November 10, 2006

Economic performance since Independence


by Dr Garth Nicholls

Director of Research, Eastern Caribbean Central Bank – Special to Searchlight

Factors in the economic performance of SVG

Membership of the Eastern Caribbean Currency Union

The ECCB arrangement has served the region, including SVG, well, judged on standard indicators of performance – inflation and economic growth. The stable fixed exchange rate regime has directly contributed to the steady out-turn of inflation in the ECCU. This has been achieved largely as a result of the low and balanced prices in the USA and the decision of the domestic policy authorities not to change the exchange rate. As the floating exchange rate countries in the region have discovered, movements in the nominal exchange rate directly impact domestic prices.{{more}}

The favourable growth performance emerges precisely because of the environment created by the stable exchange rate – low inflation – and the business certainty and confidence bestowed on households and businesses to save and invest in EC dollars. Table 1 reveals that based on economic growth and inflation outcomes over the period 1980 to 2005, ECCU countries have enjoyed superior performance compared with the other countries of Caricom. They have also avoided financial sector instability partly a direct result of the stable fixed exchange rate. Indeed, inspite of the difficulties that Dominica, Grenada and Antigua and Barbuda have had in managing their fiscal imbalances, and high public debt, the ECCU monetary and exchange rate arrangements have held steady with a sufficiency of foreign exchange to satisfy the legitimate needs of economic agents. The arrangement has provided an insurance mechanism for those countries undergoing structural reform, providing certainty to savers and investors. That is, it has provided the environment necessary for sustainable economic growth and development.

It is important, perhaps, to further articulate the benefits of sustained growth and relatively low inflation for the economic welfare of the citizens of the ECCU. This is important, as having had a period of relative success on these two variables, it is likely to have diminished citizens’ appreciation of what the environment would be without these favourable outturns. I deal first with the consequences of high inflation.

Consequences of high inflation

• It reduces the real income of fixed income earners and thereby increases poverty

• It redistributes resources between debtors and creditors

• It creates noise in the price system and it becomes difficult to discern changes in relative prices important in the allocation of scarce resources.

• It makes the setting of prices and wages difficult and may actually result in industrial unrest.

• It results in substantial time and effort being spent to avoid domestic money?

• It increases uncertainty, makes long-term planning difficult and lowers potential and actual economic growth

Consequences of no economic growth

• It reduces available resources to tackle poverty and income redistribution and other social welfare objectives

• It results in unemployment beyond the natural level.

• It increases the burden of past financial obligations

• It lowers the standard of living and increases poverty

• It puts a fiscal squeeze on the public sector.

Export sector performance

The golden era of economic growth in SVG was associated with 10.3 per cent per annum real growth in agriculture and in particular banana output (rose by 43.6 per cent per annum), associated with favourable export prices in the UK. This affected the economy via two channels, first with prices above the world banana price levels there was a direct transfer of income to the Vincentian economy. Second, with these favourable prices farmers were encouraged to produce more bananas – a supply response.

An additional factor was the favourable exchange rate movements, which also intermittently transferred real income to the farmers and thereby enriched and stabilised the rural economy. In the same vein the erosion of international trade preferences for bananas has resulted in a significant fall in export prices and consequently income to farmers. This fall in prices has had a significant negative impact on the real incomes and welfare of the banana exporting countries within the ECCU including SVG. The lower level of preferences has resulted in lower prices, which have had a negative effect on output. Agricultural output fell by 1.3 per cent per annum (banana output fell by 5.5 per cent per annum) over the period 1991 to 2005. The consequences of the preference erosion can be summed up as follows: Lower export revenue results in lower real income, lower private expenditure, lower imports and hence lower tax revenue for the public sector – in effect a fiscal squeeze.

In 1990 banana export revenues amounted to EC$110m, but only EC$23.7m in 2005. Meanwhile, the member states’ obligations under the WTO and CSME require fundamental adjustments to the management of policy.

The tourism sector also continued its expansion during the golden era of growth. Real output in the hotels and restaurants sector, an indicator of tourism activity, grew by 8 per cent during the 1984 to 1990 sub-period following growth at a similar rate in the 1980 to 1983 period. In the final sub-period, 1991 to 2005, however, the pace of expansion in this sector slowed appreciably to 3.4 per cent per annum.

Fiscal Policy and Public Debt

Real government services in SVG expanded at a slightly lower rate of 2.7 per cent per annum during the golden era compared with the 1980 to 1983 period. It must be further noted that during the period 1991 to 2005, while real growth in other sectors slowed, that of real government services grew at a faster rate, 3.2 per cent. The contribution of the fiscal and debt policies can be assessed more fully by analysing the actual fiscal outturns. In the period 1980 to 1983 the overall balance for the ECCU deteriorated partly due to the effects of adverse natural events between 1979 and the early 1980s but these were financed by a steady flow of grants. Henceforth the overall balance improved in line with the growth experienced in the golden era, only to deteriorate in the final sub-period 1991 to 2005 as growth and grants declined.

The overall pattern of the fiscal out-turn for SVG generally moved in tandem with the overall regional trends. For example, in the first sub-period on average the overall balance was rising, partly as a result of the difficulties with hurricane damage and the 1979 volcanic eruption of La Soufriere. In the golden era of growth the fiscal out-turn improved significantly, in line with robust growth consequent on the favourable external environment for exports. Finally, in the 1991 to 2005 sub-period, in line with a deceleration of growth, the fiscal out-turn also deteriorated, as evidenced by the gradual rise in the size of the overall deficit.

Consistent with the aforementioned fiscal policy paths, the total debt stock of the ECCU public sector rose from an average of 64.1 per cent of GDP in the period 1990-97 to 91.9 per cent of GDP in 2001, but averaged over 106.6 per cent of GDP by 2004 for the ECCU as a whole. The region has recently begun to reorient its fiscal policy to address the fiscal imbalances and debt. This along with debt restructuring in Antigua and Barbuda, Dominica and Grenada has resulted in some reduction in the region’s debt to GDP ratios. Table 4 presents the public sector debt to GDP ratios for 2001 to 2005 on an individual country basis.

It must be recognised that a large proportion of the high overall deficits and consequently public debt for the ECCU has been the result of post-hurricane rehabilitation, especially in the latter half of the 1990s.

In line with the growth of public sector debt has been the rise in public sector interest payments.

The other sources of growth in national income

A glance at table 6 reveals that during the golden era of SVG’s growth, apart from agriculture and government services the sectors driving national income were banking and insurance (7.8 per cent) mainly reflecting the activity of the banks and also the expansion of the offshore sector during the period. Communications grew by 15.8 per cent, whilst the retail and wholsesale sector also witnessed a surge in activity (8.4 per cent), consistent with developments in the tourism sector during this period. Construction and associated activities such as electricity and water also grew fastest during this period of all the sub-periods by 10.4 per cent and 6.9 per cent respectively. In the final sub-period, except for government services, real estate and housing and manufacturing, all sectors grew at a slower rate than that experienced during the golden era.

Sustained and High international oil prices

In recent years (at least since 2004) sustained high international oil prices have negatively affected the fiscal deficit and public debt, as some governments (including SVG) used the consumption tax to absorb any price increases. The effect on economic growth has been muted, however, largely as a result of some governments’ policy of oil price subsidisation.

The oil subsidisation policy has also delayed the full inflationary effects of higher oil prices on the domestic economy. The effect of higher international oil prices has largely been confined to larger balance of payments current account deficits, higher fiscal deficits and public debt.