Supplement Memorandum Of Economic Policies
1. The government confronted one of the most difficult economic situations of its recent economic history. Over the last few years, our economy was subject to a series of significant shocks to the banana sector—the traditional economic mainstay—and offshore banking and tourism sectors. Unfortunately, the policy response, which favored financing rather than adjustment, fell short of what was required, in part because the shocks turned out to be more permanent than transitory, and their economic impact larger than anticipated. As a result, the economy contracted by almost 10 percent in 2001–03, the public debt doubled to 115 percent of GDP in the period 1998–2003, private investment collapsed to an estimated 7 percent of GDP in 2003 (almost one third of its level in 1997) and the budgetary situation was on an unsustainable path. Against this background and uncertain economic prospects, we recognized that, even with ambitious fiscal adjustment policies, the debt situation had become unsustainable.
2. The government adopted a bold two-stage strategy in mid-2003 to stabilize the situation and address the deep-rooted problems in the economy. The idea was to address short-term financing and budgetary problems in the first stage and longer-term growth and sustainability issues in the second stage.
II. Program Performance
3. Following the sharpest and most prolonged contraction since independence, the economy appears to be growing for the first time since 2000. The economic decline was stopped in 2003 and there are indications of a modest but broad-based economic recovery in the first quarter of 2004. Similarly, exports are beginning to rebound for the first time since 1998 and import growth has accelerated. We expect real GDP to grow by 1 percent in 2004. Inflation remains under control as we expect prices to grow by merely 1½ percent in 2004.
4. The PRGF-supported program has had a good start. The strong performance observed under our revised program since the modification of the SBA in July 2003, continued under the successor PRGF arrangement. The first PRGF review was completed in March 24, 2004 and all performance criteria and structural benchmarks for end-March 2004 were observed.
5. A debt exchange offer was announced on April 6, and we are negotiating in good faith with our creditors, in line with international best practices. We offered to exchange eligible creditor’s claims for a menu of three bonds involving longer maturities and principal haircuts for two of them at an interest rate of 3½ percent. The deadline for participation was extended to June 11. Thus far, the take up has fallen short of initial expectations. However, in the last week significant progress has been made with two of our major creditors coming on board and participating in the restructuring. We continue negotiating with our other creditors. We intend to leave the exchange offer open for a few months. However, in the interest of inter-creditor equity, the terms of the offer are not expected to be better than those given to creditors that participated in a timely manner in the initial exchange offer.
III. Macroeconomic Policies for the rest of 2004
6. In order to signal to our creditors the seriousness of our policies, we have strengthened the primary surplus objective for 2004/05 from ½ percent to 2 percent of GDP. While we retain our long-term objective of achieving a primary fiscal surplus of 3 percent of GDP in 2006/07, we are prepared to further front-load our efforts. This reflects the strong implementation of our policies which allows us to run the program ahead of schedule.
7. The budget for 2004/05 will require fiscal measures equivalent to 2½ percent of GDP to achieve the more ambitious fiscal objective. One of these measures, equivalent to ½ percent of GDP, was taken in December 2003 at the time of the PRGF arrangement approval. It consists of a significant reduction in the number of discretionary tax exemptions. We will remain vigilant in this area to ensure that the original objective is achieved. We have conducted a comprehensive overview of tax exemptions (a benchmark for end-June under the program). As regards other fiscal measures, initiatives equivalent to 2 percent of GDP (mostly on the expenditure area, as described below) are included in the budget for 2004/05 that was approved by Parliament. In addition to the policies agreed in the MEP of December 2003, we are announcing further expenditure cuts to facilitate the elimination of the stabilization levy.
On the expenditure side:
On the revenue side:
8. The aid program agreed with China will allow us to further expand the public sector investment program (PSIP) without creating an additional debt burden. We reached agreement with the Government of China to provide grants for US$110 million over the course of the next six years to finance development projects as well as budgetary support for US$10 million to cover the costs of ongoing projects for which financing was interrupted. We estimate that the country can absorb high quality public investment for about 12 percent of GDP in 2004/05. However, we will try to overshoot our target by using additional grants from China. Our PSIP consists of high-value projects and its implementation is generally on track. The ministry of finance will continue to centralize borrowing decisions for externally-financed projects.
