Public Information Notice No. 06/14

Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with St. Lucia

February 9, 2006

On December 21, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with St. Lucia.¹

Background

St. Lucia's economy is dominated by tourism, which accounts for almost three-quarters of the island's exports. Though less exposed to hurricanes than other Caribbean islands, St. Lucia remains vulnerable to natural and other exogenous shocks. Since 1990, the production of banana and other export products has been declining. Banana exports have suffered from rising costs and the gradual erosion of preference margins in the EU market. A restrictive trade regime, high cost of capital, and labor market rigidities appear to have delayed structural change.

Economic activity in St. Lucia has been slowing since the 1980s, but it has picked up since 2003, driven by tourism and related investments. Real GDP growth was 4 percent in 2004 and is expected to exceed 5 percent in 2005 and 2006. The rebound in tourism since 2003 was facilitated by a favorable global environment, and investment in tourist resorts and infrastructure is fueling demand for construction ahead of the 2007 Cricket World Cup. Plans exist to increase the stock of hotel rooms by about 30 percent, or 1,100 new units. At the same time, inflation, which had been subdued under the ECCU currency board arrangement, has recently pointed upwards, reaching 4.4 percent in the 12 months to November, 2005. The partial pass-through, in August 2005, of higher oil prices to controlled fuel and transport prices may further add to price pressures.

Central government fiscal policy has tightened markedly since 2003 and deficits have narrowed. The 2005/06 budget would sharply set back fiscal consolidation but full implementation of the high levels of budgeted capital expenditure appears unlikely due to capacity constraints. The overall fiscal deficit for FY 2004/05 narrowed to 4 percent of GDP, and the primary deficit to 1 percent of GDP, compared to a primary deficit of 5.1 percent of GDP in FY 2002/03. The improvement reflected public sector wage restraint, reduced capital spending and cyclical factors boosting tax revenue as the economy recovered.

The rapid rise in public debt in recent years has slowed with total public debt reaching almost 68 percent of GDP by end-FY 2004/05. But while this is lower than the debt ratios of other ECCU countries, it remains high by international standards, thus exposing St. Lucia to financial risks. As regards the banking sector, the stock of nonperforming loans in commercial banks' balance sheets remains high and well above the ECCU average.

Real depreciation of the E.C. dollar against major currencies has strengthened the external competitiveness of the tourism sector as measured by a competitor-based real effective exchange rate. Other measures indicate that rising real wages, stagnant productivity, and recent price pressures may undermine competitiveness and the emergence of a more diversified export structure.

Regarding the external balance, increasing tourism receipts have not fully compensated for declining agricultural and manufacturing exports over recent years. Imports are being boosted by strong consumer demand and investment activities related to the Cricket World Cup. The current account deficit is set to widen through 2006, but should begin to narrow thereafter as investment demand eases. This deficit is expected to be largely financed by foreign direct investment related to the tourism sector.

Executive Board Assessment

Directors welcomed the recent strong growth performance of St. Lucia's economy, with a recovery in tourist arrivals and strong investment in tourism infrastructure more than offsetting the continued decline in banana exports. Directors commended the authorities for their record of prudent public debt management—the best within the ECCU—and for the progress made in fiscal consolidation over the past two years. At the same time, Directors cautioned that more recently, public debt had risen sharply, and they urged the authorities to take advantage of the robust growth to follow through with plans to reduce the debt over the medium term. They considered that the authorities are well placed to avail of the economy's present strength to address the economy's structural and fiscal challenges, so as to lay the groundwork for continued sustainable high growth in the long term and a reduction in unemployment.

Directors underscored the importance of continued progress toward fiscal consolidation. The FY 2005/06 budget, which calls for a large increase in capital spending, would set back progress in this regard. Directors considered that much of the fiscal improvement in recent years has reflected cyclical factors, and a combination of revenue and expenditure measures is still needed to strengthen the underlying fiscal position. These include rebuilding petroleum tax revenues and converting the petroleum tax into an excise tax, limiting the growth of the civil service wage bill, and eventually introducing a modern system of VAT and excise taxation. Directors emphasized in particular the need for greater discipline over tax concessions, and called for a regional approach to phasing out such concessions that curtails destructive competition for investments. The need for careful management and prioritization of capital expenditures was also noted, which would help to lessen the emerging strains on capacity stemming from the construction boom and to contain inflationary pressures.

Directors noted that the banana sector is likely to continue to contract owing to competitive pressures and the coming erosion of its trade preferences in export markets. Efforts to ameliorate the social impact of the sector's decline should include labor retraining, support for business start-ups, and the creation of an appropriate safety net for older workers.

Directors considered that, to boost St. Lucia's growth potential, the investment climate should be strengthened, competitiveness enhanced, and the outward orientation of the economy further increased. They encouraged efforts to lower the cost of capital by easing foreclosure laws, reviewing the ECCU savings rate floor, and better targeting investment incentives. Directors noted that the real effective exchange rate has depreciated in recent years. Nevertheless, given the ECCU exchange rate arrangement, St. Lucia's competitiveness needs to be supported by increased labor market flexibility and measures to improve skills and opportunities for the unemployed. Directors also recommended lowering peak tariff rates and eliminating restrictive licenses that draw resources into noncompetitive activities, drive up the cost of tourism services, and impede diversification.

Directors welcomed the progress that has been made in strengthening the banking sector. However, nonperforming loans remain high and balance sheet exposure to the public sector is rising, warranting close monitoring, especially if liquidity conditions in financial markets tighten.

Directors encouraged the authorities to continue to improve the timeliness and accuracy of data for economic analysis and policy-making, especially with regard to the national accounts, and consumer prices and wages. They also recommended strengthening information on private remittances by introducing a regular survey of financial institutions.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.