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WASHINGTON, USA -- On March 1, 2013, the executive board of the International Monetary Fund (IMF) concluded an Article IV consultation with St Lucia.

Background

St Lucia has weathered the difficult post-crisis environment, becoming the largest economy in the Eastern Caribbean Currency Union (ECCU). It has avoided a recession throughout most of the recent global crisis, but activity remained anemic in the face of external headwinds and domestic supply shocks. Weak demand from its tourism source countries, natural disasters and a major outbreak of a banana leaf disease held back growth during 2009–11, but lingering external and domestic uncertainties finally led to a broad-based decline in activity in 2012. The already high unemployment increased sharply during the cyclical downturn, and the introduction of the value added tax in October 2012 led to a jump in cost-push inflation. The pre-crisis imbalances -- stemming from a debt-financed growth that left the country with high external, public and private debt -- have yet to be unwound.

Activity is expected to regain some momentum in 2013, with an anticipated recovery in agriculture from a three-year downturn, a pick-up in tourism, and a recent fiscal stimulus that may provide some support for economic activity. Inflation will remain elevated until the fourth quarter of 2013 following the VAT-related step increase in prices, but should return to around 3 percent subsequently. A faster near-term recovery will be held back by tight monetary conditions, a weakened financial system and continued external headwinds.

The policy response to support flagging growth has been strong, with a significant injection of public demand over the past three years, but policy space has been virtually exhausted and fiscal vulnerabilities have built up. The central government’s overall deficit has gradually widened to an estimated 12 percent of Gross Domestic Product (GDP) by fiscal year 2012 (ending in March 2013), and public debt increased to about 78 percent of GDP. Monetary conditions, on the other hand, have not been supportive of a stronger recovery: policy rates have remained unchanged for the past nine years despite the policy easing in the United States, and lending rates have declined only marginally, propped up in part by the 3 percent interest floor on saving deposits. With high real lending rates, weak demand and tightening lending standards, private credit has remained flat over the past two years.

The financial system has weathered the downturn, but weak economic activity is taking a toll. The pre-crisis credit boom, which was among the largest in the ECCU, left financial institutions with notable asset quality problems: nonperforming loans almost doubled during the past two years, their resolution hampered in part by the inability of banks to foreclose on available collateral due to cumbersome procedures. Reported capital adequacy remains high, however, and liquidity in the system ample with continued deposit growth, but increased liquidity, along with stepped up provisioning, also subdued profitability.

Executive Board Assessment

The executive directors noted that St Lucia’s economy has suffered from a weak global environment and external shocks. The outlook remains challenging, and vulnerabilities have built up in the fiscal, financial, and external sectors. Directors welcomed the authorities’ commitment to address these vulnerabilities, and underscored the need for prompt and resolute action.

Directors agreed that the main policy imperative is to address the fiscal imbalances and set debt on a sustainable path. They urged the authorities to start consolidation without delay, while minimizing the negative impact on growth. In this regard, they recommended focusing the adjustment on current spending, including wages and subsidies, while protecting productive investments and targeted social spending. Wage agreements should be consistent with fiscal and economic fundamentals. Directors welcomed the introduction of the value-added tax and underscored the need to protect its base. They saw scope to further widen the tax base by reducing tax incentives and exemptions. Directors highlighted the importance of broad reforms to the fiscal policy framework to anchor policies and strengthen public financial management.

Directors encouraged the authorities, as members of the central bank’s governing council, to support the phase-out of the interest rate floor on saving deposits. They stressed the importance of undertaking the banking supervision and regulatory reforms put forward by the Joint Financial Sector Task Force, enforcing existing regulations, and strengthening information sharing arrangements between the regional supervisor and country authorities. Directors welcomed the progress in launching the nonbank supervisory authority and looked forward to further steps to make the authority fully operational and strengthen the regulatory framework for nonbanks.

Directors emphasized that structural reforms to boost growth and address high unemployment are a key priority. Reforms should focus on strengthening the education system; improving the business climate, including through a more efficient public sector; increasing efficiency and reducing costs in product, labor and financial markets; and pursuing deeper regional integration.

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