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2 ANNEX 1. IDENTIFICATION Title/Number St. Kitts and Nevis Accompanying Measures for Sugar Protocol Countries Allocation 2010 CRIS Number: Budget heading Budget line Total cost EU contribution: EUR of which EUR are budget support and EUR are complementary support Aid method General budget support centralised management DAC-code Sector GBS 2. RATIONALE AND COUNTRY CONTEXT Regulation (EC) No 1905/2006 of the European Parliament and of the Council of 18 December 2006 establishing a financing instrument for development cooperation Accompanying Measures for Sugar Protocol (AMSP) countries, with the overall objective to accompany the adaptation process of such countries affected by the EU sugar reform. Financial and technical assistance, including budget support where appropriate, was established to accompany the adjustment process. As the Government of St. Kitts and Nevis (GoSKN) decided to discontinue sugar production the objectives stated in art. 4.1(c) of the Regulation applies, i.e.: To promote the economic diversification of sugar dependent areas and to reduce poverty Country Context and National Policy and Strategy Economic and social situation and poverty analysis Over the past decade, economic developments in SKN have been shaped by the need to respond to a series of shocks - a succession of hurricanes in the late 1990s; the sharp drop in tourism after the September 11 attacks and the closure of the sugar industry in Fiscal policy typically responded through reconstruction and social programmes to maintain employment and limit the impact of these shocks. The result was an accumulation of public debt peaking at a ratio of 183% of GDP in Government made significant efforts to reduce the public debt ratio in recent years to 165% in 2008 but with the crisis it grew back to 185% in The Country Poverty Assessment (CPA) was completed and submitted to Cabinet in August The report concluded that SKN had made significant progress in reducing the number of people living in poverty and in achieving the millennium development goals. The poverty rate has fallen from 30.5% in 2000 to 23.7% in 2009 and the level of indigence declined from 11.0% to 1.4% in St. Kitts. In Nevis the poverty rate change was more dramatic with a decline from 32.0% to 15.9% and the indigence level fell from 17.0% to 0.0% National Development/ Cooperation Policy and Strategy In 2005 SKN closed its sugar industry in the wake of the changes made in the EU sugar protocol. The loss of the sugar industry has had repercussions on the entire socio-economic structure and implications for other sectors of the economy in terms of challenges and opportunities. In order to cope with these changes, the country adopted a National Adaptation Strategy (NAS, ) aiming at enhancing economic diversification and social development. The NAS was prepared through extensive consultations involving open dialogue between key stakeholders: Government, Cabinet, sugar industry officials, sugar workers, regional organisations, non-state actors and development partners. Given the significance of the sugar industry in the economy of SKN there was widespread EN 1 EN

3 media coverage and public consultations on the future of sugar which began as early as Following the completion of the CPA, SKN objective is to develop a Poverty Reduction Strategy by beginning of Eligibility for budget support National Development or Cooperation Policy and Strategy The NAS represents an agreed and coherent policy framework over the 8 year period, outlining national development priorities and providing a framework for diversifying the economy out of sugar production. The strategic focus includes the following objectives: a) macro-economic policies to reduce vulnerability and encourage and facilitate investment; b) improved competitiveness in the production and export of goods and services; c) social policies to support economic development and protect the most vulnerable; d) an environmentally sustainable development agenda and successful economic restructuring and transformation through better organization. The establishment of institutional structures has been a vital component in the monitoring framework of the NAS. These include a Cabinet Committee on Finance and the Economy; an Inter-Ministerial Technical Committee on National Transformation (IMTEC) and a Coordination and Programming Unit (CPU). The GoSKN developed a Performance Assessment Framework (PAF) in 2009 for the period covering objectives corresponding to MIP focus. The implementation of the NAS is tracked through successive reports (2007, 2008, first half 2009) submitted to EU in the framework of on-going General Budget Support programmes. In conclusion, the analysis of national policy and strategy confirms that a well defined national policy and strategy that responds to the challenges and problems faced by SKN is in place and under implementation. As a result this national strategy is an appropriate basis for providing EC general budget support Macroeconomic situation The effects of the worldwide slowdown along with the fallout of the collapse of the Trinidad based CL Financial Group and the prolonged closure of the Four Seasons Hotel in the aftermath of Hurricane Omar resulted in a sharp projected contraction of real output in 2009, the first negative growth in over five