Public Information Notice No. 01/69

Public Information Notice: IMF Concludes Article IV Consultation with Grenada

July 20, 2001

On July 11, 2001, the Executive Board concluded the Article IV consultation with Grenada.¹

Background

Grenada's economic performance has improved markedly in recent years in response to the authorities' strategy that has focused on promoting private investment through sound fiscal management and improvements in infrastructure. Real GDP growth averaged 7½ percent in 1998-1999, and the economy continued to perform well in 2000, with output estimated to have risen by 6½ percent; unemployment declining further to 12 percent; and inflation remaining in the low single digits. Growth was fairly broad-based, with manufacturing, residential and hotel construction, and other services (particularly communications and financial services) registering strong advances. After two years of steady expansion, activity in the tourism sector slowed in 2000 because of the withdrawal of the only direct air service between Grenada and the U.S. mainland, and cancellation of weekly visits by the largest cruise ship. Indications are that real GDP growth will slow to about 5 percent in 2001, owing to the completion of the public sector and tourism projects, and continued weak tourism demand. Despite these achievements, social conditions have remained difficult, with poverty affecting an estimated 30 percent of the population.

The strong growth in economic activity was accompanied by a fairly robust expansion in banking system deposits, as well as in credit-mainly for construction and consumer goods. The increase in credit, coupled with the sharp growth in imports, associated with a pickup in infrastructure and tourism projects, led to a doubling of the external current account deficit to almost 16 percent of GDP in 2000, which was financed by direct investment, and grants and loans associated with the public investment program. Exports performed well over the past two years owing to high nutmeg prices, increased shipments of electronic components to the U.S market, and strong growth in fish products. Receipts from services experienced virtually no growth in 2000, reflecting the slowdown in tourist arrivals.

During 1998-2000, the central government budget registered deficits averaging 3½ percent of GDP, financed by grants, mainly concessionary loans, and banking system borrowing. However, government savings rose from 1½ percent of GDP in 1998 to an estimated 6 percent in 2000 owing mainly to continued efforts to strengthen tax and customs administration through the hiring of additional staff, increased use of audits, greater focus on large taxpayers, and the payment of cash incentives to tax collection agents. Also, the wage bill was reduced, as about 200 temporary government employees were released.

Structural reform efforts during 1999-2000 continued to focus on reducing the scope and size of the public sector, and making the civil service more efficient. Currently, discussions are taking place with the labor unions on (i) options for restructuring the sugar industry; (ii) the modalities for making certain government departments more efficient by converting them into independent agencies run on commercial lines; and (iii) developing a performance-based pay system for the civil service. In the second half of 2000, the Grenada International Financial Services Authority (GIFSA) introduced measures designed to correct weaknesses in the regulation and supervision of offshore financial institutions that were revealed in the wake of the failure of the largest offshore bank, and the subsequent closure of several others. The key measures include (i) audits of all offshore banks by an international firm; (ii) improved staffing to facilitate on-site inspections and closer monitoring; and (iii) proposals for changes in legislation to address weaknesses in the legal framework. During the first half of 2001, a self assessment exercise for the offshore financial services sector was initiated, with the assistance of the Fund and the Eastern Caribbean Central Bank (ECCB).

Executive Board Assessment

Directors noted that Grenada's economic performance in recent years has been among the most favorable of the ECCB member countries-real GDP has risen sharply, unemployment has declined, and moderate progress has been made in improving social conditions. This performance, which followed the virtual collapse of the banana industry in 1997, demonstrated the country's capacity to adapt to adverse shocks through a strategy of promoting private investment by means of sound fiscal management and improvements in infrastructure. Directors observed that the main challenge now facing Grenada is to sustain investment, economic growth, and social progress in the face of a less favorable international environment.

Directors cautioned that maintaining a strong fiscal position in 2001 and beyond could be difficult, because of emerging revenue weaknesses and increasing rigidities in expenditure. They noted that while the recent slowdown of revenue appeared to be associated with a softening in the demand for tourism and imports, it also reflected the erosion of the tax base that had resulted from the authorities' wide-ranging concessions and exemptions to various industries. Directors therefore recommended that the government begin promptly to review all exemptions, and phase out those which are no longer consistent with government policy. In particular, they urged the authorities to discontinue the discretionary nature in which concessions are granted, as it creates distortions, lacks transparency, and makes revenue administration unduly complex. It was suggested that, in view of the prevalence of similar tax incentives throughout the ECCB area, the government might propose a region-wide reappraisal and harmonization of these incentives, possibly as part of a joint initiative to reform the tax systems based on the introduction of a common value-added tax.

Directors observed that expenditure management had been generally prudent in Grenada, but cautioned against the further growth of commercially-financed lease-to-own infrastructure projects and the civil service wage bill. In this connection, they welcomed the authorities' commitment to refrain from such projects in the future, and encouraged the government to press ahead with its discussions with labor union representatives on ways to rationalize the civil service.

Directors expressed concern with the weakness in debt management, which has been affected by poor statistics and inadequate control over borrowing. They encouraged the authorities to press ahead with their plans to document comprehensively all debts contracted or guaranteed by the central government and state entities.

Available indicators point to a broadly sound domestic system. To maintain the system in good financial health, Directors urged the authorities to ensure that banks, without exception, report on a regular basis to the ECCB, and satisfy all legal and prudential requirements. Directors commended the efforts of the supervisory agency for the offshore center to address weaknesses in the regulatory framework through the ongoing audits of all offshore banks. They suggested that these audits, together with the results of the self-assessment exercise initiated with the assistance of the Fund's Monetary and Exchange Affairs Department, could be used as bases for a more rigorous supervisory framework in which the ECCB would play a greater role. Directors welcomed the plan to follow up with a region-wide Financial Sector Assessment Program. The issuance of legislation and a set of anti-money laundering guidelines, as well as the enhanced enforcement capacity in this area also were seen as positive steps.

Directors welcomed Grenada's participation in the General Data Dissemination Standard, but expressed concern with the poor quality of the information in a number of areas. They stressed the importance of clarifying the large unidentified private capital inflows and the inconsistencies in the debt data with the help of the ECCB, and of addressing the weaknesses in the national accounts, the finances of public enterprises, and labor statistics.