WASHINGTON, USA – The Eastern Caribbean Currency Union (ECCU) economy is facing a lingering pandemic and heightened price pressures exacerbated by the war in Ukraine. The near-term policy priority should be to protect the vulnerable through health spending and temporary targeted transfers and enhanced social safety nets to cope with rising living costs.
Meanwhile, adopting well-designed fiscal frameworks would help achieve fiscal consolidation, enhance resilience to shocks such as natural disasters, and preserve the credibility of the regional debt target. Over the medium term, policies should shift focus towards supporting resilient and inclusive growth, with climate resilience building, investment in renewables, and a strong framework for financial inclusion and payment system modernization, including the central bank digital currency. Financial sector policies should aim to address pandemic legacies such as high non-performing loans, reinvigorate private credit growth, and reinforce resilience to climate-related shocks.
Economic recovery from the pandemic has been slow.The ongoing pandemic has inflicted large output losses in the ECCU, leaving scars on the tourism and transportation sectors, education, labor force, and fiscal position. Real GDP is estimated to have expanded by 3½ percent in 2021, following a sharp contraction of 16¼ percent in 2020. Strong tourism rebound led the recovery in some countries, while activity in other sectors, particularly construction, helped cushion the drag from a slower tourism revival in others.
Headline inflation increased strongly across the region, driven by rising food, fuel, and transportation prices. The current account deficit is estimated to have widened further in 2021, as higher goods imports offset the improvement in services balance. The ECCB’s stock of international reserves remained stable. The labor market remained weak with high unemployment.
A continued gradual recovery is expected, amid rising price pressures. The impact of the war in Ukraine is a setback to the nascent recovery, compounding existing supply chain disruptions and severe intra-regional transportation bottlenecks, and threatening food and energy security. Real GDP is projected to grow by 7½ percent in 2022, leaving output still well below the pre-pandemic level. With higher commodity prices and shipment costs, inflation could reach over five percent in 2022.
Fiscal deficits are estimated to remain sizable, given continued pandemic and disaster-related spending and temporary support to address rising living costs, thereby keeping gross financing needs and public debt at elevated levels in the near term. The outlook is subject to large downside risks, primarily from rising food and energy prices and outbreaks of new COVID variants amid vaccine hesitancy, which could affect tourism and construction activities. The ECCU remains highly susceptible to natural disasters.
The ECCU financial system has remained broadly stable so far, despite lingering legacy weaknesses. Financial institutions have mostly maintained adequate capital and ample liquidity up to end-2021. However, intensified competition has compressed bank lending margins and the pandemic further constrained credit growth. The two-year loan moratoria that expired end-March 2022 could have deferred pandemic-related earning losses and therefore lead to an uptick in NPLs, which remained elevated at end-2021.
To support adequate loan loss provisioning, the ECCB introduced more stringent provisioning guidance under its Treatment of Impaired Assets Standard, in effect from January 2022, and most banks are compliant with the required initial coverage ratio of 60 percent of all NPLs. The recent stepped-up global financial market volatility has implications for institutions with large overseas asset portfolios.
Strengthening Fiscal Frameworks to Withstand Shocks and Safeguard Debt Sustainability
Near-term policy should focus on protecting the vulnerable while maintaining fiscal prudence. The limited fiscal space necessitates balancing difficult trade-offs, giving priority to health spending and fiscal support to cope with rising living costs. Temporary and targeted transfers could be provided to vulnerable households by expanding the most effective existing social assistance programs. To help contain fiscal cost and avoid adverse distributional impact, countries should allow a gradual pass-through of international energy and food prices to domestic prices, while phasing out generalized subsidies. This should be accompanied by expedited efforts to improve coverage and targeting of social safety nets, including by leveraging digitalization of beneficiary information and payment systems.
Over the medium term, fiscal consolidation should resume with the composition of fiscal support shifting to ensure a resilient and inclusive recovery. High-debt countries should proceed with fiscal consolidation efforts by mobilizing domestic revenues and rationalizing lower-priority spending, and rely largely on low-cost long-term financing to safeguard debt sustainability. Meanwhile, fiscal policy should move from income support and job retention measures to those that facilitate labor reallocation and training. It is also critical to create space for productive investment and resilience building to boost medium-term growth. This will require further progress in implementing revenue administration reforms, rationalizing tax expenditures, enhancing the efficiency of spending, and strengthening public investment management.
Well-designed rule-based fiscal responsibility frameworks (FRFs) are key to achieve fiscal consolidation and preserve the credibility of the regional debt ceiling. To support the regional debt rule at national levels, some ECCU countries have adopted national rule-based FRFs, but suspended their implementation since 2020 due to the impact of the pandemic. Given the potential increase in external borrowing costs, accelerating the adoption or reactivation of well-designed FRFs by ECCU countries has become more pressing to signal credible medium-term fiscal plans and boost market confidence.
When setting up or amending their FRFs, ECCU countries should internalize the impact of natural disasters to enhance their effectiveness. International experience suggests that FRFs are generally more effective when having medium-term fiscal anchors supported by operational targets . FRFs should also allow for much-needed climate-resilient investment, in addition to having well-designed clear escape clauses and an independent fiscal oversight council, as well as robust common standards and a regional fiscal oversight entity. Greater exposure to natural disasters would warrant setting a lower country debt ceiling than the regional ceiling, unless disaster mitigating financial buffers are readily available.
