Public Information Notice No. 05/115

Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with Barbados

August 15, 2005

On August 5, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Barbados.¹

Background

Barbados compares favorably with other Caribbean countries on economic and social indicators. The economy is heavily dependent on tourism and financial services. The population is about 272,000, and per capita income (on a PPP basis) is about US$15,700. Poverty rates are the lowest in the Caribbean. Social indicators compare favorably in both a regional and global context; in 2004, for example, Barbados was ranked 29^th among 177 countries on the United Nations Development Program's Human Development Index.

Barbados was one of the better-performing economies in the Caribbean in the 1990s. During 1993-2000, Barbados grew at 3 percent, inflation was less than 2 percent, and public sector deficits were maintained at less than 3 percent of GDP.

The economy—especially the tourism and financial services sectors—suffered a sharp recession in 2001-02 following the September 11^th attacks and the global slowdown. In response to the deterioration in the external environment, the government implemented a public investment program to help revive economic activity. Combined with public sector wage increases, this contributed to a widening of the overall nonfinancial public sector fiscal deficit from about 2 percent of GDP in FY 2000/01 to about 13 percent of GDP in FY 2002/03. As a result, the public sector debt-to-GDP ratio rose from 74 percent in March 2001 to 87 percent in March 2003. The external current account deficit remained at around 6 percent of GDP over 2001-03.

A strong economic recovery appears to have taken hold in 2004. Real GDP growth in 2004 is estimated at 4.4 percent, led by a recovery in tourism, construction, and communications. The public sector deficit fell to 6½ percent of GDP in FY 2003/04 and 6 percent of GDP in FY 2004/05 as capital expenditures declined from their high levels of the previous years. Following the rebound in economic activity and a reduction in mortgage lending rates, growth in credit to the private sector—especially to households—accelerated in 2004. Private sector credit grew by almost 17 percent during 2004, reflecting strong demand for mortgages. Higher personal incomes of households also spurred private credit growth. Base money declined, however, owing to the resulting from the decline in commercial banks excess reserves. The banking sector appears to be sound and financial sector indicators have improved with the pickup in economic activity.

The external current account deficit rose from 7 percent of GDP in 2003 to 10½ percent of GDP in 2004, reflecting a broad-based import surge related to the rapid increase in private sector credit and the expansion in economic activity. Capital inflows also declined with the cessation of privatization receipts from abroad. As a result, the balance of payments moved from a surplus to a deficit of 5½ percent of GDP in 2004, with gross international reserves (GIR) falling to 3¾ months of imported goods and nonfactor services.

Structural reforms have advanced in taxation, telecommunications, and the public enterprise sector. Corporate and personal tax rates have been further lowered, in line with the multiyear reduction in these rates initiated in FY 2002/03. In telecommunications, the final phase of reform began in early 2005, and will involve the liberalization of external telecommunications and the issuance of new licenses for fixed telephone lines on a competitive basis. Legislation to corporatize the Airport Authority was also recently approved.

Executive Board Assessment

Executive Directors observed that based on a recovery in tourism, construction, and communications, Barbados recorded stronger economic activity and low inflation in 2004. Directors noted that growth prospects for the next three years remain favorable, reflecting the positive global environment and the boost to growth from the buildup to the 2007 World Cup cricket games. At the same time, Directors underscored that a key challenge in maintaining and sustaining strong economic growth going forward will be to address macroeconomic imbalances, including a high level of public debt, large fiscal and external current account deficits, and declining international reserves.

Directors observed that the expansionary public investment program, implemented to revive the economy after the recession of 2001-02, contributed to raising Barbados' public debt to a level far exceeding the average for Latin America and the Caribbean. While welcoming the efforts to reduce the public sector deficit over the past two years, they noted with concern that the primary deficit remains among the highest in the region and that public debt will rise steadily in the absence of fiscal consolidation. Against this background, they cautioned that the injection of fiscal stimulus in FY 2005/06, in the midst of a robust private-sector led recovery, could make the path to debt reduction more difficult. Directors therefore urged the authorities to seize the opportunity provided by the external economic environment to reduce the fiscal deficit decisively, thereby placing public debt on a firmly declining path and building a fiscal cushion in the event of negative shocks. Directors noted that faster fiscal consolidation will also help strengthen the external reserve position, without overburdening monetary policy, while allowing credit to be channeled to the private sector to support growth.

Directors welcomed the government's plan to reduce public expenditure over the medium term. Most Directors recommended that the authorities complement these efforts with revenue measures, as well as a rationalization of the tariffs of major public enterprises, with a view to reducing subsidies to these entities. Directors were encouraged by the authorities' preparation for the implementation of output-based budgeting within a medium-term framework, which is expected to improve budget formulation. While welcoming the authorities' efforts to promote private-sector participation in the provision of economic infrastructure and services, Directors cautioned that expenditure commitments associated with these activities should be carefully monitored and accounted for in budget documents. To assist their efforts to improve fiscal transparency, a few Directors recommended that the authorities consider requesting a fiscal Report on the Observance of Standards and Codes.

Directors supported preserving Barbados' fixed exchange rate regime, noting its positive role as an anchor for price stability and investor confidence. They emphasized, however, that going forward, the exchange rate peg will need to be supported by sound policies aimed at addressing the recent macroeconomic imbalances. Directors also stressed the need to strengthen competitiveness by tightening the link between wage increases and developments in labor productivity, as well as accelerating productivity growth through structural reform.

Directors welcomed the recent steps to slow the growth of credit, and recommended further tightening to help arrest the decline in foreign reserves. Directors encouraged the authorities to make greater use of indirect monetary policy instruments and enhance competition in the banking system. They noted that this would facilitate the gradual phasing out of the minimum deposit rate and improve the efficiency of financial intermediation. Directors noted that while the banking sector appears well poised to absorb shocks, risks related to the large share of public debt held by domestic financial institutions will need to be monitored carefully. Directors were encouraged by the progress made in addressing the outstanding issues from the Financial Sector Assessment Program report of 2002, and called for strengthened efforts to curb money laundering and the financing of terrorism.

Directors underlined the importance of structural reforms to encourage foreign direct investment, improve competitiveness, and enhance Barbados' long-term growth potential. They welcomed the significant progress that has already been made in some areas, including the reduction in corporate tax rates, telecommunications reform, and the corporatization of the airport. They welcomed the authorities' focus on reforms relating to tax policy and privatization, as well as their continued commitment to further trade and capital account liberalization within the context of the Caribbean Single Market and Economy initiative and the envisaged Free Trade Area of the Americas. Key areas for further reforms include the removal of import and export licenses; reform of the sugar sector; restructuring or privatization of the public enterprises that do not meet public policy objectives; and enhanced labor market flexibility. Directors also urged the authorities to rationalize costly fiscal incentives to investment.

Directors observed that statistical information provided by Barbados is broadly adequate for surveillance purposes, but noted the need to strengthen the quality, coverage, and timeliness of data for the public enterprises and the capital account of the balance of payments