Grenada Economic Report for 2006[2]

GRENADA 1. RECENT ECONOMIC PERFORMANCE A. Overview The Grenada economy continued to recover from the effects of hurricane devastation in 2004 and 2005, although economic and social conditions remained difficult, reflecting the enormity of the disaster. Following on the strong economic growth in 2005 (12.1%), reflecting high levels of replacement investment after Hurricane Ivan in 2004, real GDP growth slowed to about 2.1% in 2006. Over the past two years, a determined local effort aided by international assistance has led to progress in rehabilitating the country’s infrastructure. Private sector activity has mostly recovered, with export agriculture being the one exception, where tree replanting, in particular, has been slow. Consumer inflation eased to 1.7%, compared with 5.8% in 2005 as a result of improved domestic food supplies and more moderate increases in energy costs. Central Government’s recurrent savings2 improved to $28.6 mn, 5.5% of GDP, enhanced by growth recovery and new taxation measures. The overall fiscal balance, however, shifted from surplus to a deficit position of 7.4% of GDP, as fiscal operations accommodated large capital spending during the year both to rebuild and host a number of CWC matches in 2007. On the external front, the balance of payments turned in a surplus, relative to the deficit in 2005, despite the severely weakened agriculture-based export capacity. The turnaround was the result of a falloff in hurricane-related import payments and higher net inflows on service and capital transactions. The year 2006 marked the first year of Government of Grenada’s implementation of a three-year, mediumterm economic reform programme supported by the International Monetary Fund (IMF)2. Coming after a 2 Including current grants. 3 An IMF Poverty Reduction and Growth Facility was approved in April 2006. The PRGF is a concessional loan facility for low-income countries and carries an annual interest rate of 0.5%, repayable over 10 years with 5 ½- year grace period on principal payments. number of destabilising economic shocks since 2001, including a Category 3 hurricane in 2004, the reform programme is seeking to restore macroeconomic stability, re-establish sustained economic growth, and promote social recovery. B. Sectoral Performance Agriculture Output in agriculture is estimated to have increased by more than 50% in 2006. Although indicating some recovery after the hurricane, this growth reflects the low volume of output in 2005 as output of the major traditional crops remained well below pre-hurricane levels. Total production of nutmeg, cocoa, mace and bananas is estimated to have more than tripled from 0.38 mn kgs in 2005 to 1.3 mn kgs in 2006, but still 30% below average annual production during 2000 and 2003. One exception was banana production of 0.9 mn kgs, production of which had risen above 0.79 mn kgs in 2003. Output of domestic food crops such as tubers, plantains, vegetables and fruits also rebounded strongly, reflecting favourable weather, as well as government initiatives to boost crop recovery. Government initiatives to revitalise the sector included an Agricultural Enterprise Development Programme. As part of this initiative, an agricultural loan scheme provided over $1.1 mn to 435 farmers involved in the rehabilitation of cocoa, nutmeg, and banana fields. Farmers involved in livestock, poultry and cash crop production also benefited. The programme also provided funds to support the purchase and distribution of fertiliser, irrigation equipment and other farm supplies. Farmers were trained in irrigation system management and operations, and in the preparation of agribusiness plans and credit proposals. In complementary programmes to support sector recovery, agriculture extension services were strengthened, while Government distributed cattle, seeds and cash crops to farmers. CDB Annual Economic Review 2006 Grenada 51 Construction While construction activity remained relatively strong in 2006 (with sector output well above pre-Ivan levels), value added is estimated to have contracted by 15%. This contrasts with the exceptional high growth of 91% in 2005, when the bulk of the country’s restorative work was undertaken. Privatesector commercial and residential construction activity would have slowed, reflecting the winding down of the hotel rebuilding effort and housing repairs, as well as the short supply of building supplies. The Government’s housing recovery programme continued (with funding from the Governments of Trinidad and Tobago, and Venezuela, and from the domestic National Reconstruction Levy), resulting in an additional 500 homes built and 300 repaired. In addition, the rebuilding of the sports stadium progressed in preparation for the hosting of the CWC 2007 cricket games. Related to these preparations, work on upgrading the road and bridge network accelerated during the year. Public investment also focused on upgrading key infrastructure within the main urban centre, St George’s, including a new cruiseship pier and commercial centre. Tourism Tourism, the main source of foreign exchange earnings in Grenada, was devastated by hurricane Ivan in 2004. The industry contracted (42.5%) in 2005, with more than half the room stock lost and with most of the island’s major hotels closed. Following the re-opening of the hotel industry for the 2005/06 winter season, with added room capacity and improved quality standards, the industry’s value