Public Information Notice No. 07/113

Public Information Notice: IMF Executive Board Concludes 2007 Article IV Consultation with Barbados

September 13, 2007

On September 10, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Barbados.¹

Background

Barbados has one of the highest per capita incomes in the region, ranks high on social, political, and competitiveness indicators, and enjoys an investment grade rating. Services, particularly tourism and increasingly financial services, account for three-quarters of GDP and an even higher share of exports.

The economy has been growing at a solid pace, and the outlook for this year is generally favorable. Robust output growth of about 4 percent is expected to continue this year, supported by tourism and construction. Inflation, which was pushed up in 2006 by higher energy prices and a temporary import surcharge, is set to decelerate to 5½ percent in 2007. However, the current account deficit, despite having narrowed in 2006, is still high and projected to remain unchanged at about 8½ percent of GDP.

Macroeconomic policies were tightened significantly in 2006. Nominal interest rates were raised in line with U.S. rates, and even though real interest rates declined, financial conditions tightened as a result of an appreciating real exchange rate. More importantly, the combined public sector position strengthened by 3¾ percentage points of GDP to achieve a balance in 2006. This year, however, the public finances are projected to return to a deficit of 4 percent of GDP, reflecting mainly a number of large-scale government projects.

Discussions took place against the backdrop of the government's decision to liberalize the capital account, starting next January vis-à-vis other Caribbean countries. This move reflects a commitment under the CARICOM Single Market and Economy (CSME), and the government has announced that liberalization with respect to all other countries will follow as soon as practical thereafter. At the same time, it remains firmly committed to the dollar peg, which has been in place since 1975.

Executive Board Assessment

Executive Directors welcomed Barbados' strong economic performance and the favorable near-term outlook for economic activity and inflation. Looking forward, Directors observed that the authorities should be prepared to tighten fiscal policies in order to improve the public sector position and reduce the large current account deficit.

Directors generally regarded the announced liberalization of the capital account as a milestone in the government's strategy of regional and global integration. They noted that, while the removal of remaining controls is not expected to trigger large immediate market reactions, liberalization does entail medium-term risks. In particular, sizeable current account deficits financed by short-term capital inflows could heighten the risk of sudden capital account reversals and challenge the credibility of the peg or force sharp and disruptive policy adjustments. Directors agreed that Barbados' real exchange rate currently appears to be broadly in line with fundamentals, and stressed the importance of continued sound policies to maintain competitiveness and contain risks. Sufficient internal economic flexibility will be needed to allow the real effective exchange rate to continue to move in line with the equilibrium over time.

Directors welcomed the government's commitment to fiscal consolidation and to a reduction in the public debt. Given the government's debt objective and the importance of reducing vulnerabilities arising from high current account deficits and a declining trend in international reserve coverage, they observed that fiscal policy needs to be strengthened further, while acknowledging the authorities' commitment to take additional steps should risks materialize.

An early tightening of policies would reduce the risks of stronger and more disruptive adjustments later. Directors saw a range of options for the government to achieve fiscal savings, including reining in future public projects, raising VAT rates, reducing tax exemptions, and adjusting selected utility tariffs. Directors also encouraged the authorities to consolidate the activities of all public entities in the budget presentation to facilitate proper planning.

Directors welcomed the authorities' recognition that market-based monetary policy instruments will need to be developed to effectively manage domestic liquidity in a more challenging open capital account environment. In this connection, they supported the authorities' intention to liberalize domestic interest rates and stimulate banks' use of the discount window. They recommended a gradual phasing out of the minimum deposit rate and encouraged the authorities to also put in place procedures for conducting open market operations.

Directors also noted that capital account liberalization will expose the financial sector to greater volatility and risk taking, and thus will require stronger prudential regulation and supervision. Directors welcomed the progress being made on containing financial risks in the banking sector and encouraged the authorities to proceed with the speedy passage and implementation of pending financial sector legislation, and improved prudential oversight of non-bank financial institutions, and encouraged the development of a regional framework for financial regulation and supervision.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.