctions and supporting mechanisms for enhanced fiscal transparency and accountability.

9. Monitoring of the public sector should be extended to further limit fiscal risks. The definition of central government debt should be reviewed to comply with GFS guidelines. In addition, the authorities should consider expanding their definition of debt to the consolidated non-financial public sector to make sure that all public debt is monitored. A rapid approval of new legislation on public financial management and a new chart of accounts would also be important steps in improving the quality of fiscal statistics.

10. CIP revenues should be used primarily to reduce debt, and limits should be placed on amounts used to finance high-priority expenditure. After receiving relatively few applications in 2016, the authorities expect that the recent easing in the requirements and lowering of the costs to qualify for this program will encourage an increase in revenues. To minimize the risks of fiscal dependence on these revenues, which can be volatile and subject to sudden stops, and to reduce the impact of globally rising interest rates on public finances, priority should be given to amortizing existing debt. A capped amount could be used for investment projects of primary importance if public investment management can be strengthened further to ensure high quality investment. Transparency, appropriate governance, and careful due diligence remain paramount to reduce risks of sudden stops.

11. Banks are still burdened by nonperforming loans (NPLs) and the cost of corresponding bank relationships (CBRs) has increased . Swift resolution of NPLs is critical to revive credit and economic growth. Authorities should give renewed priority to the establishment of the regional asset management company (ECAMC). The Insolvency Act needs to be urgently adopted and legislative work to reform the resolution framework initiated to facilitate foreclosures and debt restructuring. The authorities have made significant progress in increasing compliance with international standards to mitigate the impact of reduced CBRs. Nonetheless, banks continue to suffer from increasing costs with correspondent banks owing also to the low volume of transactions.

12. Structural reforms to improve the business climate and address the skills mismatch should be implemented rapidly. The authorities have made significant progress in designing a reform strategy under the Caribbean Growth Forum aimed at addressing as immediate priorities: (i) skills and productivity; (ii) logistics and connectivity; and (iii) investment climate. In addition, a six-pillar Long-Term National Development Plan has been designed in the areas of building human and physical capital, strengthening institutions, improving social resilience, and mitigating and adapting to climate change. These efforts need to be supported by the elaboration of specific policies and timelines for their implementation, which the authorities intend to do in the forthcoming budget presentation. In light of the persistent skills mismatch and the large costs associated with the public education system, a review of the sector is overdue.

13. Statistics are among the most comprehensive in region and adequate for surveillance. However, a lack of resources is hampering quality in several areas. Data are subject to large revisions, which often reflect pre-existing weaknesses as methodological improvements are introduced. As St. Lucia intends to subscribe to the Special Data Dissemination Standard, these improvements need to be sustained by providing adequate resources to the Central Statistics Office for data collection and compilation. The timeliness of data provision by government agencies also needs to be enhanced.

The mission met with the Honorable Prime Minister Allen M. Chastanet, the Honorable Minister in the Ministry of Finance Ubaldus Raymond, Director of Finance Cointha Thomas and other senior government officials, the Leader of the Opposition, the Honorable Phillip J. Pierre, and representatives of the private sector and labor unions. The mission is grateful to the authorities for their valuable collaboration and kind hospitality.