IMF Executive Board Concludes 2024 Article IV Consultation With St Kitts And Nevis

(MENAFN- Caribbean News Global) BASSETERRE, St Kitts – On May 2, 2024, the executive board of the International Monetary Fund (IMF) concluded the Article IV consultation with St Kitts and Nevis and endorsed the staff appraisal without a meeting on a lapse-of-time basis.

Despite a continued strong tourism performance, growth fell to 3.4 percent in 2023 (from 8.8 percent in 2022) due to delays in public and private sector investment projects. Higher food and oil prices and shipping costs pushed average inflation to 3.6 percent, which subsided at end-2023. The current account deficit narrowed to 5.4 percent of GDP in 2023 (from 10.9 percent in 2022) supported by the robust tourism recovery.

Pandemic support is being phased out (from 3.5 percent of GDP in 2022 to 1.1 percent of GDP in 2023) and CBI revenues have remained solid (at 22 percent of GDP in 2023). As a result, the fiscal position moved to a surplus of 1.0 percent of GDP in 2023, allowing gross debt to fall to 54 percent of GDP. CBI revenue is expected to face a gradual decline to 10 percent of GDP in 2028, which will raise the fiscal deficit over time (to 3.9 percent of GDP). Public debt will, though, remain below 60 percent of GDP. The systemic bank has high NPLs, low capital and a large foreign investment portfolio funded by public sector deposits.

The economic outlook is positive thanks to the renewable energy projects that would significantly reshape the economy. A privately funded utility-scale solar and battery storage project is expected to be completed in 2025 and a geothermal project in Nevis is at the planning stage. Geopolitical risks, commodity price volatility, an abrupt slowdown in key source markets for tourism, and natural disasters represent important near-term downsides. Over a longer horizon, greater-than-expected production of solar and/or geothermal energy could turn St. Kitts and Nevis into a net energy exporter, creating an additional source of growth. A balanced budget with a more ambitious fiscal path, and a further strengthening of the CBI framework will help cushion the risks stemmed from volatility of CBI, while undertaking an overhaul of the systemic bank will strengthen the financial sector further.

Executive board assessment

Economic growth is poised to accelerate in the near term. Public and private sector investments, including on renewable energy, will add to the productive capacity of the economy, and lower energy imports will increase national income. It is also expected that cheaper energy prices will support competitiveness, foster economic diversification and ultimately raise potential growth. Carefully crafted policies in the areas of natural resource taxation, utility prices, investment tax incentives will be required to fully seize the potential of energy transition and harness renewable energy resources towards sheltering the country from growing climate risks.

The fiscal stance should be tightened to maintain a balanced budget over the medium term. While a small deficit is expected in 2024, balancing the budget over the medium term will require tightening the fiscal stance in response to an expected decline in CBI revenue. Foregoing further unbudgeted and untargeted payments, such as the CBI dividends, and returning current expenditures to their pre-pandemic level as a share of GDP will be essential. Improving control over the wage bill and goods and services expenditures, along with fully phasing out of electricity subsidies, should form the core of the effort. Progress in these areas would support an expansion of targeted social assistance and capital expenditures for natural disasters' resilience.

A comprehensive roadmap for tax reform would help prepare for a future decline in CBI revenues. A more progressive tax system would address the distortions created by broad tax concessions and bring greater fairness and economic efficiency. Reforming the property tax to reflect the current market value of properties and abolish stamp duty, as well as focusing on tax arrears collection, are steps in the right direction. Conducting a review of CIT concessions, with a view to abolishing negotiated tax concessions and income tax holidays, is time critical given the window of opportunity opened by the implementation of the OECD pillar II. Bringing unincorporated businesses under the CIT would allow for the full expensing of capital spending and the carryforward of losses. There is also scope to scale back VAT exemptions and expand VAT coverage to professional and financial services.