years. GoSKN recorded a primary balance surplus for the fifth consecutive year in 2009, a strategy aimed at addressing the problem of high indebtness. But the country s still heavy debt burden (debt-to GDP ratio of 185% in 2009) has left no space for fiscal policy to respond to the downturn. The most recent Article IV IMF mission took place in April/May The key conclusions are that SKN's tourism-dependent and highly indebted economy has been buffeted by the global financial and economic crisis, resulting in about 5.5 % contraction in 2009, as opposed to average real GDP growth of about 5% during Despite recent progress in reducing the debt-to-gdp ratio, primary fiscal surpluses have not been sufficient to place debt on a firmly declining trajectory. As a consequence, arrears have accumulated, debt service costs have risen significantly and liquidity risks posed by large rollover needs of short term debt have also risen. The first government response to macroeconomic challenges was announced already in the 2010 Budget Address and numerous measures have been already implemented. Further short term measures aimed at fiscal stabilisation in 2010 and beyond were agreed with the IMF during the recent Art IV mission and subsequently announced by the Prime Minister in the Parliament and outlined in a letter addressed to EU. Their implementation is either completed or on-going: streamlining tax expenditures, closing loopholes in the duty free shopping system, increase of the social service levy, revision of the electricity base tariff, casino license and race track fees; freeze in wages and hiring; containing expenditure on goods and services; greater prioritisation of capital spending. These measures could yield about 7.7 % of GDP. Additionally, in order to ensure the security of the banking system, MoF EN 2 EN

4 has been adhering to strict cash management guidelines agreed with the banks and endorsed by the IMF. Over the medium term further structural reforms were agreed by the government in order to strengthen fiscal consolidation: corporatisation of the electricity utility, strengthening of the Public Finance management system, rationalisation of the civil service, further prioritisation of the capital expenditure, actions to improve labour market flexibility and strengthening of attractiveness of the business environment, continued efforts to streamline poverty reduction efforts and preserve the sustainability of the social security system. However, even with this significant fiscal adjustment, the IMF foresees a residual financing gap expected to grow larger over the medium term and encouraged SKN to seek financial support from multilateral financial institutions to facilitate the adjustment program as well as speed up land sales. These recommendations are currently being analysed. In conclusion, the macroeconomic environment in SKN remains very challenging in 2010 and in the medium term. However, important short term revenue and expenditure measures, as well as medium term structural reforms have been agreed with the IMF to try to address these challenges and the implementation of this fiscal stabilisation plan will be monitored during implementation of this programme Public Financial Management In 2007 and 2009, as part of the ongoing GBS programmes, the EC financed a PFM assessment based on the PEFA methodology. The 2009 PEFA assessment was conducted in August 2009 and the report was finalised in December Overall, the PEFA assessment indicates that while a fair amount of progress has been made in recent years, the existing PFM system in SKN is not entirely supporting the achievement of aggregate fiscal discipline, strategic allocation of resources, and efficient service delivery, which characterize a fully transparent and orderly PFM system. The GoSKN adopted a PEFA Action Plan on the 16 June 2008 and established a PFM Committee in February 2008 to oversee the implementation of reforms. An important part of the reform process includes strengthening the legislative basis for these reforms, enactment of the Finance Administration Act (FAA), drafting financial regulations for the FAA and a new Procurement Bill. Other initiatives since 2007 include: improved budget formulation which is now broadly compatible with international standards; linkage of capital and recurrent expenditures across projects; improved budget circular; improved budget dialogue with overall strategic plans and sectoral programmes being reprioritized and meeting the recurrent spending ceilings or envelopes by ministry; capacity building within the Ministry of Finance (MoF) Fiscal and Regulatory Division and the Debt Management Unit; improved reporting through the creation of a Cash Management Unit in 2008; partial improvement in the assessment of fiscal risk through the establishment of a Government Entities Oversight Board and Government Entities Monitoring Unit in 2008; progress in the internal audit function through the restructuring of the Internal Audit Unit within the Accountant General s Department in 2008; creation of a Procurement Board and drafting of a Procurement Bill in 2009 and the adoption of SKN-MoF guidelines, best practices, technological platform (i.e., SIGBUD, FITRIX) by the Nevis Island Administration. Additionally, following the 2009 PEFA exercise, the government expressed its commitment to review the PFM Action Plan in order to address weaknesses identified. In conclusion, the analysis of public finance management criterion shows that SKN has established a relevant programme of improvement in public financial management and is committed to improve it further and that the evidence from the PFM diagnostic and the PFM reform process shows that trends in PFM justify the allocation of budget support Lessons learnt The GoSKN is already implementing GBS programmes through the 2007, 2008 and 2009 AMSP allocations. The existing programmes have been marked by delays in implementation with only one EN 3 EN

