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Eastern Caribbean Currency Union: Selected Issues

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International Monetary Fund
Published Date:
March 2003
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IV. Fiscal and Debt Sustainability39

87. The fiscal position of the region has deteriorated sharply in recent years, resulting in public sector dissavings, marked increases in public debt, and arrears in some cases. The overall deficit widened from 5½ percent of GDP in 2000 to around 7 percent of GDP in 2001. As a result, total debt of the six countries has climbed steadily over the past 5 years, reaching more than three-quarters of GDP in 2001. Within the countries in the region, the debt stock at end-2001 ranged between 43—134 percent of GDP. Only St. Lucia, based on end-2001 data, would meet the ECCB’s proposed benchmark for debt-to-GDP (maximum ratio of 60 percent).

88. It is clear that rising deficits and debt levels pose a key risk to several ECCU member states. Furthermore, the risks of contagion that would result from the inability of one member to rollover its domestic or external debt obligations are high, given the linkage through the common currency and the ECCB. An episode of default in one country could undermine confidence in the currency, and call into question the sustainability of the currency board arrangement.

A. Fiscal Sustainability

89. Debt sustainability analyses were conducted for the six member countries of the ECCU using the recently developed framework by IMF staff40 A common definition of the public sector and debt was used where possible for each country. The definition aims at a broad definition of non-financial public sector debt, including public enterprises, netting out in some cases substantial social security holdings of government debt (see Box 1). The sensitivity analyses are based on historical averages and standard deviations for the previous 5 years (1997 through 2001) applied to the staffs current growth and debt projections for the respective country (baseline scenarios).41

90. In each case, except for St. Lucia, scenarios for the countries’ debt-to-GDP ratios using historical averages for key macro-variables (real GDP growth, real interest rate and primary balance) exceed the staff’s own baseline medium-term projections:

  • The fiscal situations in Antigua and Barbuda and St. Kitts and Nevis appear particularly vulnerable. For the former, the staff projection shows a gradual diminution in public sector debt after peaking at 96 percent of GDP in 2003. However, stress tests using historical averages for key macroeconomic variables result in a continual increase in the debt ratio, reaching more than 120 percent in 2007. Moreover, the debt-to-revenue ratio, which stands at 340 percent, although below the peak of 428 percent in 1995, remains high through the projection period (mostly above 350 percent), raising questions about the ability to service the public sector debt. The debt-to-GDP ratio for St. Kitts and Nevis is among the highest in the world, projected at 160 percent in 2002. Under the combined shocks—using historical averages for real GDP growth, the real interest rate, and primary balance—there is a marked divergence through the period between the stress tests and staff projections for debt-to-GDP: the stress test scenario is 45 percentage points higher in 2007 than the staff’s projection (169 percent of GDP against 124 percent), indicating possible downside risks to the staff outlook.
  • Similarly, the risks to staff’s debt-to-GDP ratio for Dominica appear to be on the downside: using historical averages under the stress tests results in steady increases, up to 120 percent of GDP in 2006, while the staff projection is for gradual declines from 2003 to 2006 (105 percent to 98 percent).
  • Grenada’s large public debt, projected at 104 percent of GDP at end 2002, tops out in 2003 and declines thereafter (88 percent in 2007) under the staff’s medium-term projections. However, using historical averages for key variables, the stock of debt continues to increase as a percent of GDP, reaching 113 percent over the medium-term horizon.
  • For St. Lucia, with the lowest debt-to-GDP ratio of the six ECCU members (57 percent at end-2002 (projected)), the medium-term scenario prepared by the staff assumes continued fiscal consolidation and is compatible with sustainable debt levels even in the presence of adverse economic shocks. Debt-to-GDP declines gradually through 2007 under the scenario using historical averages for key variables.
  • Although the public sector debt for St. Vincent and the Grenadines is projected to climb to 72 percent of GDP in 2002, the debt dynamics appear well behaved and sustainable through the period. The ratio remains virtually unchanged if real GDP growth, the real interest rate, primary balance and non-debt flows are at historical averages in 2003-2007, while the staff projection peaks in 2003 before declining through 2007.

