IMF reaffirms gradual recovery of St. Kitts and Nevis’ economy, commends authorities for fiscal consolidation

BASSETERRE, ST. KITTS, AUGUST 16TH 2011 – The Washington-based International Monetary Fund (IMF) has reaffirmed that the St. Kitts and Nevis economy is gradually recovering from a prolonged downturn but that the elevated public debt-to-GDP ratio poses significant risks to the outlook.

“Against this background, Directors agreed that urgent action is needed to restore debt sustainability and achieve a higher growth path. They encouraged the authorities to pursue their ambitious fiscal adjustment plans, including a comprehensive debt restructuring, and the wide-ranging reform agenda at the core of the economic program to be supported by a Stand-By Arrangement with the Fund,” the IMF Executive Board said in its July 27, 2011 Article IV consultation on St. Kitts and Nevis.

Directors commended the St. Kitts and Nevis authorities for embarking on front-loaded fiscal consolidation, which includes introduction of a VAT, implementation of an excise tax and electricity tariff reform, and a freeze of the public wage bill. They agreed that fiscal adjustment must be sustained over the medium term and welcomed the authorities’ commitment to adopt further measures in case of a revenue shortfall.

Directors underscored that, in addition to fiscal adjustment, a comprehensive debt restructuring is key to a sustainable fiscal position. They commended the authorities for taking steps in this direction through public announcements and initial discussions with creditors.

Directors noted that further strengthening of the financial sector is also a critical element of the authorities’ economic program. They looked forward to the establishment of a Banking Sector Reserve Fund for temporary liquidity support to solvent banks, if needed. Directors also welcomed the ongoing efforts to strengthen the oversight of non-bank financial institutions, including establishment of the Single Regulatory Unit.

Directors encouraged the authorities to fully implement their structural reform agenda. These forms should aim at strengthening public financial management, improving the business climate, enhancing the social safety nets, removing obstacles to growth, and restoring lost competitiveness.

In its background, the IMF noted that St. Kitts and Nevis’ tourism-dependent and highly indebted economy is recovering slowly from a two year-long recession. Activity is estimated to have declined both in 2009 and 2010, due to a fall in tourism receipts and foreign direct investment (FDI)-related construction activities. A mild recovery is underway in 2011, driven primarily by the outlook for the United States (St. Kitts and Nevis’ major export market) and the reopening of the Four Seasons Hotel in Nevis. Inflationary pressures, which remained subdued in 2009, have begun to intensify towards the end of 2010, as a result of oil and food price increases.

Faced with increasing fiscal imbalances in 2010, the authorities started to implement a strong fiscal adjustment program at the end of the year and beginning of 2011. In response to a rising fiscal deficit, the authorities implemented revenue reforms and expenditure cuts, with yields starting to materialize in 2011.

On the revenue front, a VAT and excise tax reforms were implemented in November 2010. Other measures implemented include streamlining import duty exemptions, strengthening auditing and monitoring of duty free shops, and introduction of an environmental levy on new vehicles.

They also changed the structure of the Housing and Social Development Levy and increased electricity tariffs in January 2011. On the expenditure side, the authorities froze public wages, but increased capital expenditure to acquire two new electricity generators in order to stem island-wide black outs. The primary fiscal balance deteriorated by 5.4 percentage points of GDP to a deficit of -0.5 percent of GDP in 2010 and the public debt-to-GDP ratio increased to about 200 percent in 2010.

Reflecting the recession, the external current account deficit improved in 2010. Available data suggest that, while exports of goods and services remained broadly stable, imports of goods and services declined by about 6 percentage points of GDP. As a result, the external current account imbalance is estimated to have narrowed by about 6½ percentage points of GDP. The deficit was financed by official inflows, FDI, commercial banks, and a further accumulation of arrears on fuel imports.

The authorities have requested IMF’s financial assistance in support of their economic reform program. The main objective of the authorities’ program is to put public debt on a firmly downward trajectory, thereby creating a virtuous cycle of lower debt and higher growth. The authorities’ reform agenda encompasses a three-pronged approach.

The first priority is fiscal consolidation—allowing revenue to rise upfront and containing spending increases, while at the same time, making efforts to protect the most vulnerable groups. The second priority is a comprehensive debt restructuring to address the debt overhang.

The third priority is to further strengthen the financial sector, including through the establishment of a Banking Sector Reserve Fund as a backstopping mechanism for liquidity support, if needed. The authorities have also outlined a structural reform agenda to help strengthening fiscal management, improving the effectiveness and efficiency of the public sector, and removing obstacles to growth. The authorities’ economic reform program is expected to catalyze financing from international and regional financial institutions and is supported by a Stand-By Arrangement with the IMF, which was also approved by the Executive Board on July 27, 2011.