added rose by over 30% in 2006. Boosted by additional airlift and enhanced marketing aimed at regaining lost market share, stay-over visitors increased by 20.4% to 118,653 in 2006. In 2005, stayover visitor arrivals had declined by 26.6% from 135,536 in 2004 to 98,241. This recovery was broad-based and covered all source markets. The number of cruiseship passengers and ships calling to Grenada, however, declined. This contrasts with the industry’s recent positive performance where, although the number of ships calling has been declining, the number of passengers visiting has continued to increase, owing to the use of larger vessels. Other Sectors Manufacturing output is estimated to have declined by 1% in 2006, mainly reflecting lower soft drink production and the closure of the sole tobacco company at the beginning of the year. This was partly offset by strong growth in the production of animal feed and other beverages. Value-added in electricity and water production and distribution, mining and quarrying, telecommunications, and banking and 52 CDB Annual Economic Review 2006 insurance services also increased, partly associated with the recovery within other sectors of the economy as well as the improvement in the road network, both as a result of actual road-reconstruction activity, and the improved transportation and communication arrangements provided by road improvement. After two successive years of decline, the real estate and housing sector recovered in 2006 reflecting, in part, increased land sales, some of which related to new foreign investment projects in tourism. Value-added in the wholesale and retail trade as well as in transportation contracted, however, reflecting developments in the construction sector and in the cruiseship industry. C. Prices, Wages and Employment The 12-month point-to-point inflation rate at endDecember 2006 declined to 1.7% compared with 5.8% during 2005, although average inflation was higher at 3.9% during 2006 compared with 3.4% in 2005. The main factors that underpinned the lower inflation were sharp reversals in energy prices during the year and increased domestic supplies of food, which caused food prices, which had been rising, to decline. The fuel and light sub-index declined by 11.1% compared to an increase of 29% increase in 2005, while the sub-index for food and non-alcholic drinks rose by 4.7% compared with 6.9% in 2005. The 4.5% increase in the sub-index for accommodation compared to 9.9% in 2005, also helped to push on the rate of inflation downwards. Public sector wages remained unchanged during 2006 as wage negotiations covering the period 2006 to 2008 were not concluded during the year. Public sector wage restraint, however, is an important one component of the expenditure adjustment effort, and, as such, increases granted through to 2008, are not expected to lead to any real increase in the public sector wage bill over the adjustment period. The public sector wage bill currently accounts for approximately 10% of GDP. D. Fiscal Policy and Debt Operations Fiscal reform is at the core of government’s adjustment programme, which aims gradually to reduce the fiscal imbalance and restore the level of public debt to more prudent and sustainable levels. Under this programme a primary surplus (excluding grants) of 2.5% of GDP is being targeted in 2008. In the intervening years, primary deficits are programmed to accommodate large reconstruction-related spending. In 2006, in line with this stance, the emphasis of fiscal reform was placed on strengthening revenues. Grenada After some delay due to strong public opposition, the authorities implemented a 3% payroll tax, the National Reconstruction Levy (NRL)4, in May 2006. A petrol tax of $3.00 per gallon was also introduced as part of a broader amendment of the Petrol Tax Act to allow for the introduction of an automatic fuel pricing mechanism to adjust local fuel prices in line with world oil market prices. Initiatives were also introduced to improve the efficiency and the effectiveness of the tax system. Preparatory work progressed for the introduction of a VAT in late 2007; while in the area of tax administration, legislative amendments to the Income Tax Act, as well as the drafting of a new Investment Act, were undertaken with a view to rationalise the existing liberal system of tax incentives which had served to erode the tax base over time. During the year, the authorities halted the granting of tax holidays granted and took steps, in lieu of pending legislative changes, to provide new incentives in the form of tax write-offs. Against that backdrop, recurrent revenues rose by 5.9% to $141.1 mn (27.2% of GDP) in 2006. All major revenue categories with the exception of taxes on income and profits, and taxes on international trade and transactions, increased. Sizable corporate tax arrears collections in 2005 was largely responsible for the decline in receipts from taxes on income and profits during 2006. On the expenditure side, recurrent expenditures rose by 6.3% to $119.2 mn. Current transfers and subsidies reached $25.1 mn, an increase of 24.4%, associated with higher spending on safety nets for poor and vulnerable groups, as well as for contributions to regional and international institutions. Similarly, interest payments also went up relative to 2005, but remained well below historical trend on account of the debt restructuring undertaken in late 2005. In 2006, the ratio of interest payments to current revenues