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St Kitts and Nevis_ Macroeconomic Framework


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									A Macroeconomic Framework for St Kitts and Nevis
Contract N° 2010/247214
Framework Contract Beneficiaries Lot 11: Macro economy, Statistics, Public Finance

Professor Paul Hare and Mr Richard Stoneman                      DRAFT, v7, 11/12/10
October – December, 2010

Table of Contents

List of Tables and Charts
Executive Summary

1. Introduction

2. Outline of a Macroeconomic Framework

2.1   The real balance
2.2   The general government balance
2.3   The balance of payments
2.4   The monetary balance
2.5   Connections between the four accounts
2.6   Indebtedness
2.7   Competitiveness
2.8   Economic growth
         2.8.1 Investment
         2.8.2 Productivity growth
         2.8.3 Institutional improvements
         2.8.4 Sources of demand

3. Implementing the Framework on St Kitts and Nevis

3.1 Data Issues
       3.1.1 Measuring GDP
       3.1.2 GDP Projections
       3.1.3 Projecting Government Spending and Revenues
3.2 Improving and Strengthening the Framework: Economic Issues

4. Conclusions and Recommendations

References/Reports Consulted


Annex 1. Indebtedness Analysis
Annex 2. Definitions and Accounting Conventions
Annex 3. Extending the Macro-framework to Several Years
Annex 4. Dealing with Risk
List of Tables and Charts

Table 1. National income and expenditure for St Kitts and Nevis, 2007-2012
Table 2. Government accounts for St Kitts, 2008 to 2012
Table 3. Balance of payments for St Kitts and Nevis, 2008, 2009 and 2010
Table 4. St Kitts and Nevis: Monetary Survey, 2007-August 2010
Table 5. St Kitts and Nevis: Public debt and debt servicing, 2007-2010
Table 6. Three examples of value added calculations
Table 7. PSIP projects and their budgetary impact

Figure 1. Inter-connections between the four main macroeconomic accounts

Table A1. Debt-to-GDP ratios; the impact of policy variables


ACP         African, Caribbean and Pacific (countries)
APD         Air Passenger Duty (a UK excise duty)
CARICOM     Caribbean Community
CARIFORUM   Caribbean Forum of ACP States (15 states)
CARTAC      Caribbean Regional Technical Assistance Centre
CDB         Caribbean Development Bank
CGD         Commission on Growth and Development
DSA         Debt Sustainability Analysis
ECCB        Eastern Caribbean Central Bank
ECCU        Eastern Caribbean Currency Union
EC$         Eastern Caribbean dollar
EPA         Economic Partnership Agreement
EU          European Union
FDI         Foreign Direct Investment
GDP         Gross Domestic Product
GEOB        Government Entities Oversight Board
GoSKN       Government of St Kitts and Nevis
IFI         International Financial Institution
IMF         International Monetary Fund
MF          Ministry of Finance, SKN
MPC         Monetary Policy Committee (of the Bank of England)
MSD         Ministry of Sustainable Development, SKN
MTESP       Medium Term Economic Strategy Paper
NAO         National Authorising Officer (Permanent Secretary in MSD)
NHC         National Housing Corporation
NIA         Nevis Island Administration
NTB         Non-tariff barrier
OECD        Organisation for Economic Cooperation and Development
OECS        Organization of Eastern Caribbean States (8 countries)
OHE         Offshore higher education
PSIP        Public Sector Investment Programme
QE          Quantitative easing
SITC        Standard International Trade Classification
SKN         St Kitts and Nevis
SNA         System of National Accounts
VAT         Value added tax
WTO         World Trade Organization

Executive Summary
1. This report presents our analysis, findings and recommendations concerning economic
   aspects of the macroeconomic framework for St Kitts and Nevis. Accompanying reports
   discuss organisational and institutional aspects of implementing our proposed
   macroeconomic framework, discuss training needs related to the framework, and provide
   a training manual to guide the future training of staff in the Ministry of Sustainable
   Development and the Ministry of Finance who would be working on the framework.

2. St Kitts and Nevis is a small and very open economy that has been badly affected by the
    recent recession, and has uncomfortable levels of government debt, now approaching
    200% of the GDP (according to the IMF). Managing this debt is in our view the most
    urgent problem for the government to deal with, and we believe that a sound
    macroeconomic framework provides the tools for doing so.

Outline of a Macroeconomic Framework
3. Accordingly, this report has explained in general terms what should be meant by a
   macroeconomic framework and how and why it is useful in supporting analysis of the
   behaviour and performance of an economy, with particular emphasis on the public
   finances. The eight elements or components around which the macroeconomic
   framework was examined were:
       (a) the real balance
       (b) the government balance
       (c) the balance of payments
       (d) the monetary balance
       (e) connections between the above four basic balances
       (f) indebtedness
       (g) competitiveness
       (h) economic growth

4. In each case, general introduction to an element in the framework was followed by
   discussion and analysis of points particularly relevant to the economy of SKN. Indeed this
   is why item (f) was highlighted especially strongly, since it is critical for the future of the
   country, whereas in discussing other countries it might have been relegated to a far less
   prominent position in the framework.

5. Items (a) to (d) concern the four basic balances of the economy, though since SKN
   belongs to the ECCU, its monetary policy is handled – for the whole OECS sub-region –
   by the ECCB. Likewise, the ECCB maintains the exchange rate of the EC$ against the
   US$, which has remained fixed at EC$ 2.7 = US$ 1 for over 30 years.

6. Accordingly, while having regard for the monetary balance and the balance of payments,
   GoSKN is most able, through its policy choices, to influence the first two balances,
   namely the real balance and the government balance. Fiscal policies – tax rates,
   expenditure decisions, and the like – must therefore be chosen to achieve the best feasible
   outcome in these balances, given government priorities and all known constraints.

7. Item (e) highlights inter-connections among the basic balances, emphasising, however,
   that the fact of multiple inter-connections does not entail the need for any single
   economic authority controlling everything. Instead, economies generally work best with

   multiple authorities, provided that there is a well designed structure of communication
   between them.

8. The fundamental reason for having a well constructed macroeconomic framework for
   SKN is to create the conditions for sustained economic growth to raise general living
   standards and reduce poverty. This in turn, in such a highly open economy, also entails
   promoting competitiveness. As background to both, given the country‟s high and still
   growing public debt, it essential for the indebted ness to be brought under better control.
   These three issues – debt, competitiveness and economic growth – are the subjects of
   items (f), (g) and (h) in the macroeconomic framework.

9. On indebtedness, we propose the use of a new, simple to use debt sustainability tool that
   makes it quick and easy to check whether the public debt-to-GDP ratio is on a declining
   trend or not, and to explore alternative fiscal policies to achieve any desired path.
   Naturally, as in all analyses of this sort, debt sustainability is far easier to achieve when
   the economy as a whole is growing fairly rapidly, say at 5% per annum or faster.

10. Hence the purpose of the subsequent analysis of competitiveness and growth is precisely
    to explore the conditions under which such a growth rate might be achievable, and the
    sorts of practical and detailed policy intervention that can help to do so.

Implementing the Framework
11. Moving on to implementation of the macroeconomic framework, the report reviewed
    some important data-related issues and then considered ways of improving the existing
    practices and procedures on SKN, focussing on a number of critical economic issues.

12. As regards the data, this was discussed in three stages, starting with estimating the real
    GDP of SKN using the output method. Then the GDP has to be projected forwards to the
    relevant budget year and the two following years, which is done by projecting output
    sector-by-sector and summing the results using appropriate weights. Finally, the GDP
    projections, along with other data where relevant, are used to estimate budgetary revenues
    for the forthcoming budget year and the two subsequent years. The MF then has a basis
    for drawing up the rest of the budget, since with revenue estimates and knowledge of
    priority spending needs – on debt servicing, public sector pensions, and civil service
    wages – it can estimate what (limited) funds will be available to meet the non-salary
    spending needs of the various line ministries, including the social safety net.

13. Four critical economic issues were highlighted, and these form the basis for our principal
    conclusions concerning economic aspects of the macroeconomic framework.

Economic Issues
14. SKN’s present government debt, with current government policies, is plainly
    unsustainable. However, while we expect GoSKN to honour its debt obligations, we
    would advise the government to engage in discussions with the major creditors with a
    view to refinancing much of the debt to longer maturities, and perhaps better terms. We
    would expect the ECCB and IMF to be helpful partners in such discussions.

15. With or without some debt rescheduling of this sort, we conclude there there are really
    only two effective ways of bringing down the country‟s debt to more manageable levels.
    The first entails a period of severe fiscal pain in order to generate primary surpluses that

   might need to be as high as 20% of the GDP (rather less than this if the economy can
   deliver more rapid GDP growth) – though as this would amount to roughly 50% of
   government revenues, it may be difficult to achieve.

16. The second approach might therefore prove more feasible initially. This entails the sale of
    public assets, which might involve a mix of land sales and the privatisation of publicly
    owned entities. If this approach is to be pursued, however, some early decisions would be
    needed to get the process started, and the programme should then be pursued with vigour.

17. After two-three difficult years, GoSKN would gradually regain both a degree of „fiscal
    space‟ allowing it a little more flexibility over public spending plans, and would also get
    its indebtedness down to levels where the country could more readily cope with an
    unexpected adverse shock (such as another damaging hurricane).

18. It is high time for all SKN’s public enterprises (i.e. government departments delivering
    services; public enterprises proper; and a variety of statutory corporations) to be put on a
    sound economic footing.

19. No economic service activity should remain as a government department, and in our view
    this implies the immediate corporatisation of such entities as the Electricity Department
    on St Kitts (we understand that preparations for this are well under way, with
    corporatisation likely in 2011). It is also important, for all entities providing a marketable
    service, that economically sensible prices should be charged to all customers, and that all
    should pay.

20. Further, wherever possible we would urge that these public entities be privatised at the
    earliest opportunity, while any that cannot be restructured to enable them to cover their
    costs should normally be closed down.

21. Many PSIP projects have implications for future current public spending, and these
    should be embedded in the annual budget cycle estimates.

22. Although there are no doubt many good quality PSIP projects that could be developed
    and implemented, it is unwise for GoSKN itself to fund such projects beyond current
    commitments, until the country‟s debt position has been brought under much better
    control (aside from any spending needed to deal with national emergencies). However,
    once the debt position had improved, one of the early benefits could be the opportunity
    for the government to start funding some new PSIP projects.

23. Regarding improving forecasting methodology, we have not chosen to make any
    recommendations of a technical nature. For although some mostly minor technical
    improvements could undoubtedly be made in the present methods for forecasting GDP,
    public spending and finally the overall SKN budget (with parallel processes for the Island
    of Nevis), our main concern has been with wider aspects of the current budgetary

24. Specifically, we consider it desirable for the entire budgetary process, from start to finish,
    to be conducted far more publicly than has been the norm in the past. For this to work,
    regular reports on GDP projections, budget revenue projections, the overall budget, and
    the subsequent monitoring and review processes need to be published rapidly on MSD

   and MF websites as appropriate. Such reports should not merely publish the basic data,
   but there also needs to be some analytical commentary to accompany the data.

25. This will facilitate public discourse on budgetary issues, a vital element of democratic
    life, and will also strengthen public accountability of all aspects of the government
    budget, including the all important handling of public sector debt and the public

Further Issues
26. Multi-year budgeting was referred to in the main text and is potentially an important
    extension of the framework that we set up and analyse in this report. The most important
    aspects of multi-year budgeting are addressed in summary form in Annex 3. Although it
    has many strengths, we do not see moving to comprehensive multi-year budgeting as an
    urgent priority for SKN, largely on resource cost grounds, though we acknowledge that
    elements of such an approach are already in place and working well..

27. Dealing with risk. Again this was referred to in the main text, but we decided that to
    discuss it properly would have entailed deviating far too much from our main line of
    argument, and this could have caused unnecessary confusion. Accordingly, an overview
    of the topic is provided in Annex 4.

A Macroeconomic Framework for St Kitts and Nevis1

1. Introduction
St Kitts and Nevis (SKN) is a very small highly open, middle-income economy facing
significant vulnerabilities both to natural factors (notably hurricanes) and to economic cycles
in the world economy that affect key markets – both for exported goods, and for services
such as finance and tourism. Thus the world financial crisis and recession that began in 2007
and which adversely affected virtually all advanced economies has had major knock on
effects on most other economies, including that of SKN. Aside from its direct impact on
trade, the crisis has also led to falls in income from remittances to SKN, and has made the
conditions for foreign direct investment (FDI) far less promising than they seemed just a few
years ago.

This situation would have been difficult enough to manage, but for SKN the economy faces
an additional challenge, namely the country‟s exceptionally high public sector debt-to-GDP
ratio (around 185% and still rising), and this necessarily has to be managed carefully as part
of any credible macroeconomic framework. The debt has grown so large for a number of
reasons. First, several hurricanes during the 1990s inflicted severe damage, and the
government undertook substantial borrowing to rebuild housing and restore the economy.
Second, the state-owned sugar industry accumulated losses over several years, and was
closed in July 2005, with large additional costs associated with that decision; taken together,
sugar added about 29 percent of GDP to overall public sector debt. Third, various public
entities have regularly recorded losses that have contributed to the rise in public sector
indebtedness (because their losses and debts are understood to have government guarantees).
Fourth, considerable and generally much needed infrastructure investment has taken place in
the past decade or so, some of which has been financed by additional public sector borrowing
in the expectation that subsequent growth and higher tax revenues would allow the debt to be
serviced without undue strain. The combined effect of these factors gives SKN the very high
debt levels with which it must now contend2.

In an important sense, while the above points help to explain the background to SKN‟s
current high indebtedness, what really matters now for the SKN economy is not specifically
why and how the current debt levels arose, but how they can now be managed and reduced,
as part of the country‟s overall macroeconomic policy. These issues are explored in depth
later in this report.

Meanwhile, it is worth pausing briefly to consider ways in which the small size of the SKN
economy affects how one should most appropriately analyse and think about it. Most
obviously, the usual substantial „gap‟ between the micro-economy and the macro-economy
makes little sense for SKN, since we are dealing with an economy of around 50,000 people
earning an income per capita of around US$ 11,000. Thus, roughly speaking, the entire
economy has a GDP amounting to little more than US$ 0.5 billion, truly tiny. This means that
the fortunes of any single firm employing a hundred or more people – of which there are
several – have a noticeable impact at the macroeconomic level via tax revenues generated by
the firm, the associated wage and salary bill (affecting personal consumption), and exports
and imports. In addition, just a handful of significant investment projects – such as housing

  The authors are grateful to the NAO‟s office for the provision of useful comments on an earlier, incomplete
draft of this report. Remaining errors and infelicities are our own.
  There are also additional contingent liabilities of the government, such as future pension obligations, that we
do not account for explicitly in the present report.

developments, hotel projects, infrastructure developments or whatever – suffice to generate a
ratio of investment to GDP that would otherwise be considered surprisingly high.
Correspondingly, a pause in major investment projects and/or the closure of just a few
significant firms would be sufficient to bring about a significant fall in the equilibrium
income level.

Thus as the recession unfolded, the Marriott holiday complex at Frigate Bay, St Kitts,
temporarily laid off many workers, while hurricane damage in 2008 forced the closure of the
Four Seasons Resort on Nevis; after extensive reconstruction, this is due to re-open in
December 2010. For a small economy, these two events both have to be regarded as major
shocks. In this sense, the SKN economy is likely to experience relatively greater volatility
than one might expect in a much larger economy. This needs to be taken into account in the
design of appropriate economic policy.

A further aspect of SKN‟s smallness has to do with its implications for the political
environment. On the one hand, everyone of importance – both in politics and business –
knows everyone else, and one might expect that to facilitate constructive communication that
could actually be quite helpful for managing the economy. To an extent that might be correct,
but our over-riding impression is much less benign than that, namely that the extensive
informal links between politicians, senior civil servants and the business community tend to
facilitate informal „protection‟ and forbearance in regard to firms experiencing difficulties.
Firms can and do argue that if they are not „helped‟ there will be job losses that will be
damaging to the local economy, and politicians don‟t like to see that, for fear they may be
held responsible – so tax arrears are tolerated, as are arrears in utility payments. Moreover,
the more formal consultations between government and business that take place each year
over the government‟s budget and other aspects of economic policy appear not to work well,
as they are perceived by the business community more as information sessions – in other
words, the government simply tells business what it has already decided to do.

2. Outline of a Macroeconomic Framework
“The macroeconomic policy framework over the medium term will aim to maintain a
favourable macroeconomic environment necessary for increasing competitiveness in the
production of goods and services and sustaining economic growth in SKN.” (Medium Term
Economic Strategy, 2010-2013, Volume II, p33, draft).

This statement, from a useful draft report published earlier this year (2010), sums up
succinctly and well the key reasons why St Kitts and Nevis would benefit from a carefully
formulated macroeconomic framework, namely to promote competitiveness in production,
which essentially means creating conditions under which local production can meet market
demands in both domestic and foreign markets; and to foster sustained growth of GDP. In
order to achieve these highly desirable outcomes, the basic economic conditions on SKN first
need to be stabilised, notably to ensure that the country‟s large debt overhang can be
managed without unduly harming medium and longer term growth.

The natural starting point for thinking about a country‟s macroeconomic framework,
however, has to do with the four basic economic balances that represent the current situation,
namely: (i) the real balance; (ii) the general government balance; (iii) the balance of
payments; and (iv) the monetary balance. In what follows, therefore, we briefly discuss each
balance, first in generic terms and then with reference to SKN.

This discussion of basic balances provides the necessary background to our subsequent
analysis of debt and the public sector accounts. Next, we go on to examine competitiveness
issues; and finally we bring everything together by analysing economic growth. In the course
of the analysis, we shall naturally need to pay some attention to employment and job creation
on SKN, as well as the maintenance of reasonably stable prices, always important for
economic security and business confidence.

In SKN‟s current practice, GDP is projected three years ahead (i.e. for the coming budget
year and the two following years), and the budget itself is presented for the budget year plus
projections for the two subsequent years. The PSIP also looks three years ahead. In this
sense, elements of a multi-year macroeconomic framework are already in place and are well
established. However, the core of current practice on SKN is based on projections for the
budget year itself, and to this extent it remains in its essentials a single-year framework
(albeit with improvements).

