IMF Dominica: Staff Concluding Statement of the 2019 Article IV Mission

DOMINICA: Staff Concluding Statement of the 2019 Article IV Mission

May 14, 2019

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments. 

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

1. The economy is recovering strongly following the destruction wrought by hurricane Maria. Output growth in 2019 is estimated at 10 percent, largely offsetting the cumulative decline of 10 percent since the hurricane. Construction has been the main sector leading the recovery, with large investments in infrastructure and public services, aimed at building resilience to natural disasters. Tourism and agriculture, key for exports and employment, are growing with support from government programs and financing, but remain significantly below potential in light of the significant loss of trees and equipment. Output is projected to reach pre-hurricane levels by 2020, and growth to rise above potential in the medium-term, owing largely to significant foreign investment in new hotels expected to start operations by end-2019. In the context of an uptick in tourism prospects, the increase in room supply above pre-hurricane levels should give a fillip to economic activity.

2. Large-scale public investment aimed at rehabilitation, reconstruction and resilience while contributing to growth, has worsened the fiscal outlook. The fiscal deficit is projected to remain large in FY2019/20 at 7 percent of GDP, but this is a significant improvement (4 percent of GDP) relative to the estimated outturn for FY2018/19. The narrowing of the deficit is explained by the recovery of tax revenues and more measured execution of public investment, owing to the decline of readily-available Citizenship-by-Investment (CBI) deposits. Beyond the near term, fiscal deficits are expected to narrow gradually with financing constraints becoming binding, constraining the space to sustain elevated levels of public investment. Based on conservative projections of CBI revenues and loan disbursements from multilateral and bilateral creditors, and given downwardly-rigid recurrent spending, staff projects the fiscal space for public investment to decline to 4 percent of GDP by 2023. This low level of investment is insufficient to sustain resilient infrastructure needs and is a large decline from the 15 percent of GDP annual investment average in the previous five years. Public debt remains high at around 80 percent of GDP in the medium term.

3. External current account deficits are projected to decline over the medium term, from over 40 percent of GDP in 2018 to 10 percent of GDP by 2024. This goes in tandem with a recovery of exports and a depletion of CBI and insurance deposits, which would reduce domestic demand to more sustainable levels. The outlook is, however, subject to significant uncertainty. In particular, higher-than-projected CBI revenues would increase external and fiscal deficits and increase growth further.

4. Reaching the ECCU public debt target of 60 percent of GDP by 2030 while sustaining resilient investment requires a well-designed fiscal consolidation plan. The government should prepare fiscal consolidation measures expeditiously, targeting savings of at least 6 percent of GDP to be adopted gradually over the medium term. Measures should be staggered over 5-6 years to smooth the likely negative impact on growth. The plan will support growth by increasing fiscal space for public investment while reducing government consumption, along with tax measures aimed at improving the efficiency of resource allocation:

· On the revenue side, key measures could include a rationalization of tax incentives, with a cap on discretionary concessions and clear prioritization consistent with national development plans; a strengthening of tax auditing, which will require additional human resources; a restructuring of water and sewage service tariffs to achieve financial sustainability of the public provider; and a broadening of the base for personal income taxes, including by introducing a presumptive tax.

· On the expenditure side, the government could consider a review of public wage allowances and a containment of wage increases below inflation; an acceleration of ongoing social security reform by bringing forward the planned increase in the retirement age and contribution rates and review of conditions for retirement eligibility–including longer contribution period and revised rules for pension determination in line with contribution effort. The efficiency of social transfers can be improved with proxy means-testing and better monitoring system of beneficiaries to minimize duplication and abuse.

5. Fiscal institutions can be strengthened to support the achievement of the regional debt target. Key enhancements could include (i) the adoption of a fiscal rule anchored on public debt, with escape clauses for natural disasters and other specified challenges; (ii) establishing a system to monitor the operations of state-owned enterprises, including for fiscal planning and identifying contingent liabilities; and (iii) setting aside CBI revenue in a well-governed government saving fund for natural disaster insurance, resilient investment, and debt reduction. These enhancements will help safeguard the fiscal space for building resilience to natural disasters, especially costly physical infrastructure and financial insurance, the core objective in the government’s national development plan. These measures will also support fiscal sustainability, by helping internalize the future costs associated with natural disasters and contain public debt accumulation.

