On July 22, 2011, the executive board of the International Monetary Fund (IMF) concluded the Article IV consultation with Dominica, and considered and endorsed the staff appraisal without a meeting.
Dominica has made significant progress over the past decade in strengthening its macroeconomic policy management. Prudent fiscal management in the years leading up to the crisis has served the authorities well, leading to primary surpluses that average 3 percent of Gross Domestic Product (GDP) over the past eight years and to a significant reduction in public debt, to about 67 percent by mid-2011. Social indicators have also improved, with a major fall in unemployment and poverty levels, although these remain high at 14 percent and 29 percent, respectively, as of 2009.
Dominica is emerging from the crisis. The decline in global activity led to a relatively mild contraction due to a strong countercyclical fiscal response and limited reliance on tourism. Growth turned positive in 2010, but tepid demand and the needed fiscal consolidation will weigh on the near-term prospects, with activity projected to growth at 0.9 percent in 2011. Near-term risks to growth are tilted to the downside on account of a potentially stronger impact of a slowing demand in advanced economies and weaker performance in agriculture, manufacturing and trade.
High world commodity prices are expected to put some pressures on inflation and the balance of payments in 2011, but these should be manageable and should subside in line with world fuel and food prices.
The financial system has weathered the crisis, although tremors in the regional financial markets, to which Dominica is heavily exposed, have heightened solvency and liquidity risks. Modest credit expansion prior to the crisis limited the accumulation of nonperforming loans and preserved capital ratios, but the financial system remains exposed to the failed regional insurance companies, other impaired investments in the Eastern Caribbean Currency Union (ECCU), and potential spillovers across segments of the financial system.
With regard to macro policies, the weakening of the fiscal position during the past two years is set to reverse in fiscal year (FY) 2011 that started in July. The proposed budget for FY 2011 targets a primary balance of 0.6 percent of GDP, an adjustment of almost two percentage points of GDP, the brunt of which falls on investment. As the achievement of the budget target hinges critically on the ability to raise revenue from house sales, which has proven difficult in recent years, staff projects that under current policies the primary balance would remain marginally negative in FY 2011 and debt will remain broadly unchanged in GDP terms.
Executive Board Assessment
In concluding the 2011 Article IV consultation with Dominica, Executive Directors endorsed staff’s appraisal, as follows:
Dominica has managed the crisis well, but the recovery has been lackluster and growth prospects remain weak. The fiscal stimulus during the crisis helped the country avoid a deep recession, but tepid demand in advanced countries (Dominica’s main tourist source), weak competitiveness and lack of clear growth drivers have led to a slow recovery and will constrain future growth.
While appropriately supportive during the crisis, fiscal policies need to be returned to a sounder footing to correct the weakening fiscal position. Staff welcomes the authorities’ plan to start withdrawing the fiscal stimulus in FY 2011 but underscores the importance of a close monitoring of fiscal developments with a view to ensuring that the budget’s primary deficit target of 0.6 percent of GDP for FY 2011 will be achieved. Given weakening revenues, staff believes that achieving the authorities’ target will necessitate additional fiscal measures beyond those envisaged in the budget. In this context, staff urges the authorities to contain the growth in current spending, as this reduces space for investment critical for future growth and makes further fiscal corrections more difficult in light of the likely permanent nature of the spending increase.
The adjustment effort will need to continue over the next few years, as debt levels remain uncomfortably high and current policies do not provide sufficient assurances that debt would remain on a downward path given the country’s exposure to external and natural disaster shocks. In this regard, staff welcomes the authorities’ commitment to the primary surplus target of 2.4 percent of GDP by FY 2013 and encourages them to develop a clear plan for achieving it. This long-standing fiscal objective has served the authorities well in the past and achieving it will help put the public debt back on its downward path, preserve the hard-earned confidence in the country’s fiscal management, and improve its ability to cope with future shocks. In this context, staff suggests focus on reining in current spending, safeguarding revenues, and ensuring sustainability of the adjustment efforts through structural reforms. Achievement of the FY 2011 fiscal targets will be an essential stepping stone and will boost fiscal policy credibility.
Increased vigilance is needed to safeguard against financial stability risks. Impaired investments in the failed insurance companies and other regional institutions are creating solvency and potential liquidity pressures. The authorities’ efforts to improve the regulation and supervision of nonbank institutions are commendable, but renewed efforts to identify and counteract sources of risks in the financial system are needed, including through (i) strengthened monitoring of credit unions, and a stricter enforcement of the newly legislated provisioning and capital requirements; and (ii) improved information-sharing arrangements with the Eastern Caribbean Central Bank, the bank supervisor, to allow the authorities to monitor risks in the banking system.
Improving growth prospects will require wide-ranging structural reforms. These should focus on increasing the country’s capacity to attract and absorb private investments, especially through swift reforms of the regulatory environment for investments. The upcoming review of the government’s medium-term Growth and Social Protection Strategy will provide a good opportunity to articulate a strong strategy of dealing with existing obstacles to growth.
Increased engagement with the Fund may be useful. While Dominica does not face an immediate financing need, the narrowing space to handle economic and natural disaster shocks and the need for policy correction suggest that such an engagement could be beneficial. Staff indicated that it stands ready to engage should the authorities deem appropriate.
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