However, we note the recommendations of CARTAC and the IMF that a sound
macroeconomic framework should ideally be built around a multi-year approach to
forecasting, budgeting, and so on. Accordingly, in Annex 3 we outline the advantages and
disadvantages of developing a comprehensive multi-period framework. We also note the
resource costs of doing so.

2.1 The real balance
The real balance for an economy describes conditions in the markets for goods and services
for a given accounting period, typically a year. Part of the balance is an accounting identity
(by which we mean a relationship that has to be true, regardless of concrete economic
circumstances). This is commonly expressed in the form of the familiar income-expenditure
identity that arises in national income accounting. The identity is shown as equation (A1) in
Annex 1, and is repeated here for convenience.

                              Y=C+I+G+X–M                                                 (1),
Y = GDP (gross domestic product)
C = personal consumption
I = investment (gross fixed capital formation + change in inventories)
G = government demand for goods and services
X = exports of goods and services
M = imports of goods and services

In most larger economies, GDP is measured independently in both ways implied by equation
(1). Thus taking the left hand side first, output in the economy is measured by adding up the
value added in each sector of the economy, which gives the total, Y, usually measured in
producer prices or basic prices. The result is the output-based measure of GDP, and we
discuss it more fully later, in section 3.1.1 of this report; this is the main way of measuring
the GDP in St Kitts and Nevis at present.

Next, the right hand side of (1) is the sum of various expenditure components, as listed below
the equation. These are usually measured independently, to give a second measure of the
GDP of the country, the expenditure-based measure. In SKN, however, as we explain below,
only certain parts of the expenditure are measured directly, with personal consumption, C,
being obtained as a residual. What this means is that those expenditure components that are

actually measured are deducted from the output-based GDP to obtain an estimate for C. In
doing this, account must be taken of the fact that expenditure components are normally
measured in market prices, while, as noted, output is measured in basic or producer prices 3.
Hence one side or the other in (1) needs adjustment to ensure that both are measured in
equivalent prices. For convenience, some of these price definitions and other accounting
conventions are brought together into Annex 2.

Table 1 shows the output and expenditure accounts for St Kitts and Nevis for recent years, in
order to illustrate the above.

Table 1. National income and expenditure for St Kitts and Nevis, 2007-2012

Item                           2007          2008          2009          2010          2011          2012
                                                                         Proj.         Proj.         Proj.
GDP in current basic           1138          1264          1202          1195          1240          1287
prices, output measure
Nominal growth rate, %         7.6           11.1          -6.1          0.7           3.8           3.8
Real growth rate, %            4.2           4.6           -9.6          -1.4          1.1           1.6
  (SKN Stats)
GDP in current market          1386          1539          1471          1431          1486          1541
prices, expenditure
Nominal growth rate, %         5.4           11.1          -7.7          0.7           3.8           3.8
Personal consumption           845           1149          1094
Government                     258           263           288
Capital formation              594           627           583
Exports of goods and           610           591           517
Imports of goods and           922           1092          1011

Source: MTESP (2010), Annex 3; ECCB (2009)
Notes: Figures are in million EC$, except where stated.

Since the output measure of GDP is built up from data on different branches of the economy
(see section 3.1.1), we naturally have available data on the structure of GDP by broad sector,
and from this it turns out the banking and insurance, government services, construction,
wholesale and retail trade, tourism, and manufacturing each accounts for over 10% of the
GDP; no other sector exceeds 5% of GDP. More importantly in some ways, it would be
useful to know about the respective GDP levels – and per capita GDPs – in St Kitts and Nevis
separately, but this information is not currently available4. We understand that separate GDP
estimates for the two islands are in preparation, and may be available early in 2011. This will
be useful, partly for its inherent interest, partly for the practical reason that it will help the

 See Annex 2 for definitions.
 Based on driving round each island and informally assessing housing standards, services available to visitors,
and the quality of local infrastructure, we would not be surprised if per capita GDP on Nevis turned out to be
25% higher than that on St Kitts.

authorities on St Kitts and Nevis to reach a satisfactory and equitable revenue sharing rule for
the new Value Added Tax (VAT)5.

Now, aside from the basic accounting identity that we have been discussing, which will
always hold (leaving measurement errors aside), the real balance also concerns the level of
economic activity in the given economy relative to some notion of full capacity. Ideally,
policy-makers seek to achieve a level of activity that is as close as possible to full
employment, through a judicious mix of fiscal and monetary policy instruments. When
employment is too high in relation to the available labour force, there tends to be upwards
pressure on money wages which, with a fixed exchange rate, tends to harm competitiveness
in external markets; and conversely if employment is too low.

In SKN, there is no regular data collection concerning the labour force, employment,
unemployment and the like, so it is not so easy to judge the state of the labour market.
However, it would not be too difficult to assess current wage settlements in a sample of firms
and other workplaces, including the public sector, as a basis for making a reasonably well
informed judgement. Certainly, if wages rose too fast, in particular at a faster rate than
average productivity was growing, then there would be upwards pressure on prices, and this
would be picked up quite rapidly by the authorities as consumer prices are surveyed monthly
and a consumer price index calculated. Recent reports show consumer prices rising at under
5% per annum except in 2008 where the inflation rate was closer to 8% (IMF, 2009a), and
the latest CPI data on the ECCB website shows inflation close to zero.

When considering the policies that can be used to influence the state of a country‟s real
balance, it is usual to look to the tools of fiscal policy. In other words, features of the tax
system such as tax rates, the tax base, and elements of public spending can all, in principle,
be adjusted in order to achieve some desired level of equilibrium national income (GDP),
presumably at or close to full employment. However, governments never enjoy complete
freedom in this regard, since the decisions they would like to take to do with tax rates and
government spending also influence – and are influenced by – the government‟s own
financial balance, to which we turn next.

2.2 The general government balance
Governments raise money through taxes and a variety of non-tax charges (e.g. fees for
specific services, licences and the like) and use it to pay for public administration itself (civil
service salaries and non-salary administrative costs), publicly provided services such as
schools, health clinics, the police, and so on. In addition, governments make a variety of
transfer payments to individuals, like pensions, and to firms (including public enterprises),
notably specific subsidies. Here we make no judgements about the economic desirability or
otherwise of any of these transactions, merely noting the wide range of possibilities that need
to be allowed for in the public accounts. These are all current transactions of the government.

Capital account transactions also occur, involving both asset sales and public investment (i.e.
the part funded by government), the latter mostly involving projects to develop the public
infrastructure; in SKN, these projects – whether funded by government or from other sources

  The recently reported temporary revenue sharing agreement for the VAT gives Nevis 24% of the revenues
(with the remaining 76% going to St Kitts), and since Nevis has roughly 20% of the total SKN population, this
amounts to assessing the Nevis GDP per head 26% above that of St Kitts. On the hand, it remains arguable
whether the outcome is wholly fair to Nevis, since the taxes dropped when the VAT was introduced accounted
for a relatively higher share of NIA government revenues.

– are brought together to form the Public Sector Investment Programme (PSIP). Last, after all
these transactions are listed, the resulting government accounts can show either a surplus or a
deficit – in either case, this is called the primary balance.

Normally, governments have in the past funded themselves partly from tax revenues as just
discussed, and partly through borrowing, generally by selling securities of various maturities
on the private financial markets, and sometimes by selling them to the Central Bank; in
addition, most governments have the option of financing part of their spending though
printing money, a power that should be used sparingly in order not to stimulate inflation.
Within the OECS region, individual governments do not enjoy this particular power, since
the monetary system is overseen by ECCB, and all commercial banks are required to follow
the ECCB‟s Prudential Guidelines governing large exposures. However, concerns are
sometimes expressed that some actions of member governments are tantamount to money
creation, for instance when governments make excessive use of local bank overdraft facilities
to fund their activities.

As a result of past borrowing, for whatever reason, governments enter the current period with
a certain level of accumulated debt. This can be denominated entirely in the domestic
currency, or in a mix of domestic and foreign currencies, depending on how the financing of
past deficits was undertaken. In the current period, the government will obviously have to
service the outstanding debt.

Debt servicing takes three forms. First, interest will be payable on the outstanding principal.
Second, some repayments of principal may fall due in the current period, and these
repayments also have to be allowed for. Meeting these two types of charge entails outgoings
from the government budget. Depending on the overall financial position of the government,
such outgoings can be wholly or partly offset by taking on new borrowing, the third aspect of
debt servicing. Such borrowing can be used to ameliorate the flow of future repayments by
improving – generally extending – the maturity structure of the outstanding debt; or it can
reflect a decision by government that the country‟s financial position is sufficiently secure
that it can afford to take on additional debt without putting the country‟s financial stability at

The overall balance in the government‟s accounts is then the net (combined) result of all
these transactions except the third type of debt servicing just referred to. And whether a given
balance is „good‟ or „bad‟ depends on the context, the wider economic circumstances in
which the government finds itself, as we shall explain more fully below. If the overall
balance is positive (a surplus), the outstanding debt is being fully serviced and some may be
being paid off. If the balance is negative, servicing can only be managed by incurring new
debt, essentially through refinancing operations.

To complete this summary of the government‟s balance, two further points need to be
brought into the discussion. The first has to do with a range of off-balance-sheet transactions
that governments often choose to keep separate from their main accounts. For instance, social
security funds are often handled this way, the justification being that such funds should not be
accounted for as if they were simply another part of the government‟s budget, since they are
set up for a specific purpose and are not intended to finance general government spending.

Explanations along these lines, though, are not entirely fair, however, for two reasons:
(a) when they have accumulated surpluses, social security funds sometimes lend to their

government; when they have deficits, they borrow from their government to meet their
commitments, e.g. to pensioners. Hence to gain a realistic and complete picture of the public
finances, it is normally considered good practice to consolidate the general government
budget with all such off-budget funds.

Table 2. Government accounts for St Kitts, 2008 to 2012

Item                         2008     2009        2010   2011      2012     2010      2010
                                                  Est.   Est.      Est.     (1-8)     (1-8)
                                                                            Exp.      Act.
1.Total revenue and grants   523      596         617    628       635      311       287
Recurrent revenue            432      454         433    486       509      273       261
Of which:
 Tax revenue                 337      363         319    368       386      198       172
 Non-tax revenue             96       91          114    119       123      75        88
Capital revenue              62       77          105    91        84       27        11
Grants                       28       66          79     51        41       11        16

2.Total expenditure          511      558         536    544       514      333       329
Recurrent expenditure        428      447         430    438       430      278       269
Of which:
 3.Interest payments         111      124         106    105       100      68        69
Capital expenditure and      83       111         106    106       84       55        59
net lending

Overall balance (1 – 2)    12         38          81     84        121      -22       -41
4.Primary balance (1 - 2 + 123        162         188    189       221      46        28

5.Principal payments         70       64          76     140       120      43        38

New debt (5 + 3 – 4)         58       26          -6     56        -1       65        79

Source: Estimates (2010); Monthly Fiscal Data, Jan-Aug 2010, Excel spreadsheet, St Kitts:
GoSKN. Figures for 2008 and 2009 are actual out-turns.
Notes: All figures are in million EC$. The data shown in the table are reported in current
prices. Rounding errors mean that some sub-totals appear not to sum to the correct total. Last
row – authors‟ calculation.

The same is true for revenues and outlays associated with publicly-owned enterprises, or
public production even if not set up using a commercial model, since they too enjoy implicit
(and often explicit) government guarantees to fund any deficits that might arise, and to
finance their accumulated debts. For SKN, this category of activity includes public
corporations, various statutory bodies and, in effect, certain government departments. Thus
electricity production in St Kitts is still organised as a government department, though there
are plans to commercialise it shortly; while electricity on Nevis is already organised as a
public corporation. Other bodies include the port authority, the NHC, and a number of
others. Several of these activities have been surprisingly delinquent over the production of
up-to-date, audited accounts, while collectively they have amassed substantial debts with

minimal accountability. The recent creation of a Government Entities Oversight Board to
monitor these activities is therefore an important and very useful step; however, its remit is
limited to the public corporations on St Kitts, so does not include, for instance the St Kitts
electricity supply body (see GEOB, 2009).

Second, another form of budgetary consolidation is very important. Many jurisdictions have
multiple levels of government such as nation, province, county, and so on, and to obtain a
complete picture of the public sector/government accounts it is essential to consolidate the
accounts across all these levels. For SKN this is relatively simple, since the country is
constitutionally a Federation with two principal constituent units, namely the Federation of St
Kitts and Nevis, and the Nevis Island Administration. Hence to form consolidated
government accounts, or accounts for general government to use the standard IMF
terminology, we simply need to combine the two sets of government accounts, that for St
Kitts, and the other for Nevis..

Table 2, above, shows the government accounts for St Kitts for 2008 and 2009, together with
the approved estimates for 2010, 2011, 2012 and some data on budget out-turns for the early
months of 2010. This all serves to illustrate the above discussion. We have not shown here
the separate Nevis accounts, or the consolidated accounts.

Using the Table 1 data on GDP in market prices for 2009, we can see that in that year, from
Table 2, total government spending (capital plus current) amounted to 39.3% of GDP, while
total revenues were 41.9%. Expenditure on servicing the country‟s debt, both interest
payments and principal, came to 13.2% of GDP, and 31.5% of gross government revenue.
The corresponding figures projected for 2010 were expected to be as follows. Total
government spending was expected to be 37.5% of GDP, with total revenues coming out at
43.1%. Total debt service was planned at 12.7% of GDP, 29.5% of total budgetary revenues.
Up to August 2010, however, the public finance out-turn was looking less favourable than
planned, with total spending close to target, and total revenues about 8% down.

It is not yet clear how much the position might recover by year end, but for the moment the
implication is that GoSKN has been obliged to take out new debt this year in order to service
the existing debt on time. Actually, much of the new debt takes the form of borrowing for
urgent capital projects, namely the purchase of new generator sets for St Kitts.

Nevertheless, instead of remaining static or even falling slightly as planned, the county‟s
outstanding public debt has been on the rise again in 2010, as confirmed by IMF (2010a). We
discuss the wider implications of this position later in the report, where we shall show that the
current and likely future position of SKN as regards debt and the burden of debt servicing
departs substantially from the relatively optimistic picture presented in MTESP (2010).

When taking decisions about the types of taxes to impose, their scope, and the rates of tax, as
well as about the level and structure of government spending, governments must have regard
to the overall general government balance they wish to achieve in the current period. This in
turn will depend on the past history of deficits, the accumulated debt, and the desired future
path of the country‟s indebtedness. For SKN under present conditions, these considerations
highlight the need to achieve substantial surpluses in the government‟s primary balance to
enable existing debt to be serviced and its level gradually reduced. As we shall see later when
we analyse debt more carefully (section 2.6), this is a major challenge for SKN, and some
form of (managed) rescheduling cannot be ruled out.

Moreover, if it had more room to manoeuvre, the government of SKN might well prefer to
adopt a somewhat laxer fiscal stance in order to stimulate the aggregate level of economic
activity – for instance through additional public sector infrastructure spending, as proposed in
MTESP (2010, p.22) – given the impact of the financial crisis and subsequent world
recession that hit the islands especially hard in 2009. With the present barely manageable
debt levels, this is not really an option for the time being, in our view.

2.3 The balance of payments
All the international transactions of a country are brought together in its balance of payments
account. Conventionally, the account is split into two parts: the current account and the
capital account. The current account records exports and imports of goods and services, and
inward and outward flows of interest, profits and dividends. In addition, it includes flows of
remittance income in both directions, as well as aid flows and any other unrequited transfers.
The balance of all these current transactions is then referred to as the current account balance
of the balance of payments.

The capital account of the balance of payments includes all inward and outward capital flows.
These include foreign direct investment (FDI), portfolio investment, and a variety of short-
term capital flows. Normally, the balance of payments is presented in such a way that it does
indeed balance. This is accomplished in the following way. We take the current account
balance together with all the private sector capital inflows and outflows, and combining these
gives what is commonly referred to as „the balance of (international) payments‟ for the
country. The remaining part of the capital account, which makes the overall account balance,
consists of transactions that are often referred to as „financing the balance of payments‟; they
include increases or decreases in foreign exchange reserves, and external borrowing or
lending operations by government.

Table 3 shows the balance of payments for St Kitts and Nevis for 2008 and 2009, and with
estimated data for 2010, in order to illustrate these various types of transaction and to show
how they should be presented in the accounts. It can be seen that SKN consistently operates
with a large current account deficit in the balance of payments, amounting to somewhat over
one-third of GDP (as measured in market prices). This very large current deficit is, of course,
largely offset by the correspondingly large surpluses shown on the capital account of the
balance of payments, underlining the importance for the country of maintaining favourable
conditions for foreign investment of all kinds, especially FDI. For only under such conditions
can the present balance of payments be maintained in the medium and longer term.

Of course, since St Kitts and Nevis belongs to the Eastern Caribbean Currency Union
(ECCU), with the ECCB serving as central bank to the OECS sub-region, the balance of
payments for SKN per se does not matter in the way that it would for a country with its own
independent and freely floating currency. For instance within the UK, no one is especially
interested in the balance of payments for Scotland (though it is sometimes calculated/
estimated by economic analysts), since Scotland has belonged to the UK economic area for
several centuries already, using the pound sterling as the area‟s common currency. Likewise,
within the Eurozone, there is little interest in the balance of payments for Belgium or
Slovenia. Again, these balances are sometimes still estimated, but the main interest focuses,
as it should, on the balance of payments for the entire Eurozone. This is what the European
Central Bank constantly monitors as part of its overall market surveillance, as background to
its monetary policy decisions.

