Public Information Notice No. 98/73

Public Information Notice: IMF Concludes Article IV Consultation with Dominica

September 21, 1998

On August 25, 1998, the Executive Board concluded the Article IV consultation with Dominica¹.

Background

The rate of growth of real GDP declined to about 2 percent in 1997, reflecting the effects of a flood on banana and other agricultural production as well as a fall in soap exports to Jamaica; the unemployment rate was estimated at about 23 percent in December of that year. Prices have remained relatively stable in recent years, with the 12-month rate of increase in the consumer price index at about 1 percent at end-June 1998. The moderate inflation reflects the low rate of increase in import prices and the stability of the Eastern Caribbean dollar, which has been pegged to the U.S. dollar since July 1976 at the rate of EC$2.70 per U.S. dollar.

After moving back to balance in 1996/97 (fiscal year beginning July 1), the operations of the nonfinancial public sector shifted to an overall deficit of 2½ percent of GDP in 1997/98, mainly because of a decline in central government saving. The overall deficit of the central government doubled to 4 percent of GDP in 1997/98, as a reduction in expenditure relative to GDP—principally in investment—was more than offset by a fall in receipts relative to GDP, particularly corporate income taxes, nontax current revenue and capital grants.

Broad money grew at a faster pace than nominal GDP during 1993–97, with the 12-month rate of increase at 2 percent at end-May 1998. In the context of the return of the public sector as a net borrower, the banking system had to draw down its net foreign assets in 1997 to support the expansion of credit to the private sector of 4 percent in real terms. Interest rates have remained broadly unchanged in recent years, with lending rates averaging 11¾ percent per annum and deposit rates 4½ percent per annum in 1992–97.

While the merchandise trade deficit widened in 1997 (to 22 percent of GDP) owing to a decline in banana and soap exports, the external current account deficit narrowed somewhat to about 16 percent of GDP, in part because of sustained growth in tourism. Net transfers from emigrants, workers abroad and foreign donors remained important in 1997 (12 percent of GDP) helping to offset the large trade deficit, with capital transfers to the government amounting to about 70 percent of the total. Surpluses in the capital and financial account have more than covered the current account deficits in recent years, with the overall balance of payments registering small surpluses.

Public and publicly guaranteed external debt has declined in recent years from 45 percent of GDP at end-1995 to about 36 percent of GDP at end-1997. This reduction was aided by the substantial debt forgiveness granted in October 1997 by the British Government to Dominica under the debt agreements reached at the Commonwealth conference last year (Mauritius mandate). Concurrently, the ratio of external debt-service to exports of goods and nonfactor services plus net private transfers rose somewhat in 1997, reflecting a bunching of repayments.

In the structural area, the government sold its stake (50 percent) in the electricity company to a foreign investor in the first half of 1997. Present plans are for the reduction of the maximum external tariff to 20 percent in August 1998, in line with phase IV of the CARICOM schedule.

Executive Board Assessment

Directors observed that while inflation remains low, unemployment in Dominica is high, infrastructure inadequate, and export performance poor. The country is beset by frequent weather-related shocks, high production costs, and uncertainties about continued access to protected markets for its main export, bananas. Although tourism has been gaining importance in recent years, it is constrained by deficiencies in infrastructure.

Executive Directors expressed support for the authorities’ medium-term objective of creating the basis for the sustained growth of output and employment and for economic diversification, but noted that action is required in the immediate term to strengthen the public finances, particularly raising public saving to support improvements in infrastructure. They indicated that, in the absence of upfront action to raise public saving substantially, reliance on increased external assistance to finance the public investment program entailed risks as donors would most likely expect a counterpart effort from Dominica. At the same time, they emphasized theimportance of improving project selection criteria to ensure that investment spending is aimed primarily at facilitating private output and exports.

Efforts to increase public saving should focus mainly on restraining government current spending. In particular, it will be essential to reduce the government wage bill in relation to GDP through wage moderation and downsizing of the civil service. Also, it will be important to achieve economies in spending on goods and services, and to check the growth of transfers. Improvements in tax administration and other steps to raise revenue also would be needed. This would require strict enforcement of the tax code, with penalties applied on a regular and timely basis, curtailing tax exemptions, and reforming property taxes, including the establishment of a tax on idle lands. Directors welcomed the authorities’ intention to study the experience of Barbados with the value-added tax, as the introduction of a similar tax in Dominica could help improve the efficiency of the tax system.

Directors also welcomed the authorities’ intention to intensify efforts aimed at institutional strengthening. This is particularly urgent in the areas of tax administration, fiscal analysis and programming, treasury and debt operations, and in the preparation of the public sector investment program, and the authorities are working with external technical assistance to strengthen macroeconomic planning, tax auditing, and enforcement, and program budgeting. In addition, efforts are required to harden the budget constraint and avoid adding commitments to approved budgets, particularly if corresponding sound financing sources have not been secured.

Directors encouraged the authorities to press ahead with structural reforms. To this end, a firm timetable for privatizing remaining enterprises should be established, the state monopoly on the importation and distribution of selected commodities should be abolished, and price controls eliminated. At the same time, Dominica should move to increase efficiency by expediting import tariff reductions in line with the CARICOM schedule.

It will be important to maintain close surveillance over the financial system. The ECCB recently reinforced its bank inspection procedures and surveillance over nonperforming loans and strict monitoring of bank portfolios and enforcement of provisioning requirements should remain a priority. Also, it will be important to strengthen supervision of the nonbank financial institutions, particularly by tightening loan classification and other standards and transferring the mandate to supervise credit unions to the ministry of finance. In addition, it will be essential to maintain close vigilance over the offshore financial institutions.

The present exchange rate arrangement has served Dominica well. To safeguard international competitiveness, the authorities will need to intensify efforts to control costs, particularly wages. In addition, action is needed to reduce the high labor costs at the port, and to eliminate cross subsidization in utility rates.

Dominica’s external position is vulnerable to shocks. In order to strengthen its production base, sizable external assistance for improving infrastructure will be needed over the medium term, which will depend on the pursuit of prudent economic policies, particularly policies that increase public saving. Directors commended the authorities’ preparation of a medium-term economic strategy paper that sets forth their objectives and policies for the period ahead. This exercise ought to be updated yearly, specifying in detail an investment program that can be supported by the international community.

Dominica has made some progress in the provision of core statistics to the IMF despite its limited resources. However, additional efforts are needed to improve data on national accounts, labor statistics and the government finances. In addition, increased resources are needed to support the statistics producing units.