ST. KITTS and NEVIS 1. RECENT ECONOMIC DEVELOPMENTS

ST. KITTS and NEVIS 1. RECENT ECONOMIC DEVELOPMENTS A. Overview Economic growth in St. Kitts and Nevis (SKN) rose slightly in 2006 to 4.4% from 4.1% in 2005, driven mainly by a surge in construction, strong gains in agricultural and manufacturing output, and continued growth in tourism and related services. Inflation rose substantially during the year (to 8.5% in 2006 from 3.6% in 2005), with price increases recorded for all categories of goods and services. Fiscal performance strengthened in 2006, owing mainly to strong revenue performance. Continued administrative improvements at both the Customs and Inland Revenue Departments together, with policy measures that included the introduction of an electricity surcharge, a higher rate for the social services levy, and higher excise duties on alcohol and tobacco accounted for higher revenue collections. Current expenditure was contained, and these factors contributed a small recurrent account surplus in 2006, compared with a small deficit in 2005. Lower net capital spending resulted in a smaller overall deficit in 2006, compared with 2005. B. Sectoral Performance Agriculture Agricultural production increased by 3.8% from the level in 2005, falling slightly short of reversing the decline of 3.9% which had occurred in 2005. Contributing to the turnaround was an increase in the number of crop farmers and in the land area under cultivation, a longer growing season, improved pest and disease management, and better weather conditions. Increased output levels were recorded for most crops (including carrots, tomatoes, onions, sweet peppers, potatoes, peanuts, and watermelons) except yams and cabbages, with the 10% decline in the production of the latter resulting from pest management difficulties. Peanut production more than doubled from 25,000 kg to 56,000 kg, due mainly to production by former sugar workers. In the livestock sub-sector, output declined, partly as a result of a 30% decline in beef production to 60,000 kg that was not offset by a 7% increase to 74,000 kg in pork production. Small ruminant production rose marginally, reflecting increases in the production of mutton from shhep and goats. The livestock industry continued to be plagued by several constraints including insufficient lands for livestock farming, the high incidence of canine attacks, an increasing incidence of praedial larceny, and insufficient commercialization of farming operations. Fish production rose in 2006 with higher catch of pelagic such as snapper, dolphin, tuna, and conch; and further improvement in the output of marine products is expected in 2007 following the completion of the Old Road Fisheries Complex, funded by the Government of Japan, at the end of 2006. Agricultural production was helped during the year by a $0.4 mn FAO-fi n anced project to establish new small-farming and livestock enterprises, as part of the adaptation to the closure of the sugar industry. As part to the support to livestock farmers, the project included improvements to the abattoir. Tourism Value-added in tourism, as proxied by hotels and restaurants, grew by an estimated at 11.8% in 2006, compared with 10.8% in 2005, for the fourth successive year of growth. The expansion reflected continued expansion in the country s tourism markets, primarily the US, improved airlift, and the effects of ongoing marketing and promotion. The authorities continued to develop a niche for meeting and conferences, and have focused effort to promote the destination for weddings, diving, and cultural events. The increase in flights to St. Kitts and Nevis also contributed to a rise in stayover arrivals. In contrast, cruiseship and yacht arrivals declined during 2006, as the number of cruiseship calls declined. Manufacturing Value-added in manufacturing grew 74 CDB Annual Economic Review 2006 St. Kitts and Nevis