Table 3. Balance of payments for St Kitts and Nevis, 2008, 2009 and 2010

Item                                          2008                            2009                          2010 Est.
                                 Credit     Debit     Net        Credit     Debit     Net        Credit     Debit     Net
Current account                  784        1272      (488)      688        1187      (499)      656        1172      (516)
 Goods and services                     619      1103     (484)         510      1029     (519)         476      1014     (538)
 Income                                  27       120       (93)         25       113       (88)         25       113       (87)
 Current transfers                      138        49         89        153        45        108        155        45        109

Capital and financial account    754          254         500          789         287          502          604         88        516
 Capital                                 60           1           59          18            1           17          43         1          42
 Finance                                694         253          441         772          286          485         562        88         474

Net errors and omissions                                  27                                    31                                 0

Overall balance                                           40                                    34                                 -

Financing                                     40          (40)                     34           (34)

Source: MTESP (2010), Annex 3; ECCB data tables, various.
Notes: All figures are in million EC$. Some sub-totals might not sum to the totals shown due to rounding errors.
That said, it would not be correct to suggest that either the ECCB or the authorities in SKN
can safely regard the country‟s balance of payments as a matter of indifference. On the face
of it, participation in a monetary union appears to create incentives – or at least the
opportunity – for individual member states to be relatively careless as regards international
transactions and their overall balance. However, this is not really the case, as a monetary
union can only be sustained for any length of time if the monetary authorities of the region
(in this case, the ECCB) are able to operate a prudent monetary policy that sustains the fixed
exchange rate between the Eastern Caribbean dollar and the US dollar (EC$ 2.7 = US$ 1),
maintains low inflation on average across the region, and maintains the balance of payments
for the monetary union as a whole in acceptable condition, as the ECCB has done quite

Thus the ECCB, in managing the balance of payments across the entire union, must be in a
position to maintain adequate foreign currency reserves (mostly US dollars) to enable it to
support the trade and other international transactions of the member countries. In practice,
this is easier said than done, and among other things it requires the member countries of the
union to exercise a degree of restraint and prudence in the management of their individual
fiscal polices. This is essential, since across the union there has been no pooling of
sovereignty, no formal agreement on a union-level fiscal policy for the region6. Ideally, too,
the ECCB should hold sufficient foreign currency reserves to enable it to cope with the
economic shocks most likely to effect either member countries or the region as a whole.
However, IMF (2009b) suggests that under some circumstances, current levels of reserves
might not prove sufficient to manage such an eventuality.

As far as policy is concerned, the government of SKN has few macro-policy instruments
available to it if it wishes to improve its balance of payments, and the measures it can feasibly
take are generally microeconomic in nature rather than macroeconomic. For the usual
macroeconomic levers – the exchange rate and the interest rate – are both managed by the
ECCB for the entire region. The former, the exchange rate, is fixed as noted above. The
latter is determined as part of the monetary policy of the ECCB, as we discuss in the
following sub-section. That leaves a range of microeconomic measures, and they can take a
variety of forms which it is convenient simply to list briefly at this point, leaving a fuller
discussion until later in the report:

        policies to encourage FDI;
        policies to improve competitiveness and hence stimulate (net) exports of goods and
        policies to improve the trade regime by reducing average tariffs, simplifying the tariff
         system, removing all or most special levies, rebates, and so on7.
        industrial policy actions to foster activities in which SKN might reasonably be
         expected to enjoy some comparative advantage, e.g. tourism; off-shore higher
         education; selected manufacturing; fresh and processed agricultural produce;
         specialised financial services; and possibly others.

  The recent difficulties in the Eurozone illustrate some of the problems that can arise when fiscal discipline by
member states is insufficient, in an environment where rules established to foster collective discipline (the so
called Stability and Growth Pact) have been widely flouted. See Buiter (2010), Buiter and Rahbari (2010).
High-level meetings held in October 2010 to secure a new agreement on fiscal policy coordination and
discipline across the Eurozone yielded results that are neither convincing nor credible, in our view. The latest
financial crisis in Ireland (November 2010), unfortunately, illustrates this point all too well.
  For a thorough review of the trade regime on St Kitts and Nevis, see WTO (2007).
       policies to attract remittances;
       policies to encourage wealthy individuals to establish local residency and citizenship.

2.4 The monetary balance
In formal terms, the monetary balance of a country describes the balance between the supply
of and demand for money, the standard assumption being that the monetary authority uses the
base rate of interest as its principal instrument for regulating the balance. However, in
practice the situation is a bit more complicated than this, and for SKN the picture is further
complicated by two factors: (a) the country‟s membership of the ECCU; and (b) the limited
availability of traded government securities – GoSKN itself only offers three-month Treasury
Bills, and there is a very thin and limited market in longer-dated securities in the sub-region.
Let us now explain what all this means.

Normal practice is for the relevant central bank to collect data on the operations of the
financial institutions, both for public information, to facilitate analysis and to support
regulation. Thus, for example, the UK‟s Bank of England regularly reports on money and
lending by the commercial banks; balance sheets and the income and expenditure accounts of
monetary financial institutions; public sector debt and money market operations; issues of
bonds, equities and commercial paper; financial derivatives; and interest and exchange rates.
The Bank also publishes a quarterly financial stability report that assesses the current position
in the financial markets and the wider economy in relation to the Bank‟s objective (as agreed
with Her Majesty‟s Treasury) of keeping inflation as close as possible to the target rate of 2%
per annum; the financial stability report also assesses the key risks facing the economy as
seen by the Bank. To achieve its inflation target, the Bank‟s key policy instrument is the base
interest rate, which is set each month by the Monetary Policy Committee (MPC) of the Bank,
whose Minutes appear on the Bank of England website not long after each meeting..

As a result of the financial crisis that began in 2007, the Bank has for a time paid more
attention to the overall level of activity in the economy than to its key inflation „target‟, and
has used active „quantitative easing‟ (QE) to get more money into the economy in the hope of
shortening the recession and preventing a so called „double-dip‟. Similar action has been
taken in the Eurozone by the European Central Bank, and in the United States by the Federal
Reserve8, though it must be admitted that the „theory‟ of how QE actually works is still quite
poorly understood. Moreover, once the advanced countries‟ economic and financial situation
becomes more normal, their central banks are faced with the difficulty of how best to unwind
QE in a timely manner without either stimulating a burst of inflation or returning their
economies to recession conditions. Some delicate choices will be needed quite soon (see
IMF, 2010b).

SKN is part of the ECCU, with the region‟s monetary policy and financial market regulation
overseen by the ECCB. Monetary statistics for SKN are collected and published by ECCB,
and Table 4, below presents data from the monetary survey of the country. M1 and M2 are
respectively narrow and somewhat broader definitions of the money supply.

  In the first week of November, the Fed announced the start of a second round of quantitative easing, popularly
referred to as QE2. It is hard to see how this can have much impact on aggregate demand in the short-term,
though it may do so indirectly via its effect on longer term asset prices.

Table 4. St Kitts and Nevis: Monetary Survey, 2007-August 2010

Item                                 2007           2008           2009           2010,
Net foreign assets                   558            747            632            657

Domestic credit, of which:           1567           1609           1677           1746
 Government (net)                            465            337            375             414
 Private sector                             1173           1243           1295            1375
 Other public sector                         -71             29              7             -43

Monetary liabilities (M2), of 1625                  1651           1748           1821
 Monetary supply (M1)         226                   252            244            276
 Quasi-money, of which:       1399                  1399           1504           1545
  Time deposits                              378             398            491            523
  Savings deposits                           566             603            639            645
  Foreign currency deposits                  455             398            375            376

Other items (net)                    -500           -705           -561           -582

Source: MTESP (2010), ECCB (2010), ECCB website
Notes: All figures are in million EC$ and indicate outstanding stocks at end-of-period.

GoSKN has little discretion over matters of monetary policy, since the exchange rate is fixed
and base interest rates are set by the ECCB. In conducting monetary policy, the ECCB‟s
policy objective is “To maintain the stability of the EC dollar and the integrity of the banking
system in order to facilitate the balanced growth and development of member states” (ECCB
website), and base interest rates are set periodically by the Monetary Council in order to
promote this goal. In practice, of course, being part of a fixed exchange rate system normally
leaves the authorities very little practical flexibility as regards setting these rates.

At the same time, regardless of the ECCU monetary policy stance, the SKN government
deficit has to be financed, as does the entire outstanding public debt of the country. In an
economy with only short-term securities and lacking a long-term bond market, there are
limited options, of which the principal ones would appear to be borrowing from domestic and
foreign banks. Given the existing level of indebtedness, domestic (and to a lesser extent,
foreign) banks‟ exposure to SKN government debt has already reached worrying levels, with
the result that even a modest rescheduling of the country‟s debt would put at risk the
liquidity, and possibly even the solvency, of some of the major local banks. Given these
dangers, it seems quite surprising that ECCB has not hitherto (to our knowledge) acted more
forcefully to control the indebtedless of local banks to GoSKN. That said, we acknowledge
that ECCB would wish to do all in its power to maintain orderly financial conditions, because
of the risks of contagion across the ECCU area.

2.5 Connections between the four accounts
We have now introduced the four accounts that, taken together, sum up a country‟s
macroeconomic framework. In outlining the policies that are often used to influence one or

other balance, we already noted some of the main linkages between the accounts. But it is
important to understand that all four accounts are interconnected through several different
channels, and in designing sound macroeconomic policy this must always be kept in mind.
Figure 1 on the next page illustrates some of the key inter-connections, which we now briefly

Some of the connections follow directly from writing down the basic accounts. Thus exports
and imports both appear in the real balance and in the balance of payments, government
spending on goods and services appears in the real balance and in the government balance.
Less direct, but still important connections are the following: (a) the government balance and
monetary balance are interconnected since government deficits and accumulated debt need to
be financed; (b) the monetary balance influences the real balance since much spending in the
latter requires credit from the banking system to support it; (c) the balance of payments
influences the monetary balance as net income from abroad, as well as some capital flows,
involves transactions with local banks. We conclude that it would be a serious error to try to
use policy to manage one or other of these accounts without taking into account their inter-
relations with the others.

Later, we show what this implies for the design of a well functioning and effective
macroeconomic framework for St Kitts and Nevis. For the moment, however, there is one last
general point that is worth making. This is the simple point that the unavoidable fact of
multiple inter-connections between the different elements of the framework does not imply
that the entire framework ought to be managed by a single authority. In other countries there
are always multiple authorities, each managing its own component of the macroeconomic
framework, and the situation should be no different in SKN. The issue, therefore, is never
how to achieve unified control – in most countries that is neither feasible nor desirable – but
rather how best to achieve good communication between the different authorities which,
collectively, are charged with the task of managing the economy.

              Real balance                         Balance of payments

            Y=C+G+I+X-M                         X-M plus net income from
                                                 abroad plus net capital
                                                  flows plus financing

            Government balance

         Tax revenues plus non-tax
       Spending on goods and services
           Spending on transfers
              Deficit and debt

                                                     Monetary balance

                                                 Assets and liabilities of the
                                                   central bank (ECCB)
                                                 Assets and liabilities of the
                                                     commercial banks

                                               Net lending to the private sector

    The Eastern Caribbean Central Bank            Net lending to government

Figure 1. Inter-connections between the four main macroeconomic accounts

2.6 Indebtedness
We start this section by presenting some basic data on the debt situation of St Kitts and
Nevis, and its recent evolution. This is shown in Table 5, below.

Table 5. St Kitts and Nevis: Public debt and debt servicing, 2007-2010

                                       2007          2008           2009          2010 debt servicing
    Item                                                                          Principal Interest
    Total stock of debt        2511                  2619           2644          77         106
     % of GDP in market prices 181                   170            185           5          7

    External debt (by debtor)          818           891            830           49            37
     St Kitts Government                      462           578            510
     NIA                                      111           100            109
     Public enterprises                       246           213            211

    External debt (by creditor)        818           891            830
     Bilateral                                105            92
     Multilateral                             289           303
     Commercial                               424           490

    Domestic debt (by debtor)          1690     1685     1816     28                            69
     St Kitts Government                   1170     1134     1178
     NIA                                    158      179      227
     Public enterprises                     363      372      411

    Domestic debt (by creditor)        1690          1685           1816
     ECCB                                      15             9
     Commercial banks                        1194          1085
     Social security                          248           252
     Other                                    234           339

Source: Estimates (2010), IMF (2009a), IMF (2008b); GoSKN (2010a), Appendix IV
Notes: Figures are in million EC$ except where noted.

From the table, it can be seen that the public debt-to-GDP ratio, which had been falling, rose
again substantially in 2009 and is reportedly continuing to do so9. In terms of structure, a few
years ago (not shown in the table) the total debt was divided about equally between domestic
and external debt, while by now the proportions have shifted, with external debt accounting
for under one-third of the total. Nearly two-thirds of the domestic debt is funded by the
domestic commercial banks, not a particularly comfortable situation. We understand that thus
far, servicing of government debt has been exemplary in the sense that all obligations have
been met; however, at times bank overdraft facilities have been used to enable due payments
to be made; this is not, of course, a desirable way of managing the debt, as such financing is
normally expensive and and in many countries would only be available against significant
collateral. In addition, some of the public enterprises are said to be in arrears in regard to their
  Indeed, the IMF‟s Public Information Notice on the St Kitts and Nevis: 2010 Article IV Consultation, estimates
that by end-2010 the debt-to-GDP ratio will have risen further to 196% of GDP (PIN 10/145, November 3 rd
2010, IMF website).

debt servicing obligations, though we lack detailed data on this. Overall, it is apparent that the
SKN debt situation has already reached a point where it is proving difficult for the authorities
to manage their day-to-day obligations.

The recently published study of debt and default through the ages, Rogoff and Reinhart
(2009), argued that a public debt-to-GDP ratio above 90% was high enough to slow down
growth and to create difficult conditions for the country concerned, with an increasing risk of
default as the ratio increases. What would be an „optimal‟ debt-to GDP ratio is not entirely
clear, especially as economic theory provides virtually no practical guidance on the matter.
Empirical evidence from the above and other studies certainly favours relatively low ratios,
and this has been reflected in the ratios recommended by various bodies. Thus until the recent
crisis, the UK government operated for about a decade with the ratio targeted at around 40%
of GDP, while under the EU‟s Maastricht Treaty, members of the European Monetary Union
were required to maintain the ratio below 60% of GDP. One suspects that these targets/limits
arose because they were perceived to be the lowest that were realistic at the time, rather than
as the outcome of a careful analytical exercise. In this sense, the targets were more political
in nature than economic. And neither the UK (Bank of England) nor the European Central
Bank proved able to hold the actual ratios close to their preferred levels, once the economic
crisis and recession took hold.

In the Eastern Caribbean, the ECCB has set a 60% debt-to-GDP ratio as its preferred or target
value, and members of the ECCU with ratios well above this target are „encouraged‟ to adopt
policies that bring the ratio down to the target within a reasonable period. We discuss the
mechanics of such adjustments further below, but meanwhile it is worth asking the more
general question, namely how exactly do countries with high ratios get them down. In other
words, what does historical experience reveal about such processes?

This is an important question, as recent discussions about debt reduction seem to imply that
countries should normally get their debt levels down by „simply‟ paying off the outstanding
debt over a period. On the whole, though, this has not been the universal practice. Instead,
countries have often opted for either formal default or a spell of inflation, and in either case
this is sometimes aided by moderate economic growth rates. Which is best, or which is
feasible in a given case depends both on the local monetary policy environment and on the
currency in which the bulk of the debt is denominated. Thus in the postwar period, the UK,
most of whose debt was denominated in the home currency, the pound sterling, brought down
its public debt-to-GDP ratio quite dramatically through a mixture of economic growth (since
raising GDP raises the denominator in the debt-to-GDP ratio) and modest inflation, without a
formal default. The process was certainly helped by a degree of fiscal discipline, the
government mostly keeping government deficits and surpluses within a narrow range of plus
or minus two percent of GDP. For most of the period, however, there was no attempt – or
need – to deliver very large primary surpluses of the sort currently discussed for highly
indebted countries. In contrast, most of Argentina‟s debt was denominated in US dollars, so
when the debt became unmanageable a few years ago, the country had no choice but to
default and also to devalue the currency.

What do these observations imply for SKN? It seems to us that they imply four things, some
of which are elaborated further later on:

(a) Dealing with debt through a spell of inflation is probably not a serious or realistic option,
    in part because of ECCB commitments to price stability and the fixed exchange rate

    between the EC$ and the US$, in part because in a fixed exchange rate regime, domestic
    inflation quickly erodes domestic competitiveness. Also, at least in theory, inflation only
    works in this way to bring down the real burden of debt when it is „unexpected‟, as
    expected inflation ought to be incorporated into the average interest rates payable on
    government debt.
(b) However, if US policies to stimulate their economy, including the fiscal expansion
    package of 2009-10, quantitative easing (QE) by the Federal Reserve, and the recently
    announced second round of QE (known as QE2), end up stimulating inflation of the US
    economy two or three years down the line, as must be moderately likely, then it would
    make good sense for the countries of the ECCU to allow their respective domestic
    inflation rates to track US inflation; this will maintain competitiveness while eroding the
    real value of each country‟s indebtedness, including that of SKN.
(c) Economic growth provides a second channel through which public debt-to-GDP ratios
    can be brought down. This is potentially a very important route, and in the next sub-
    section we discuss ways of stimulating growth in SKN.
(d) The last way of bringing down debt levels is through fiscal discipline, sustained over
    quite long periods. This is the most difficult route, but also the most effective in terms of
    fostering conditions for favourable long-term development. What it typically means is
    cutting back on government spending while taking steps to stabilize or even raise
    revenues, hence generating a substantial primary surplus. A recent paper that studied a
    number of successful debt reduction episodes in Europe found that a „drastic and
    permanent fiscal consolidation mainly concentrating on the expenditure side‟ was usually
    the key to success (Nickell et al., 2010). We explore the implications of this line of
    argument for SKN below.

From this discussion, it is clear that for a highly indebted country such as SKN, it is vital for
any serious analysis of the macroeconomic framework to include an examination of the debt
burden and its sustainability, leading on to ways in which the total debt can be brought back
down to more manageable levels. None of this is straightforward, and analysing the debt
cannot be done in a completely objective manner since any future projections are inevitably
subject to a high degree of uncertainty. Nevertheless, it is extremely helpful to develop
projections relating to a number of possible scenarios, as is already done by GoSKN, in order
to contribute to the development of appropriate policies.

In this regard, the IMF has developed a very useful framework for analysing the question of
debt sustainability at country level; see IMF (2008a) and Escolano (2010), among other
sources10. However, while technically correct, the IMF‟s DSA framework is quite complex to
apply, very demanding in terms of its data requirements, and hence not especially intuitive in
its approach. For this reason, we have chosen in this report to develop a more „rough and
ready‟ approach that we think is easier to understand and use, and hence more practical as a
tool to guide policy-makers. Our approach is outlined relatively formally in Annex 1, while
here we offer a more informal account.

