Washington, DC – February 12, 2021:The COVID-19 pandemic has hit the ECCU economy hard, and until it is brought under control, tourism activity will remain subdued and will, in turn, limit the strength of economic recovery. The near-term policy imperative is to protect lives and livelihoods and limit potential scarring, while ensuring medium-term debt sustainability with strengthened fiscal frameworks and maintaining financial system stability, with a view to safeguarding the quasi-currency board system. Once the post-pandemic recovery takes hold, policies should focus on resuming fiscal consolidation, further strengthening the financial system, and accelerating other structural reforms to make the economy more competitive and resilient.
1. The COVID-19 pandemic has taken a heavy toll on the ECCU economy. Tourism receipts have dried up as visitor arrivals have come to a halt. GDP is estimated to have contracted by 16 percent in 2020, with negative inflation and stagnant credit growth. With sizable revenue losses and spending pressures, aimed at limiting the socio-economic impact of the pandemic, fiscal positions have deteriorated significantly, raising public debt sharply. The current account deficit is estimated to have widened sharply due to the decline in tourism exports. Nonetheless, the ECCB’s foreign asset position has held up relatively well, partly reflecting increased official financing. The economic impact of the COVID-19 pandemic has differed widely across countries, largely reflecting the size of the tourism sector and the severity of lockdown measures.
2. The recovery will be protracted and depend on how quickly the COVID-19 pandemic is brought under control. Growth in 2021 is projected to be weak. The 2020-21 tourism season will continue to be depressed due to travel restrictions and the renewed surge in COVID-19 cases in the northern hemisphere and Europe. The rollout of vaccines offers hope, but the challenging logistics of mass distribution and vaccination are causing delays globally. More generally, tourism activity is likely to remain subdued until the pandemic is brought firmly under control. Accordingly, the baseline scenario assumes that the pace of recovery in tourism will be gradual, with tourist arrivals in the Caribbean projected to return to the pre-pandemic level only in 2024. Risks to the outlook are skewed to the downside, primarily because it could take longer-than-expected for the pandemic to wane and because of the existential threat of natural disasters in the Caribbean.
3. Financial system risks are gradually increasing. The swift and coordinated introduction of loan moratoria led by the ECCB and national authorities’ fiscal response measures to the pandemic have helped smooth the immediate impact of the pandemic on asset quality, and financial system liquidity remains ample thus far. Persistence of the crisis is, however, expected to undercut the ability of borrowers to service their debt and may also start eroding banks’ and credit unions’ deposit-based funding as the existing support initiatives expire. Sizeable pre-pandemic capital and liquidity buffers in most ECCU financial institutions provide substantial cover against these risks. However, the pandemic is expected to leave them with thinner margins against any other shocks, particularly those entities with concentrated asset exposures.
A. Supporting the Economy and Re-Anchoring the ECCU’s Fiscal Framework
4. Protecting lives and livelihoods remains the near-term policy priority. This should include: (i) enhancing testing, contact tracing, treatment capacity and strengthening the enforcement of public health protocols; (ii) maximizing COVID-19 vaccine access and affordability in collaboration with international and regional partners; and (iii) mitigating the socio-economic impact by maintaining support for the vulnerable. Cash-constrained countries should rationalize non-essential spending and rely largely on concessional borrowing, when necessary, to safeguard medium-term sustainability.
5. It is critical to maintain the credibility of the regional debt anchor. The regional public debt target of 60 percent of GDP by 2030 has served as an important fiscal anchor for the ECCU. However, given the demands and constraints imposed by the pandemic, meeting the target is no longer feasible for several countries in the region without drastic fiscal consolidation, which would be ill-advised as it would both slow the recovery from the pandemic and constrain long-term growth prospects through scarring. Postponing the debt target by five years could balance the creation of near-term fiscal space needed to support the economic recovery with the confidence-boosting effects of a firm fiscal anchor. The pushing out of the debt target, however, puts the onus on countries in the ECCU to further enhance their fiscal responsibility frameworks to boost market confidence. In particular, the adjustment of the regional debt target should be supported with a package of reforms,including regional common standards and arrangements to guide national fiscal responsibility frameworks, a regional fiscal oversight body, peer reviews, and incentive mechanisms to ensure compliance and reap the benefits from lower government borrowing costs.
