Public Information Notice No. 99/31

Public Information Notice: IMF Concludes Article IV Consultation with St. Lucia

April 8, 1999

On March 23, 1999, the Executive Board concluded the Article IV consultation with St. Lucia.¹

Background

Over the five years through 1997, economic performance in St. Lucia had weakened reflecting the erosion of preferential access to the EU banana market and low productivity of the St. Lucia banana industry. Aiming to widen the economic base, the government has relied heavily on tax incentives. However, this policy resulted in a lack of buoyancy of tax revenue which together with large increases in current expenditure, including the wage bill, led to a declining public sector savings. The fall in public sector savings and a downward trend in foreign grants resulted in a large reduction in public sector capital outlays.

The new administration that took office in mid-1997 introduced revenue measures in the 1998/99 (April–March) budget, and maintained strict control on current expenditure on goods and services. As a result, public sector savings are expected to rise to 8 percent of GDP (6½ percent in 1997/98). With foreign grants (mainly disbursements of STABEX funds from the EU) rising to more than 3 percent of GDP, the public sector was able to raise investment to 10½ percent of GDP (6½ percent in 1997/98) while maintaining an overall surplus in 1998/99. In 1998, output growth picked up to 3 percent (2 percent in 1997) as a rapid rise in revenue from tourism more than offset the continued fall in banana production. The external current account deficit narrowed to 6¾ percent of GDP (12½ percent in 1997) as the fall in banana exports was more than offset by an increase in receipts from tourism and a fall in imports.

Executive Board Assessment

Executive Directors observed that for a ten-year period through the early 1990s, sound public finances and preferential access to the EU banana market enabled St. Lucia to achieve strong economic performance. However, in the five years up to 1997 real GDP growth slackened because of the effect on banana production of both weather-related problems and the erosion of preferential access to the EU banana market. Directors noted that the banana industry remains key in terms of both output and employment, and given the prospect of further reductions in such a preferential access, economic growth over the next several years will largely depend on achieving increased efficiency in the banana sector and on expanding into nontraditional crops, tourism and other services. Directors said that economic diversification, based on increased private sector participation, will require sizeable investment in basic and social infrastructure and continued sound macroeconomic policies. They welcomed the authorities’ resolve to achieve high public sector savings in order to assure the sound financing of the needed public investment.

Executive Directors commended the authorities for the revenue and expenditure measures introduced with the 1998/99 budget that helped reverse the declining trend of public sector savings. However, they said that such efforts have not been sufficient to establish a strong enough public savings performance, and the prospect is for some weakening in this area in the next fiscal year. Directors were of the view that an additional fiscal adjustment of the order of 3 percent of GDP over a three-year period would be required to meet the public saving objective needed to enhance investment and growth. Thus, they urged the authorities to introduce revenue measures without delay, such as the intended increase in water rates, a rise in the rate and widening of the base of the property tax, and curtailment of the over-generous tax incentives. The latter is important from the viewpoint of both public revenue and economic efficiency, and Directors encouraged the authorities to approach their counterparts in other OECS countries as a matter of urgency to discuss ways to achieve regional harmonization of incentives. Executive Directors noted that for the medium term, the authorities were well advised to consider introducing a VAT, with a view to improving the efficiency of the tax system, but the VAT also could be used to raise revenue on a net basis if necessary. They also stressed the importance of reducing the government wage bill (in relation to GDP) through civil service reform, including downsizing as needed, and through wage moderation; the latter, in addition, would set an example for the private sector and have a positive effect on external competitiveness.

Directors said that, supported by a large public sector component, investment in St. Lucia has been sizeable in relation to GDP, but the incremental capital output ratio has been high. While the high ratio might be reflecting the relative scale indivisibility of many investment projects that appear very large in relation to GDP of a country as small as St. Lucia, it might also denoteweaknesses in the public sector’s project selection and implementation as well as unwise tax incentives for the private sector. Directors added that it was important that the proposed increase in public investment be subject to more stringent selection criteria than in the past, and be financed with savings, external grants and concessional financing so as to preserve a sustainable level of external debt. Directors were of the view that reliance on "lease to own" contracts with foreign firms may offer apparent advantages, but these contracts should be subjected to strict scrutiny to assess their ultimate costs, and should therefore be avoided except in very pressing cases with attractive terms. In any event "lease to own"operations should be contracted in such ways that the conditions are fully transparent so as to guarantee governance and public accountability.

Regarding the public sector outside of the central government, Directors found that there was an urgent need to address the operational deficit of WASA, which requires not only the planned adjustment in water and sewerage rates, but also an improvement in bill collection and the elimination of over staffing. An improved financial position of WASA should set the stage for its privatization, which is desirable on both fiscal and efficiency grounds. Directors encouraged the authorities to consider privatizing other public assets such as the Marketing and Fisheries Board and some activities of the port authority. In addition, they recommended that the authorities give greater independence to the management of the National Insurance Scheme, which should be subject to benchmarks in line with international standards so as to improve transparency and accountability.

The authorities have introduced a three-year banana recovery plan to induce improvements in the efficiency and product quality of the banana industry. Directors noted that as this will inevitably result in some retrenchment, efforts in the banana sector should be complemented with actions to encourage less efficient banana growers to switch to alternative crops and to enhance job opportunities outside the banana sector. Executive Directors welcomed the privatization of the St. Lucia Banana Growers Corporation and the decision to refrain from extending government guarantees on the new debt of the corporation.

Directors noting the rapid growth of credit funded with foreign resources in recent years and St. Lucia’s vulnerability to external shocks, called for close surveillance over the financial system. Monitoring of bank portfolios and compliance with provisioning requirements, under the aegis of the ECCB, should remain a priority. Supervision of nonbank financial institutions should be strengthened without delay, taking into account the regional efforts currently underway. In any event, the ministry of finance should give priority to building up a staff with relevant expertise and seek improvements in the quality of information, supervisory reporting, and public disclosure. Moreover, they found it crucial that a framework for screening and supervision be put in place before the government grants licenses for offshore financial activities.

Directors underlined that the present exchange rate arrangement has served St. Lucia well in maintaining price stability and stimulating investor confidence, and said that tourism may havebenefited from the recent real effective depreciation of the E.C. dollar for St. Lucia. While this depreciation has reflected changes in the value of the U.S. dollar against other major currencies, developments in the domestic economy, such as changes in government expenditure and wage rates, may also play a role in real exchange rate movements. Directors encouraged the authorities to closely monitor developments in these areas and their effect on competitiveness.

Directors encouraged the authorities to implement in 1999 the long-delayed plan to reduce import tariffs within the context of the CARICOM Agreement. This will be a welcome step, but they said that it would be highly desirable to complement it by the phase-out of the quantitative restrictions that apply to a number of items and certain duty exemptions used as fiscal incentives; this would serve to improve both fiscal transparency and economic efficiency.

Directors underlined that St. Lucia has improved the provision of basic statistics to the Fund. However, deficiencies remain in several areas, particularly the national accounts, labor statistics, balance of payments, and operations of the public sector other than the government. They urged the authorities to accelerate the implementation of their plans to address these problems, including with technical assistance from the Fund.