What we propose is built around a simple, single period model of the economy in which there
is an initial level of outstanding debt, and available data on the debt servicing obligations in
the current period, this referring both to interest payments and repayments of principal. It is
then a decision for the government, how much new debt to take on during the period. With
  The World Bank has also developed an approach to debt performance management using 15 indicators, and
based on the well established PEFA methodology. For our purposes, we find this less useful than the IMF‟s
approach, but for details, see World Bank (2009).

data on tax rates and revenue raising; government spending of all types, and the projected
growth rate of GDP, we can then step through the model for one period and project what debt
will be outstanding at the start of the next period.

What we find, by computing paths of total debt and the debt-to-GDP ratio for a variety of
initial conditions and fiscal parameters, is that starting from the country‟s current public debt-
to-GDP ratio (already above 1.8, as noted), it proves very difficult to devise a fiscal policy
mix that is capable of bringing the ratio down (see Table A1 in Annex 1). Rapid economic
growth certainly helps considerably, as does a high average tax rate combined with low
government spending (implying a large primary surplus). But under present conditions it will
not be easy to achieve the needed growth rates (though we examine this more carefully
below), and we have serious concerns over the political economy of the necessary fiscal
policy mix. In other words, will the citizens of SKN be prepared to tolerate the fiscal policy
mix that would be required to bring down the debt-to-GDP ratio? Or will the politicians be
prepared to implement such a mix? Moreover, with the debt-to-GDP ratio standing at such a
high level, the government‟s ability to bring it down – leaving aside the tricky political
economy consideration just mentioned – will be vulnerable to further adverse economic

Once the public debt-to-GDP ratio has been brought down, the „space‟ for domestic fiscal
policy to operate widens considerably. Even with a debt-to-GDP ratio of 1 (i.e. 100%), still
fairly high by European standards11, though below the ratios of the two problem countries,
Greece and Ireland, our scenario analysis in Annex 1 shows that there is already a fairly wide
range of fiscal policy combinations that can sustain or even reduce the ratio. This debt ratio,
therefore, is thus far more manageable for the government and less vulnerable to troublesome
adverse shocks. This is, naturally, even more true for the lowest debt-to-GDP ratio we
consider, of 0.6 (i.e. 60%), which would then be in line with the norm advised by the ECCB.
This analysis implies, we believe, shows just how fragile the current financial situation facing
the Government of St Kitts and Nevis appears to be. Current debt levels are only sustainable
with quite draconian fiscal policies, requiring both a high tax take and very tough controls on
government spending. Moreover, such policies will only succeed if the wider economic
environment remains moderately benign, with no substantial adverse shocks. Accordingly,
some debt restructuring might be needed, in agreement with the country‟s principal creditors,
to lay the foundations both for future growth and for a better balanced macroeconomic

2.7 Competitiveness
For a small open economy such as that of SKN, competitiveness has to do with producing
goods and services for the market – either domestic or overseas, or both – that are of good
quality, while production costs are sufficiently low that these goods and services can be sold
profitably. There is no long term economic advantage to be had from selling goods at a loss;
likewise, subsidising production directly or indirectly is rarely desirable for any length of
time, especially in a country like SKN where the public finances are already under
considerable strain. There is a wide variety of policy instruments that can influence

  It may be questioned why we make a comparison with Europe here. The reason is simple and certainly has
nothing to do with Europe‟s good record in managing its public debt, indeed quite the contrary. The point is,
though, that Europe‟s debt problems have reached crisis point in some countries of the EU essentially because
major creditors began to doubt the ability of the governments concerned to meet ttheir debt servicing
commitments. As soon as that situation arose, these governments were unable to borrow in the markets except at
penal interest rates.

competitiveness, many of which lie outside the scope of this study. For completeness,
however, we list them all here, then examine more closely those that fall under the broad
heading of „macroeconomic framework‟, bearing in mind that for such a small economy, the
usual distinction that is made between microeconomics and macroeconomics is far less valid
than it would normally be, as we noted above. So what influences competitiveness? We
suggest the following factors:

       The exchange rate of the Eastern Caribbean Dollar (EC$);
       Trade and tariff policy (including any NTBs in place, and also restrictions/
        preferences operated by trading partners);
       Wage rates, labour force skills, and productivity; training and education;
       The business environment – conditions for start ups, business development, exits
        from the market, and general business regulation;
       Availability and terms of business credit;
       Local taxes that influence business operating costs.

The exchange rate
Of these, the exchange rate is set for the members of the ECCU (Eastern Caribbean Currency
Union) by the ECCB; the rate has been held stable for many years now, at EC$ 2.7 = US$ 1,
and can only be changed by unanimous vote of the Monetary Council. The rate is highly
unlikely to be changed in the foreseeable future. Holding the rate steady in this way provides
a helpful monetary anchor for the member states of the ECCU, including SKN; however,
should any member experience domestic price inflation at a rate markedly more rapid than
the rest of the region, its economic competitiveness in external (export) markets would
deteriorate quite rapidly as its exports would be relatively more expensive in their normal
external markets. At the same time, imported goods and services would appear relatively
cheaper, and so some domestic demand would shift more towards imports. The net effect
would be a deterioration in the St Kitts and Nevis balance of trade, accompanied by job
losses as uncompetitive firms were forced to close. For these reasons, given what is
effectively a near-fixed exchange rate system for the region, the maintenance of domestic
price stability is very important. Any member country facing a persistent imbalance would
have to undertake urgent and probably quite difficult structural reforms to improve its

Trade and tariff policy
As far as trade and tariff policy are concerned, the general approach within the CARICOM
area is to operate free trade within the region, and to propose low or zero external tariffs.
However, progress towards this goal has been impeded by delays in reaching an acceptable
revenue-sharing agreement, though the CARICOM „vision‟ is generally considered to be an
efficient arrangement, conforming to WTO rules and promoting trade. Current trade practice
as operated by GoSKN falls well short of this theoretical ideal, with diverse tariffs and other
trade policy measures in effect; for details, see WTO (2007).

In fact tariff and other trade-related revenues are important elements in the country‟s budget
revenue. Thus in 2008, import duties charged on imported items amounted to EC$ 44 million,
while customs service charges amounted to EC$ 31 million; in the approved budget for 2010,
the corresponding figures were import duties EC$ 45 million, customs charges EC$ 32
million. Taken together, the trade-related revenues for 2010 came to 12.5% of total budget
revenues and grants (Estimates, 2010), a significant contribution. These trade-related

revenues also came to about 7.6% of imports of goods and services in 2010, implying
moderately low average tariffs, albeit markedly higher on goods than on most services.

Now, from January 2011, these revenues will start to fall as SKN implements the first stage
of the agreed tariff reduction schedule that forms part of the country‟s Economic Partnership
Agreement (EPA) between CARIFORUM countries and the EU (see OJ, 2008). The initial
impact of this change will be quite small as only a modest proportion of SKN trade is
conducted with the EU, an almost negligible fraction of exports and about 7% of imports;
over three-quarters of merchandise exports go to the US and almost two-thirds of imports
originate there. Over 80% of exports belong to just one SITC broad sector, namely SITC 7,
machinery and transport equipment; imports, naturally, are far more diversified.

To comply with WTO rules, the current customs service charges also need to be converted
from their present ad valorem basis (which makes them, economically, just like a
supplementary tariff) to specific charges for services rendered, a change that would
undoubtedly cut the resulting revenues; at present GoSKN is seeking to delay this change.
These forthcoming revenue changes will in any case be partly offset by the new VAT that
just came into force in November 2010, since this will be levied on most imports (in line with
standard international practice), while the previous sales taxes on imports only applied to a
limited range of goods.

Labour force skills
Labour force skills can always be improved though a mix of work experience and well
designed training programmes, and SKN has benefited from some significant training in
modern IT skills recently. However, in general, training provision needs to reflect both the
needs of the economy – in other words, what types of skill will be demanded in the future as
the economy grows? And the capabilities and needs of the (potential) trainees themselves –
for instance, displaced sugar workers might well be able to turn their hands to other
agricultural work, especially if GoSKN releases enough public land to facilitate that; but
retraining for IT or manufacturing work might be less successful. This broad area has great
practical importance, but lies outside the remit of the present study.

The business environment
Turning to the business environment, the World Bank‟s annual Doing Business surveys
provide useful and up-to-date assessments of the current position (see DB, 2010). These
surveys assess the business environment along nine principal dimensions, namely: (i) starting
a business; (ii) construction permits; (iii) registering property; (iv) obtaining credit;
(v) protecting investors; (vi) paying taxes; (vii) trading across borders; (viii) enforcing
contracts; and (ix) closing a business. For indicators (i), (ii), (v) and (vii), SKN is ranked in
the top third of the 183 countries surveyed for Doing Business 2011. The country‟s
performance is rather less impressive in regard to indicators (iii), (iv), (vi) and (viii), with
registering property proving most problematic. Last, while indicator (ix) is shown as the
worst (rank 183 out of 183), it seems to us that the ranking is spurious, as it was apparently
based on no data; however, we do understand the closing a business can take a long time and
be very costly. As a result, the overall SKN business environment ranking of 87 out of 183
countries is probably a little too harsh. That said, SKN clearly has several elements of a very
good business environment, though in the areas indicated there is room for active policy
measures by the government to bring about improvements there too; the details lie well
beyond the limited remit of the present report.

2.8 Economic growth
According to CGD (2008), sustained rapid growth of GDP depends on high rates of
investment (fixed capital formation), productivity growth (linked to improvements in human
capital, together with innovation), and institutional improvements that facilitate private sector
business activity. Much of this concerns strengthening the supply side of the economy,
though investment itself plays a dual role: on the one hand, investment is a component of
aggregate demand, and to that extent increases in investment expand current economic
activity; on the other hand, investment today should raise productive capacity and hence
output tomorrow, contributing to future growth.

For this latter part of the growth model to work, it clearly matters that the economy not only
has a substantial volume of investment going on, but also that most of it should be highly
productive. Hence it is not particularly good for sustained growth to invest in the building of
pyramids or presidential palaces, and so investment selection – the choice of economically
sound, profitable projects – is very important. This is the case whether such investment takes
place in the private sector or the public sector. In the private sector, however, we normally
assume that investors will be motivated by the prospective profits they can earn when their
projects bear fruit, comparing these as needed with the costs (mostly interest, but also
arrangement fees, some legal costs, and the like) of securing any necessary credits. For this
mechanism to work well, it is very important that private investors should not be able to
„distort‟ their profits unfairly by negotiating special deals with the government concerning
such matters as taxes, subsidies, „special‟ fees for services from government enterprises,
„special‟ prices for government-owned land, or anything else. In other words, the profit
motive works best when rent-seeking behaviour by private agents is effectively restrained.

For public sector investment, except for projects associated with public enterprises delivering
clearly identifiable services to the general population where the approach ought to be quite
similar to that just outlined for the private sector, some form of cost-benefit analysis should
ideally be used to evaluate individual projects. However, while the team managing the PSIP
within MSD certainly have regard to securing value for money when they analyse, approve
and implement public sector projects, no formal cost-benefit analysis is at present undertaken.

Now, what elements of this approach to growth make sense for the economy of SKN? We
shall study this under the three supply-side headings referred to above. In addition, it also
proves helpful to think systematically about potential sources of future demand.

2.8.1 Investment
The estimated ratio for St Kitts and Nevis has exceeded 40% of GDP in recent years;
however, we doubt whether investment has really been quite so high there (as we discuss
later). The investment is funded from a mix of domestic savings and foreign inflows,
including FDI. Since CGD (2008) argues that for sustained economic growth an investment
ratio of at least 25% of GDP is desirable, it seems that SKN is already quite well placed. But
leaving aside the recent recession, the reported volume of investment has not delivered very
rapid growth rates, suggesting that much of the investment has not been very productive in
terms of raising GDP levels. This is an issue that needs further investigation.

Our initial thoughts on the matter are summed up in the following points:

   Much investment has gone into traditional and established sectors such as tourism that
    might already have peaked. There may still be scope for successful investment in up-

    market and niche tourism but this is a risky and difficult area, and tourists are quite
    capricious regarding their preferred destinations. Hence good marketing and high quality
    services are essential for the sector to be sustainable.
   Some investment has supported low-cost housing, which is good in social policy and
    poverty-reduction terms, less good in terms of contributing to future GDP and economic
    growth (it can also add to strain on the public finances).
   Investment in infrastructure sometimes takes a long time to bear fruit in terms of
    stimulating additional private sector activity and much infrastructure is subject to
    substantial increasing returns to scale, e.g. airports, port facilities, electricity generation,
    etc. Thus on small island economies these facilities, while important, deliver relatively
    low returns – they are either large enough to deliver economies, but are then too large for
    the local economy; or they are small and relatively high cost. There may actually be scope
    for some creative thinking in this area to design infrastructure better adapted to very small
   Rates of innovation have generally been low, and investors – along with the local banks
    that finance them – have been rather cautious about entering new and potentially highly
    profitable business areas.

2.8.2 Productivity growth
The second supply-side factor fostering economic growth is productivity improvement, that
depends in part on raising capital per worker (in other words, the investment channel just
discussed above), in part on improving average worker quality through education, skills
enhancement, and the like. Now, basic education in SKN is good, with literacy almost
universal, but at the secondary and especially at the higher levels the picture is more uneven,
and probably more needs to be done to enable people to work productively in new activities
such as jobs that make use of ICT skills, and various high value-added service-sector
businesses. Again, further investigation is needed that would take us well beyond the limited
scope of this report.

2.8.3 Institutional improvements
Institutions that are thought to influence economic growth are important background factors
such as the „rule of law‟, protection of property rights, protection of business contracts, and
the like; „rules of the game‟ such as business accounting and tax rules, registration and
licensing procedures, regulation regarding employment practices, and so on. This heading
also includes organisations like banks, business associations, parts of public administration
that interface with business. And last, the heading includes the broad area of business culture,
the often informal and un-codified practices that govern many business transactions and
activities in most societies (see North, 2005). The difficult part in all this is to combine these
various elements into a form of institutional matrix that enables a given society to deliver
sustainable growth.

For SKN, the main elements are generally in place, but there is scope for significant
improvement, for instance by drawing on the lessons of the World Bank‟s annual Doing
Business exercises (see World Bank, 2010) as suggested above. Focussing more sharply on
competitiveness issues, WEF (2010) also offers important lessons for the region, especially as
several of the larger Caribbean countries have been slipping down the World Economic
Forum rankings in recent years. The rankings are based on a combination of indicators in
three areas, namely: basic requirements; efficiency enhancers; innovation and sophistication
factors. Even without its own explicit ranking, by reviewing these areas SKN should be able
to identify concrete steps that it can take to enhance competitiveness.

Another critical aspect of the institutional framework in small economies has to do with the
nature of the state and its close and often very personal relationships with the private business
community. For the result is often to create a far from level playing field for business, a
situation that commonly deters new entry into various markets, and impedes the orderly exit
of failing firms, harmful for longer term growth and efficiency. It is not easy to design and
operate political structures in such a small economy that fully eliminate these shortcomings.
Nevertheless, reforms are needed to improve the functioning of government in relation to
managing the economy, and in part this will entail cutting back on government functions and
regulation to enhance private sector flexibility.

For the economy per se, the implication is that in many markets, even when the firms are not
very large, there will not be many of them. Consequently, rather than being properly
competitive, markets are often structured as local monopolies or oligopolies. Small to
medium firms on small island economies have far more market power than one would
normally assume. This is an alternative way of expressing the point that in such economies
the usual gap between the micro-economy and the macro-economy is not very wide.

It is probably unwise to think of the institutional matrix entirely at the single country level
for SKN, since many aspects of institutions are associated with fixed costs and there is much
to be said in favour of cross-country sharing of some institutions where this is feasible. There
may be significant opportunities here for resource saving across the Eastern Caribbean sub-

2.8.4 Sources of demand
From the basic national accounting identity that we discussed above, it follows that the
potential sources of additional demand – to drive forward future economic growth on SKN –
are, respectively, private and public consumption, investment, and net exports. Of these,
severe public spending constraints will prevent public consumption from contributing to
growth for some years, at least until the country‟s indebtedness has been brought under better
control. Private consumption offers a little more promise, though at present wages/incomes
are likely to advance only slowly, if at all; however, additional job creation would quickly
translate into additional consumer spending, setting off a virtuous circle.

The important question then is this, namely where such additional jobs might come from.
One possible answer is simply that the recently successful sectors on SKN such as tourism,
construction, and perhaps financial services, might revive as demand in the advanced
countries picks up after the recent recession. This would be a rather passive approach to
future economic growth, involving little more than waiting for recovery elsewhere, keeping
in mind the normal adjustment lags implying that SKN‟s recovery ought to follow one-two
years later.

There are some factors in the external environment that make this seem quite a risky
approach. For instance, at the beginning of November, the UK government raised quite
substantially the rates of APD charged for each passenger on long-haul flights, such as those
to the Caribbean, and this is likely to discourage some travel to the region. No doubt in
different ways, other major source countries for Caribbean tourists can be expected to adopt
equivalent measures, sooner or later. Hence in the future, we expect that tourists who stay
over on the islands – and they are the main spenders – will increasingly be those who seek
high quality, up-market facilities and services. For SKN, this could be good news in the

longer term, but for the immediate future it is not good at all, as much of the existing tourism
infrastructure is visibly „tired‟, and is in need of substantial new investment.

A more active approach to fostering economic growth in SKN, which is what we would
prefer to see, would start from the two remaining components of aggregate demand,
investment and net exports of goods and services. Since we have reason to believe that
investment is not at present correctly measured in the national accounts – see elsewhere in
this report for our detailed analysis – we focus here on net exports, by which we mean:
exports less imports. Thus an overall stimulus to growth from the demand side can be
achieved if either exports rise or imports fall, or both. How can this happen? We see several

   Recovery and expansion of recently successful exports, e.g. electronic components;
   Stronger export performance in existing services such as insurance, financial services,
    offshore higher education, etc.
   Development of new manufactured export capabilities focussing on high value added
    niche production;
   Development of new services.
   Import substitution, i.e. develop local production to replace some existing imports of
    goods. Fresh and processed foods, soft drinks, and alcoholic beverages are among the
    products that come to mind here.

