Public Information Notice No. 97/6

Press Information Notice: IMF Concludes Article IV Consultation with St. Kitts and Nevis

June 26, 1997

The IMF Executive Board on June 18, 1997 concluded the 1997 Article IV consultation¹ with St. Kitts and Nevis.

Background

St. Kitts and Nevis has a small, highly open economy, with exports (including tourism) equal to 40 percent, and imports equal to 50 percent, of GDP. Historically, sugar has been an important export but in recent years there has been considerable diversification into tourism and light manufacturing. The country shares a common currency (the Eastern Caribbean dollar) with the other seven members of the East Caribbean Central Bank. The central bank is effectively operated as a currency board and the currency has been pegged to the U.S. dollar at a rate of EC$2.70 since 1976.

Economic performance has been marked by strong and almost uninterrupted growth since 1980. The steady growth of per capita income has led to graduation from concessional borrower status. In recent years inflation has been at the level of trading partners and unemployment has been relatively low. Owing to high levels of private capital inflows, the external account balances have been generally positive. The government has been pursuing a strategy of economic diversification by undertaking sizeable investments in economic infrastructure that would enhance the prospects for tourism development and expansion of light manufacturing.

Economic growth recovered in 1996 from a moderate slowdown caused by two major hurricanes and other weather damage in 1995. Growth slowed from a range of 5­5 1/2percent in 1993­94 to 3.7 percent in 1995 before resuming at a 5.8 percent rate, as output in the agriculture and tourism sectors rebounded strongly in 1996. After two years of near balance, the nonfinancial public sector registered a surplus in 1995 followed by a large deficit in 1996, as public infrastructure investment intensified. However, hurricane repairs, a temporary jobs program, and loss of concessional donor assistance for a number of social programs also contributed to higher central government current expenditures in 1996. Outside of the central government, the state-owned sugar industry is producing well below capacity and suffering chronic financial losses, while the relatively young social security system produces steady surpluses of comparable size.

A sharp decline in tourism earnings in the past two years, due to hurricane damage and cruise ship rerouting, has caused the external current account deficit to widen to 26 percent of GDP in 1996. Nevertheless, the overall balance of payments registered a surplus of 1 percent of GDP in 1995 because of large unidentified capital inflows, and in 1996 there were large private foreign direct investment inflows which limited the overall balance of payments to a small deficit.

Executive Board Assessment

Directors commended the authorities for the prudent economic policies pursued in recent years that had contributed to continued strong growth, relatively stable prices, and a generally low level of unemployment. However, they expressed concern that the financial account of the nonfinancial public sector had shifted into deficit, and that the deficit of the central government had widened.

Directors stressed the need for vigilance in the management of the public finances, particularly in light of the revenue reduction that would occur if the planned reform of the corporate tax and the move to meet the common external tariff targets of the Caribbean Community (CARICOM) were implemented. They noted that measures to safeguard revenues should include improved tax administration­­which a simplified and less steep corporate tax should facilitate­­better cost recovery for public utility services, and strengthened property taxation. In addition, Directors acknowledged that the budget would have to carry a heavier burden because of the country's graduation from concessional financing for social programs and technical assistance. Also, the government should strengthen education and training programs to prepare the labor force for the demands of the coming years. At the same time, Directors advised the authorities to constrain public sector wages, as well as minimum wage increases, to levels justified by productivity gains so as to avoid an erosion of competitiveness.

Directors expressed concern that the bunching of public sector investment and an increased reliance on domestic financing might cause some crowding out of the private sector and upward pressure on interest rates in 1997. While supporting the authorities' commitment to social and economic infrastructure, Directors believed that control over the rate of execution of the public investment program, particularly that of the housing program, would be desirable in avoiding a possible overheating of the economy. Also, the efficiency of public investment projects should be carefully assessed.

Directors observed that the prospects for the state-owned sugar company were not favorable, and financing its continued operation would remain burdensome. In that regard, they welcomed the authorities' intention to review solutions with the assistance of the World Bank. While the pronounced widening of the current account deficit in recent years had been financed by large inflows of foreign direct investment, Directors noted that the large deficit needed to be addressed by promoting greater diversification into tourism and light manufacturing and by expanding non sugar agriculture.

Directors underlined the importance of investing the surpluses of the social security system in a prudent manner. There would be a danger if those surpluses were to be used to provide low-cost housing that could not recover its financing, just as there was a danger in the continued use of those savings to indirectly finance the losses of the sugar company.

Directors supported the continued arrangement of a common central bank among Eastern Caribbean countries and the discipline provided by the fixed exchange rate regime. The authorities were encouraged to approach the issue of possible secession of Nevis carefully, and to assess its economic implications, noting its potential destabilizing effects on the economy. Some Directors thought that the staff could play a useful role by studying the economic consequences of secession and making the results of its study available to the authorities.