Public Information Notice (PIN) No. 08/42
April 1, 2008

On February 4, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with St. Kitts and Nevis.1

Background

The closure in 2005 of the sugar industry””the historical mainstay of the economy””set the stage for a new economic course. Indeed, despite the closure, growth remained strong in 2006, with output increasing by 4 percent, driven by tourism, construction, and communications. Some slowdown is expected for 2007, with growth projected at 3.3 percent. Medium-term prospects look promising, with a number of high-end foreign investment tourism projects in the pipeline.

Large adjustments in retail fuel prices and a new fuel surcharge for electricity created a temporary inflation spike in 2006, but inflation has since decelerated as these one-off effects dissipated. Reflecting strong construction-related imports, the current account deficit increased to around 30 percent of GDP in 2006/07, but has been largely financed by tourism-related foreign direct investment (FDI).

Considerable progress has been made in strengthening the fiscal accounts. The government achieved a sizable primary surplus in 2006 for the second year in a row. A buoyant economy, the electricity surcharge, strengthened tax administration, and wage restraint have contributed to this improvement. However, expenditure management remains a challenge. The primary surplus is projected to decline to 2 percent of GDP in 2007 (from around 4½ percent in 2006), largely because of a sharp increase in net lending in St. Kitts and a near-tripling of capital expenditure in Nevis, with major road projects underway.

Despite the fiscal improvement, public debt remains high””at about 185 percent of GDP at end-2006″”leaving little room for maneuver in the event of an adverse shock. Facing tightened external borrowing conditions, the government has relied mainly on domestic sources to meet its financing needs. There also continues to be insufficient financial information on public enterprises, whose share in public debt reached 38 percent by end-June 2007.

Monetary and financial developments have been largely favorable, although the high and rising public sector exposure of the banking system is a concern. Credit to the private sector rebounded on the back of buoyant economic activity and, partly reflecting this, the nonperforming loans ratio declined. However, the banking system’s holdings of public debt had risen to 44 percent as of end-June 2007. The nonbank sector has been growing rapidly, while progress in establishing an appropriate supervisory and regulatory framework for this sector has been limited so far.

Executive Board Assessment

Executive Directors commended the authorities of St. Kitts and Nevis for their efforts to strengthen macroeconomic performance, with growth rebounding and fiscal balances improving markedly. Directors observed, however, that the country’s high public debt leaves little room for maneuver in the event of adverse shocks. Sustained fiscal consolidation, backed up with the development of a contingency plan to respond to economic shocks, would help mitigate the risks associated with the high debt stock.

Directors welcomed the important steps that have been taken towards strengthening fiscal performance, including the improvement of tax administration and the adoption of an automatic pass-through of fuel prices. They encouraged the authorities to continue their efforts to achieve their medium-term fiscal goals and put debt on a solid downward trajectory. Expenditure restraint, including comprehensive civil service reform, will be key. Plans to broaden the tax base, improve the oversight and transparency of public enterprises and strengthen debt management capacity will also support these goals. Directors noted that public debt would remain elevated throughout the medium term, and encouraged the authorities to explore options for a more rapid debt reduction, including by accelerating the pace of asset sales, which could also promote private sector-led growth.

Directors noted that the real effective exchange rate does appear broadly in line with fundamentals. Further fiscal consolidation would support external competitiveness and underpin the regional currency arrangement. Directors also encouraged the authorities to accelerate the implementation of planned structural reforms aimed at improving the business climate and strengthening the economy’s flexibility and resilience. Directors noted that the country’s large external current account deficit, mainly financed by foreign direct investment, although likely to remain high over the medium term, could be expected to decline as investment in infrastructure and tourism projects taper off.

Directors noted that financial sector risks need to be carefully monitored. They called for further progress in mitigating risks, including through enhancing supervision of vulnerable banks and reducing the large government exposure. They welcomed the authorities’ plan to establish a single regulatory unit for the nonbank financial sector.

Directors also welcomed the progress made in improving the quality and coverage of fiscal data, and looked forward to similar progress in other areas.