9. The financing of the program will be covered by the debt restructuring exercise. We continue negotiating with our creditors in good faith and remain confident that we will reach full participation in the next few months. For the purpose of the 2004/05 budget, we have assumed that all creditors participate according to the terms expressed in the exchange offer. We will maintain the terms of the exchange offer open to creditors after the deadline of June 11. Creditors that decide to participate after the June 11 deadline will be considered “late participants.” The government has budgeted enough resources to cover those interest payments, signaling the sustainability of the operation. For those claims not tendered, the government intends to deposit in an escrow account the proceeds according to the new bonds to which they are entitled. The program will include a new adjustor to the credit to the government target to take into account potential deviations in interest payments from the programmed levels due to a differences in the composition of bonds selected by creditors.
IV. Structural Reforms for the rest of 2004
10. The structural reform agenda aims to remove impediments to growth, and ensure medium-term sustainability. We reiterate our commitments included in the MEP of December 2003. While the reform agenda covers several areas, it focuses on fiscal issues in the short term, especially on public sector reform, tax policy, pension reform, and budgetary procedures.
11. The wage bill will be reduced by 5 percent through reduction in employment. We remain committed to reduce the wage bill by 10 percent over the next two years. The 2004/05 budget includes the retrenchment of enough positions to generate savings of 5 percent of the wage bill. Severance payments are being covered by a EU grant.
12. The value added tax will be introduced in 2005/06. The 2004/05 budget has announced the introduction of the value added tax (VAT) in the upcoming budget and the consequent elimination of the consumption tax, the sales tax, the hotel occupancy tax and other minor levies. The 2004/05 budget includes the preparatory regulations for the VAT to be introduced in July 2005. In addition, we are conducting a review of all tax exemptions to improve our collections.
13. The retirement age of public employees will be increased from 55 to 60 years. We are sending legislation to Parliament shortly to increase the retirement age for public employees in a phased manner.
14. The 2004/05 budget includes three-year projections. In an attempt to enhance transparency, standardize practice with the PSIP, and further strengthen the burgeoning culture of fiscal discipline, the 2004/05 budget will include for the first time three-year rolling budgetary projections based on our medium-term macroeconomic framework.
15. In keeping with fiscal sustainability principles, we will introduce legislation or amend an existing one with a view to providing guidelines on how to design and implement the budget in the future. This legislation will include numerical targets and procedures to follow in the design of the budget with the aim of preventing an episode of rapid accumulation of debt in the future. We will embrace other transparency initiatives in the budget, including publishing of statutory tax concessions and the level of public employment. We expect that this modified legislation will guide the budget for 2005/06.
16. The regulatory framework for electricity supply will be strengthened. We expect to introduce this framework in September 2004 following the recommendations of the World Bank.
V. Contingencies and Modifications
17. We remain fully committed to the program, and will take any additional action that is necessary to ensure that the objectives of the program are achieved. We will remain in contact with the IMF to identify potential problems. We are proposing some technical modifications and the introduction of an adjustor to the target on credit to the government to improve on the program design. These changes are reflected in the revised technical memorandum of understanding.
Technical Memorandum of Understanding
1. Dominica’s performance under the Stand-By Arrangement and Poverty Reduction and Growth Facility (PRGF), described in the letter of the Government of Dominica dated June 22, 2004, will be assessed by the IMF on the basis of the observance of quantitative performance criteria as well as compliance with structural performance criteria and benchmarks. This Technical Memorandum of Understanding (TMU) sets out and defines the performance criteria (and adjustors), indicative targets, and benchmarks specified in Table 1 of the Supplement of Memorandum of Economic Policies, as well as the monitoring and reporting requirements.
2. The authorities of Dominica are committed to transmit to the Fund staff the best data available. All revisions or expectations thereof shall be promptly reported to the Fund staff.
3. The variables mentioned herein for the purpose of monitoring the performance criteria, which are not explicitly defined, are consistent with the Government Financial Statistics (GFS). For variables omitted from the TMU which are relevant for the program targets, the authorities of Dominica shall consult with the staff on their appropriate treatment, based on GFS principles and Fund program practices.
I. Fiscal Targets
4. The central government overall balance will be measured from the financing side as the sum of the net domestic borrowing plus net external borrowing. The floor on the overall balance is cumulative from the specified dates.
5. Net domestic financing by the central government is the sum of: (i) net domestic bank financing as reported by the consolidated balance sheet of the banking system adjusted for double signature accounts1 and for the proceeds of borrowing from the International Monetary Fund, (ii) net nonbank financing measured by the net changes in holdings of government securities by nonbanks, and net borrowing from nonbank institutions (including special tranches from the ECCB); (iii) the change in the stock of domestic arrears of the central government defined as net changes in unpaid checks issued, unprocessed claims, invoices pending, plus accrued interest payments, and other forms of expenditures recorded above the line but not paid; (iv) gross receipts from divestment; and (v) any other exceptional financing, including related to debt restructuring of interest or arrears.
