Public Information Notice No. 99/112

Public Information Notice: IMF Concludes Article IV Consultation with Barbados

December 10, 1999

On November 5, 1999, the Executive Board concluded the Article IV consultation with Barbados.¹

Background

Since the early 1990s, Barbados has been experiencing steady economic growth founded on prudent economic management and generally favorable external conditions. Economic policy has incorporated fiscal and wage restraint, consistent with the maintenance of the long standing exchange parity with the United States dollar. Barbados relies heavily on tourism, high-cost sugar exports to protected markets and, in recent years, offshore business services.

In 1998, real GDP growth picked up, based on strong performances in the tourism and construction sectors, although a drought led to a decline in sugar output. While the pace of growth slowed to 2¾ percent in the first half of 1999 (compared with a year earlier) domestic demand continued to expand vigorously as the development of tourism facilities and private consumption responded to strong growth of credit to the private sector. Inflation was down to 0.4 percent during the year ending June 1999, while the unemployment rate declined further to 10.6 percent.

The nonfinancial public sector balance is estimated to have shifted from a small deficit in FY 1997/98 to a small surplus in FY 1998/99 (fiscal years begin in April). The central government deficit remained at about ¾ percent of GDP in FY 1998/99 as higher current spending was broadly offset by a reduction in capital spending. The rise in current spending partly reflected the introduction in September 1998 of government-subsidized mortgage facilities and other incentives to encourage home ownership, increases in pensions and an increase in government employment. The combined deficit of the public enterprises declined from 1.9 percent of GDP in FY 1997/98 to 1.5 percent of GDP in FY 1998/99, while the surplus of the National Insurance Scheme remained at about 2 percent of GDP.

The external current account moved from balance in 1997 to a deficit in 1998, which widened in early 1999 as private consumption and investment pushed up imports and tourist arrivals slowed. Nonetheless, following a decline in 1998, official gross international reserves rose sharply during the first half of the year (to over three months of imports of goods and services) in large measure because of government borrowing in the regional capital market in April 1999.

The authorities continued to implement a prudent incomes policy and in May 1998 representatives of the government, business and labor signed a third social pact covering 1998-2000, which maintains productivity-based wage increases. Progress continued on structural reforms including some restructuring of the Barbados National Bank and the financially troubled private sugar industry, while import duties were lowered. Anti-money laundering legislation was passed in December 1998.

The authorities' economic objectives are to keep inflation low and sustain the growth of output and employment based on service exports, while reducing vulnerabilities as the economy continues to open up and preparing for the aging of the population in the long term. Accordingly, their strategy is to maintain the finances of the nonfinancial public sector near balance in support of the exchange rate peg by taking steps to increase public saving, while carrying out a public sector investment program focused on economic and social infrastructure and environmental protection. The strategy also calls for tightening credit policy and increasing public sector deposits at the central bank to help build the official international reserves cushion, and implementing structural reforms covering education, health, the public pension system, the regulation and supervision of utility monopolies and the nonbank financial sector, and privatization.

The authorities have recently taken steps to slow the expansion of domestic demand, including delaying the implementation of certain public investment projects since the latter part of 1998, a 1 percentage point increase in the reserve requirement on bank deposits to 6 percent and an increase in the central bank discount rate from 9 percent to 10 percent in May 1999. However a further boost to domestic demand is likely to come from the impending payment of public sector wage increases retroactive to April 1999.

With the aim of reducing production costs and improving competitiveness and the investment environment, in late August 1999 the authorities announced several measures that on balance are expected to weaken the public finances by ½ percent of GDP on an annual basis. These include reductions in energy taxes and seaport rates; new tax and import tariff incentives for the tourism, agriculture and fishing industries; replacement of import licenses on a few manufactured items by tariffs from April 2000; and measures to improve the collection of property transfer and land taxes.

Executive Board Assessment

Executive Directors commended the authorities for the successful implementation of stabilization policies and structural reforms which have contributed to Barbados's continued strong economic performance, and they also welcomed the impressive improvements in social indicators. Directors noted, however, that Barbados remains vulnerable to exogenous shocks because of its undiversified economic base, and that the country faces the challenge of dealing with an aging population in the context of the generous welfare system.

Directors emphasized that in the short term, the authorities should keep the fiscal deficit near balance to temper the expansion of domestic demand, contain the expected widening of the external current account deficit, and reduce pressures on official international reserves. In this context, restraint on the public sector wage bill is essential. In addition, it would be important to apply priorities on capital spending, and to refrain from taking steps that could undermine tax collection, while acting to strengthen tax administration.

Directors noted that over the medium term, maintaining the public finances broadly in balance would be required in order to lower the public debt-to-GDP ratio, and leave room for continued strong private investment, while securing balance of payments viability. To do so, while keeping an appropriate level of public investment spending, it would be necessary not only to continue implementing a cautious wage policy, but also to raise the efficiency of public services and the social safety net. It would also be important to undertake a comprehensive reform of the public pension system in which the authorities' efforts to facilitate the development of private pensions would be helpful. Noting the rapid expansion of bank credit to the private sector that has contributed to the strong growth of domestic demand, Directors supported the actions recently taken by the authorities to tighten domestic credit conditions.

Directors encouraged the authorities to develop market-based instruments of monetary control. They took note of the progress being made to improve the health of the financial system and to strengthen its supervision and regulation, and encouraged the authorities to continue these efforts in line with international best practice.

Directors noted that the exchange rate peg to the U.S. dollar, supported by appropriate macroeconomic policies, has been effective in keeping inflation low and bolstering confidence. They welcomed the authorities' efforts to increase official international reserves to strengthen the credibility of the peg in the context of the economy's vulnerability to exogenous shocks.

Directors commended the spirit of the cooperation between the labor unions, employer associations, and the Government, as manifested in agreements on a series of income protocols which have been vital to securing wage restraint and stable labor relations. However, pointing to the significant increase in real wages relative to trading partners in the last decade, they underscored the need to maintain external competitiveness, and in this connection they welcomed the creation of the commission on competitiveness. Directors recommend that steps be taken, also, to promote labor market flexibility. More generally, they considered that trade and tax changes, and structural reforms are needed to fortify external competitiveness, and welcomed the authorities' recognition of, and attention to, these issues.

Directors welcomed the planned restructuring of the regulatory framework covering utilities. They recommended that the authorities redouble their efforts to privatize state-owned entities, rationalize tax incentives, and reduce corporate tax rates, once fiscal and macroeconomic conditions allow.

Directors encouraged the authorities to continue their efforts to improve the quality of national accounts, balance of payments, and public finance data in order to provide a better basis for policy formulation.