Public Information Notice No. 01/65

Public Information Notice: IMF Concludes Article IV Consultation with Dominica

July 13, 2001

On June 15, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Dominica.¹

Background

Output and employment growth have been sluggish for the past several years, reflecting a difficult restructuring process associated with the retrenchment of the banana industry and the low productivity of public investment. In 1996-98 real GDP growth averaged 2½ percent, but slowed to ¾ of 1 percent in 1999-2000, reflecting declines in banana production and in manufacturing. The 12-month increase in consumer prices was 1 percent in 2000. Unemployment remains high.

The public finances have deteriorated in recent years as capital expenditure has increased sharply, while saving has been declining and foreign grants have fallen from their levels of the mid-1990s. The overall deficit of the consolidated public sector more than doubled to 11 percent of GDP in FY 1999/2000 (year ending June 30) and public savings (i.e., current account balance) fell by half to 1¼ percent of GDP, mainly reflecting a deterioration in central government finances. Central government saving turned negative, reflecting a lack of buoyancy in the tax system, while the government wage bill and debt service obligations increased substantially. The rising deficit of the central government was financed by increased recourse to the banking system and external commercial borrowing, as well as a substantial accumulation of domestic arrears, particularly to the social security system. In the current FY 2000/01, saving of the central government is projected to weaken further, while the overall deficit is expected to be smaller than the previous year due to lower investment expenditure.

During 2000 broad money increased by only ½ percent, sharply down from an average increase of 11 percent in 1998-99. Banking credit to the private sector rose by 7¼ percent (in relation to broad money at the beginning of the period), up from 2¼ percent in 1999, mainly due to an increase in retail trade and consumer-based loans.

With respect to the Fund's offshore financial sector program, Dominica is participating in the Module I self-assessment exercise.

The external current account deficit, which averaged 12 percent of GDP in 1996−97, increased to an average of 19 percent of GDP in 1999-2000, owing to a decline in banana exports, stagnating tourism receipts, and a large increase in imports. An increased surplus in the capital and financial account, reflecting heavy government borrowing and a substantial increase in foreign direct investment, financed the large current account deficit in these latter two years.

Little progress was made on structural reforms during 1999-2000. The authorities postponed the planned privatization of a development bank and deferred scheduled reductions in the common external tariff under the CARICOM agreement of 1992 due to concerns about the possible impact on industry and on government revenue, as well as administrative difficulties.

Executive Board Assessment

Directors noted that Dominica has experienced several years of slow growth resulting from the retrenchment of the banana industry and sluggish activity in other sectors. Further diversification and improvements in competitiveness were seen as needed to raise long-term growth and to reduce the external vulnerability of the economy. In this regard, Directors called on the authorities to persevere with structural reforms to raise national savings and investment.

Directors expressed particular concern about the continued weakness of public finances, as the overall deficit of the consolidated nonfinancial public sector more than doubled last year. Mainly responsible for this outcome was the central government, which had to borrow heavily from domestic banks and commercial external creditors and build up arrears, especially to the social security system. Directors emphasized the need for strong fiscal consolidation, and noted that generating higher public saving is the key for supporting the investment needed to improve Dominica's growth prospects.

Directors considered that immediate steps needed to be taken to increase tax revenue and tighten expenditure controls. On the revenue side, it was important to phase out the extensive array of tax concessions, and enforce the tax code to reduce the high level of tax arrears. Directors also encouraged the authorities to simplify indirect taxation and to initiate steps to introduce a VAT, possibly in the context of a region-wide agreement. Directors also advised the authorities on the need to adjust domestic fuel prices.

Directors noted that a cautious expenditure policy also would be crucial to support fiscal consolidation. They emphasized the importance of exercising utmost restraint on wage increases in the context of the ongoing three-year wage negotiations. Directors noted that reducing public employment through attrition and moving forward with civil service reform would help increase efficiency.

Directors considered that the authorities should monitor carefully the selection of projects for inclusion in the public investment program and to choose only those that can be financed on concessional terms and that are aimed at redressing the main impediments to growth. In this connection, Directors recommended that the authorities consider postponing or canceling the costly construction of a new sports stadium if concessional financing is not available.

Directors encouraged the authorities to begin lowering the government's indebtedness to the state-owned commercial bank to enable it to comply with prudential regulations. Directors also emphasized the importance of strengthening nonbank financial institutions, including through the transfer of supervisory responsibilities to the Eastern Caribbean Central Bank.

Directors welcomed the authorities' intention to strengthen the regulatory and supervisory framework of the offshore financial sector and commended them for the steps taken thus far. A few Directors questioned whether diversification into the offshore sector was appropriate, while others noted that a well-regulated offshore sector could provide economic benefits. Directors noted that recent amendments to offshore legislation as well as the pending establishment of a Financial Intelligence Unit to address money laundering issues are expected to ensure that the regulation and supervision of the sector will be consistent with international best practices.

Directors considered that the exchange rate regime and membership in a currency union has helped Dominica to maintain price stability. At the same time, the fixed exchange rate regime underscores the need for continued fiscal discipline, wage moderation, and structural reforms to strengthen competitiveness.

Directors stressed that completing the orderly restructuring of the banana sector, implementing the final phase of the common external tariff, undertaking further trade reform, and strengthening the financial position of the large state-owned bank are essential to diversify the economy and strengthen the basis for high growth.

Directors noted that Dominica's statistical database is inadequate for effective economic analysis and surveillance, particularly in the area of national accounts and government finances. Directors encouraged the authorities to provide adequate resources to the Central Statistical Office in order to establish a solid foundation for effectively absorbing technical assistance in statistics, which may be available from bilateral and multilateral sources, including through the Caribbean Regional Technical Assistance Center.