As natural disasters increase the volatility of both output and debt, the choice of the operational target would need to balance the trade-off between supporting activity (which would favor an expenditure rule) and the speed of debt convergence to target (which would favor a primary balance rule), and hence must be tailored to country circumstances. For small open economies with high exposure to natural disasters and elevated initial level of debt, primary balance rules could be preferable to expenditure rules.
Addressing pandemic legacies, reinvigorating private credit growth, and reinforcing financial sector resilience to climate related-shocks
Asset quality and provisioning buffers should remain under close monitoring following the exit from loan moratoria. Loans that have benefited from restructuring may still give rise to additional provisioning needs, given likely continued fragilities in borrower balance sheets and emergence of new uncertainties, including from the war in Ukraine. The ECCB’s recent provisioning guidance will help address these risks and lagging loss recognition from long-standing NPLs. While banks and credit unions on aggregate have sufficient capital buffers to absorb additional losses, the ECCB and national regulators should continue to ensure that provisioning accurately reflects balance sheet risks and intensify scrutiny of weaker financial institutions with high NPLs and lagging provisioning compliance. Resolving problem loans remains constrained by ineffective foreclosure processes in some jurisdictions and the Eastern Caribbean Asset Management Corporation’s limited resources.
The protracted recovery from the pandemic calls for renewed emphasis to support private sector credit growth. Bank lending remains sluggish even as deposit growth has proven robust and despite significant local investment needs. The ECCU would benefit from renewed focus on measures to address long-standing lending and credit access constraints. In particular, establishing a regional credit bureau and registry and modernizing national insolvency laws can help facilitate out-of-court settlement and clarify creditor rights.
Equally important are ongoing initiatives to address collateral constraints in micro-, small- and medium-sized enterprises’ (MSME) access to credit, finance the recently relaunched regional partial credit guarantee scheme to meet expected demand for MSME credit, and support MSME capacity building. In the context of compressed lending margins, the ECCB could consider revisiting the 2 percent minimum savings deposit rate. In addition, passage of relevant securities legislation by jurisdictions where these remain pending is important. It is also essential for the ECCB to establish a framework that sufficiently addresses potential systemic risks such as cyber risk.
Decisive steps should be taken to protect local bank correspondent banking relationships (CBRs). The European Parliament recommendation to restrict visa-free EU access to third countries with citizenship-by-investment (CBI) programs could, in addition to the potential loss of fiscal revenues, intensify the scrutiny of compliance risks in the ECCU financial system, thereby increasing CBR risks for local banks that are becoming systemic with the exit of international banks. This makes addressing any shortfalls in the region’s financial integrity, AML/CFT, governance and offshore tax frameworks of critical importance.
ECCU members should pursue regional coordination of oversight and transparency of CBI programs, tackle issues identified in the national CFATF mutual assessments, complete designation of the ECCB as the competent AML/CFT authority over institutions licensed under the Banking Act in all jurisdictions, and ensure consistency with global taxation standards.
Efforts are needed to resolve the currently fragmented non-bank supervision framework. The proposed new regional standards setting body can help move the ECCU non-banks under a common regulatory rulebook, but more resolute parallel efforts are required to advance consolidated supervision of financial conglomerates that operate across the region, strengthen risk-based insurance supervision and risk-mitigation standards, and address notable data gaps and increasing unregulated financial operations. Some ECCU members should expedite passage and implementation of the Virtual Assets Business Bill to govern digitalized financial services including crypto assets.
Strengthening supervision and regulation of climate change risks can help build financial system resilience. The ECCB has launched an ambitious program to integrate climate risks in supervisory and regulatory frameworks and, in collaboration with international agencies, has commenced a technical assistance project to build capacity in ECCU regulators and financial institutions. Efforts should extend to integrating physical climate risk scenarios in the authorities’ financial system crisis management plans to ensure adequacy of policy intervention frameworks.
Enhancing competitiveness and fostering a resilient and tnclusive recovery
Building resilience to natural disasters and climate change and improving competitiveness should continue to be a priority. This includes implementation of national disaster resilience strategies and adaptation plans, financed by long-term concessional resources. The authorities should build on progress in investing in resilient infrastructure and insurance for natural disasters. Accelerating the shift to renewables and investment in energy conservation, supported by an enabling regulatory environment, can help lower energy costs and strengthen competitiveness while reducing carbon footprint.
Upgrades to transportation infrastructure are urgently needed and will require public-private sector collaboration. This will help mitigate supply disruptions, facilitate trade, and support tourism, together with initiatives to better integrate the local agriculture sector with tourism. An action plan is being developed by the authorities to enhance regional integration and ensure food and nutrition security, including by removing intra-regional trade barriers. Continuing investment in skills development and broadband technology are critical for inclusive growth.
Continued efforts to reinforce capacity and fully implement safeguard measures are needed to reap the benefits of DCash and contain risks. DCash has the potential to increase economic efficiency and foster financial inclusion, but the ECCB will need to further raise public awareness and improve communication with end-users to boost confidence and uptake. While financial disintermediation risk is mitigated by ample excess liquidity in the system and the design of the pilot DCash as a non-interest retail instrument with holding limits , the ECCB and national supervisors should closely analyze liquidity and funding conditions of financial institutions.
The DCash outage experience underscores the need to enhance the ECCB’s operational resilience and business continuity plans, including through contingency planning and increasing staffing and skills. The ECCB should also clearly divide the operational, oversight, and risk management responsibilities between the central bank and technology providers, and establish a project management governance framework.