6. Net external financing of the central government is defined as the sum of (i) disbursements of project and nonproject loans, including securitization, but excluding the proceeds of borrowing from the International Monetary Fund; (ii) proceeds from bond issues abroad; (iii) exceptional financing (rescheduled principle plus interest), net changes in cash deposits held outside the domestic banking system, (iv) net changes in short-term external debt; (v) any change in arrears on external interest payments and other forms of external expenditures recorded above the line but not paid; (vi) any other exceptional financing, including related to debt restructuring of interest or arrears, minus (vii) payments of principal on current maturities for bonds and loans on a due basis and any prepayment of external debt.
The following adjusters will apply:
7. The floor on the overall balance of the central government will be adjusted upward2 (downward) to the extent that project loans fall short of (exceed) programmed amounts. This adjustor applies up to June 2004 and will be discontinued thereafter. Project loans are defined as the receipt of loan proceeds to finance the central government’s portion of the Public Sector Investment Program. For the purpose of this adjustor, the project loans amount to: cumulative from June, 30, 2003, US$5 million by end-March 2004 and US$6.6 million by end-June 2004; upward adjustments will not exceed US$6.35 million by end-March 2004 and US$7.7 million by end-June 2004. This adjustor does not apply after end-June 2004.
8. Budgetary grants are defined as grant receipts that are not earmarked for capital outlays. Budgetary grants will be programmed as part of revenue if the funds are to be used to cover the cost of any specific reform, otherwise the floor on the overall balance of the central government will be adjusted upward to the extent that budgetary grants exceed programmed amounts.
9. The floor on the overall balance of the central government will be adjusted downward by the amount of severance payments or administrative expenditures linked to the debt strategy. It is expected that these costs will be mostly covered by grants, which would also be excluded from the measurement of the overall balance of the central government. In the event of bridge loan financing for this purpose, it will not count toward the measurement of the overall balance of the central government.
10. The central government primary balance will be defined as the central government overall balance (from the financing side as defined in paragraph 4) plus scheduled domestic and external interest payments. Interest payments do not include either domestic or external interest payment made by the central government on behalf of other parties.
The following adjusters will apply:
11. The same adjustors described in paragraph 7, 8 and 9 apply to the primary balance.
12. The central government wage bill will be measured as the total expenditure of the central government on wages and salaries of central government employees net of wage refunds, including acting allowances, special duty allowances, responsibility allowances, subsistence allowances, the employer contribution to Dominica Social Security, and any wage payment made to units transferred outside the Treasury in the context of the 2004/05 budget, but not including retirement benefits, severance payments or other related one-off payments (i.e., accumulated leave). As such, the ceiling does not include wage-related transfers to schools, the National Development Corporation, and local governments.
13. Net changes in central government arrears to domestic private parties is defined as changes in the sum of all pending payments by government for goods and services already purchased from these parties, as well as pending interest and amortization obligations on domestic debt, which has already been restructured according to the debt exchange offer. Private domestic parties exclude DOWASCO, Dominica Social Security, National Development Corporation, Dominica Broadcasting Corporation, DEXIA, and the Ports Authority. The measure used will be unpaid checks issued and pending invoices for which payment is overdue. This ceiling will be monitored on a continuous basis.
14. The floor on the overall balance of the central government revenue is defined as the minimum of tax collections and nontax revenues reported in the treasury accounts (economic classification), excluding: (i) revenues from the economic citizenship program, (ii) foreign and domestic grant receipts, (iii) loan repayments, (iv) wage refunds, and (v) privatization receipts, and includes income tax refunds.
15. Central government primary savings is measured on an accrual basis (including unpaid checks issued and unprocessed invoices) and is defined as the central government revenue before grants (i.e., excluding grants) minus current noninterest expenditure. The adjustors described in paragraph 8 and 9 apply to the central government primary savings.
Monitoring discretionary tax exemptions
16. Discretionary tax exemptions are defined as tax exemptions granted under sections 6(2) and 313 of the Consumption Order Act, Section 26 of the Sales Tax Act, Section 60 of the Customs (Control and Management) Act, Section 25(2) of the Income Tax Act, or remissions of tax under section 109 of the Income Tax Act (except in cases where the Comptroller certifies that the tax to be remitted is uncollectible).
The number of discretionary tax exemptions will be monitored on a continuous basis.
II. Monetary Targets
17. Net credit of the banking system is defined as in paragraph 5. The banking system is defined as the consolidation of the Eastern Caribbean Central Bank operations in Dominica (including credit extended under the fiscal tranche window), with the accounts of all banks licensed by the ECCB to do business in Dominica as commercial banks, but excluding the proceeds of borrowing from the International Monetary Fund.