The first and second of these essentially come under the heading, „more of the same‟, in other
words the country seeks to expand activity in areas where it already has expertise and a track
record of successful production. It is always desirable to make the most of what is already
doing well.

The third and fourth points, however, offer more difficult challenges, and might even be
considered somewhat controversial. Let us explain. First, as regards finding new
manufactured exports, that is fundamentally a matter for the private sector, both existing
firms and potential new ones. From a governmental, or public policy perspective, what
matters is the broad business environment within which new firms are established, existing
ones grow, and failing ones exit from the market; and this, government policy can and should
influence for the better. Among other things, government should not normally be offering tax
concessions or other „favours‟ to stimulate new businesses. And government should not be in
the business of identifying the next sectors that will become export earners for SKN in the
future, as most governments have an atrocious track record when it comes to „picking
winners‟. We have no reason to believe that GoSKN would perform any better. So the
government cannot „pick winners‟, but it can do a good deal to improve the business
environment, and hence foster stronger export capability, as we explain elsewhere in this

As regards the fifth point, it is well known in the development literature that import
substitution as a general development policy was followed with mixed results in Latin
America, and mostly unsuccessful results in sub-Saharan Africa. The approach is largely
discredited except when accompanied by other policies that vigorously promote innovation,
learning, and productivity improvement. So if we consider such an approach for the
economy of SKN, we cannot envisage it in the old fashioned way with local industrial
expansion being supported behind tariff walls and other forms of trade restriction, especially
as the SKN economy is too small to generate economies of scale when producers are only

serving the domestic market. In any case, SKN has long been a WTO member and its trade
policy commitments would therefore – quite properly – preclude such an approach.
Accordingly, we have to think of import substitution in more modern, economically
sustainable terms. Even then, we suspect its practical scope will be fairly limited.

As a starting point, it is worth referring to Summary (2010a, 2010b), the first an overview of
economic development in 2009, the second, one of a series of quarterly reports on recent
economic development produced by MSD for GoSKN. These reports begin by discussing
agriculture, and they include tables that show agricultural production by commodity, national
demand for each product, and hence the fraction of demand that is satisfied by domestic
production. The rest, of course, is met by imports, but the implication of the reports is that
there is a big potential for local producers to expand production to meet more of the demand
and displace some imports. But is this really the case, and if it is, what has been preventing
local producers, i.e. farmers, from expanding already? We list some possible factors:

   Additional production might not be (perceived to be) profitable by farmers, with the
    prevailing technology (e.g. due to unreliable rainfall);
   There may be genuine resource constraints, such as:
        o A lack of additional land available for farming (government may need to lease or
            sell more, though we have been advised that sufficient land has already been
        o There may be a shortage of people with the right farming skills, or with a desire to
            go into farming;
        o Adequate credit may not be available, or collateral requirements may be too
   What grows well on SKN might not be the precise varieties that consumers prefer to buy;
   Infrastructure linked to agriculture, to do with crop storage, packaging, transportation,
    and the like may be deficient and that might be a barrier to new development.

These points show that in a free market environment, import substitution is actually a rather
complex policy with all sorts of dimensions even in the simple case just discussed. But
thinking through such examples does nevertheless suggest ways in which a pro-active
government can help. In the above case, for instance, help/advice may be needed to improve
the technology being used by farmers, to promote skills development, to find mechanisms for
making credit available on improved terms, to undertake market research, and to improve
infrastructure. This adds up to a significant and quite differentiated package of measures.
That said, even with such extensive support in place, additional farm output may just not be
profitable on SKN, not least because the major supermarkets demand year-round supplies of
consistent quality and local producers might struggle to provide that at adequately
remunerative prices.

As a second potential example where expansion on SKN might be economically attractive, let
us now consider a service, offshore higher education (OHE), by which we mean the location
on SKN of branches of foreign universites, offering particular courses, either leading right up
to degree level or requiring one or two years back in the home country (mostly the US) to
complete the degree programme. Several such institutions already operate on SKN and have
done so successfully for some years, and hence it is only natural to speculate about expansion

At the moment it is not easy to obtain a clear picture of the scale of the sector, since its
activities are not yet measured as part of the GDP. However, accompanying the GDP
rebasing exercise noted below, we expect that this gap in coverage will shortly be filled.
Meanwhile, we have been advised that OHE on St Kitts and Nevis could account for over
10% of the GDP.

Nevertheless, exporting additional higher education services by having more external
students come to SKN can be good business. In the first place, naturally, it has to be good
business for the institutions concerned; in the second, once an institution is up and running
and taking students, its activities give rise to additional local consumer demand, including
demand for accommodation services; also additional demand for local material inputs and
services, e.g stationery, computers, IT services, and much else besides. Through these
activities, the government also benefits though the extra tax revenue they generate, now
including the new VAT, offset to some degree by the additional public services that need to
be delivered. Assessing the economics of, and future prospects for, the OHE sector would
therefore be a useful exercise12.

A few points are worth noting, based on the existing experience with OHE activities on St
Kitts and Nevis.

    The sector took off at least in part due to constraints imposed by professional bodies in
     the US, e.g. restricting the numbers of veterinary or medical students in the US, at a time
     when there was nevertheless a shortage of well trained vets and doctors. This opened up a
     market opportunity which several institutions have taken advantage of.
    Thus OHE did not, on the whole, develop in the region due to especially attractive local
     conditions, it was more the result of „push‟ factors in the US. Hence it is not clear what
     real basis there might be for further expansion, and even some of the existing
     establishments might have reached their peak.
    Further, the costs for students are no lower than they would be in the US, and can
     sometimes be higher, depending on local living costs. Most students are dependent on
     Federally funded student loans, and so the viability of these offshore academic
     programmes is critically dependent on maintaining Federal approval of the respective
     courses. This in turn depends on maintaining high quality and a good academic
    Some countries in the sub-region have probably not fully understood the importance of
     quality here, and have to some degree undermined the Caribbean „brand‟ by allowing
     relatively poor quality institutions to register.
    Last, there is an important security issue. When US students come to live in the a country
     such as SKN they reasonably expect to be safe, and some governments have not treated
     this aspect with sufficient seriousness, obliging some OHE operations to spend substantial
     resources on their own security. This raises their operating costs, and at the margin is a
     factor reducing the economic attractiveness of OHE in the Caribbean.

In our view, exactly this sort of detailed, micro-level thinking – for each sector or product
group, old and new – is needed to make an export expansion and import substitution policy
work for SKN.

  It was not within our remit to carry out such an exercise in the present report, but the main points we make are
in line with a recent very useful consultants‟ report on the OHE sector, from which the executive summary was
made available to us.

3. Implementing the Framework on St Kitts and Nevis
While the previous section outlined the elements of the macroeconomic framework and
showed how they are inter-connected in various ways, we now turn to more practical matters
concerning how the framework might be operated and implemented on SKN. We start by
discussing some important data and measurement issues, after which we explain how existing
practice on SKN can be built on and improved.

3.1 Data Issues
3.1.1 Measuring GDP
The Gross Domestic Product (GDP) of a country is a measure of the value of goods and
services produced on that territory in a given period13. There are three standard ways of
measuring the GDP of a region or country. These are the expenditure method, the income
method, and the production (or output) method. Since the three methods represent different,
and independent, ways of measuring exactly the same thing, then for any given accounting
period – a quarter or a year, say – they should come up with the same number.

In practice, this rarely happens as precisely as one might like, for two principal reasons:
(a) the different measures of GDP are commonly measured using different prices, so to make
them come out the same some correction is needed to allow for that, as we noted above; and
(b) inevitably, some economic activities are recorded incompletely or with errors; as a result,
in most countries of the world, the national GDP accounts are made to balance by the
inclusion of an item, „errors and omissions‟. Naturally, one hopes that this item will be quite
small (less than 2-3% of GDP, ideally), and that it doesn‟t fluctuate greatly from one year (or
accounting period) to the next, so that users of published GDP data can have some confidence
that the main magnitudes and trends are being picked up fairly reliably.

Now, in St Kitts and Nevis, the estimates of GDP are exclusively made using the output
method. The estimates are made by the Statistics Department within the Ministry of
Sustainable Development. In order to do so, the economy is sub-divided into branches of
production, and for each branch the production units (firms, public enterprises, government
departments, etc.) are surveyed in order to determine their output in the relevant accounting
period. For national accounting purposes, the relevant measure of output is not the one that
most people would consider most natural. Thus the „output‟ of a firm is not its gross output
(or total production), but its value added.

Since the concept of value added is surprisingly widely misunderstood, even by experienced
professionals, it seemed useful to illustrate it here by providing three examples. For private
sector firms with marketed output, the value added can be measured relatively easily, as
Example 1 in Table 6 (the chosen activity is a bakery business), below, indicates. For a public
enterprise that nevertheless markets its output, the calculation is a little different, as shown in
Example 2 (the chosen example is electricity supply – we realise this is at present a
government department on St Kitts, but for purposes of the example we treat it as a public
corporation). Last, for publicly provided services such as schools, the calculation is different
again as there is no marketed output. In all three examples we neglect complications that can
arise due to features of the tax system.

   Alternatively, many countries also measure the Gross National Product (GNP), which measures the total
income of residents of a country in a given period; it differs from the more usual GDP by net income from

In Example 1, everything is straightforward and value added is measured as shown, the figure
in bold. This figure represents the bakery‟s contribution to the GDP. As can be seen, the
gross output of the bakery (312) is nearly three times the value added (121). Notice that the
value added can also be measured as the sum of the next two rows, wages and salaries plus
profits before tax, and using this approach would give us the income method for measuring
GDP. Thus the same business accounts give us both the production and income measures of
GDP, making clear why they have to be the same.

Table 6. Three examples of value added calculations

Example 1. Bakery
                                       (1) Sales of bakery goods                                              312
                                       (2) Flour                                                               88
                                       (3) Other materials                                                     62
                                       (4) Purchased services                                                  41
                                       Value added (1) – (2) – (3) – (4)                                      121
                                       (5) Wages and salaries                                                  71
                                       (6) Profits before tax                                                  50

Example 2. Electricity
                                       (1) Electricity sales revenue                                        6,988
                                       (2) Fuel costs                                                       2,570
                                       (3) Other generation costs                                           1,125
                                       (4) Distribution costs                                                 544
                                       Value added (1) – (2) – (3) – (4)                                    2,749
                                       (5) Wages and salaries                                               3,200
                                       (6) Profit/loss                                                      - 451

Example 3. A School
                                       Revenues                                                                Nil
                                       (1) Non-salary budget                                                   84
                                       (2) Wages and salaries                                                 733
                                       Value added (2)                                                        733

Note: All figures shown are in ‟000 EC$; also all figures shown in these examples are made
up – the examples are purely illustrative.

In Example 2, the picture is quite similar, except that we show the electricity company with a
positive value added14 (again, the figure in bold) but with negative profits, in other words the
company is running at a loss. However the company is organised legally, the loss has to be
covered from somewhere. In the short run, this presumably requires a subvention from the

  In principle, it is possible for some activity to exhibit negative value added, which means that increases in its
scale would actually reduce the GDP. This is never a good idea!

government‟s current budget. In the longer term, though, the situation requires some careful
analysis to investigate why there is a loss and to explore ways of dealing with it. For instance,
wage costs might be far too high, non-wage costs might be too high or, more likely, the prices
being charged for electricity might be much too low – it is claimed that in SKN, electricity
prices only cover about 60% of costs. Moreover, we understand that on St Kitts government
departments are not even metered for electricity, let alone charged anything for their usage;
economically, this is clearly inadvisable. The NIA does, however, pay for its electricity
usage, we understand.

Many governments around the world tend to think of electricity as an „essential‟ public
service, and subsidise it accordingly. This is rarely economically or socially justified unless
the country‟s public finances are in exceptionally good shape; for SKN, allowing the public
electricity utility15 (still organised as a government department, as noted) to operate with
regular losses is unwise. A further issue here is not only setting the right prices, but getting
people to pay them in full and on time. Such payments discipline is very important, but we
understand that payment arrears and even write offs are sometimes tolerated in SKN as a
„back-door‟ way of supporting businesses in difficulty; again, this is generally inadvisable16.

It might be thought that this short digression on electricity pricing and policy was not relevant
for our analysis of the macroeconomic framework. For a very large and diversified economy,
that view would certainly be right. But for a very small economy such as that of SKN, with a
high level of public debt and at most a very narrow „gap‟ between the micro-economy and the
macro-economy, this is not the case. For SKN, indeed, getting good policies in place for
entities such as the Electricity Department can contribute very positively to the whole
macroeconomic framework.

Example 3 shows that for a public service such as a school we measure the value added
simply as the wages and salary bill. That ensures the needed equality between output and
income measures, since in this instance they are exactly the same thing.

This completes the basic picture of how we measure the GDP using the output method. There
are, of course, some practical issues to do with data collection, accounting periods, changes in
stocks (e.g. for construction firms, as well as for farms), financing methods, and the like, but
for present purposes it is not necessary to go into any more detail.

SKN‟s output-based GDP is measured both in current basic prices, and in constant prices.
The latter has used 1990 prices as the base, and all the GDP data we have seen in the course
of our investigations has used that base year. However, we understand that that a
comprehensive GDP rebasing exercise has just been completed. This updates the base year to
2006; as well as updating the accounting conventions used from those in SNA68 to SNA93
(see UN, 1968; and for the 1993 version, with updates, the website:
http://unstats.un.org/unsd/sna1993/toctop.asp). Such changes are very welcome.

   It is conventional to refer to electricity supply as a public utility even when, as on St Kitts, it remains a
Government Department.
   There is much more that could be said here about electricity pricing, and indeed about the pricing of other
public utilities such as water supply, much of which might be extremely useful for GoSKN, but these are not
core issues within the remit of the present study. However, we naturally remain willing to provide additional
detail, analysis and advice on these important matters.

Accompanying the rebasing exercise, we expect that known gaps in coverage of the output-
based GDP measures on SKN will also shortly be filled. As noted above, OHE is probably
the largest such gap, and it will be most interesting to see how large its contribution is
estimated to be. Clearly, GDP measurement on SKN is advancing rapidly, all of which is
very helpful for the wider macroeconomic framework.

On the expenditure side of the national accounts, no complete and independent set of
estimates for the main expenditure components of GDP is available for SKN, though there do
appear to be plans to produce such estimates in the future. Instead, what we have is a partial
picture of expenditure, with information available on the following:

G, government demand for goods and services;
I, gross fixed capital formation;
X, exports and goods and non-factor services; and
M ,imports of goods and non-factor services.

From these data, and the GDP estimate, Y, from the output method just discussed above
(adjusted to market prices, of course), personal consumption, C, can be calculated as a
residual. In other words, we assume that the income-expenditure identity, (1), holds, and
rearrange terms to get:
                            C = Y – (I + G + X – M)                                   (2)

This approach certainly works, in that we do indeed obtain an estimate for personal
consumption, C, but any „errors and omissions‟ that there might be in the accounts are simply
hidden, absorbed into the estimated value of C. In addition, strictly speaking, investment, I,
should have two elements, namely gross fixed capital formation as already indicated; and the
change in stocks across the economy. In most economies, most of the time, the latter is quite
small, often no more than half to one percent of GDP, only occasionally higher. By ignoring
it for SKN, we are making two assumptions: (a) it is small and fairly stable for the country;
and (b) it can safely be absorbed into the estimate for C. This is probably not unreasonable,
but the truth is, we simply don‟t know for sure.

Using data provided by the SKN authorities, CARICOM (2009) has published expenditure-
based national accounts for SKN for the years 2003 through 2006. Tables 11.4 and 11.4A
(pp128-9) provide these accounts, the data being presented in current prices; Table 11.4 gives
the accounts themselves, Table 11.4A gives the same information in percentage breakdown
for each year. The reported results are, however, somewhat puzzling and need to be checked
against other data. For the 2006 expenditure account shows private consumption at 62.4% of
GDP, general government consumption at 18.2%, gross fixed capital formation at 37.8%,
exports of goods and non-factor services at 47.4% and imports of goods and non-factor
services at 65.7% of GDP.

For a very small, highly open economy, the import and export figures given here seem a little
on the low side, and we wonder what might be missing from the reported accounts. However,
the figures are consistent with the experience of other small Caribbean nations, with declining
shares of world trade.

Perhaps more remarkable, though, is the very high reported rate of fixed capital formation,
just a little under 40% of GDP; moreover, this rate for 2006 is actually the lowest rate
reported in the period 2003 to 2006. If correct, therefore, St Kitts and Nevis has enjoyed, in

the middle years of the decade, the most amazing investment boom. We noted earlier that
this has not given rise to very rapid economic growth, and suggested some possible reasons
for this, but now our focus is on the actual data.

Table 1, above, updates the CARICOM data by presenting the expenditure accounts for SKN
for the years 2007, 2008 and 2009. Thus in 2007, the last year before the international
financial crisis started to affect the Caribbean region, the account shows personal
consumption at 61% of GDP, general government consumption at 18.6%, capital formation at
42.9%, exports of goods and non-factor services at 44% of GDP and imports at 66.5%. these
GDP shares are very similar to those reported above for 2006. By 2009, by which year St
Kitts and Nevis was already being hard hit by the recession in advanced countries, these GDP
shares were: personal consumption, 74% of GDP; general government consumption, 19.6%;
fixed capital formation, 39.6%; exports, 35.1%; and imports 68.6% of GDP at market prices.
Thus consumption has advanced as a share of GDP, exports have fallen back significantly,
and investment (as currently measured) has dropped back a little, perhaps less than one might
have anticipated.

We are convinced that the reported investment data in the SKN expenditure-based national
accounts cannot be right. Nevertheless, ECCB economists (private communication) have
confirmed that in their view these investment figures are in fact broadly correct. Further
investigation is therefore needed to establish why/how such a high apparent rate of
investment has yielded such modest economic growth. The matter cannot be fully resolved
here, but a few points can be noted:

(a) Some of the reported investment might have have been misclassified as such, and might
    actually be consumption;
(b) Other parts of the GDP, notably consumption, may be underestimated, and this would
    tend to make the estimated investment ratio higher than it should be.
(c) The output-based measure of GDP may itself be underestimated, due to the omission of
    some activities, or incomplete coverage, as noted above.

