Mission Concluding Statement 

Grenada -- 2005 Budget Mission, February 15-22, IMF Concluding Statement

February 22, 2005

1. At the request of the Government of Grenada, an IMF mission visited St. George's from February 15-22 to update its assessment of the economic situation as the country nears the six-month mark since Hurricane Ivan struck.

2. The efforts of the people of Grenada to put their lives back together in the wake of this disaster have been impressive. Nevertheless, the economic situation remains difficult.

• The economy contracted by nearly 3 percent last year, and is only expected to expand by about 1 percent this year given the depressed level of activity in the two main sectors, tourism and agriculture.

• The National Insurance Scheme (NIS) estimates that about 8 percent of the labor force was displaced by the effects of the hurricane, though some may subsequently have been absorbed in employment in other sectors such as construction. The NIS has launched an EC$10 million unemployment benefit scheme.

• Inflation remains subdued within the framework of the regional currency board arrangement—the annual inflation rate in December 2004 was 2.5 percent.

3. Looking beyond the situation this year, a recovery in the private sector and continued boost from reconstruction activity should deliver growth of 7 percent in 2006. Thereafter, growth is projected to return to a medium-term trajectory of about 4 ½ percent per year.

The Fiscal Situation

4. The focus of the mission was discussions of plans for the 2005 budget, which is expected to be presented to the Cabinet by early-April and must be approved by Parliament by the end of April. Discussions were also held on the country's strategy to reduce public debt to sustainable levels, in part by reaching a cooperative agreement with creditors.

5. With the support of the international community, a number of steps have been taken to maintain a degree of fiscal stability in the difficult post-Ivan period:

• Nonessential expenditures were curtailed last year to make room for relief and rehabilitation expenditures.

• Donor pledges of US$150 million (about a third of 2004 GDP)—including disbursements of over US$25 million in budgetary support—were quickly marshaled to fill financing gaps in 2004. Without support on this scale, it may have been difficult to overcome the effects of the damages of 200 percent of GDP inflicted by the hurricane.

• In addition, in November 2004 the IMF approved a loan of US$4.4 million to Grenada, which was disbursed immediately to support the government's needs. In January 2005, the IMF reduced the interest rate on this loan—and on an earlier loan given in the aftermath of Tropical Storm Lili—to a concessional rate of 0.5 percent a year.

• The government announced in October 2004 that the public debt was unsustainable and, in January 2005, appointed professional debt advisors to help seek a cooperative restructuring agreement with creditors.

6. Despite these efforts, and against the backdrop of a weak economy, the 2005 budget situation is challenging. Extraordinary reconstruction expenditures have to be undertaken to help the country recover from hurricane-related damages. At the same time, revenue sources remain weak and the high public debt level—130 percent of GDP—sets tight limits to further borrowing by the government.

7. Our estimate—which is preliminary given that the government's expenditure plans for the year have yet to be firmed up—is that the government will run a deficit (after grants) of about 8 percent of GDP in 2005. The current fiscal deficit is projected to increase from 1.2 percent of GDP in 2004 to 5 percent of GDP in 2005.

8. We estimate that revenues for the year are expected to total EC$295 million, or 24 percent of GDP. Expenditure plans remain fluid, but are presently expected to be about EC$588 million, or 48 percent of GDP, including EC$230 million in capital expenditures. The resulting gap between revenues and expenditures is being bridged in large part through very strong donor support—grants are expected to be EC$200 million (16 percent of GDP).

9. Nonetheless, a financing gap of EC$66 million this year (5.4 percent of GDP) remains.¹ Support from creditors is needed to close this gap, but we encourage the government to also contribute to improvements in the fiscal situation through control of current expenditures and potential revenue measures. Moreover, the mission recommends that capital expenditures be carried out at a measured pace, in step with developments on the financing side. These expenditures should be carefully prioritized and planned keeping in mind the implementation capacity of the line ministries. We expect the Agency for Reconstruction and Development (ARD) will play an important role in enhancing prioritization and planning within the ministries.

10. We encourage the phasing out of temporary relief measures so that they do not turn into a permanent drain on the budget. These measures include the exemption from import duties for building materials, which is scheduled to be removed by end-February, and the NIS unemployment benefit plan, which is to end by mid-year.

Preparing for Fiscal Contingencies

11. Difficult enough as the present fiscal situation is, it is unfortunately quite easy to envisage circumstances that would make it even more so. Shortfalls in donor financing and tax revenues, or events such as a further rise in global oil prices, pose a grave risk to the fiscal outlook. Hence, it would be prudent to identify expenditures to postpone in the event of financing shortfalls, and—if needed—temporary revenue measures to put in place to keep essential recurring and reconstruction expenditures on track.