Additional stress tests were conducted for four of these countries based on two alternative scenarios:42

  • No growth scenario: Assumes no (zero) real growth for three years (2003 to 2005) and then 1 percent and 2 percent growth in 2006 and 2007 respectively. This scenario attempts to take account of the global economic and regional uncertainties.
  • Worst-case scenario: Assumes negative growth of 2 percent for three years (2003 to 2005) followed by no (zero) growth for 2 years (2006 and 2007). This scenario is intended to capture extreme events, including the possibility of a war with Iraq, increased terrorism, repeated hurricanes, etc.

91. As would be expected, the results are comparatively worse under the no growth and worst-case scenarios. The debt-to-GDP ratios range from 58 percent (Grenada, under no growth scenario) to almost 200 percent (St. Kitts and Nevis, worst case) in 2007 using historical averages. Debt profiles for these countries under the alternative scenarios are shown in Figure 1.

92. No hard or simple rules can be cited for the level of debt that is sustainable or the level beyond which a crisis would emerge. Indeed, the distribution of the debt-to-GDP ratio ranges widely in a study of 53 debt corrections over the period 1979-2001—from less than 10 percent to more than 150 percent.43 However, about two-thirds of the observations occur at a debt-to-GDP ratio of below 60 percent and more than three-quarters of the observations occur at a debt-to-GDP ratio of below 70 percent. The latter ratios are well below those now observed for most of the ECCU members. While staffs baseline projections are for debt ratios to diminish over the medium-term in each country, the stress tests indicate that the balance of risks may be for debt levels to increase even further from the present high levels—clearly in some cases approaching dangerous levels that would call into question their sustainability.

93. The ECCB’s suggested fiscal benchmarks, which would place a ceiling on debt-to-GDP at 60 percent, could prove a useful binding commitment to reverse this disturbing trend. The stress tests underline the need for prompt and vigorous action by some national authorities.

B. External debt sustainability

94. External debt for the region, most of which is denominated in US dollars, stood at 45 percent of GDP at end 2001(excluding external arrears).44 The level varies considerably by country, reaching as high as 70 percent of GDP for St. Kitts and Nevis. Large proportions of foreign-currency denominated debt (FCD), particularly for those under fixed exchange rate regimes, can be a source of risk. ECCU countries are counting on the development of the regional government securities market to provide a viable source of domestic financing that could ultimately supplant FCD (see Box 2.).

95. Staff’s own baseline projections appear to show that the external debt burdens are manageable. However, sensitivity to shocks to the projections indicate that some countries remain vulnerable, particularly those countries with high initial external debts:45

  • Dominica’s program baseline scenario for external debt appears sustainable. The debt-to-GDP ratio is expected to increase in 2002 and 2003 owing to the high financing requirement of the public sector, which is envisaged to be covered by external multilateral disbursements. The debt ratio would stabilize in 2003-2005 and begin declining in 2006. The sensitivity tests show this is consistent both with historical trends (using 10-year averages) and with interest rate and external inflation shocks as well. The use of ten-year averages for the key parameters increases the debt ratio by about 5 percent of GDP in the period 2001-2003, while the baseline scenario shows a build-up of about 15 percent of GDP. For 2001-2006, both past values and the scenario would indicate an 11 percent of GDP debt increase. For the standard interest rate and external inflation shocks, the sensitivity tests produce about the same increase in external debt as the baseline scenario, in both periods. In the case of shocks to the non-interest current account balance, which would cause deficits to be much higher than envisaged, the test suggests the shock would make the debt about 40 percentage points higher through the forecast period than under the baseline projection. Nevertheless, the likelihood of this much larger deficit is considered low in light of the observed link between current account deficits and non-debt creating flows, typically for high import-content investment outlays, most of which are externally financed.
  • Grenada, for which the external debt burden is projected to decline smoothly (from 57 percent of GDP in 2002 to 44 percent in 2006) through the period, would fare even better if interest rate, GDP growth, inflation and the non-interest current account deficit are maintained at the average of the past 5 years (the debt-to-GDP ratio drops to 15 percent by 2006). However, the forecast is highly sensitive to adverse shocks to these variables: debt-to-GDP rises sharply in each case, rising to above 130 percent in the case of a two-year/two standard deviation shock to GDP.
  • The position of St. Kitts and Nevis, burdened with a high external debt position projected at 70 percent of GDP in 2002, appears sustainable under the staffs baseline projection. Using historical averages (over the past 5 years) for the key parameters, the external debt would decline through 2007.
  • Initial external debt burdens are lowest for St. Lucia (projected at 32 percent of GDP in 2002) and St. Vincent and the Grenadines (46 percent), which the staffs project to remain roughly unchanged during the period 2003-2007, This debt appears manageable under most adverse scenarios.