3.1.2 GDP Projections
It is difficult enough to estimate the GDP for the current year and for the recent past, but it is
far harder to develop GDP projections for the medium term, generally interpreted on SKN to
mean the next three years. Yet such projections are needed by the Ministry of Finance to
enable it to construct its estimates of government expenditures and revenues as part of the
annual budget cycle. We therefore outline here the methods used to obtain the required GDP

To our knowledge there are no formal statistical or econometric models of the SKN
economy, and even if there were, such models never determine everything. Their projections
are always dependent upon estimates of certain pre-determined variables, as well as on
judgements about key trends in the world economy that are expected to influence the
economy in question. Aspects of the external policy environment are also relevant. In making
GDP projections for SKN, even in the absence of a formal model, such estimates,
judgements and policy assumptions are nevertheless vital features of the projection process.
In addition, however, certain leading indicators are used to try to pick up very local and
current factors that influence the likely growth of GDP, factors that are found from
experience to change in advance of any measured change in the GDP itself.

Let us now outline how all this comes together in making a projection.

(i) Estimates
Some variables are important to know when projecting parts of the GDP, but they are either
not economic variables at all, or perhaps only react to economic circumstances with very long
and highly unpredictable lags. The natural example of such variables would be anything to do
with demographic trends.

(ii) Judgements
A small open economy such as that of SKN is highly dependent upon trends in the wider
world economy. It was already hard hit, albeit with a lag, by the financial crisis and recession
that started in the advanced countries in 2007; the economy of SKN being most severely
affected in 2009, with a more than 9% decline in real GDP as we saw above. Likewise, as the
advanced countries slowly recover, it is to be expected that the demand for SKN‟s exports
will soon pick up, as will the demand for tourism services. The hard part is to make the
judgements about the likely rates and timing of recovery in these key variables. The general
point to make here, of course, is that SKN‟s GDP and economic growth cannot sensibly be
projected without first attempting to assess these important trends in the wider world

(iii) Policy environment
Not only external trends, but also external policies influence the outlook and opportunities
available for the SKN economy. For instance, the world trading environment as governed by
WTO rules, supplemented by a variety of regional trade agreements, preferences, and the
like, clearly affect the economic opportunities open to SKN; this was very clear when the EU
sugar regime changed, leading to the end of sugar production on the islands in 2005.
Adjustment to this particular – externally imposed – economic shock is still on going. Hence
in thinking about projecting exports or when thinking about new activities that might be
encouraged to develop in SKN, likely trends in the external policy environment have to be
borne in mind. Aside from trade per se, other external influences that could be relevant for
SKN include international agreements on environmental policies, labour force standards,
financial regulation, and so on.

Normally, these things change quite slowly and predictably, but from time to time more rapid
and substantial changes occur, as for instance in the area of finance recently (as advanced
countries try to stem the leakage of potential tax revenues into so called tax havens). Hence
SKN needs to be alert to the evolving external policy environment.

(iv) Leading Indicators
Finally, to make projections of GDP in the coming quarter, year, and for the coming three
years, data on various leading indicators are collected quarterly, some of the work being done
jointly with ECCB. Typical indicators used include such measures as early crop production
reports in agriculture, tourist arrivals, production (gross output) in selected key firms, and so
on. In each case, it is assumed that the historically observed ratio between sector value added
and the indicator(s) being used will remain constant. Interviews are also held with key local
businesses to assess the latest trends in their sectors, and once indicators and interview
findings are put together, growth rates of value added (i.e. sectoral contributions to GDP) are
forecast sector-by-sector in real terms.

All this enables the growth of real GDP to be projected, using the output method of
estimating GDP. Inevitably, any such projection involves considerable experience and
judgement, and the Statistics Department of MSD has developed the necessary skills. Given
their quite modest resources, however, we were not surprised to learn that these GDP
projections are basically point projections, with no attempt made to assess risks and assign
probabilities to a range of possible outcomes. In a more developed and comprehensive
macroeconomic framework, we suspect it could nevertheless be quite helpful to assess some
of the principal risks facing the SKN economy and incorporate them into the projections, and
later we shall indicate how this might be done in Annex 4.

Once the projections of real output by sector are available, judgements are made about likely
future prices, also sector-by-sector, so that projections of nominal GDP can be estimated.
Some of this statistical work is done in conjunction with CARTAC.

3.1.3 Projecting Government Spending and Revenues
The resulting projections of GDP, real and nominal, are then used by the Ministry of Finance
in the process of drawing up the government‟s budget. The budgetary cycle covers just one
fiscal year, identical to the calendar year, but each cycle involves making projections for the
budget year itself, and the two subsequent years. Thus on an annual basis, the Ministry of
Finance, with assistance from CARTAC, undertakes a Financial Programming mission where
projections of Government revenues and expenditures are made for the coming three years;
this exercise is carried out for both St Kitts and Nevis. We make some remarks about multi-
year budgeting in Annex 3.

Put simply and briefly, the sequence of „events‟ in a typical budgetary cycle on SKN,
according to the prevailing arrangements, is as follows:

A. Constructing the annual budget
(i)    GDP projections (in output terms), real and nominal, are made by MSD, built up from
       projections for individual sectors;
(ii)   Tax revenues, and non-tax revenues, are projected by MF for the coming budget year,
       using these GDP projections. Where a tax or other revenue item relates to a specific
       sector or activity, then the relevant sector‟s output projection is used as the basis for
       forecasting that part of budgetary revenue. Otherwise, GDP as a whole is used as the
       basis for forecasting. In both cases, if there is other information available that might
       affect part of the budget, then such information is used as appropriate; e.g. discussions
       with the very largest firms can help project (corporate) income tax revenues.
(iii) Given the 2010 revenue shortfall shown in Table 2 and noted at point (x) below, there
       may well be scope for reviewing the methods used by the MF to make these revenue
       projections, especially under conditions of economic recession and financial stress. In
       general, though, we understand that the methods used to form these budget revenue
       projections have worked well in earlier years, with only small deviations between
       budgetary projections and revenue out-turns.
(iv)   Debt servicing obligations for the coming fiscal year are estimated by MF, including
       both the interest payments falling due, and scheduled repayments of principal. So far,
       we understand, GoSKN has scrupulously met all its repayment obligations in full and
       on time, though not without some arrears in regard to the obligations of public
       enterprises. At times new debt has been issued to enable the country to meet its
       current obligations. To date, SKN has always been able to refinance in this way, and
       we understand the loan terms have not (yet) been too onerous. The country‟s overall

       debt burden, however, is extremely onerous, as our earlier analysis indicated, and
       hence the fact that a strategic review of SKN‟s government debt is currently in
       progress is to be welcomed.
(v)    Expected obligations to the Electricity Department, public enterprises and statutory
       bodies for the coming year then have to be settled. In practice, what this entails within
       the budget framework is that through a process of discussion/negotiation the MF sets
       for each entity the expected surplus/ deficit for the coming year. These „targets‟ can
       never be truly binding, and it is not clear what, if any sanctions the MF/government is
       able or willing to apply in the event of performance falling short of these targets. In
       any event, the government retains the residual obligation to underwrite any
       unexpected deficits that might arise. This is not a comfortable situation, given the
       overall debt and deficit problem faced by SKN, but for the time being it seems to be
       unavoidable. This points to an urgent need, however, to review the public enterprises
       in all their legal forms, in order to manage them better and bring down as rapidly as
       possible the large drain they currently impose upon the public finances.
(vi)   Given the projected tax revenues, and these obligations, the Budget Division of MF
       then has the task of setting budgets for individual ministries. This involves a series of
       bids and counter proposals between the spending ministries and the MF, an iterative
       process that continues until total ministry spending is contained within the overall
       budget envelope determined by the MF.
(vii) In this process, the priority for the MF is to service the debt, fund civil service salaries
       and to meet pension obligations, and to ensure that sufficient funds are available to
       Line Ministries to enable them to carry out their programmes, including the
       maintenance of social safety nets.
(viii) Once this sequence of events has been completed, the budget documentation and
       detailed proposals are prepared and presented to parliament by December, just ahead
       of the forthcoming budget year.

B. Monitoring revenues and spending: Budget implementation
(ix)  In early January, the Financial Secretary and Minister of Finance sign an order that
      authorises spending to commence for the new budget year.
(x)   For each spending department, the approved budget for the year is broken down into
      monthly segments, but actual spending should only take place in line with the budget
      revenues brought in by the Revenues Department of the MF. In principle, the budget
      monitoring and control system as described to us appears to be very strict, even
      coming down to the level of determining which bills will be paid, week-by-week. But
      on closer consideration, it can be seen that the current control arrangements are quite
      defective for two key reasons:
           a. They suffer from the myth that close and detailed control implies effective
           b. There is too much that lies outside the tight control system, i.e. civil service
               salaries, pension payments, funding for the PSIP, obligations to public
               enterprises, and debt servicing obligations.
(xi)   Hence it was not surprising to discover, despite the best efforts of all concerned, that
       by end-August 2010 (as we showed above, Table 2), revenues were well behind the
       targets for the year, while spending had scarcely declined at all in relation to the
       budgeted allocations. In other words, the stated intention to hold budgetary spending
       within the limit of actually accruing revenues was simply not working very well.

This is a sketch of the present budgetary mechanisms that operate on St Kitts, and we
understand that somewhat similar procedures are in place on Nevis, administered by the NIA.
We now go on to make some concrete proposals for strengthening economic aspects of the
whole macroeconomic framework so that it serves better the needs of GoSKN.

3.2 Implementing and Strengthening the Framework: Economic Issues
From the above analysis and discussion, several issues came up that call for urgent treatment
as part of the process of implementing an improved macroeconomic framework.

(a) Public sector debt
Having referred to debt earlier in this report, and having presented analysis showing that
SKN‟s present debt, with current government policies, is plainly unsustainable, it is now time
to specify carefully our views regarding how the accumulated and excessive debt of GoSKN
ought now to be managed.

First, our basic assumption/judgement on the debt issue is that GoSKN fully intends to
honour its debt obligations; equally, we assume that GoSKN wishes to avoid a situation
where it is forced into financial difficulties by a sudden adverse turn in market sentiment.

Second, we note that as a medium-income country, St Kitts and Nevis is not eligible for debt
relief of the sort that the IMF offers or facilitates for the world‟s very poorest countries.

Third, however, it is perfectly feasible for GoSKN to hold discussions with its major
creditors, including both domestic and overseas banks, to seek their forbearance and support
in arranging extended loan facilities to spread loan repayments over a longer period than
current arrangements allow for, and hopefully at „reasonable‟ interest rates. Whether major
creditors, as part of such discussions, would be willing to accept a modest „haircut‟ on their
outstanding credit, and whether they could do so without threatening the liquidity position of
major local banks, we have insufficient information to judge. Regardless of this point, we
would be extremely surprised if – formally or informally – GoSKN were not currently
engaged in discussions with creditors. Indeed, given all the circumstances, it would be unwise
of GoSKN not to do so, and we fully expect that the IMF, ECCB and other relevant
international organizations would quietly support such discussions.

Fourth, in order to bring down the debt at a reasonable rate to more sustainable levels, a
period of severe fiscal pain is unavoidable. Starting with a total debt of almost 200% of GDP,
bearing an average interest rate of 5% (which, if anything, is probably on the low side), and
aiming to bring the outstanding debt down by 10 percentage points each year, GoSKN is
obliged to plan for a primary surplus in the annual budget round of about 20% of GDP if
GDP remains static or grows very slowly, as currently projected. With fast GDP growth, say
of 5% per annum, the required primary surplus is much less, dropping to about 15% of GDP.

In either case, this will be difficult to achieve even for one year, even harder to sustain for
several years, but doing it will send a strong signal to the country‟s creditors that SKN is truly
determined to meet its debt obligations, and this in turn should help to encourage economic
recovery, not least by creating better conditions for new FDI-funded investment projects.

Fifth, if it proves politically impossible to deal with the debt issue by generating such large
primary surpluses, an alternative way forward could proceed via a substantial programme of
public asset sales (e.g. land sales, or privatisation of publicly owned entities).

Whichever approach is chosen, once the public debt-to-GDP ratio is falling, there is an
opportunity to get into a virtuous circle in which serious and sustained efforts to bring down
the debt improve confidence and hence FDI, stimulate economic growth and hence gradually
generate some „fiscal space‟ for the government.

(b) Financing public enterprises
The existing financial arrangements for public enterprises on SKN are highly unsatisfactory.
In an economy where the public finances are under such severe strain, it is rather worrying to
find that nearly a quarter of the outstanding debt rests at the door of public enterprise (see
Table 5), and it is clear that this is a situation that should not be allowed to continue for a
moment longer than necessary. True, the GEOB has started to monitor the sector and has
already obliged some entities to publish updated accounts, in other words, compelling them
to comply with existing laws on such matters. But as we noted above, the Board‟s remit does
not include the Electricity Department (whose deficits are still part of government rather than
part of public enterprises, of course); it also doesn‟t include various statutory bodies that are
not formally set up as public corporations. Thus we have a combination of limited remit and
weak powers, implying that GEOB is at best a modest start to the urgent problem of getting
all SKN‟s public enterprises onto a sound economic footing. They simply cannot continue to
impose such a massive continuing drain on public funds.

So what should be done? We proposed a mixed strategy, involving four main elements, and
with different combinations probably suiting different entities. First, for any entity that
provides a marketable service (e.g. electricity, port authority), prices should be charged that
at least cover basic operating costs and preferably more than that, while parallel efforts are
made to get costs down; all relevant customers should pay (including the government itself).
For the Electricity Department, we understand that some significant prices increases are
likely in the current budget round.

Second, no economic service activity should remain as a government department; all that are
should be converted to the form of a commercial entity maintaining separate accounts, and
subject to the relevant Companies Act provisions.

Third, where possible, urgent efforts should be made to privatise public corporations, under
conditions where it is clear to all that they can no longer rely on government guarantees of
their future funding.

Last, entities that cannot be reformed into a more commercial mode of operation, and which
seem likely to impose a continuing drain on the public finances, should be closed down.

(c) The Public Sector Investment Programme
The PSIP is a wide-ranging investment programme, the project analysis and operational
management of which are located within MSD, and with close liaison being maintained with
the various ministries that propose individual projects. As one would expect, as a component
of public spending that involves investment, the planning and management of the PSIP does
have a multi-year perspective, looking two years back, three years forward.

One of the difficult aspects of managing the PSIP programme is that a high proportion of
public investment projects – if they are to deliver the expected benefits – have implications

for the government‟s current budget spending in future years. A few simple examples will
illustrate this point see Table 7, below.

Table 7. PSIP projects and their budgetary implications

Investment project                  Implications for future budget spending
New road                            Maintenance costs: manpower and materials
Health centre                       Doctors, nurses, other health staff; medicines; medical
Improved port/harbour               Additional maintenance costs.
Facilities                          Also, for the project to be worthwhile, need to stimulate
                                    additional port business (private sector activity)
Land drainage and/or                Additional maintenance cost.
Reclamation                         Again, such a project is only worthwhile if the improved land
                                    is then productively used, and hence generating some future
                                    tax revenues.

We are uncertain as to how far these future budgetary implications of current PSIP projects
are embedded in the budget cycle outlined above. Evidently, however, they should be, and
indeed this is one element of the budget planning processes that one would expect to be
generally better handled in a more comprehensive multi-year macroeconomic framework,
such as we sketch in Annex 3.

PSIP projects are financed in three ways: (1) loans from various bodies, including
commercial banks and multilateral IFIs; (2) grants, generally from aid donors;
(3) subventions from the SKN government budget. Grant-funded projects are naturally
relatively unproblematic, and they can go ahead without having any impact on the
government deficit or debt position (aside from the implications for future current spending,
as just discussed). On the other hand, in present conditions it is probably unwise to take on
additional loans, even on fairly „soft‟ terms, to fund new projects, though projects that
already have loan funding in place should naturally be completed (but again, subject to their
future current spending impact being manageable).

Given the government‟s overall debt and deficit position, we think it unwise for the time
being for funds from the SKN government budget to be allocated to new PSIP projects, over
and above what is needed to complete projects already committed17. That said, clearly in the
event of some emergency, such as a natural disaster, the government would be expected to
provide funding to restore/repair key items of the national infrastructure and to protect the
economic life of the nation. Thase are, after all, basic functions of government.

In the longer term, there is considerable attraction in a PSIP programme with an annual
spending envelope amounting to 5% of GDP, and we have no doubt that there would, in
principle, be sufficient good quality projects to develop a very strong PSIP. Project selection
would be critical here, and we would encourage PSIP managers to adopt cost-benefit analysis
to support this. For the moment, however, in our view it is simply not realistic for GoSKN to
fund PSIP projects beyond current commitments until the country‟s debt position has been
brought under much better control.

  This includes some large items of capital spending in the next three years needed to replace electricity
generating units for the Electricity Department, following a fire.

To end this section on a more positive note, it seems to us that as soon as government net
spending on the public enterprises has been drastically curtailed – by following the mix of
approaches outlined above – there would be scope for a modest injection of public funds into
PSIP, perhaps initially only one or at most two percent of GDP, but rising gradually as the
government regains some „fiscal space‟. As ever, managing the public finances is about
choices and trade offs, and it is surely impossible for GoSKN both to support loss-making
public enterprises on the scale that it currently does and to fund a substantial PSIP at the same
time (aside from „emergency‟ projects that cannot reasonably be delayed).

(d) Improving the methodology for forecasting budgetary revenues
This is in principle a more technical matter than the three issues discussed above. We have
outlined above the existing practice on St Kitts and Nevis, and found that to a substantial
extent, what is currently done actually serves its purpose quite well and largely meets the
needs of the relevant government departments, notably MF. True, as noted above, budget
revenues in 2010 fell rather short of forecast, giving rise to some additional budgetary
management problems for the government, but this is not regarded as indicative of a
fundamental deficiency in current practice. Rather, it simply reflects the impact of the recent
crisis and recession upon the economy of SKN, which hit some sectors and some components
of government revenue far harder than had been anticipated. Officials nevertheless expect
that, as the economy resumes growth and recovers from the recession, the established
forecasting methods will again prove their worth. Nevertheless, it is useful to consider what
alternative approaches there might be, in order to determine whether and to what extent the
current practices might be improved.

