USA / ST KITTS – An IMF mission, led by Alexandre Chailloux, visited St Kitts and Nevis during February 15-26, 2024, for the 2024 Article IV consultation discussions on economic developments and macroeconomic policies.
The mission team benefited from candid and constructive discussions with public and private sector counterparts and other stakeholders and issued the following statement:
St Kitts and Nevis continues to recover from the pandemic and cost of living crisis. The general government has ended 2023 with a surplus, thanks to fiscal prudence and the outperformance of the citizenship-by-investment program (CBI). The outlook is positive, particularly as large-scale renewable energy projects begin to be implemented.
Nonetheless, there are still important downside risks ahead potentially from a less hospitable external environment, natural disasters, or CBI underperformance. Increasing the effectiveness of government spending, improving the tax system, setting up a Sustainability and Resilience Fund, and putting in place an explicit fiscal rule would help strengthen the fiscal framework and insulate the country from possible shocks.
There is also a need to reform the pension system and increase investments in both renewable energy and climate adaptation. Addressing vulnerabilities in the banking sector would improve financial stability, and greater accountability and transparency in the management of CBI resources would strengthen the integrity of the program.
A rebound in tourism has powered growth in the past two years. The economy expanded an estimated 3.4 percent in 2023 after a growth of 8.8 percent in 2022. GDP is expected to return to the pre-pandemic level this year. Higher commodity prices and shipping costs pushed average inflation to an estimated 3.6 percent in 2023 from 2.7 percent in 2022 despite fiscal measures to reduce the pass-through. The 2023 budget recorded a surplus of 1 percent of GDP, thanks to strong CBI performance and continued fiscal prudence.
The economic outlook is positive. While near-term risks are somewhat tilted to the downside, renewable energy projects are likely to provide further growth momentum in the medium-term. Growth is projected to strengthen to 4.7 percent in 2024, supported by tourism, an acceleration of housing and public infrastructure project execution, and investment in renewable energy. Over the medium term, growth is expected to gradually moderate to 2.9 percent. Geopolitical risks and commodity price volatility, as well as a global slowdown weighing on tourism, represent key downside risks in the near term.
CBI revenues pose a two-sided risk with significant uncertainty. Over a longer horizon, faster-than-expected implementation of solar and geothermal energy projects could boost near term activity, turn the country into a net energy exporter, support economic diversification and incentivize capital investments to utilize surplus energy.
CBI has performed well in recent years but there is scope to further improve integrity of the program. The authorities have improved the governance of the program by advancing CBI legislation and creating the CBI Board of Governors to improve oversight. The transparency and accountability of the CBI program could be enhanced further by publishing an annual financial report on the CBI unit’s operations and key data on applications.
The fiscal stance should be tightened to maintain a balanced budget over the medium term under conservative assumptions about future CBI inflows. While a broadly balanced budget is expected in 2024, achieving a balanced budget over the medium term will require a gradual tightening of the fiscal stance in response to the potential CBI revenue decline expected by IMF staff. This could be achieved by foregoing further CBI dividends and other untargeted payments and by returning current expenditures to their pre-pandemic level as a share of GDP. This would require firm control of the wage bill and goods and services expenditures and the full phasing-out of electricity subsidies. Progress in these two areas would allow for an expansion of targeted social assistance and capital expenditures (particularly those that improve the resilience of physical infrastructure to natural disasters).
Tax policy reform should move in parallel along multiple tracks. A comprehensive roadmap for tax reform, that increases progressivity and reduces distortions, would help frame a broader platform of improvements and prepare for a potential future decline in CBI revenues. The authorities’ current focus on property tax reform (to reflect the current market value of properties), stamp duty, and a more effective collection of arrears is appropriate. A review of CIT concessions should be quickly concluded given the window of opportunity opened by the implementation of the OECD pillar II with a view to abolishing negotiated tax concessions and income tax holidays. Consideration should be given to bringing unincorporated businesses under the CIT (rather than subjecting them to turnover taxes), allowing for full expensing of capital spending, and allowing for the full carryforward of losses. There is scope also to scale back VAT exemptions and preferences and expand VAT coverage to professional and financial services.