6. The financial sector remains stable and is recovering gradually from the impact of the hurricane. However, more decisive action is needed to safeguard financial stability and support growth. Bank lending is expected to remain soft, owing to insufficient bankable projects, lack of financial statements required for loan qualification for most micro and small entrepreneurs, and lingering difficulties to enforce lending contracts in courts, including lengthy procedures for foreclosures and the seizing of collateral. The government should explore new options to strengthen capitalization and reduce NPLs of the indigenous banking sector. To this end, the plan submitted to the ECCB to assess the balance sheet impact of alternative capitalization options is an important first step. However, decisive action is needed to fully assess banks’ capitalization requirement. In this regard, two important steps are needed. First, the impact of IFRS9 standards on banks’ investment portfolio should be completed. Second, absent banks’ acceptance of NPL acquisition offers by the Eastern Caribbean Asset Management Corporation and the International Finance Corporation Asset Management Company, write-offs should begin expeditiously—NPLs remained stable, albeit elevated, at 17 percent in the past year. Progress on reducing NPLs would increase space for private sector financing to support growth.

7. Addressing balance sheet weakness of credit unions is important to safeguard membership savings, maintain financial inclusion, and minimize contingent fiscal cost. Capital and provisioning should be increased to meet the regulation requirement while doubling the effort to reduce NPLs. Options could include the use of retained earnings, notably by prohibiting dividend distribution if undercapitalized, capital calls to the membership, or through mergers to increase efficiency and reduce operating cost. To this end, the government should approve the already-prepared legislation to strengthen the enforcement power of the Financial Services Unit (FSU). This legislation should be passed without further delay and could be amended at a later stage when there is agreement on harmonized regulation across the region. In addition, the legislation should be reviewed to ensure the regulator has enough power to monitor and regulate high-interest pay-day lending, which is accelerating—it explains the bulk of the loan portfolio growth in 2018. Financial and human resources in the FSU need strengthening and would benefit from technical support from international experts. To strengthen regulation enforcement, the FSU should be established as an independent entity outside the Ministry of Finance. It should also be granted financial independence with legal power to collect fees and issue penalties for non-compliance.

8. Operations of the domestic insurance company should be discontinued, considering its insolvency and inability to honor outstanding claims following the hurricane. To this end, the government should approve the FSU plan recommending intervention and liquidation. Given risk of natural disasters, strong regulatory enforcement would enhance competition in the insurance market with more participation of internationally-diversified institutions and risk transfer.

9. Progress on improving AML/CFT legislation towards international standards will help reduce the risk of losing correspondent banking relationships.Ongoing actions to strengthen the AML/CFT framework, in line with 2018 CFATF mutual evaluation recommendations, will facilitate information access and coordination among all competent authorities, while improving the FSU’s analysis and enforcement. The phase-out of the off-shore banking sector should continue, and approval of revisions to the Offshore Banking Act, including higher capital requirements, license application process reform, and enactment of regulations, should be expedited.

10. The private sector needs to play a more prominent role to sustain growth in the long term:

· To increase employment, legal constraints on working hours should be removed and severance payments for redundancy should be reviewed. Addressing educational gaps, in consultation with private employers, will help improve labor force adaptability and facilitate mobility –important considering seasonal demand in key sectors. The government could reform existing employment programs to facilitate labor market entry with on-the-job training in expanding sectors, especially tourism and agriculture.

· Ongoing efforts to review construction and zoning regulations should be enforced strictly in light of vulnerability to natural disasters. This could reduce insurance costs and help coverage.

· With low-cost geothermal generation expected by mid-2021, reduction of electricity tariffs will be feasible, improving competitiveness and reducing dependence on imported fossil fuels.

11. Data provision has shortcomings due to resource constraints in the statistical agency, resulting in insufficient coverage, accuracy, frequency, and timeliness of data. More timely and improved data pertaining to the national and fiscal accounts, labor market, the balance of payments, and non-bank financial institutions are needed for improved economic monitoring, budget planning, and policy formulation. Stronger incentives could be adopted for timely provision of data to the Central Statistics Office by reporting public and private entities.

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