12. A number of specific steps are under consideration by the government to expand the resource envelope should the need arise:

• Consideration is being given to the introduction of a more flexible mechanism for changes in retail fuel prices. The IMF mission's calculations suggest that adjustment of retail fuel prices to world levels would provide revenues of at least EC$20 million, the equivalent of nearly 2 percent of GDP. Retail fuel prices could be raised in a phased manner, thereby giving people more time to adjust to the change. Moreover, careful attention should be given to the socio-economic impact of the price increase. The poverty and labor market surveys conducted by the Ministry of Finance and, more recently, the NIS could be used to design well-targeted measures to protect vulnerable segments of society from the impact of fuel price increases.

• The authorities also noted that they had proposed wage restraint during 2005 in their initial consultations with trade unions. As the contractual wage bill is expected to increase by 4.5 percent (EC$6.5 million) this year—following cumulative increases in the wage bill of nearly 25 percent over the last 5 years—any restraint would make a valuable contribution to easing the fiscal situation.

• The authorities have calculated that revenue forgone from customs duty exemptions exceeded 11 percent of GDP per year in 2001-03. Moreover, IMF staff estimates that revenue forgone from corporate income tax holidays have exceeded 3 percent of GDP per year. Hence, limiting the granting of tax concessions would also make a strong contribution to the revenue effort.

The Medium-Term Fiscal Outlook

13. Financing gaps are expected to be very large, as reconstruction expenditures remain high and grant commitments beyond 2005 fall off sharply. Hence, even though revenues are expected to recover—helped by growth and a strong fiscal effort—and current expenditures are assumed to be controlled, we estimate a financing gap to be over 10 percent of GDP in 2006 and between 6 to 7 percent until 2009.

14. While donor and creditor support would help significantly, filling these gaps will require updating and implementing the medium-term fiscal strategy that the Cabinet had passed in September 2004 before Hurricane Ivan struck. On the expenditure side, the measures contemplated include reduction of government guarantees; implementation of the recommendations of the World Bank-supported Public Expenditure Review, including steps to improve fiscal management and correct the institutional weaknesses of the Public Sector Investment Program; and restructuring of the Public Service to improve efficiency. The proposed revenue measures include institutional strengthening of customs to improve revenue collection; rationalization of tax incentives; and re-introduction of the VAT, albeit on a revised timetable from the previous target date of January 2006. Together with increased flexibility in the petroleum price mechanism, these measures could help alleviate financing pressures on the budget.

15. Tightening up of enforcement at Customs could also yield much-needed fiscal revenues. A project financed by the Caribbean Development Bank is underway to improve internal auditing and enforcement procedures and intensify anti-smuggling efforts.

The Role of the Agency for Reconstruction and Development

16. We recognize that ARD can play a useful overarching role of coordinating the reconstruction effort and, in part by bringing in specialists, help strengthen the project planning and implementation capacity of line ministries. Our discussions suggest a need for greater clarity on the respective roles of ARD and the line ministries in carrying out the task of reconstruction. ARD's comparative advantage would appear to be in areas where several ministries and agencies are involved in the execution of a project. Looking further down the road, ARD must, as intended, be phased out as the task of coordinating the reconstruction projects draws to a close.

17. The government should ensure that mechanisms for transparency and accountability that ARD is setting up are working as intended, and that—by reflecting better building codes, for example—reconstruction expenditures reduce vulnerability to any future natural disasters. ARD's own expenditures should be reflected transparently in the budget and there should be regular reporting and auditing of its financial statements.

Reducing Debt to Sustainable Levels

18. The government's commitment to formulating a debt strategy in consultation with its advisors to strike a cooperative debt restructuring agreement with creditors is welcome. Any agreement should be nested in a comprehensive medium-term macroeconomic framework to ensure that not only are near-term debt service obligations met but that the stock of debt is reduced to a sustainable level. This would ensure that the government would be able to meet its obligations falling due, even if there is an unforeseen deterioration in the economic environment. The government should maintain a constant and transparent dialogue with all creditors and ascertain the preferences of creditors with respect to the new debt instruments to be issued. There should be comparability of treatment among creditor groups.

Bolstering Financial Sector Supervision

19. We urge close monitoring of prudential indicators to detect any signs of stress as a full evaluation of bank portfolios is completed in the coming weeks. We welcome the intent to strengthen supervision of the insurance sector, including through the recruitment of additional staff and passage of new legislation to provide a more rigorous framework for regulation of the sector.

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20. The IMF mission extends its thanks to the Ministry of Finance—Permanent Secretary Timothy Antoine and Deputy Permanent Secretary Lennox Andrews, in particular—for fruitful policy discussions. We are also grateful to Deputy Prime Minister Bowen, Finance Minister Boatswain, ARD Chairman Marius St. Rose and Deputy Chairman Richardson Andrews, leaders from opposition parties, members of agricultural, business, banking and insurance groups, and members of the donor community for taking the time to meet with us. We also join the people of Grenada in mourning the passing of former Prime Minister Ben Jones on the occasion today of his state funeral.

21. The IMF stands ready to continue assisting in Grenada's rebound from the effects of Hurricane Ivan. IMF missions will visit St. George's in mid-March as part of the regional surveillance of the ECCU countries and at the end of April for the annual Article IV consultations.