96. Much of the external debt is concessional, from bilateral and multilateral international financial institutions and development agencies. Several countries have also contracted external debt with private banks in the region, a number of which are domiciled in Trinidad and Tobago. These debts are reported to carry high overall interest charges, when sinking fund provisions are included, relative to current interest rates. The mandate of the Regional Debt Coordinating Committee, comprising Directors of Finance and Financial Secretaries of ECCU members and the ECCB, in addition to helping plan and guide debt issuance on the domestic market through the RGSM, should be extended to include debts issued externally.

97. A one-to-one ratio of reserves to short-term external debt (public and private) has been suggested as a useful rule-of-thumb to reduce vulnerability.46 Most public sector external debt of ECCU countries is longer term.47 External debt data for the private sector are unavailable. The high foreign currency-backing ratio under the CBA would likely exceed the combined short-term external debts of the public and private sectors for ECCU countries, but the ECCB and national statistical offices should as a priority address the gap in their data collection on private sector debts.

Box 1.Definition of Public Sector Debt in the ECCU Region for the Purpose of the Debt Sustainability Exercise

Agreed practice for the DSA Exercise

Definition of Debt
  • Widest possible inclusion of debts of the NFPS consistent with the Fund definition of debt, which would include, inter alia, comfort letters, and privately and publicly held government and publicly guaranteed debt.
  • Government guarantees to private enterprises in the form of a minimum rate of return should be mentioned in a footnote.
  • In general, any outstanding debt within the IMF definition of debt, which cannot be included because of lack of data availability, should be mentioned in a footnote.
Coverage
  • Central Government, net of social security holdings of government debt.
    • Central government debt held by social security should be reported as a memorandum item and a comment on the solvency of the social security system included in a footnote.
  • Public Enterprises’ debt should be included to the extent information is available.
  • Financial public sector’s (central bank and banks owned government) debts should be excluded.
External versus domestic
  • Treasury bills are classified as domestic debt (unless the foreign holdings are known).
  • Interregional debt (including debt to Anguilla and Montserrat) would be classified as domestic debt with a footnote specifying the treatment.
  • For all other cases, the IMF definition of residency would apply.
Gross versus net
  • External debt: Gross basis, netting out only sinking funds (tied to particular borrowing).
  • Domestic debt: Gross basis. Further research needed to examine maturity and liquidity of existing deposits of NFPS in domestic banks.
  • Debt projections need to take into account possible financing of NFPS deficits by drawing down domestic deposits and/or use of privatization proceeds. The corresponding assumptions need to be specified in a footnote.
Nominal versus real value
  • Nominal versus
Book versus face value
  • Face value (including a note if any large differences between the face and book value are known).
Residual versus original maturity
  • Residual maturity where possible. Assumption should be specified in a footnote.