fell sharply to 8.6%, fromt 18% before debt restructuring. With recurrent revenue outpacing expenditure, the recurrent account showed a substantial surplus: $21.9 mn or 4.2% of GDP. Public sector grant receipts in 2006 remained high, totaling $43.9 mn compared to $51.8 mn in 2005. Of this, $6.8 mn were in the form of budgetary support and $37.1 mn were capital grants. The People’s Republic of China, the Government of Venezuela and CARICOM entities were the main donors. Capital expenditure rose to $104.3 mn (20.1% of GDP) in 2006. This exceeded the budgeted total of $85.1 mn, and was 38.7% above capital spending in 2005. The level of spending primarily reflected higher infrastructure 4 The initial proposal was for a 5% levy. outlays, and contributed to an overall deficit of $38.5 mn (7.4 % of GDP), more than double the budgeted deficit. This outturn contrasted with an overall surplus of 0.5% of GDP in 2005. The primary deficit of $26.4 mn also ended-up at a higher than programmed level. The authorities financed the deficit by loans from domestic and external sources. The total external debt increased from $449.1 mn (95.2% of GDP) in 2005 to $475.8 mn (91.6% of GDP) in 2006 with loans sourced mainly from the CDB, the World Bank, the Government of Venezuela and the Government of Trinidad and Tobago. Central Government’s total disbursed debt rose by 4.5% to $548.6 mn in 2006. As a percent of GDP, the debt stock contracted from 111.2% in 2005 to 105.6% in 2006. Government received additional interest relief from the rescheduling of its debt with its Paris Club Creditors. In addition, the Grenada authorities continued to have discussions with the remaining commercial debt holders who had not participated in its bond exchange offer. E. Financial Sector Broadly-defined money supply, M2, increased by 0.9% to $549 mn at the end of December 2006. This growth reflected a 1.7% increase in quasi-money as private sector time and savings deposits rose in response to higher interest rates. Demand deposits, however, contracted, reducing M1 by 1.8%. On the assets side, domestic credit rose by 13.1%. The net domestic assets of the banking system increased as a result of higher commercial bank credit to the private sector and to Central Government. The net indebtedness of government to the banking system more than doubled to $37.3 mn from $13.8 mn as government reduced deposits (11.8%) and acquired additional credit (11.3%). Private sector credit rose by 12.5%. In contrast, the net foreign assets of the banking system contracted by 20.7% as commercial banks increased their liabilities abroad. During the year, efforts focused on improving the regulation and supervision of the financial system. All licensed commercial banks in Grenada are regulated by the ECCB. In June, the ECCB stepped up its banking supervision operations, conducting on-site visits. The Grenada authorities introduced and passed a bill in May to strengthen the regulatory framework covering off-shore banks and companies, insurance companies, credit unions, development foundations, money transfer institutions, and non-bank financial institutions generally. The new Act provides for the establishment of a single supervisory agency covering non-ECCB regulated institutions, and was expected to become CDB Annual Economic Review 2006 Grenada 53 operational in 2007. F. External Sector Grenada’s current account deficit narrowed by 8.8% to $417.1 mn in 2006. This improvement was the result of a reduction in the merchandise trade deficit (13%) and a net increase (60.3%) in services-related inflows. On the trade account, merchandise import payments contracted due to a fall-off in the imports of construction materials. The lower outflow on imports offset a 15.1% reduction in export earnings due to lower agricultural exports. On the services account, gross travel receipts increased by 30.9% to $252.4 mn. The narrowing in the trade deficit, the recovery of travel receipts, and higher official grant and private investment inflows were all reflected in a balance of payments surplus of $15.2 mn, a turnaround of the deficit position recorded in 2005. To foster agricultural growth and exploit the sector’s potential, given the significant role that agriculture can play in promoting balanced and sustainable development, and in reducing poverty especially in rural areas, Grenada’s agriculture rehabilitation programme will need to be accelerated. The sourcing of plant material and replanting, as well as the rationalisation and modernisation of the traditional export crop industries to encourage commercial practices and greater private production interests, and export emphasis on agroprocessed and value-added products, will be imperative for the long-term survival of the sub-sector. Restoring Fiscal Balance Significant expenditure allocations for reconstruction and preparatory works for hosting matches in CWC 2007, have resulted in a worsening of Grenada’s fiscal imbalance in 2006. Unless concerted efforts are made to redress the fiscal slippage and to consolidate, the authorities could put the reform objectives of restoring balance and achieving debt sustainability in jeopardy. The authorities now need to intensify the adjustment effort above what was initially programmed for 2007 in order to get the mediumterm reform programme back on track.. Under the PRGF, Government’s fiscal position is expected to be strengthened, with the deficit on the primary balance being converted to a surplus of about 2.5% of GDP in 2008. With this fiscal consolidation, the debt ratio is programmed to fall gradually to within the ECCB’s benchmark ceiling of 60%. Fiscal consolidation is important to reduce policy uncertainties caused by the current high level of public debt, and importantly, to improve the investment climate to facilitiate higher investment levels and support sustainable growth recovery. 