Public Information Notice No. 06/106

Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with Barbados

September 13, 2006

On August 4, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Barbados.¹

Background

Barbados has favorable economic and social indicators by regional standards, as well as strong and stable political institutions. Tourism and financial services are major sources of employment and foreign exchange. Per capita income is the highest in the region (US$17,300 on a PPP basis) and the country enjoys an investment grade rating. The country ranks high in the United Nations Development Program's Human Development Index, poverty is low, and unemployment has been declining. Business conditions are adequate, and corruption and crime are low.

Barbados' economy did well in the 1990s, but the post-9/11 global slowdown led to the emergence of macroeconomic imbalances. Following eight years of 3 percent average real GDP growth, low inflation and fiscal deficits under 3 percent of GDP, economic growth turned negative in 2001 and stayed low in 2002-03. In response, the government launched a "national emergency program" of public investment in late-2001. While this helped revive economic activity, it also contributed to a widening of the overall budget deficit, an increase in government debt, and increasing external imbalances.

Barbados' economic growth rebounded to 4 percent a year in 2004-2005, and unemployment fell to a historical low of 9 percent. Higher inflation reflected the pass-through of higher oil prices, as well as domestic demand pressures, as highlighted by an increase in core inflation—which excludes food, transportation, fuel, and light—from almost zero in 2004 to 4 percent in 2005.

The overall fiscal position, which had begun to improve in 2003-04, deteriorated slightly in 2005, as a result of a sharp increase in extrabudgetary capital expenditures. Partly offsetting this, the central government balance strengthened as a result of buoyant tax revenues, public enterprises continued to lower their deficits, and the National Insurance Scheme achieved a surplus of 3.3 percent of GDP.

The authorities tightened monetary policy in 2005, with a four-step 250 basis points increase in the minimum deposit rate to 4.75 percent. Nevertheless, credit to the private sector continued to grow at a fast pace, rising by 21.7 percent in 2005—driven mostly by lending to the tourism and personal sectors. Commercial banks reduced excess reserves and net foreign assets to finance this expansion. Financial indicators suggest that the banking system continues to be sound.

The external current account deficit deteriorated further, reaching 12.4 percent of GDP in 2005, but the level of gross international reserves stabilized. Almost half of the deterioration in the current account deficit in 2004-06, relative to 2000-03, is explained by increased oil imports. Large increases in private spending, fueled by rapid credit growth, have also contributed to the deterioration in the current account—despite the real effective exchange rate depreciation and falling unit labor costs. Strong capital inflows in 2005 nevertheless curbed a decline in international reserves that had started in 2003.

Barbados has made progress in structural reforms in some key areas. The authorities continued their program to cut income tax rates aimed at improving competitiveness. They have also liberalized further the telecommunication sector, and privatized a major insurance company. In 2005, arrangements were concluded for Barbados' formal membership in the CARICOM Single Market and Economy (CSME). More recently, a reduction in foreign exchange controls has effectively liberalized travel arrangements within CARICOM and facilitated the holding of foreign currency accounts.

Executive Board Assessment

Executive Directors welcomed the strong economic growth and the positive outlook for continued economic expansion. At the same time, Directors noted that significant macroeconomic imbalances have emerged, in particular an accelerating inflation and a large external current account deficit.

Directors also welcomed the authorities' commitment to tighten macroeconomic policies if downside risks materialized, and recommended an early tightening of policies to reduce the risks of overheating and help support the exchange rate peg. While increases in oil prices explain in part the acceleration of inflation and the external deficit, Directors stressed that expansionary macroeconomic policies and associated rapid credit growth have contributed to an acceleration in core inflation and imports over the last two years.

Directors observed that the procyclical fiscal stance has contributed to these imbalances, and recommended a return to the fiscal consolidation efforts of recent years. On expenditures, they underscored that further increases in extra budgetary expenditures or public-private partnership projects that add stimulus to an already buoyant private sector could be postponed or offset by reductions in other outlays. On revenues, they encouraged the authorities to increase value-added tax revenue in anticipation of the removal of the import tariff surcharge, carry out a comprehensive review of the pricing policies of public enterprises to help consolidate their finances, and ensure a full pass-through of international oil prices to consumers. Directors also welcomed the authorities' interest in a fiscal Report on the Observance of Standards and Codes to help improve transparency in the fiscal accounts.

Directors noted the envisaged reduction in public debt ratios, but considered that the slow pace of debt reduction left Barbados vulnerable to exogenous shocks, and encouraged a faster pace of adjustment. Directors commended the authorities for the strong performance of the public pension system, and endorsed a further diversification away from public sector assets.

Directors agreed that further monetary policy tightening would be needed to contain inflation, curb excessive credit growth, and support the peg. They pointed out that real interest rates are low, and that the prospects of higher international rates further underscore the need to increase policy rates. Directors welcomed the authorities' plans to develop money and capital markets, which would facilitate the gradual introduction of indirect instruments of monetary policy.

Directors were encouraged by sound banking indicators and upgraded financial sector regulations, and emphasized the importance of monitoring potential risks associated with large capital inflows and rapid credit growth. Directors commended the authorities for the introduction of measures to strengthen the financial sector regulatory framework and to develop the financial market infrastructure. However, Directors noted that, since financial indicators generally lag the development of credit and liquidity problems, credit quality and reductions in net foreign assets need to be carefully monitored, especially in an environment of increased competition from regional banks.

Directors felt that strengthening competitiveness through structural reforms could also facilitate external adjustment and support the exchange rate peg over the medium term. In this regard, they welcomed the authorities' efforts to advance the agenda of the CSME and in this context recommended further reforms to facilitate private sector-led growth, such as trade liberalization, the rationalization of incentive programs, and privatization, rather than selective support to sectors that generate or save foreign exchange. Directors also noted that the support for the sugar adaptation strategy should be limited to commercially viable activities.

Directors noted that the statistical information was broadly adequate, and suggested improvements to the coverage and transparency of data on public sector entities and capital account transactions.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.