Box 2.The East Caribbean Securities Exchange and Regional Government Securities Market

The East Caribbean Securities Exchange (ECSE) was officially launched on October 19, 2001, providing a regional trading platform for primary and secondary securities trading for the eight ECCU member states. The exchange is regulated by a uniform Securities Act of 2001, covering both equity and debt securities. The exchange supports fully electronic trading, remote trading and access, with settlement meeting G-30 standards on a T+1 basis. The ECCB acts as the settlement bank and the ESCE owns separate registry and depository facilities—the Eastern Caribbean Central Securities Registry (ECCSR) and Eastern Caribbean Central Securities Depository (ECCSD), respectively. The exchange has 47 owners, the largest of which is the ECCB, with a 30 percent share. There are 6 intermediaries, all of which are banks.

The ESCE is designed to support both equity trades and government and private debt securities. Secondary trades are executed by a daily call auction. In its first year of operation, the ESCE has been unable to generate much volume. At present, only two companies are listed—the Bank of Nevis Ltd., and the East Caribbean Financial Holding Company Ltd. (holding company of the Bank of St. Lucia), and one debt issue (a 10-year Government of St. Kitts and Nevis bond, issued). Secondary trading volume has been low. Of 27 publicly held companies in the region, about roughly, half are deemed by the ESCE to be eligible for listing. Listing requirements for equities were recently relaxed somewhat to entice further participation.48

Listing requirements for the regional government securities market (RGSM) include quarterly reporting, annual audited financial statements, and timely disclosure of material information by issuers. The ECCB acts as the fiscal agent for government issuers. Bonds and bills can be sold under one of three formats—uniform- or multiple-price auctions, or fixed price/quantity. The St. Kitts and Nevis bond, issued in November 2002, was sold at a fixed price, and was slightly oversubscribed.

The viability of both the ESCE and RGSM depends on a substantial build-up in volume. The possibility of opening up the trading platform by the ECCU to other countries in the Caribbean region should be explored. A liquid regional market for government securities would give fiscal authorities added flexibility in debt management, and potentially reduce external vulnerability by replacing foreign-currency denominated with domestic debt. This may be particularly important in the context of the fixed exchange rate. The authorities will need to be cautious that this flexibility does not itself reduce the resolve to reduce the overall debt burden. The overall increase in public debt has largely been financed domestically over the past 5 years, with much of the increase being taken up by governments and government institutions, including the national insurance and pension schemes. Moreover, the currency board arrangement provides little scope for active debt management operations by the central bank, including the support of primary auctions.

39Prepared by Robert Price (PDR)
40See “Assessing Sustainability,” May 28, 2002, http://www.imf.org. As that paper discusses, assessments of sustainability are inherently probabilistic; the proposed framework does not supply these probabilities explicitly, but traces the implications of alternative scenarios and leaves the user to determine the probabilities that should be attached. In this case, no specific probabilities were assigned to the alternate scenarios for ECCU countries.
4110 years was used in the case of St. Lucia. The 5-year time frame is a departure from the proposed framework in “Assessing Sustainability,” which is based on 10-year averages and standard deviations. A shorter time frame was chosen to capture the period of lower inflation and lower average growth and for the more pragmatic reason that reliable data were in some cases not available for some countries for the longer period.
42The countries arc Antigua and Barbuda, Grenada, St. Kitts and Nevis, and St. Vincent and the Grenadines. The staff projection and baseline stress test for Grenada were recently updated, and the no-growth and worst-case scenarios are not comparable (figure 1, Chart 3).
43See “Assessing Sustainability,” Appendix I, May 28, 2002, http://www.imf.org.
44External arrears continue to be high in Antigua and Barbuda.
45No projections were made for Antigua and Barbuda.
46Sec “Debt- and Reserve-Related Indicators of External Vulnerability” March 23, 2000, http://www.imf.org.
47At end December 2000, 81 2 percent of external debt had a remaining maturity of greater than 10 years, and 97.6 percent was beyond 5 years.
48The new requirements include (i) semi-annual reporting of (unaudited) financial statements within 30 days, with a two-year grace period for new issuers (previously quarterly, with no grace period); (ii) provision of annual audited financial statements within 120 days (90 days previously); and (iii) disclosure of material changes within 7 days (no change).

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