On May 12, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation^[1] with Dominica, and considered and endorsed the staff appraisal without a meeting^[2].

The recovery from Tropical Storm Erika (August 2015) has been slower than anticipated, with output growth of 1 percent in 2016, dragged down by a storm-related decline in manufacturing.  Moreover, capacity constraints and unfavorable weather slowed public investment more than anticipated. Despite ample liquidity, bank credit to the private sector remains weak, although this is in part relieved by growing lending by credit unions.

Growth is projected to accelerate to above 3 percent in 2017-18 on the back of a pickup in public investment and several large-scale private projects with citizenship-by-investment (CBI) and grant financing, and to stabilize at a potential rate of 1.5 percent over the medium term. The external current account deficit is projected to widen due to the increase in imports of goods and services with the increase in investment, and then to gradually improve as agriculture, tourism and manufacturing recover, and geothermal electricity generation reduces oil imports.

Despite high CBI revenues, the fiscal outlook has deteriorated largely due to lower projected grant revenues, a downward revision in the projected yields of the fiscal consolidation measures, an increase in social transfers and the reduction of the corporate income tax rate in January 2016. As a result, reaching the regional debt target of 60 percent of GDP by 2030 without increasing the fiscal consolidation effort above the commitments in the RCF disbursement would require the use of government deposits for debt reduction.

Executive Board Assessment^[3]

Economic activity in 2016 was weak, but is expected to pick up this year on the back of public investment and several large-scale private projects now in execution. The recovery from tropical storm Erika has been slower than anticipated, mainly because grants have been much lower than expected and capacity constraints have slowed down the execution of public infrastructure reconstruction efforts. However, most sectors are now on a recovery path, including tourism, agriculture, and construction. Public investment has picked up, with large CBI revenues offsetting the shortfall in grants; and large-scale investment projects in execution are boosting demand in the near term. As a result, growth is projected above 3 percent in 2017 and 2018. However, the outlook remains subject to significant risks, mainly from recurrent natural disasters, delays in reconstruction and public investment affected by capacity constraints and uncertain sources of grant and CBI financing, and natural disasters. Weaknesses in the financial sector will continue to pose risks to financial stability and weigh on credit and growth.

The priorities facing the authorities are to maintain momentum with the reconstruction program while ensuring that the public finances are put on a sustainable footing. The government should continue to focus on implementing the fiscal consolidation plan committed to at the time of the RCF disbursement aimed at reducing debt to 60 percent of GDP by 2030. This adjustment of over 6 percent of GDP includes public wage restraint, reduction of tax incentives, and the gradual unwinding of storm-related spending on reconstruction, goods and services, and social assistance. The increase in CBI revenues, which eases financing pressures in the near-term, should not detract from the resolute implementation of the consolidation plan, which should target reductions in the underlying primary balance (i.e., excluding CBI revenues, grants, and storm-related spending).

Low donor grants and unpredictable CBI revenues require prudence in fiscal management to ensure sufficient financing for reconstruction with fiscal sustainability. It is thus important to avoid the allocation of CBI flows to recurrent spending, which would be relatively difficult to reverse. Rather, the scope to the VF for natural disasters should be broadened to include also a saving sub-fund of CBI resources earmarked for debt reduction and public investment.  Given the several sources of uncertainty, including the sustainability of CBI flows, the government should consider contingent fiscal measures to create fiscal space for reconstruction and further strengthen the fiscal sustainability outlook.

Improving fiscal institutions, in line with recent Fund TA advice, should also be a priority. The budget process should be strengthened to make it the key instrument for medium-term fiscal planning, and the introduction of fiscal rules within a formal fiscal responsibility legal framework could provide a commitment mechanism to support the fiscal consolidation effort. A formal framework to set a limit on tax incentives, and to limit the scope of discretional tax concessions would also be beneficial and could provide additional savings. Given that these reforms are complex, early preparation is crucial for a timely implementation.

Strengthening financial sector institutions is critical to enhance financial stability and facilitating a return to lending by the banks. Further action is needed to clean up bank balance sheets by reducing still-high NPLs and increasing bank capital. Toward this end, the ECAMC should be made operational as soon as possible to facilitate removal of NPLs from bank balance sheets. The government should also seek to eliminate the ECCB’s MSR, which reduces banks’ profitability and delays progress on NPL reduction. Vulnerabilities in the credit union sector, which is systemically important, and suffers from high NPLs and low capitalization, should also be addressed. In particular, the authorities need to move quickly to strengthen supervision and regulatory powers of the FSU and to move ahead with the regional credit union legislation that has been pending for some time. Credit by public financial institutions should be better targeted to address missing or incomplete credit markets, in line with national development objectives. The initiative to establish a credit bureau is welcome, which should facilitate access to credit. Furthermore, a review of the legislation aimed at strengthening the enforcement of loan contracts could counterbalance the increase in banks’ risk aversion in recent years.

Lowering the risk of withdrawal of CBRs is critical to support investment and sustain growth. Notwithstanding the significant progress made to strengthen AML/CFT legislation closer to international standards in recent years, there is still a need to improve enforcement.  The authorities should also encourage respondent and correspondent banks to improve communication and information sharing; remove obstacles for bank consolidation; and encourage banks to explore options for the bundling of financial services.

Beyond the reconstruction efforts, there is a need to improve resilience to future disasters and address constraints that result in low potential growth. Toward this end, the government’s effort to increase the resilience of public infrastructure is commendable and should be sustained; this will also improve the business environment. Moving ahead with plans to develop geothermal energy capacity will lower electricity costs that are among the highest in the world, thereby improving competitiveness. To increase labor productivity and employment, labor market legislation should be updated to remove rigidities in working hours and align severance payments with the needs of a more dynamic labor market.

Incentivizing educational attainment, including in skills for which there is excess demand, would also facilitate labor adaptation across sectors and increase employment. Public wage negotiations should also be mindful of their impact on private sector wages, which affect production costs, investment, employment, and external competitiveness.

Data provision has shortcomings due to capacity constraints in the statistical agency, including weaknesses in coverage, accuracy, frequency, and timeliness of data. Although it is broadly adequate for surveillance, these limitations constrain economic analysis and policy formulation. Specifically, surveillance would benefit from more timely and improved data pertaining to the national and fiscal accounts, labor market, the balance of payments, and credit unions.

[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.

Source: imf.org