5 fixed tranche disbursed at the time of formulation of this programme. The main lessons learnt relate to the need for: further technical support to strengthen the national institutional framework; the creation of an annual budget support review process assuring greater predictability of disbursements; more realistic determination of conditions and targets for variable tranches; establishing a clear correlation between the calendar of disbursements and the timing of availability of supporting evidence for general conditions and variable tranche indicators Complementary actions The EU is the largest development partner to Saint Kitts and Nevis followed by the Caribbean Development Bank (CDB). The CDB is providing assistance through its policy based loan of USD10 million. This EU budget support programme and the CDB assistance share the same global objectives and there is close dialogue between both institutions to ensure coordination and complementarity. The EU assistance from the 9 th EDF also contributes to the government efforts to create growth and reduce poverty, but with a specific focus on education and information technology. While the main focus of the EU assistance from the 10 th EDF addresses another specific and important component of the National Adaptation Strategy: Safety and Security. Additionally, 15% of the 10 th EDF funds are earmarked to support the government to manage all EU grants and to finance studies and technical assistance linked to our cooperation Donor coordination National responsibility for donor co-ordination is vested with the Ministry of Sustainable Development. The Delegation works closely with other donors including CDB, IMF, DfID, UNDP, Canadian CIDA and Caribbean Regional technical Assistance Centre (CARTAC) to coordinate donor interventions in the areas of macroeconomic support and strengthening of capacities in public finance management reform process. 3. DESCRIPTION 3.1. Objectives This programme is the fourth annual General Budget Support (GBS), in line with the MIP In coherence with the EU Response Strategy, the overall objective of the GBS is to support the government's growth and poverty reduction objectives as stated in its National Adaptation Strategy (NAS). The specific objective is to contribute to the implementation of NAS in the areas of pro-poor, sustainable economic growth, civil service reform, private sector development and good governance through improvement of Public Finance Management (PFM) systems and macroeconomic management Expected results and main activities The key results anticipated from the 2010 framework are: - Improved policy framework for social sectors through support to the Technical Vocational Education and Training (TVET) policy to target some of the root causes of poverty (e.g. low education attainment, low skills, unemployment) and through support to the Social Safety Nets Strategy aiming at improving efficiency in the delivery of the programmes targeted at the poor; - Improving transparency and increasing efficiency and effectiveness of the delivery of services in the public sector through support to Civil Service Reform and its legal basis; - Enhancement of the investment climate through support to development of an Investment Code; EN 4 EN

6 - Improvement of the PFM system through strengthening of Government's own accountability mechanism, dialogue on conditions and indicators related to public finance management and implementation of TA component of the programme; - Strengthening of the macroeconomic environment through technical assistance, dialogue and financial support. The programme activities relate to policy dialogue around the 3 eligibility criteria and fulfilment of variable tranche indicators, implementation of Technical Assistance component and donor coordination. In relation to the Technical Assistance, a needs assessment will be carried out Stakeholders The Ministry of Sustainable Development (MoSD) is the lead ministry for the implementation of the NAS and consequently for this budget support programme, with coordination and assistance of the Ministry of Finance. Monitoring of the implementation of the EC Response Strategy as specified in the MIP will therefore be carried out within the institutional structures described in the NAS - a Cabinet Committee on Finance and Economy; an Inter-Ministerial Technical Committee on National Transformation; and a MoSD Coordination Unit. The GoSKN has also established a Non- State Actors Panel which will be the forum for regular consultations on implementation of the strategy Risks and assumptions Financial and Economic Risks: The main risk for the GoSKN stems from its challenging macroeconomic environment. The implementation of fiscal adjustment strategy agreed with the IMF which will be closely monitored during the implementation of the programme will address this risk. Administrative capacity risks: Given its relatively small size, the human capacity of the administration to implement NAS and to adopt international PFM standards is challenging. Provision of TA support under this and other on-going budget support programmes will mitigate this risk. Hurricane related risks: The continued threat posed by hurricanes is the greatest barrier to the success of any development programme Crosscutting issues The programme has clear positive implications in the sphere of good governance. 