Public Information Notice No. 02/116

Corrected Public Information Notice: IMF Concludes 2002 Article IV Consultation with Dominica

October 9, 2002

On August 28, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Dominica and approved a one-year Stand-By Arrangement in the amount of SDR 3.28 million (see Press Release No. 02/37, August 28, 2002).¹

Background

Over the past several years, output and employment growth have been on the decline reflecting the ongoing retrenchment of the key banana industry (due to weak export prices and the beginning of the phase out of preferential access to the European Union market), and the weak growth of non-banana agriculture and tourism. After growing on average by about 2½ percent during 1996-99, real GDP stagnated in 2000 and is estimated to have contracted by 4½ percent in 2001, as banana production fell (owing also to adverse weather conditions) and tourism was hit by the global slowdown and the events of September 11. The 12-month increase in consumer prices was just under 2 percent in 2001. Unemployment remains high.

The public finances have deteriorated in recent years as capital expenditure has increased sharply, while saving has been declining. The deficit of the consolidated public sector almost quadrupled over the period 1997/98-2000/01 (years ending June 30) to about 12½ percent of GDP and public savings fell by 3½ percent of GDP, mainly reflecting the deterioration in central government finances. However, the overall deficit of the central government is estimated to have declined slightly to about 10½ percent of GDP in 2001/02. The deficit continued to be financed by external borrowing, recourse to the banking system, and arrears accumulation, especially to social security and public and private enterprises. Central government dissaving is estimated to have reached 6¾ percent of GDP in 2001/02, as current revenues declined sharply owing to economic contraction. Capital expenditure is estimated to have declined to 6 percent of GDP from 16½ percent of GDP in 2000/01, owing to the completion of major investment projects in the areas of infrastructure and education, as well as emerging financing constraints.

During 2001, broad money increased by about 7½ percent, fueled by net credit to the nonfinancial public sector, as well as a steady inflow of remittances and private transfers from abroad. In contrast, banking system credit to the private sector declined by over 3 percent, in line with the downturn in economic activity. As a result, commercial banks built up their net foreign asset positions.

The external current account deficit, which averaged about 11½ percent of GDP in 1998-99, widened to about 18⅓ percent of GDP in 2000, on account of a sharp decline in banana exports, stagnant receipts on services (including tourism), and higher interest payments, following the substantial build-up of public sector external debt in recent years. The current account deficit narrowed to about 16½ percent of GDP in 2001, due to the economic contraction and lower imports. The capital account remained in surplus, leading to a small increase in imputed reserves (compared to a decline in 2000).

Little progress was made on structural reforms in 2001, other than the implementation of the much-delayed reduction in the common external tariff under the CARICOM agreement of 1992.

Executive Board Assessment

Directors regretted Dominica's sluggish recent economic performance, a result of the retrenchment of the banana industry and slowdown in tourism receipts. Further diversification and enhancements to competitiveness will be needed to improve long-term growth prospects and reduce external vulnerability. This calls for perseverance with structural reforms to improve economic efficiency, and raise national savings and investment.

Directors expressed particular concern that the overall deficit of the consolidated nonfinancial public sector—after nearly doubling in 1999/2000—remained at an unsustainable level in 2001/02. The public sector's serious cash shortage is the main impediment to output and employment growth, and poses a threat to economic stability. In this context, Directors welcomed the authorities' program for 2002/03, which aims to put the public finances on a path consistent with public debt sustainability and lay the foundation for sustained economic growth.

Directors commended the authorities for the strong measures already taken in the context of the 2002/03 budget. While noting that the decision to focus in the budget on revenue-raising measures had been taken with the objective of securing public support for the program and strengthening social and labor harmony, they would have preferred more emphasis to be placed on expenditure containment, which they saw as a surer path to regaining growth momentum. It was broadly agreed that government spending should be reduced in the medium term, including through structural reforms in the civil service, government financial management, and public investment. A comprehensive reform of the tax system and tax administration will also be important.

Directors agreed that a tight public expenditure policy will be crucial to support fiscal consolidation. They emphasized the need to implement the prudent government wage policy envisaged in the program and, in the medium term, to put in place a wage policy based on performance and productivity gains. Directors welcomed the authorities' intention to implement a comprehensive civil service reform. Reducing public employment through attrition would help increase efficiency in the provision of public services.

Directors advised the authorities to implement only those public investment projects that are aimed at redressing the main impediments to growth, and that can be financed largely with external resources on concessional terms. They welcomed the authorities' ongoing review of the public investment program and their planned review of public expenditure.

Directors were encouraged that the banking system is considered by the Eastern Caribbean Central Bank (ECCB) to be generally sound. However, they noted the risks to the large state-owned commercial bank stemming from its heavy exposure to the financially weak public sector and the distressed banana industry. The authorities' commitment to reduce the level of government indebtedness to this bank was therefore welcomed, as was the commitment to eliminate government domestic arrears.

Directors welcomed the Dominican authorities' intention to support fully the ECCB's efforts to strengthen financial sector regulation and supervision in the region, and their plans to strengthen the oversight of the financial system, with support from the ECCB, and to review the offshore financial sector. They commended the authorities' intention to participate in the Financial Sector Assessment Program of ECCB member countries in 2003. Directors noted the steps the authorities had taken on anti-money laundering, and encouraged them to address the few outstanding issues on an urgent basis.

Directors concurred with the authorities' decision to accelerate the ongoing restructuring of the banana sector. They also welcomed the progress made toward privatization of public enterprises, and noted that consideration might be given to using the proceeds from privatization to reduce Dominica's public debt. They urged the completion of the process of phasing out import licenses and moving toward establishing low and uniform tariff rates.

Directors noted that improvements in Dominica's statistical database are needed for effective economic analysis and surveillance, and encouraged the authorities to accelerate the planned enhancements of economic statistics in the context of the Fund's General Data Dissemination System.