6. Well-sequenced improvements to national fiscal frameworks are key to the success of the modified regional anchor. Several countries have accelerated progress toward adopting full-fledged rules-based fiscal frameworks to guide the pace and composition of the medium-term consolidation. These efforts should be supported by improved capacities and mechanisms in areas such as the annual budget processes, macro-fiscal forecasting, and debt sustainability analysis. National disaster resilience strategies are an additional tool to internalize the macro-fiscal impact of climate-related shocks. Developing state-contingent debt instruments would further support fiscal sustainability.
B. Maintaining Financial Stability
7. Supervisors should carefully balance near-term supervisory flexibility with measures to support financial institutions’ capacity to weather the crisis. Extensions of loan moratoria should be limited within the time frame announced by the ECCB, and banks and credit unions should be encouraged to ensure that any subsequent restructurings, if necessary, follow realistically achievable repayment terms. The recently issued standard on treatment of impaired assets will serve as an important guide for provisioning against expected credit losses. At the same time, supervisors should encourage capital conservation until the full impact of the pandemic is clear and, as necessary, allow for temporary breaches from minimum regulatory requirements provided the concerned institution has a credible corrective action plan in place. It is also essential to rapidly address remaining gaps in the supervision of non-banks and continue strengthening their stress-testing.
8. Crisis management and contingency plans need to be formalized expeditiously at regional and national levels to ensure system-wide risks can be effectively contained. These should be readily implementable with prioritized policy responses to identifiable contingency scenarios. They also need to clearly identify the responsible agents, coordination requirements, and enforcement mechanisms while ensuring the adequacy of the requisite legal powers. The plans should also include the scope and modalities of any ECCB or government interventions and, in the case of non-banks, resolution options.
9. Considerations for credible strategies to support reduction of troubled assets should start now. The pandemic is expected to increase significantly already elevated levels of non-performing loans in the financial system, which remain slow to resolve, partly due to rigidities in the real estate markets and legal frameworks for asset recovery. This may constrain lending and thereby limit the financial system’s longer-term ability to support the regional economies. As emphasized previously, the authorities need to consider sustainable funding options for the Eastern Caribbean Asset Management Company and/or explore alternative troubled asset resolution strategies, while also addressing long-standing deficiencies in national legal frameworks.
10. Momentum on broader financial sector reform agenda should be maintained, although their pacing should pay due regard to near-term implications. National authorities should complete long-standing financial sector reforms, including on the credit reporting and insolvency frameworks, centralized AML/CFT supervision for the banking system, and harmonized legislation for co-operative societies. Ongoing work towards the Optimal Regulatory Framework for the ECCU financial sector remains important to ensure that infrastructure gaps are addressed, and supervision follows common standards. The pandemic has also highlighted the importance of developing a regional macroprudential framework and transitioning toward Basel II/III regulatory regimes. However, implementation timelines should avoid unduly burdening supervised institutions. Considerations over a regional deposit insurance need to pay due regard to the oversight framework, financial stability conditions, and all covered entities meeting the necessary prerequisites; particularly given the pandemic’s still highly uncertain balance sheet implications across banks.
C. Safeguarding the Currency Board and Strengthening Competitiveness
11. The ECCB should keep a robust backing ratio by continuing to strictly limit credit provision. The backing ratio has remained in the range of 95-100 percent, which has lent credibility to the quasi-currency board arrangement. Given the uncertainty concerning the evolution of the pandemic, the authorities should closely monitor foreign exchange movements and prepare scenario-based policy responses. In addition, the lack of timely dissemination of external sector statistics hinders the effectiveness of external sector assessments and policymaking. Accordingly, more resources should be permanently dedicated to external sector statistics at the national and regional levels.
12. The authorities should continue to make concerted efforts to put the economy on a strong and sustainable recovery path. Repairing the scarring caused by the pandemic will require making the economic structure more competitive and resilient by implementing structural reforms. This includes investment in human and physical capital and further efforts to lower the cost of doing business by easing the regulatory burden and reducing energy and transportation costs. The ECCB initiative to modernize the payment systems and promote digital transformation would also be important to improve the overall business environment, while building resilience to natural disasters remains essential for sustainable growth. Advancing regional integration is also critical to catalyze capacity and resources for better policy responses and maximize economies of scale.
The IMF team would like to thank the authorities and private sector counterparts for their generous availability and constructive dialogue.