4. IMPLEMENTATION ISSUES 4.1. Budget and calendar The total amount allocated to this programme is EUR of which a maximum of EUR is for Budget Support tranches. The complementary support, totalling EUR consists of EUR for Institutional Strengthening/Technical Assistance component in the area of public finance management, debt management and civil service modernisation, EUR as provision for monitoring and EUR for visibility actions. The timetable of implementation of the Budget Support component covers two fiscal years (calendar years and fiscal years are the same in SKN). Operational Duration of this General Budget Support programme will be 36 months from the signature of the Financing Agreement (FA). EN 5 EN

7 Indicative budget (EUR) 1 st Tranche/fixed nd Tranche/variable Technical Assistance Visibility Monitoring & Evaluation Total The budget support component will be disbursed through: - one fixed tranche of EUR foreseen to be disbursed by the end of 2011; - one variable tranche of EUR foreseen to be disbursed by the second quarter of Budget Support modalities This direct non-targeted budget support programme will be disbursed in two instalments corresponding to fiscal years 2011 and The funds will be accounted for in the St. Kitts and Nevis Budget and transferred to the government s Single Treasury Account as revenues to support budgetary execution. Foreign-exchange transfers will be entered in the accounts under the value date of the notification of credit to the account of the Eastern Caribbean Central Bank. The exchange rate will be the middle rate of the interbank foreign currency market on the day of the transfer Procurement and grants award procedures (Complementary Support) All contracts implementing the action must be awarded and implemented in accordance with the procedures and standard documents laid down and published by the Commission for the implementation of external operations, in force at the time of the launch of the procedure in question. Participation in the award of contracts for the present action shall be open to all natural and legal persons covered by the DCI Regulation. Further extensions of this participation to other natural or legal persons by the concerned authorising officer shall be subject to the conditions provided for in articles 31(7) and (8) of the DCI regulation Performance monitoring and criteria for disbursement The fixed tranche will be disbursed in full upon fulfilment of the general conditions for budget support. So that the EC can evaluate the fulfilment of the general conditions, the SKN Government shall communicate at the time of disbursement request information on the following: (i) satisfactory progress in the implementation of the National Adaptation Strategy as evidenced by annual progress reports of GoSKN. (ii) satisfactory progress in the maintenance of a stability - oriented macroeconomic policy, as evidenced on the basis of IMF Article IV reports or equivalent and government's assessment in their request for tranche release, including budget execution reports. (iii) satisfactory progress in the implementation of its programme to improve public financial management, as evidenced by the development of a comprehensive PFM Action Plan based on weaknesses identified in the PEFA 2009 report and by reports and conclusions of the PFM Committee, specifying progress achieved on implementation of the PFM Action Plan. The variable tranche will disbursed upon fulfilment of the general conditions mentioned above and specific conditions in the areas of: technical vocation education, social safety nets policy; private sector development and public financial management EN 6 EN

8 On the basis of the information supplied, the EC shall formulate an assessment before the disbursement of all tranches of budget support Evaluation and audit It is foreseen to conduct a final evaluation of all budget support operations under the AMSP , covering thus Sugar 2007, 2008, 2009 and 2010 General Budget Support programmes. Evaluation will focus on the extent to which budget support is relevant, efficient, and effective in contributing to achieving sustainable impacts in the areas which are the focus of the objectives of budget support. Audits may be conducted for complementary measures implemented under EDF procedures. Audit and evaluation contracts will be signed by the EC Communication and visibility The Government will convene a formal high-level annual review of the macro-economic, fiscal and PFM situation while the programme is being implemented. This will ensure that discussions between the donors and Government take place at the appropriate level and promote high visibility of the programme. Communication and visibility activities will be coordinated by the MoF and the MoSD. EN 7 EN