Public Information Notice No. 01/32

Public Information Notice: IMF Concludes Article IV Consultation with St. Lucia

March 29, 2001

On March 7, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with St. Lucia.¹

Background

After a period of slow growth in the mid-1990s, mainly due to a decline in banana output, economic growth has improved since 1998. In 1998-99, real GDP rose by an average of 3 percent a year, as banana production largely stabilized (despite adverse effects from a drought in 1999) and trade and construction activity expanded rapidly with the large renovation and expansion of hotels and tourist facilities. The growth rate in 2000 is estimated to have been between 2 and 2½ percent, as growth in tourism and domestic investment moderated. The unemployment rate, which had peaked at 21½ percent in 1998, fell to 15½ percent in 2000, while 12-month inflation eased to low single digits.

After several years of weak performance, the public finances improved in 1998/99. Notwithstanding a strong increase in investment spending, the deficit of the central government after grants shifted to small surpluses in FY 1998/99 and FY 1999/2000, from a deficit averaging 1¼ percent of GDP in the previous two years. Central government saving rose by 2½ percentage points to 6 percent of GDP in FY 1998/99 and FY 1999/2000, as revenue was boosted with new tax measures and current outlays were tightened. Despite recent improvements, the underlying fiscal position has remained fragile. In FY 2000/01, saving of the central government is projected to weaken and the overall balance after grants to shift to a deficit of about 3 percent of GDP. Revenue was adversely affected by delays in fuel price adjustments in line with fuel import costs, and expenditures have increased in terms of GDP. The government recently took measures to prevent further revenue erosion (including a partial adjustment of fuel prices and an increase in consumption taxes).

In a sign of continued financial deepening (similar to other Eastern Caribbean Central Bank (ECCB) countries), since 1998, monetary aggregates and bank credit to the private sector continued to expand at rates somewhat faster than nominal GDP, though with some slowdown in 2000, while the public sector continued to build up deposits with the banking system. Somewhat later than in other territories in the ECCB area, St. Lucia enacted legislation in December 1999 permitting the establishment of offshore financial institutions. Following a visit by a Fund technical assistance team in early November 2000, the authorities began participating in Module I (self-assessment) of the Fund's offshore financial program.

Following a decline in 1998, the external current account deficit widened again to about 13 percent of GDP in 1999, reflecting a higher trade deficit owing mainly to lower banana exports and no improvement in the services account. In 2000, the current account deficit is estimated to have declined to about 12 percent of GDP, as import growth moderated while tourist receipts picked up. The current account deficits (among the lowest in the ECCB area) have been more than covered since 1998 by surpluses in the capital account, which have included rising private direct investment flows and, in 2000, an increase in official borrowing.

Executive Board Assessment

Executive Directors welcomed the recent strengthening of the St. Lucian economy and the reduction in unemployment, stemming from the stabilization of banana production and the development of tourism along with related activities. They stressed that further diversification and enhancements to international competitiveness are needed to permanently raise long term growth and to reduce the external vulnerability of the economy, particularly in light of the market uncertainties facing the crucial banana industry. This called for fiscal discipline and perseverance with structural reforms to raise national savings and investment, and to preserve macroeconomic stability.

While complimenting the authorities for their efforts to improve the public finances since 1998, which had resulted in higher public sector savings, Directors observed that the fiscal position remains fragile and strongly recommended that additional steps be taken to increase revenue and tighten expenditure controls. They supported a comprehensive tax reform to broaden the tax base, which would phase out tax concessions, and would introduce either a value-added tax or a simpler sales-based tax. Directors also advised the authorities on the need to phase out the system of fuel tax adjustments to permit domestic fuel prices to fully reflect changes in import prices.

Directors considered wage restraint to be a crucial element of expenditure control and international competitiveness. They urged moderation in adjusting wages during upcoming public sector wage negotiations to contain current expenditure as well as to provide an appropriate signal for wages in the private sector. Directors noted that the public investment program appeared to be sound, and advised the authorities to carefully monitor the selection of projects and limit financing to public savings and noncommercial borrowing. Directors encouraged the authorities to move forward with civil service reform to achieve a more efficient public sector.

Most Directors supported the authorities' effort to restructure the banana industry to make it more efficient and competitive. They noted that this would involve some dislocation of labor, which will require expanded social services and measures to enhance employment opportunities in rural areas. Directors also encouraged the authorities to phase out remaining import licenses, and to adopt a low and uniform import tariff rate. They welcomed the restructuring of the state-owned water and sewerage company, and the intention to privatize it along with other public enterprises.

Directors pointed out that rapid growth of St. Lucia's financial system and the economy's vulnerability to external shocks require close surveillance of banks and other financial institutions. Noting that the regional central bank is constrained by law from disclosing bank soundness indicators, Directors urged the authorities to seek the necessary legislative amendments that would provide assessment of banking practices necessary to comply with the Basel Core Principles. They also supported strengthened supervision of nonbank financial institutions, and encouraged the authorities to proceed with the implementation of the recent ECCB initiatives in this area.

Directors noted the intention to develop an offshore financial center as a step toward economic diversification, and stressed the importance of establishing a strong supervisory and regulatory system. They urged authorities to quickly complete review of the laws and regulations applicable to the offshore sector, and to implement the necessary amendments to ensure full compliance with international best practices. Directors encouraged authorities to follow up their ongoing self-assessment by commencing preparation for the regional FSAP expected to take place in late 2001.

Directors welcomed the background paper on the Eastern Caribbean Currency Union. They agreed that while the common currency arrangement has served the region well, it has increased the importance of the implementation of policies in individual countries to strengthen competitiveness. These include increasing public savings-as proposed by the ECCB-and improving the quality of public expenditure. There is also a need to strengthen regional money and capital markets, as well as a need for the ECCB to play a larger role in prudential supervision, including supervision of offshore financial centers.

Directors noted that data coverage, timeliness and quality have improved in recent years, but that weaknesses remain, especially in national income and balance of payments accounting. In the context of the General Data Dissemination System, which St. Lucia recently adopted, Directors strongly encouraged the authorities to step up implementation of their plans for addressing data deficiencies.