Eastern Caribbean Currency Union: IMF Staff Concluding Statement of the 2019 Discussion on Common Policies of Member Countries
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.
Growth has recovered strongly in 2018-19 but is set to moderate, with the outlook clouded by downside risks. The Eastern Caribbean Central Bank (ECCB) and individual Eastern Caribbean Currency Union (ECCU) countries have continued to advance their reform agendas, but progress needs to be accelerated. While robust national fiscal frameworks remain key to the region’s policy priorities, well-sequenced steps to regional integration can catalyze capacity and resources. This would include (i) increasing fiscal integration, (ii) enhancing financial integration, and (iii) solidifying the monetary union by raising payment’s efficiency through—but not limited to—cautiously piloting a digital currency.
1. Growth rebounded in 2018 and has remained robust so far in 2019. ECCU’s GDP growth accelerated to 3¾ percent in 2018, reflecting buoyant tourism and sizable Citizenship-by-Investment (CBI) inflows, which helped support Dominica’s reconstruction-led recovery from the 2017 hurricane. Growth momentum has remained strong in 2019, while inflation has been muted. The region’s fiscal deficits have been edging upwards in 2018-19 despite continued strength in CBI inflows, but with the deficits remaining moderate, the public debt ratio declined in 2018 and is set to fall further in 2019. While the region’s external deficits are high, they are amply financed by FDI flows. Bank credit to the private sector remains weak despite substantial excess liquidity.
2. Going forward, growth is set to moderate, and risks remain mostly on the downside. GDP growth is expected to gradually ease to 2¼ percent, a long-term historical average for the region. CBI inflows are also projected to moderate. In the near term, economic activity would be supported by further post-hurricane reconstruction, tourism investment, and some agribusiness projects. Achieving the 60 percent of GDP debt target would remain challenging for most countries. Global risks, such as adverse confidence effects from rising protectionism and weaker US growth, could weigh on the outlook. Region-specific risks include natural disasters, increasing banks’ foreign exposures, continuing exit of global banks, and continued pressures on corresponding banking relationships (CBRs) against the backdrop of elevated non-performing assets. Positive surprises in CBI inflows, if well-managed, constitute potential upside risks.
3. Greater regional integration can substantially complement robust national policies in improving the outlook and mitigating risks. ECCU’s challenges are compounded by large shocks and lack of economies of scale. Robust national fiscal responsibility frameworks that ensure public debt sustainability and buffers are crucial for improving the ECCU growth potential. ECCB’s advocacy for achieving the 60 percent of GDP debt target by 2030 through national fiscal responsibility frameworks and its efforts to improve debt management have supported this process. In addition, IMF staff analysis suggests that well-sequenced steps toward regional integration can catalyze resources for better policy responses, as elaborated below.
A. Increasing Fiscal Integration
4. Regional coordination of selected revenue policies could create fiscal space for ECCU’s public investment. The ongoing “race to the bottom” in competing for tax incentives and CBI program conditions limits the potential to raise revenue that could be channeled to productive spending, including resilience building. This highlights scope for the ECCU countries to coordinate tax incentives and CBI program conditions, while achieving the objective of making FDI more attractive through better infrastructure. In this context, the authorities’ ongoing collaboration on CBI programs’ financial integrity to improve their transparency and governance could help lower negative perceptions about the use of CBI programs. Such collaboration could support region-wide sustainability of these flows and financial stability.
5. Over the longer term, a regional pooling of fiscal resources can complement national fiscal buffers to build resilience against natural disasters and other shocks at a lower cost. While individual ECCU countries face similar risks, natural disasters put them in different economic conditions at a given time. The regional pooling of resources saved by limiting excessive growth of public consumption in good times could support macroeconomic stabilization and create scope for resilience building and other growth-enhancing investment in bad times. Staff calculations suggest that the size of a pooled fund would be about one-half of the sum of individual countries’ funds for the same stabilization effect. Such an arrangement would require a strong governance framework and should be financed by national budgets to protect ECCB’s international reserves and the credibility of its quasi-currency board arrangement. This pooling of resources could complement national insurance strategies against natural disasters, a key pillar of the Disaster Resilience Strategies currently being piloted in Dominica and Grenada.