2. MAJOR POLICY ISSUES Sustaining Growth Securing broad-based economic recovery, facilitated by an increased level of private investment, would help the authorities achieve their growth and development objectives. In 2005, reconstruction supported growth recovery as a result of the massive rebuilding effort. In 2006, economic expansion has been more broad-based. Underpinned by the relatively quick recovery of private commercial activity, most of the economy’s productive and service sectors contributed to growth in 2006. Tourism’s recovery has been particularly encouraging and the industry’s future prospects are favourable, supported by new investment in hotel construction. In agriculture, recovery has been restricted to the food crop sub-sector as the traditional, export-oriented tree crop sub-sector, by its nature, will require a longer recovery period.. The size of the increases in agricultural output observed in 2006 are not likely to be sustained. The steady decline in agricultural export earnings prior to the 2004 hurricane had highlighted serious problems in the sector and underlined the need for reform of agricultural production systems in Grenada, currently dominated by small and medium-sized farmers. An inadequate incentives and institutional framework, shortage of skilled human resources, weak market systems and linkages, poor capacity to respond to changes in international trading conditions, a high exposure to climate-induced risks, lack of appropriate financing mechanisms, and poorly maintained rural productive infrastructure, have all contributed to the loss of competitiveness in international markets. 54 CDB Annual Economic Review 2006 3. PUBLIC SECTOR INVESTMENT PROGRAMME The PSIP in 2006 continued to reflect the authorities’ rehabilitation and reconstruction policy objectives in response to the critical infrastructure damage sustained by hurricane Ivan in 2004. Focus was given to repairing and upgrading the country’s road and bridge network (43% of total investment spending) in an effort to facilitate private sector recovery, as well as to rebuilding the national stadium for the staging of CWC 2007 , the latter activity financed by a grant from the People’s Republic of China. At the same time, Government’s investment spending was also channeled into rehabilitating the productive sectors and industries, in particular tourism (6.5% of total spending) and agriculture (6.5%); rebuilding educational facilities Grenada damaged (3.1%); as well as continuing restorative work on the housing stock (15%). Total public investment spending rose by 39% to a high of 20.1% of GDP. Of the $104.3 mn spent, 59.2% was financed from external sources in the form of loans of $24.7 mn and grants of $37.1 mn. 4. MEDIUM-TERM ECONOMIC PROSPECTS The Grenada economy is projected to grow at an average annual rate of 4% over the medium term. Most of the major productive and services sectors of the economy are expected to contribute to this growth. Construction activity is expected to remain strong, associated with, inter alia, the start-up of the large Port Louis Project to construct a marina and a five-star hotel complex, as well as the construction of additional housing units and the provision of supporting public sector infrastructure. Housing re-development is expected to continue with the construction of housing units donated by the Government of the People’s Republic of China and the Government of Venezuela. In addition, the authorities propose to continue the programme to repair and rebuild school infrastructure. The hosting of CWC in 2007 is expected to have positive legacy effects for tourism. Fiscal performance will be of particular concern over the medium term. The authorities are forecasting a recurrent account surplus of about 4.8% of GDP, and an overall fiscal deficit of about 3.1% of GDP. Higher revenue growth is expected from GDP growth of about 5% to 6%, the reintroduction of VAT, and the collections of tax-payments arrears. Capital expenditures, although below 2006 expenditures, are expected to remain high, with a budgeted outlay of $83.5 mn or 14.5 % of GDP, to be financed by local resources ($39.6 mn), external grants ($34.2 mn) and external loans ($9.6 mn). The fiscal consolidation expected in 2007 is expected to be largely underpinned by robust revenue growth. To guard against further fiscal slippage as a result of the underperformance of revenue, the authorities will need to constrain expenditure growth in line with revenue by deferring lower priority expenditures for future years, and will need to lag expenditure behind revenue inflows in order to provide adjustment response options. Inflation is expected to remain relatively stable and low, averaging between 2% and 3%. The deficit on the balance of trade should continue to narrow somewhat with slight growth in export earnings and a reduction in imports, but is likely to remain high. At the same time, the continued recovery in travel receipts should allow for a further narrowing in the current account and an overall surplus. Grenada CDB Annual Economic Review 2006 55