Now, in large economies such as the UK, it is quite standard for much of the government‟s
budgetary projections and analysis to be built around a large-scale, multi-period econometric
model of the economy. Thus the model currently used by HM Treasury has several hundred
equations, some of them accounting identities, some of them behavioural or technical
relationships that are estimated and updated as often as this can be done. The model is
generally used to project a variety of future paths for the economy, based on different
assumptions about various varables not under the control of the UK government; and it is
also used to project alternative scenarios to help the government assess and adapt to different
risks that the economy might face.

The underlying database for such a large and complex model is mostly drawn from Office of
National Statistics (ONS) national accounts data; data on employment, unemployment, wages
and prices; and with financial sector data from the Bank of England, and in a few equations,
data on business expectations drawn from business surveys. The data themselves are subject
to regular revisions, updating, and technical improvement. In the case of the ONS data, it is
standard practice for each variable to publish an indication of its reliability, so that users
always understand how much weight to place on particular reported figures. For instance,
capital formation is normally estimated with lower reliability than personal consumption.

Using the resulting modelling framework, the UK government is able to project GDP and its
principal components some years ahead, forecast tax and non-tax revenues and public
spending, and hence forecast the public sector deficit and the future path of the outstanding
public sector debt.

It is clear that this approach is both highly technical and subject to very high fixed costs (to
build the model and set up all the needed software to run it effectively) and high operating
costs (to update data and equations, etc.), so for a small economy such as SKN it would be
wholly inappropriate. However, there are some lessons from the UK approach that can be
helpful for SKN, even without adopting the same technical machinery.

For we would argue that what is really important about the very UK approach to economic
and budgetary forecasting and planning is not so much the technical machinery per se, but the
wider context in which it is used. Let us briefly explain what this means:

(ii)    The key point is that the UK economic modelling framework is not merely the
        „property‟ of HM Treasury. For the entire Treasury model is made available (for a fee,
        we imagine) to the media and other economic research centres, so that the basis of
        official forecasts and projections can be checked independently. Alternatively, these
        outside bodies can put their own assumptions into the Treasury model and hence
        generate alternative projections and scenarios. In this way, we get the basis for some
        very lively debate about the basis of official projections and plans, which seems to us
        a healthy aspect of public life in a democratic society.

(iii)   In addition, we have several economic research institutes in the UK, some linked to
        universities, some wholly independent, and none of them directly answerable to the
        government. These institutes have developed their own models of the economy, or of
        parts of it, and they use them to make their own projections and to subject the
        government‟s official projections and policies to critical scrutiny. This is not only a
        valuable contribution to general academic debate on government policy, but it also
        contributes to wider media debate on economic policy.

(iv)    Last, various banks, financial service companies, consulting groups and the like make
        their own independent forecasts of future GDP, prices and inflation, employment and
        unemployment, and diverse other economic indicators, and these, too, are published
        and disseminated widely. From time to time, wholly external bodies such as the IMF,
        the EU and the OECD also make their own forecasts of UK economic developments,
        providing yet another channel in the public debate.

(v)     Overall, therefore, projecting and forecasting the economy in the UK is not merely a
        technical exercise carried out in government away from public scrutiny, but is
        actually a very public process, with many participants and a great deal of media
        attention, both supportive and critical. This is very valuable.

Thinking about what this means for SKN, therefore, our view is that the process of
forecasting both the economy in general (notably the GDP, output measure) and the public
finances – government spending and revenues, expected deficits, the likely path of the public
debt – could all be improved not so much by adopting this or the other technical „fix‟, but by
making the entire process far more public and media friendly. Accordingly, let us consider
how this might be accomplished, and what its advantages and drawbacks might be.

(i)     At an early stage in the annual budgetary cycle, GDP projections are made both for
        the coming budget year and for two years further ahead. These projections are done
        both in real terms and in nominal terms. It should not be difficult in principle for a
        short report on the GDP projections, perhaps just 5-10 pages long, to be published as

        soon as the projections are done, i.e. within a week of the projections being prepared.
        Publication could take the form of a paper report, but it would be quicker and more
        useful for the report to be made available on the MSD website, perhaps in the form of
        a pdf-file that anyone could download, and even better if that could be accompanied
        by some tables in Excel, also downloadable. Nowadays, such a form of publication is
        rapid and technically easy.

(ii)    This would be the first step towards making the whole budget process far more open,
        public and transparent, something that we consider highly desirable for SKN.

(iii)   In making these GDP projections public, a little care would be needed as a result of
        the small size of the SKN economy, and hence the small number of significant firms
        in several of the economy‟s major sectors. For it is standard practice when publishing
        economic data to avoid revealing data that might enable individual firms to be
        identified and/or that might be commercially confidential. This point is normally
        unimportant for a large economy like the UK, where most sectors have hundreds of
        firms, but even there there are some sectors with very few firms. But for SKN, most
        sectors have few firms of significant size, and this fact might constrain somewhat
        what can be said in a public report. However, it should not be allowed to prevent or
        delay publication altogether.

(iv)    The next step in the budgetary process in SKN is to use the GDP projections to
        estimate budgetary revenues for the coming year and the two subsequent years.
        Again, once these projections have been done, we suggest publishing a short report
        explaining the government‟s views about tax and non-tax revenues, along with the
        projections themselves. Such a report, probably as a pdf-file, could easily be posted
        on the MF website within a week of the projections being done, thereby making the
        figures available for public debate well before the overall budget would have to be

(v)     The budget itself is put together in December, being finalised and approved just in
        time for the new budget to come into effect in January. Extensive volumes of
        documentation are prepared at this stage, underpinned by a series of Excel
        spreadsheets, though the details are not normally published in full until the Estimates
        for the Year have been approved by the National Assembly, sometimes three months
        into the budget year (as in 2010). In our view, this part of the budgetary process could
        be handled much better, as follows:

        a. In December, when the budget is finalised, there should be at least a summary
           publication of the main budget figures placed on the MF website. This could
           easily be done before Christmas.
        b. Such a publication would enable the media, interested experts, and the general
           public to understand the broad assumptions the government was making about the
           economy and the budget for the coming year, and to form their own judgements,
           critical or otherwise.
        c. When the Estimates themselves are published, the entire set of documents and any
           associated commentary should appear on the MF website at the same time. At
           present, the Estimates are published in March for internal government purposes,
           but appear not to be widely or easily available outside government. More open

           and prompt publishing as we propose will contribute to wider debate about
           budgetary matters, and to more effective accountability.

(vi)    During the budget year, it is not uncommon – albeit not terribly good practice – for
        parts of the initially published budget to be amended. This always complicates the
        processes set up for monitoring and controlling spending, and sometimes means that
        when budget out-turns are compared with the budget, it is the amended budget that is
        used for these comparisons. However, the recommended international practice in
        these matters is to make such comparisons using the original budget, largely to avoid
        confusion and misunderstanding. Whenever budgetary amendments are approved, we
        would strongly urge that the amended budget should be published on the MF website
        immediately. At the same time, we would advise that the original budget should
        remain on the website to facilitate public understanding and accountability.

(vii)   Since a key issue for SKN, as we have repeatedly argued above, has to do with the
        country‟s debt and how to manage it, it is vital that information about it should be
        regularly published on the MF website. Initially this could take the form of a short
        report outlining how and why the debt arose, its composition (external, internal; who
        holds the debt) and size, and the steps the government is taking through the budgetary
        process to bring the debt under better control. Such a report could usefully be updated,
        possibly quarterly, or perhaps more realistically half-yearly.

(viii) Last, some government reporting on the public enterprises – understood in the widest
       possible sense to include services delivered by government departments (e.g.
       electricity, postal service, etc.), statutory bodies, and public enterprises proper –
       seems to us essential to enhance accountability of these diverse activities. As we
       noted, accumulated losses of these bodies account for over a quarter of the public
       debt, and urgent steps need to be taken to bring this budgetary drain under firmer
       control. Regular publication on the MF website of short reports on this part of the
       economy, discussing measures such as corporatisation, better pricing, and moves
       towards privatisation, as well as basic economic data, would be a very worthwhile

Taken together, we believe the measures outlined here would greatly strengthen the
budgetary processes on SKN, facilitating public debate and enhancing accountability.

4. Conclusions and Recommendations
St Kitts and Nevis is a small and very open economy that has been badly affected by the
recent recession, and has uncomfortable levels of government debt, now approaching 200%
of the GDP. Our remit was to study the existing macroeconomic framework and to advise on
improvements that could be made to it. However, we quickly learnt that there was no
complete macroeconomic framework in place on SKN, only a few elements, not terribly well
coordinated with each other. This situation naturally required us to re-evaluate what we could
usefully do. In effect, we decided to go „back to basics‟ by outlining the underlying principles
of a macroeconomic framework and then explaining their application to the specific
circumstances of SKN.

Accordingly, this report has explained in general terms what should be meant by a
macroeconomic framework and how and why it is useful in supporting analysis of the

behaviour and performance of an economy, with particular emphasis on the public finances.
The eight elements or components around which the macroeconomic framework was
examined were:

       (a)   the real balance
       (b)   the government balance
       (c)   the balance of payments
       (d)   the monetary balance
       (e)   connections between the above four basic balances
       (f)   indebtedness
       (g)   competitiveness
       (h)   economic growth

In each case, general introduction to an element in the framework was followed by discussion
and analysis of points particularly relevant to the economy of SKN. Indeed this is why item
(f) was highlighted especially strongly, since it is critical for the future of the country,
whereas in discussing other countries it might have been relegated to a far less prominent
position in the framework.

Moving on to implementation of the macroeconomic framework, the report reviewed some
important data-related issues and then considered ways of improving the existing practices
and procedures on SKN, focussing on a number of critical economic issues.

As regards the data, this was discussed in three stages, starting with estimating the real GDP
of SKN using the output method. Then the GDP has to be projected forwards to the relevant
budget year, which is done by projecting output sector-by-sector and summing the results
using appropriate weights. Finally, the GDP projections, along with other data where
relevant, are used to estimate budgetary revenues for the forthcoming budget year. The MF
then has a basis for drawing up the rest of the budget, since with revenue estimates and
knowledge of priority spending needs – on debt servicing, public sector pensions, and civil
service wages – it can estimate what (limited) funds will be available to meet the non-salary
spending needs of the various line ministries.

Four critical economic issues were highlighted, and these form the basis for our principal
conclusions, summarised below, based on the fuller discussion in section 3.2 above.

Public sector debt
We have argued above that SKN‟s present government debt, with current government
policies, is plainly unsustainable. However, while we expect GoSKN to honour its debt
obligations, we would advise the government to engage in discussions with the major
creditors with a view to refinancing much of the debt to longer maturities, and perhaps better
terms. We would expect the ECCB and IMF to be helpful partners in such discussions.

With or without some debt rescheduling of this sort, we conclude there there are really only
two effective ways of bringing down the country‟s debt to more manageable levels. The first
entails a period of severe fiscal pain in order to generate primary surpluses that might need to
be as high as 20% of the GDP – though as this would amount to roughly 50% of government
revenues, it may simply be politically unacceptable. The second approach might therefore
prove more feasible initially. This entails the sale of public assets, which might involve a mix
of land sales and the privatisation of publicly owned entities. If this approach is to be

pursued, however, some early decisions would be needed to get the process started, and the
programme should then be pursued with vigour. In the end, a mix of these two approaches
might be used. Both approaches are far more manageable if the economy as a whole is
growing, say at 5% per annum or even faster. After two-three difficult years, GoSKN would
gradually regain both a degree of „fiscal space‟ allowing it a little more flexibility over public
spending plans, and would also get its indebtedness down to levels where the country could
more readily cope with an unexpected adverse shock (such as another damaging hurricane).

Financing public enterprises
In the earlier analysis we argued that it was high time for all SKN‟s public enterprises (i.e.
government departments delivering services; public enterprises proper; and a variety of
statutory corporations) to be put on a sound economic footing.

We concluded that no economic service activity should remain as a government department,
and in our view this implies the immediate corporatisation of such entities as the Electricity
Department on St Kitts. Preparations for this are already well in hand, and should be
completed early in 2011. It is also important, for all entities providing a marketable service,
that economically sensible prices should be charged to all customers, and that all should pay.
Further, wherever possible we would urge that these public entities be privatised at the
earliest opportunity, while any that cannot be restructured to enable them to cover their costs
should normally be closed down.18

Public Sector Investment Programme
Many PSIP projects have implications for future current public spending, and we are unsure
how far these are embedded in the budget cycle outlined above. Evidently, however, they
should be, and thinking about how to do this well is an aspect of the multi-year budgeting we
discuss in Annex 3 (while noting the resource costs of doing so).

Although there are no doubt many good quality PSIP projects that could be developed and
implemented, it is clearly unwise just now for GoSKN itself to fund such projects beyond
current commitments – other than to recover from emergency situations – until the country‟s
debt position has been brought under much better control. However, once the debt position
had improved, one of the early benefits could be the opportunity for the government to start
funding some new PSIP projects.

Improving forecasting methodology
Contrary to what we expected when we embarked on this project, we have not, in the end,
chosen to make recommendations of a technical nature under this heading. For although some
mostly minor technical improvements could undoubtedly be made in the present methods for
forecasting GDP, public spending and finally the overall SKN budget (with parallel processes
for the Island of Nevis), our main concern has been with wider aspects of the current
budgetary processes.

Specifically, we consider it desirable for the entire budgetary process, from start to finish, to
be conducted far more publicly than has been the norm in the past. For this to work, regular
reports on GDP projections, budget revenue projections, the overall budget, and the

    The detailed analysis of these diverse public entities lies well beyond the scope of our present assignment.
However, we possess considerable expertise and experience in the areas of public enterprise pricing, enterprise
restructuring and privatisation, as a result of which we would be in a position to offer detailed advice on these

subsequent monitoring and review processes need to be published rapidly on MSD and MF
websites as appropriate. Such reports should not merely publish the basic data, but there also
needs to be some analytical commentary to accompany the data. In our view this will
facilitate public discourse on budgetary issues, a vital element of democratic life, and will
also strengthen public accountability of all aspects of the government budget, including the
all important handling of public sector debt and the public enterprises.

At this point our analysis of the economic aspects of the Macroeconomic Framework for St
Kitts and Nevis is essentially complete. However, despite its length, this report leaves some
loose ends that we now refer to briefly, explaining how we propose to handle them.

1. Multi-year budgeting. Some elements of multi-year budgeting are already well
   established on SKN, but further issues are addressed in summary form in Annex 3.

2. Dealing with risk. Again this was referred to several times in the above text, but we
   decided that to discuss it properly would have entailed deviating far too much from our
   main line of argument, and this could have caused unnecessary confusion. For this reason,
   the topic is reviewed in Annex 4.

3. Implementation of the Framework. How this ought to be done is very important in
   practical terms and it is being covered in other reports that are currently in preparation as
   part of this technical assistance project.

References/ Reports Consulted
Buiter, Willem (2010), „Sovereign Debt Problems in Advanced Industrial Countries‟, Global
        Economics View, London: Citibank, April
Buiter, Willem and Rahbari, Ebrahim (2010), „Greece and the fiscal crisis in the Eurozone‟,
        Policy Insight No.51, London: Centre for Economic Policy Research
CARICOM (2009), National Accounts Digest, 2003-2006, Georgetown, Guyana: CARICOM
CGD (2008), The Growth Report: Strategies for Sustained Growth and Inclusive
        Development, Commission on Growth and Development, Washington, DC: The
        World Bank
DB (2010), Doing Business 2011, Washington, DC: The World Bank
ECCB (2010), Financial Statistics Yearbook 2010, Basseterre, St Kitts: Eastern Caribbean
        Central Bank
ECCB (2009), National Accounts Statistics 2009, Basseterre, St Kitts: Eastern Caribbean
        Central Bank
Escolano, Julio (2010), “A Practical Guide to Public Debt Dynamics, Fiscal Sustainability,
        and Cyclical Adjustment of Budgetary Aggregates”, Fiscal Affairs Department,
        Washington, DC: International Monetary Fund
Estimates (2010), St Christopher and Nevis: Estimates for the Year 2010, Volumes I and II,
        St Kitts: GoSKN, March
GEOB (2009), “Report on Oversight of Public Corporations: For the Period 2009-2009”, St
        Kitts: Government Entities Oversight Board
GoSKN (2010a), Stabilization Programme Report: January to December 2009, Ministry of
        Finance, St Kitts
IMF (2010a), „IMF Executive Board Concludes 2010 Article IV Consultation with St Kitts
        and Nevis‟, PIN 10/145, International Monetary Fund website, November 3rd.
IMF (2010b), Global Financial Stability Report: Sovereigns, Funding and Systemic
        Liquidity, Washington, DC: International Monetary Fund, October
IMF (2009a), St Kitts and Nevis: 2009 Article IV Consultation, Country Report 09/180,
        Washington, DC: International Monetary Fund
IMF (2009b), Eastern Caribbean Currency Union: Selected Issues, Country Report 09/176,
        Washington, DC: International Monetary Fund
IMF (2008a), “Staff Guidance Note on Debt Sustainability Analysis for Market-Access
        Countries”, Washington, DC: International Monetary Fund
IMF (2008b), St Kitts and Nevis: Statistical Appendix, Country Report 08/127, Washington,
        DC: International Monetary Fund
MTESP (2010), Medium Term Economic Strategy, 2010-2012; Volume I: Synthesis, Volume
        II; EuropeAid/ 126688/D/SER/KN, Basseterre, St Kitts
Nickel, Christiane; Rother, Philipp; and Zimmermann, Lilli (2010), “Major public debt
        reductions: Lessons from the past, lessons for the future”, www.voxeu.org, November
North, Douglass C. (2005), Understanding the Process of Economic Change, Princeton, NJ:
        Princeton University Press
OJ (2008), Economic Partnership Agreement, L289, Brussels: Official Journal of the
        European Union
Rogoff, Kenneth S. and Reinhart, Carmen M. (2009), This Time is Different: Eight Centuries
        of Financial Folly, Princeton, NJ: Princeton University Press
Summary (2010a), „Summary of Recent Economic Development – January to December
        2009‟, internal annual report, St Kitts: MSD

Summary (2010b), „Summary of Recent Economic Development – January to March 2010‟,
      internal quarterly report, St Kitts: MSD
UN (1968), A System of National Accounts, ST/STAT/SER.F/2/Rev.3, New York: United
WEF (2010), The Global Competitiveness Report 2010-2011, Davos, Switzerland: World
      Economic Forum
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      Washington, DC: The World Bank
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      WT/TPR/S/190/KNA, Geneva: World Trade Organization


Annex 1. Indebtedness Analysis
In standard notation, the basic income-expenditure identity for the national accounts of a
country is as follows:
                             Y=C+I+G+X–M                                              (A1),
C = personal consumption
I = investment (gross fixed capital formation + change in inventories); later, it will prove
convenient to distinguish between private sector investment, IP, and public (or government)
investment, IG.
X = exports of goods and services
M = imports of goods and services

G here is just the government demand for goods and services, so it does not include any of
the transfer payments made by government, e.g. social benefits, pensions, etc. Call these
transfer payments B. Then total government current spending, G  G  B . In addition, on the
capital account, the government undertakes public investment spending, IG. Let total tax
revenue be T, inclusive of a variety of non-tax income received by government (such as fees
for services, revenues of public enterprises, etc.). The primary surplus (if positive) or deficit
(if negative) is denoted by P, and P  T  G  I G . Another way to think about this is simply
as the overall public sector balance before interest payments on outstanding debt.