The following adjusters will apply:
18. The limits on the banking system net credit to the central government will be adjusted downward to the extent that budgetary lending has been obtained and not used for the intended reform, or upwards to bridge financing for agreed reforms.
19. The limits on banking system net credit to the central government will be adjusted to the extent that actual interest payments deviate from the programmed schedule of interest payments. If actual payments are higher (lower) than programmed, then the limits on banking system net credit to the central government will be adjusted upward (downward) by the full amount of the discrepancy. The program assumes cash interest payments according to the following schedule:
III. External Sector Targets
20. Disbursements of nonconcessional external central government and central government guaranteed debt with maturity of at least one year will be monitored by the Accountant General’s Office on a monthly basis. Central government and central government guaranteed external debt is defined to include debt contracted or guaranteed by the central government.
21. The term debt is defined as set forth in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-(00/85), August 24, 2000):
“(a) For the purpose of this guideline, the term “debt” will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows:
(i) loans, i.e., advances of money to obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans, and buyers’ credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements);
(ii) suppliers’ credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and
(iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lesser retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property.
(b) Under the definition of debt set out in point 21(a) above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.”
22. Nonconcessional is defined as debt having a grant element (in net present value relative to face value) of less than 35 percent, based on the currency- and maturity-specific Commercial Reference Rates (CIRR), published monthly by the OECD.4 The limit excludes the disbursements of short-term import-related debts, the use of Fund resources, refinancing operations, and disbursements of external loans for clearance of payment arrears to DOWASCO.
The following adjusters will apply:
23. The limits on the disbursement of nonconcessional external loans will be adjusted downward (upward) to the extent that external project loans fall short of (exceed) programmed amounts. External project loans are defined as the receipt of loan proceeds to finance the central government’s portion of the PSIP. The cumulative programmed amounts are as follows: cumulative from June, 30, 2003, US$6.6 by end-June 2004. Upward adjustments will not exceed US$7.7 by end-June 2004. This adjustor does not apply after end-June 2004.
24. Stock of short-term external debt outstanding is defined as debt with original maturity of less than one year contracted or guaranteed by the central government. The term debt is defined as set forth in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-(00/85), August 24, 2000) (see paragraph 16), but excludes normal import-related credits. This ceiling will be monitored on a continuous basis. The ceiling must not be exceeded at any time. For the period beginning January 1, 2004, the ceiling is cumulative from June 30, 2003.
25. Central government and central government guaranteed external payment arrears are defined as overdue payments on debt contracted or guaranteed by the central government. The definition of arrears under the program excludes the Citibank and RBTT bond claims whose validity is in dispute, the IBM claims and other debt claims which have been irrevocably tendered in the debt exchange offer launched by the authorities on April 6, 2004, and claims of official bilateral debts which are under rescheduling or refinancing negotiation. It also does not include outstanding subscription payments to regional and international organizations for which understandings will be reached to ease payment obligations consistent with the program. The ceiling on the nonaccumulation of central government and central government guaranteed external payment arrears is cumulative from July 25, 2003, when a waiver was granted. This ceiling will be monitored on a continuous basis.
IV. Prior actions, Structural performance criteria, and Structural Benchmarks
26. Approval of the 2004/05 budget, consistent with the program, will be a prior action for completion of the Second Review under the Poverty Reduction and Growth Facility.
27. Tax policy and administration.
28. Pension reform. Submit legislation to Parliament proposing a phased increase in the retirement age for public employees to 60 years (end-June 2004).
29. Institutional strengthening. Improve the regulatory framework for electricity supply, following the recommendations of technical assistance mission (end-September 2004).
V. Periodic Reporting
30. Regular reporting on a monthly basis (and when possible weekly) will include the following:
All information will be reported to Fund staff within three weeks of the end of each month.
32. Reporting on an annual basis will include the following:
33. Other reporting will include:
1 Net domestic bank financing is
defined as the changes in the net credit extended by the domestic banking
system to the central government, excluding net changes in “double signature
accounts” in which grant receipts are deposited. The double signature
accounts include the accounts 115002797, 115002976,115002220, 115001912,
115003051, 115001911, 115003025, 115001471, 115001523, 115003053, 115001710,
and 100038724 held in the National Bank of Dominica (NBD), and any new
account in which grant receipts are deposited and which requires a signature
of an external party for the release of its funds. Cash grants from China
that are not used immediately will be treated as a double signature account.
Treasury bills will be recorded at face value, except for those held by the
banking system which will be recorded on a purchase price basis.