Efforts to enhance the CBI framework should be continued. CBI revenue have provided crucial support to the budget in the last few years but there is scope to further improve the integrity of the program. The steps taken to improve the governance of the program, advance CBI legislation, and create the CBI Board of Governors to improve oversight are commendable. The transparency and accountability of the CBI program could be further enhanced by publishing an annual financial report on the CBI unit's operations and key data on applications.

The country's legacy of fiscal prudence can be entrenched by a further strengthening of the fiscal framework. The government's implicit fiscal rule of balancing the budget and remaining below the regional debt ceiling has served the country well. Enshrining this practice into law would provide a clear fiscal anchor, improve fiscal policy-making transparency and provide solid foundations to the establishment of the SRF. An expenditure rule would help bring current expenditures back to pre-pandemic levels and cap future current spending increases from volatile CBI inflows, supporting a rebalancing towards capital expenditures. Public sector investment policy and planning should be consolidated across the public sector through a consolidated investment budget prioritizing across projects.

Debt and cash management could be improved and the social security fund requires urgent reform. Maintaining a large amount of short-term debt can be costly, particularly when fiscal buffers are available. Consideration should be given to using the Regional Bond Market as a means to diversify funding sources, and more collaboration at the federal level could optimize public finance management. Urgent and decisive action is needed to preserve the financial balance of the Social Security Fund and protect intergenerational equity. A parametric reform should increase the contribution rate, raise the retirement age, and expand pension coverage. Ensuring that public sector employees' pensions are aligned with those of the broader social security system to ensure replacement rates no greater than 100 percent is central to the fairness of the reform.

A successful transition to renewable energy will transform the economy. The government aims to bring the country to energy self-sufficiency by 2030 with 100 percent of renewable energy production. Investments planned in solar and geothermal energy will reduce energy imports, lower energy costs and could support productivity growth by boosting economic diversification and export opportunities. Fully harnessing the country's renewable energy potential calls for a comprehensive strategy, including deciding on the optimal energy mix, related investment plans and financing options, and multi-year planning for the infrastructure upgrades needed to connect the two islands power grids and increase resilience to natural disasters.

Climate adaptation requires reforming utility prices. Water and electricity prices need to reflect production costs and promote conservation. The drilling of wells, water storage investment, and creating capacity for desalination are needed to establish a reliable supply of fresh water. More progressive utility rate structures will encourage investments in conservation and provide some of the resources needed. The utility commission should provide guidance on cost-recovery pricing of electricity and water. The government should establish a taxation framework that provides incentives for renewable energy investment while allowing the public sector to receive a share of future rents from such investments.

Broad-based tax exemptions for such investments should be avoided, and more targeted and economically efficient subsidies or tax incentives considered instead.

The impact of wage increases on employment, informality, and external competitiveness should be carefully assessed. A two-tier increase of minimum wage in January 2024 and July 2025 will increase the minimum wage by nearly 40 percent compared to the previous level set in 2014, placing it higher than ECCU peers and likely subjecting one-sixth of the workforce to the minimum wage. Public sector wage setting should also consider its cascading effects in the private sector.

The financial system should be strengthened. The government should restructure the systemic bank. Provisions and capital for all banks should meet the ECCB regulatory minimum and long-standing non-performing loans be addressed. Banks unable to meet regulatory minimum should continue to work closely with the ECCB through a clear and monitorable capital restoration plan. The systemic bank has made good progress in de-risking its large foreign investment portfolio, as recommended in the last IMF Staff Report.

The establishment of the SRF -which will be accompanied by a reallocation of some of the foreign investments and government deposits from the systemic bank into the SRF – will allow the bank to focus on channeling household and corporate deposits towards private sector lending. The credit union sector has expanded briskly and should be monitored closely to ensure proper recordation of non-performing loans and adequate provisioning and capital at each institution.

The 2023 external position is assessed to be weaker than the level implied by medium-term fundamentals and desirable policies. The current account deficit is projected to fall to over the medium term supported by lower fossil fuel imports. International reserves are adequate.

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.

The executive board takes decisions under its lapse-of-time procedure when the board agrees that a proposal can be considered without convening formal discussions.

IMF Communications Department

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