Now, the next step is to incorporate debt and debt servicing into this simple framework.
Suppose that at the start of a given accounting period, typically a year, the outstanding public
sector debt (including here that held domestically, as well as that held abroad) is D, and that it
carries an average interest charge of r (e.g. if r = 0.05, average interest is 5% per annum). For
simplicity, let a fraction s of the debt fall due for repayment in the coming period. Then
taking interest and principal payments together, the total repayment obligation in the year, R
= (r + s)D. Let new debt taken on during the year be: N = nD.

This obligation can be met in two ways: (1) the primary surplus, P; and (2) public asset sales,
A. Then if we let the outstanding debt at the end of the period be D+, the following equation
                              D+ = D – P – A + R + (n - s).D                             (A2)

At the start of the accounting period, the debt-to-GDP ratio, z = D/Y. If GDP grows at rate g
per year (so g = 0.03 means a 3% growth rate), then the debt-to-GDP ratio at the start of the
following year will be: z+ = D+/{(1 + g)Y}. It follows, therefore, that if D+ < (1 + g)D, then z+
< z, in other words the debt-to-GDP ratio will be on a declining trend. For a highly indebted
small economy such as that of SKN, this is clearly an important condition to achieve. The
faster the economy grows, the easier it will be to satisfy this condition.

The critical questions, however, have to do with the factors – such as government revenues,
fiscal policy, asset sales, GDP growth, and the like – that enable the condition to be satisfied.
And further, it will also be important to assess the risks associated with these factors, since
with such high indebtedness, the SKN economy, and its ability to continue growing while
bringing its debt position under improved control, is vulnerable to a variety of possible

„shocks‟ that would obviously be far more manageable in a less indebted economy. Both
factors and risks are explored comprehensively in the main text of this report.

In doing so, we shall also bear in mind that while holding the debt-to-GDP ratio steady or
modestly declining, in line with the above inequality, is an absolutely minimal condition for
fiscal and economic sustainability in SKN, it would be far more satisfactory – and in the
longer term, safer – if a policy mix can be identified that would set the ratio on a much
steeper declining trend. Conversely, if the latter were to become an objective of the SKN
government, our framework makes it possible to explore the fiscal and government spending
conditions that would be compatible with it.

To move forward, it helps to make some simplifying assumptions. First, let taxes, T = tY,
expressing the tax take as a simple fraction of GDP; in a more complex and developed
version of the model, different parts of the tax revenue could be linked to different
components of the GDP. But for the moment, this would be an unnecessary complication.
Second, let government current spending, G  xY , and public investment, IG = iY, where x
and i are taken to be constant parameters initially; but they can later be chosen by policy
makers to suit the prevailing requirements of the macroeconomic situation. In terms of these
new parameters, the primary surplus, P = (t – x – i).Y. Third, let public sector asset sales be
expressed as a fraction of GDP; thus A = aY.

Putting all this together, we get:

                       (1 + g)z+ = {1 + (r + n)}.z – (t – x – i) – a             (A3)

This equation links the debt-to-GDP ratio in one period with that in the previous period, via a
few simple parameters. This makes it possible to explore the conditions needed for the debt-
to-GDP ratio to be on a declining trend. Moreover, once the debt-to-GDP ratio, z, is
stabilised at some level, we can study the parameter combinations that make this possible.
For instance, the stable value for z could be around 1.8, reflecting the current position in
SKN; or it could be around 0.6, reflecting the official view of the ECCB (Eastern Caribbean
Central Bank) as to the desirable longer-term level of this ratio. This latter value corresponds
to that advised for EU member states under the Maastricht Treaty, though most countries in
the Union now have debt levels significantly above 60% of GDP, following the financial
crisis. When the debt-to-GDP ratio, z, is stable, equation (A3) above becomes:

                               (t – x – i) + a = (r + n – g).z                          (A4),

and for stable z, we also require that n = g, so that sufficient new debt is taken on to keep the
debt to GDP ratio constant.

Notice that the left hand side of (A4) represents the primary surplus plus public asset sales
(PSPA), expressed as shares of GDP, while the right hand side simply shows the spending
required to service the debt, adjusted for the prevailing economic growth rate. Thus if r =
0.05, g = 0 and z = 0.6, then the right hand side of (A4) is 0.03. Hence this level of public
sector debt (60% of GDP) is comfortably sustainable provided that PSPA can be maintained
at around 3% of GDP. On the other hand, if z = 1.8, corresponding to the current situation in
SKN, then merely to maintain the debt-to-GDP ratio with growth close to zero requires that
PSPA be maintained around 9% of GDP, which is a much more demanding condition.
Among other things, holding PSPA at such a high level implies that aggregate public

spending on goods and services, and on transfers to firms and the population, would have to
be kept well below the level that would otherwise be both desirable and achievable.
Moreover, if the government‟s aim were to bring the debt-to-GDP ratio down significantly
within a reasonable period, PSPA would have to be even higher. Indeed at such levels, quite
aside from the economics of the situation, one might need to start questioning its political

The situation is far better, naturally, if the economy gears up to rapid growth, for as (A4)
makes clear, if g > r, then even a negative PSPA can be compatible with a constant debt-to-
GDP ratio.

We shall now explore equations (A3) and (A4) in greater detail numerically, starting by using
data that, to a good first approximation, fit what we know about the current situation in SKN;
we then move on to consider other cases. Results are shown in Table A1, below.

  z+        z         g         r        n            t      x         i         a
 1.88      1.8        0       0.06        0         0.35    0.3      0.02        0
 1.92      1.8        0       0.06      0.02        0.35    0.3      0.03        0
 1.91      1.8      0.03      0.06      0.02        0.35   0.35      0.03      0.01
 1.80      1.8      0.03      0.06        0          0.4   0.35      0.02      0.02
 1.60      1.8      0.05      0.03        0         0.45    0.3        0       0.02
 1.00       1       0.03      0.06      0.02        0.35    0.3      0.02      0.02
 0.91       1       0.05      0.05        0          0.4    0.3      0.02      0.01
 0.89       1       0.05      0.05        0         0.45   0.32      0.02      0.01
 0.87       1       0.07      0.06      0.02        0.45    0.3      0.02      0.02
 0.84       1       0.07      0.06        0         0.45   0.28      0.02      0.01
 0.60      0.6        0       0.06        0         0.35    0.3      0.01        0
 0.59      0.6      0.03      0.06      0.02        0.35    0.3      0.02      0.01
 0.48      0.6      0.05      0.06        0         0.45   0.32      0.02      0.02
 0.51      0.6      0.07      0.06      0.02        0.45   0.35      0.03      0.03

Table A1. Debt-to-GDP ratios; the impact of policy variables

Annex 2. Definitions and Accounting Conventions

Basic prices
Prices excluding taxes and subsidies on products.

Producers’ prices
A producer's price is the amount receivable by the producer from the purchaser for a unit of a
good or service produced as output minus any VAT, or similar deductible tax, invoiced to the
purchaser; it excludes any transport charges invoiced separately by the producer.

Market prices
Market or purchasers prices are the prices actually paid by the purchaser for goods and
services, including transport costs, trade margins and taxes. Thus:

GDP at market prices = GDP at basic prices
                       + transport prices paid separately
                       + non deductible taxes on expenditure
                       - subsidies received

Source: UK Office for National Statistics website, UN Statistics Division website.

Annex 3. Extending the Macro-framework to Several Years
Both CARTAC and the IMF increasingly recommend that the more traditional single-year
budgetary process should be extended to a comprehensive multi-year process. What this
means is that the preparation of the budget for a given year would be embedded into a multi-
year programme of GDP, public spending and revenue projections that would then be revised
and updated each year. For SKN, although well on the way to multi-year budgeting, full
implementation would be a rather larger and technically more demanding exercise than the
current approach described in earlier parts of this report. It is important to ask, therefore, what
the advantages and disadvantages of a comprehensive multi-year approach to public sector
budgeting might be.

1. Some public sector spending plans take time to implement, either because they are
   investment projects requiring spending over several successive years, or because they are
   new commitments that may start small and gradually increase to a steady state level (e.g.
   a new type of social benefit might come on stream in this way). In a multi-year budget
   framework the implications of such commitments can be foreseen and planned for far
   better than normally happens in a single-period macroeconomic framework.

2. As we noted above, PSIP projects frequently have implications for future current budgets,
   and again this is far easier to analyse and plan for effectively in a multi-year framework.

3. Revenues are mostly fairly stable from one year to the next, but this general point is
   complicated by such things as the introduction of a new tax – like the VAT in SKN just
   recently, accompanied by the cancellation of 12 old taxes – or economic shocks such as
   recession. While projections can always be done for a single year, as outlined above, the
   impact of these changes or shocks often runs over 2-3 years or even longer, so a much
   better picture is likely to be gained from a multi-year analysis.

4. When thinking about how best to manage indebtedness, we outlined in our main text how
   this can be studied in the existing budgetary framework, and we proposed a tool (a simple
   model) using an Excel spreadsheet that can used to perform a simple version of debt
   sustainability analysis (DSA). However, managing the government debt is best analysed
   in a longer term, multi-year framework since scheduled repayments of principal can be
   „lumpy‟, and the debt burden is not easily understood properly by looking at just one
   year‟s data.

5. Multi-year budgeting, with annual review, updating and rolling forward the plans
   provides some powerful tools for monitoring budget performance, understanding changes
   made in the budget, and for adapting the government‟s tax and spending plans to cope
   with unexpected events.

6. The main disadvantage of multi-year budgeting, we think, is a technical one. That is,
   implementing such an approach is more demanding in terms of data, professional
   expertise (both statistical and economic), and organisational capabilities than is the
   established partially developed muti-year framework currently in regular use on SKN. We
   seriously question whether the additional resource costs of operating such a system would
   be worthwhile in a small economy such as that of SKN

7. Systems that require a great deal of data run into difficulties if those data are not regularly
   available, regularly updated, and prepared to a consistently high standard. Again,
   therefore, even without thinking of the wider multi-year framework, the data collection
   and updating would most likely entail significant additional resource costs.

Annex 4. Dealing with Risk
There is an enormous topic with a huge literature, some of it highly technical. However, for
purposes of the present report, we think it useful to provide a summary and overview of the
topic, focussing on particular aspects likely to prove most relevant to the economy of St Kitts
and Nevis. We organise our remarks under four headings, namely: (a) sources of risk; (b)
quantifying the risks; (c) assigning probabilities; and (d) managing the economy in the
presence of major risks.

Sources of risk
For a small economy such as that of SKN, the risks that really matter are those exogenous
shocks that impose significant costs on the economy (meaning of the order of several percent
of GDP), and which impact the public accounts by reducing revenues or requiring additional
public spending, again of the order of several percent of GDP. All economies experience lots
of small shocks that might also be regarded as risks in the sense of these notes, but they are
not sufficiently important to demand our attention.

Examples of significant risks that have been experienced in the past 10-15 years by SKN
include the following:

      Hurricanes
      Closure of a major economic activity, e.g. sugar in 2005
      Economic recession, esp. 2009 with GDP falling by over 9% in real terms, and with
       knock on effects through 2010 reducing government revenues

We imagine that the main future shocks which SKN is likely to experience will mostly fall
into these three broad categories. Other types of major shock can occur, of course, such as a
volcanic eruption, but we regard these as of sufficiently low probability that current economic
policy does not need to make any allowance for them.

Quantifying the risks
In order to design policy responses to help GoSKN cope with another major shock such as
one of those listed above, the first step is to get a clearer idea of the likely magnitude of a
shock, and its impact on the GDP and public accounts.

For instance, consider a hurricane striking SKN. This might cause damage valued at EC$ A,
say, and most of this is likely to take the form of damage to private homes, damage to
commercial property, damage to economic infrastructure, and damage to agriculture (crop
damage or outright destruction of crops). The hurricane might result in a loss of economic
output (GDP) to the extent that business premises are unable to reopen quickly (obviously,
this depends on the extent of any damage), or if essential infrastructure cannot be repaired
quickly; and a loss of government revenues to the extent that reduced business activity cuts
the likely tax take.

What happens next, and who pays, depends on what insurance is in place to cover the
property damage due to the hurricane. Most commercial property should be insured, but in a
hurricane prone region it might be too expensive to insure against that particular risk. For
residential property, we judge that little insurance will be in place, either for contents or the
buildings themselves, except for some of the larger properties owned by foreigners. Hence in
the aftermath of a serious hurricane, the government faces a dilemma: should it leave most
people to find their own way of recovering from the hurricane, repairing the damage, and so

on; or should it step in quickly and commit large sums of public spending to the repair effort?
In our judgement, based on past experience on SKN, the government would step in and
underwrite most of the needed repair costs, perhaps over a period of two-three years.

To be specific, suppose the government makes good the entire economic loss A over three
years, with a spending profile (0.5, 0.3, 0.2) [thus 50% of the repair work is done in the first
year, 30% in the second, the remaining 20% in the third]. This additional government
spending stimulates the economy through the standard Keynesian multiplier, and the extra
spending will generate additional tax revenues. This is not the place to sketch how to estimate
the multiplier, but for the sake of keeping the example simple suppose the multiplier is 1.2
(probably on the low side) and the tax take is roughly 40% of GDP, as now, then over the
three years of the recovery programme there will be total extra government spending, A,
offset by an additional 0.48A of tax revenues (1.2 x 0.4), so the government deficit rises by a
net amount of 0.52A. So a hurricane that inflicts a loss in asset values across the SKN
economy of 20% of the GDP increases the government deficit by 10.4% of GDP (0.52 x 20)
by the time that reconstruction has been completed.

This gives a rough idea of the orders of magnitude we need to be thinking about.

Assigning probabilities
The next task is to assess how often a particular type of economic shock is likely to occur, or
more exactly to assess the probability distribution of likely shocks in a given period. In
thinking about this, it makes no sense to think of short periods such as a year, since with
fairly high probability, nothing significant will happen. A decade is probably a more
reasonable period to work with.

By looking back over several decades, GoSKN might conclude that the probability of a
hurricane in any given decade is, say p, while the average damage inflicted is A (as in the
above example). Assuming that only one hurricane is likely19, the expected damage at some
point during the decade is pA, though the actual damage might range from a fraction of A,
say αA, to some multiples of A, βA – with the damage distribution still having average value

Now, in its planning, should the GoSKN aim to be ready to deal with the expected damage,
pA, or should it take a more pessimistic view and base its planning on the maximum likely
damage, βA? In the literature on risk, there are no generally satisfactory answers to this
question, and so GoSKN has no option but to use its judgement. This is not easy, though the
formal analysis does provides a rough guide, and perhaps helps to organise the thinking
process in a logical way.

Managing the economy in the presence of major risks
Against the background of the above brief discussion, how should GoSKN manage the
economy in the presence of the known major risks it faces? There are several possible
answers, and we simply list them with brief comment to indicate the issues involved.

(a) Do nothing
In this case GoSKN pays no attention to the possible risks facing the economy, running the

   The analysis gets more complicated if several „events‟ can occur in a given period, but the same general
principles apply.

economy according to the established routines and practices, and simply takes the view that
if an adverse shock occurs, it will do whatever is necessary to deal with it. For a large
economy, damage due to natural disasters is nearly always handled this way, since even a
large disaster is still only a small fraction of the economy. For SKN, the wisdom of this
approach is not so clear, since the risks are much larger in relation to the size of the economy.

(b) Do nothing, but rely on external assistance.
This is a variant of (a) that would not apply in case of a recession-type shock, but would
apply in case of a natural disaster. The idea here is if there were a major hurricane causing
extensive damage on SKN, then international donors and the major IFIs would rush in to
provide aid to assist the reconstruction effort. Our suspicion is that there would indeed be
some additional aid forthcoming in such circumstances, but we would be surprised if it
covered more than a modest fraction of the damage done, and even then some of the aid
would come as loans rather than outright grants. Hence even with some aid, GoSKN would
itself take a substantial hit.

(c) Provide for self-insurance
On this model, GoSKN either manages the economy to keep the debt-to-GDP ratio low
enough so that it can bear the likely costs of a severe adverse shock without needing to allow
the debt levels to rise to unmanageable levels. Or the government maintains an explicit
disaster recovery fund into which it might pay, say 1-2% of the GDP each year. Then when a
bad shock arrived, the fund would be drawn down as needed. GoSKN would then only take a
hit if the disaster proved costly enough to exhaust the fund.

(d) Collective insurance
A problem with self-insurance and building up a fund on SKN is that it might be perceived as
too expensive. An alternative would be for a group of countries, such as the OECS, to form a
collective fund. This would be cheaper and more effective than each country forming its own
fund, provided that the typical shocks to which they are subject are either uncorrelated, or
even better, negatively correlated – this is something that would call for further investigation..


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