B. Enhancing Financial Integration
6. Accelerated progress on the ECCB’s reform agenda will help address financial system vulnerabilities. The ECCB in its capacity of a region-wide bank supervisor and regulator has continued to advance essential reforms, including strengthening its financial system stability function with deepened interaction with regional regulatory authorities, identifying regionally-systemic financial institutions, and improvement to its Financial Stability Report. The implementation of risk-based supervision, phase-in of Basel II/III standards, technology upgrades for supervisory operations, and enhanced AML/CFT frameworks continue to build supervisory effectiveness. Additional reforms are currently being pursued, such as establishing a shared services platform for indigenous banks; developing a deposit insurance scheme; implementing an e-conveyancing regime for collateral realization as part of the initiative to modernize insolvency frameworks; harmonizing non-bank financial laws; operationalizing a credit bureau; and preparing guidelines for the treatment of impaired assets. Authorities are also considering a macro-prudential framework for financial sector stability including the Lender of Last Resort (LOLR) function; and a framework for optimal regulation of the financial sector.
7. The reform agenda needs to be prioritized with key short-term actions. Despite improvements in Non-Performing Loans (NPLs) in most jurisdictions, efforts to repair bank balance sheets should be stepped up by (i) adopting effective plans for all banks to reduce NPLs below the 5-percent benchmark by end-2023, including via sales to the Eastern Caribbean Asset Management Company (ECAMC); (ii) requiring banks’ disposal of non-banking assets (including land); and (iii) strictly enforcing exposure limits and market risk management. ECCB’s and deposit-taking institutions’ governance frameworks should be reviewed and passage of critical legislation, including AML/CFT, should be expedited by remaining countries to increase compliance and enforcement. Consolidated supervision of financial groups should be advanced. Urgent measures are also necessary to monitor and address operational risk, including due to CBRs and cybersecurity. The new treatment of impaired assets standard, now expected by January 2020, should be implemented without delay.
8. Provided the critical short-term priorities are addressed, steps toward a fuller banking union could take place in the long term. These would involve: (i) enhancing the financial safety net with a robust deposit insurance scheme and (ii) establishing a regional resolution and crisis management framework. Both these steps require operationalizing credible fiscal backstopping as a key precondition, based on minimum regional fiscal responsibility commitments entrenched in national laws. Other reforms that should be implemented include: (i) advancing the regulatory regime for systemic institutions (including non-banks) to minimize regulatory gaps and shock propagation; (ii) consolidation of regional non-bank financial sector oversight to enhance coverage, address sector-specific risks, reduce compliance costs, and mitigate resource constraints; and (iii) progressing the establishment of a macroprudential mandate and toolkit to address region-wide systemic risk.
C. Solidifying the Currency Union by Raising Payment System’s Efficiency
9. Building on the successful launch of the Electronic Funds Transfer, the ECCB, national authorities, and financial institutions should continue efforts to modernize the payment system. Major banks have recently begun to offer various electronic payment services. The authorities are also examining options to integrate credit unions in the core payment systems. This would help competition, but it should be considered in the context of establishing an appropriate prudential oversight framework. The ongoing review of the legal framework pertaining to the payment system is also critical to allow emerging Fintech and nonbank e-payment services to operate and innovate. Advancing e-government initiatives would also help increase the volume of digital payments to help address small-economy constraints and enhance the business opportunities for the private sector. In this context, the Digital Economy Project, which is currently in its preparatory phase, would support digital transformation of key services provided by ECCU Governments. Early introduction of a digital ID is needed to support these initiatives.
10. The digital currency pilot project, launched by the ECCB, should proceed cautiously as planned. The authorities view the digital currency as an option to reduce excessive reliance on cash and cheques; improve the efficiency of the retail payment system; and support economic development by reducing financial frictions. To contain vulnerabilities, important safeguard measures are embedded in the design of the digital currency, such as the limited size of its holding and transaction values, no interest accrued; and does not include foreign currency transactions. That said, the digital currency could expose the ECCB and the financial system to various risks, including those related to financial intermediation, financial integrity, and cybersecurity. The pilot will provide the opportunity to examine these risks, test the design of the digital currency, and assess any policy gaps. After the pilot, the ECCB is planning to thoroughly review its results, and more work may be warranted, especially to further test the digital currency system, strengthen cybersecurity and AML/CFT operations, and update legal and regulatory frameworks.
Published: 7 January 2020