Infrastructure should be upgraded to boost natural disaster resilience. Public sector investment policy and planning should be consolidated across the public sector, including statutory bodies, through the creation and publication of a consolidated investment budget that carefully prioritizes across projects. There is scope to expand the execution of infrastructure projects with improved feasibility studies and a better procurement process. Project selection should also include a preference for climate-resilient projects. The classification of capital expenditures in the general government budget should be improved, and better data on capital expenditure plans be collected from statutory bodies to support evaluation and planning.
A Sustainability and Resilience Fund (SRF) should be introduced alongside an explicit fiscal rule. The government’s adherence to implicit fiscal rules of a balanced budget and remaining below the regional debt ceiling has served the country well for over a decade. Enshrining these fiscal rules into law – accompanied by narrowly defined escape clauses – would provide a clear fiscal anchor, improve the transparency of fiscal policy making and provide solid foundations to the establishment of the SRF. An expenditure rule should be considered that steadily brings current expenditures back to pre-pandemic levels as a percent of GDP and subsequently limit future current spending increases to the nominal growth in potential output.
This would avoid unplanned expansions in current spending from volatile CBI inflows, generate higher surpluses to be transferred to the SRF, and support an increase in capital expenditures over time. The bulk of public sector deposits, currently being held at the publicly-owned bank, should be transferred to the SRF and invested abroad according to clear institutional guidelines and a transparent reporting of financial results.
Debt and cash management can be improved. Using some of the large government deposits to pay down expensive short-term debt would reduce interest costs and gross financing needs. Re-establishing a presence on the regional bond market would be useful as a means to diversify sources of financing. The establishment of the SRF and the fiscal rule at the federal level will require greater collaboration between the central and the local government to optimize consolidated debt and cash management costs. More fiscal discipline is required from the local government, which should ideally be enshrined into law and supplemented by joint efforts to reduce the short-term debt.
The social security system requires urgent and decisive action. Without urgent reform the social security fund’s reserves will be depleted within the next two decades, and the fund will accumulate a large actuarial deficit over a few decades that follows. To protect intergenerational equity, a comprehensive reform is needed to gradually raise the retirement age, increase contribution rates, expand pension coverage, lower the replacement rates and diversify its investment portfolio. The Authorities should ensure that the public Sector employees’ pensions are aligned with those of the broader social security system to ensure that overall replacement rates are not greater than 100 percent.
A successful transition to renewable energy will have a transformative impact on the economy. Planned investments in solar and geothermal energy are expected to reduce energy imports and lower the overall cost of energy. This transition is expected to bring the country to energy self-sufficiency by 2030, boosting economic diversification, supporting the growth of energy-intensive activities, and creating new export opportunities. Fully harnessing the country’s renewable energy potential requires a comprehensive strategy, including deciding on the optimal energy mix, establishing related investment plans, upgrading and connecting the power grids of St. Kitts and of Nevis and increasing resilience of the grid to natural disasters.
The pricing of both water and electricity needs to reflect costs of production. The drilling of wells, investing in water storage, and creating capacity for desalination are needed to establish a reliable supply of fresh water. More progressive utility rate structures – that increase the tariffs for high use customers – would encourage investments in conservation and provide the resources needed for these investments. The utility commission should provide guidance on the appropriate cost-recovery pricing of electricity and water. The government should establish a taxation framework that provides incentives for investments in renewable energy while also allowing the public sector to receive a share of future rents from such investments. Broad based exemptions from VAT and corporate income taxes for such investments should be avoided, and more targeted and economically efficient tax incentives considered instead.
The impact of the recent minimum wage increases should be carefully assessed. A two-tier increase 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. An analytical assessment should be undertaken to examine the possible impact of the minimum wage decision on employment, informality, and external competitiveness. Public sector wage setting should also consider its cascading effects in the private sector.
The financial system should be strengthened. Provisions and capital for all banks should meet the regulatory minimum established by the ECCB and long-standing non-performing loans be addressed. Any bank that is unable to meet regulatory minimum should continue to work closely with the ECCB through a clear and monitorable capital restoration plan. The banks have made good progress in de-risking their 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 domestic banking system into the SRF – will allow banks to focus squarely on their primary function of intermediating household and corporate deposits to lend to the private sector and support private-sector led growth and employment. 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.
IMF Communications Department