by an estimated 10.3% in 2006 compared with 7.6% in 2005, despite the absence of sugar manufacturing during 2006. / Preliminary estimates indicate higher output of electrical and electronic components (in enclave manufacturing operations), concrete products, and beverages. Construction Value-added in the construction sector increased by an estimated 21.2% in 2006 compared with growth of 7.8% in 2005 and 9.4% in 2004 respectively. Ongoing implementation of a number of projects, some large, contributed to output growth in the sector; these included the Calypso Bay condominium project; the Cable Bay Resort; development of Warner Park (sporting complex for hosting CWC 2007 matches; shopping facilities at Port Zante; the Fisheries Complex at Old Road; water and electricity improvement projects; an airport expansion project; Beaumont Park; the West Basseterre By-Pass road; the Kittian Heights; the super-low-income housing project by the National Housing Corporation; the Basic Education Project; and residential and other smaller commercial properties in both islands. C. Prices, Wages and Employment The rate of inflation, as measured by the change in the consumer prices index (CPI), rose on average by 8.5% in 2006, compared with 3.6% in 2005. Infl a tion was driven by increases in the domestic retail price for fuel and the impact of the implementation of increased tariffs and an electricity surcharge. The higher fuel prices led to increases in transportation charges, and, together with higher electricity, prices affected all other price categories, including food. Price increases were recorded for all the major categories of items during the year. Food, the most heavily weighted sub-category, rose by 8.2%; transportation and communication (18.5%); fuel and light (2.8%); accommodation (5.8%); clothing and footwear (4.7%); alcoholic drinks and beverages (2.7%); education (11.3%); medical services (8.9%); and household supplies and operations (2.1%). In the labour market, wages and salaries in the public sector remained unchanged in 2006. Pay and employment levels in the civil service are currently being restricted under an ongoing fiscal stabilisation programme, although the programme allows for the creation and filling of critical positions. D. Fiscal Policy and Debt Operations Fiscal Policy Management Fiscal performance strengthened in 2006 for the fourth consecutive year with improvement in the current account balance, a reduction in the overall deficit, and a higher primary surplus compared with 2005. The current account balance shifted from a deficit of $2.3 mn (0.1% of GDP) in 2005 to a surplus of $6.4 mn (1.4% of GDP) in 2006. The fiscal improvement in 2006 resulted mainly from increased revenue, reflecting continued strengthening of tax administration at both the Customs and Inland Revenue Departments, the introduction of the electricity surcharge, increased retail prices for petroleum products, new excise charges on alcohol and tobacco, and a higher rate for the social services levy. Restraint in capital expenditure and net lending and a relatively high level of capital receipts and grants resulted in a reduction of the the overall fiscal deficit to $9.8 mn (2.1% GDP) in 2006 compared with $18 mn (4.2% of GDP) in 2005. The primary surplus in 2006 almost doubled to $29.1 mn (6.2% of GDP) compared with $17.4 mn (4.1% of GDP) in 2005. Notwithstanding the strong fiscal performance in 2006, the maintenance of fiscal stability will require appropriate measures to further increase revenue collections and restrain growth in public expenditure. Reurrent revenue inflows expanded by 13.3% to $182 mn in 2006, mainly as a result of continuing efforts at improving the efficiency of tax administration, strong growth in domestic economic activities, and the impact of policy measures implemented during the year. The main revenue categories, which recorded substantial increases in 2006 were receipts from the Electricity Department and from stamp duties. Receipts from the Electricity Department increased by 62% to $19.3 mn in 2006 compared with $11.9 mn in 2005. Receipts accruing from the gasoline levy rose in 2006 in contrast to declines in 2005 and 2004 as the Government introduced in December the full pass through system, resulting This in automatic changes in the retail fuel prices in accordance with changes in the landed cost of fuel imports. Total current expenditure grew by 7.8% to $175.6 mn in 2006 compared with $162.9 mn in 2005, reflecting increases in all categories of recurrent expenditure. Outlays on wages and salaries increased by 3.9% to $62.8 mn (35.7% of current expenditures) in 2006, compared with $60.4 mn (37.1% of current expenditure) in 2005. Expenditure on goods and services grew by 12.8% to $47.9 mn in 2006 from $42.5 mn in 2005, which was accounted for mainly by the cost of fuel used to generate electricity. Interest payments grew by 9.8% to $39 mn (22.2% of current expenditure) in 2006 from $35.5 mn (21.8% of current expenditure) in 2005, refl e ctive of the growing level of public sector indebtedness. St. Kitts and Nevis CDB Annual Economic Review 2006 75

Public Debt The total stock of public debt grew by 4.5% to $798.9 mn (168.6% of GDP) at the end of 2006 from $764.4 mn (174.4% of GDP) at the end of 2005. The growth of the debt over the period 2000-06 reflected mainly the financing of the Government s capital programme, and the weak financial performance of the public sector in the earler part of the period. External debt rose by 1.6% to $311.5 mn while the domestic debt increased by 6.5% to $487.4 mn at the end of 2006. The high level of public indebtedness places a significant burden for debt servicing obligations. However, despite greater debt service obligations, the Government has always serviced its debt on a timely basis and has maintained cordial relations with its creditors. The total Central Government debt servicing rose from 35.4% of recurrent revenue in 2005 to 36.7% in 2006. The Government acknowledges that the high level of indebtedness will retard the growth prospects and, with the assistance of CDB, has started a series of initiatives to address the issues. Support is likely to be forthcoming from other development partners as well. E. Financial Sector Total monetary liabilities of the banking system (M2) in SKN increased by 12.8% to $480.9 mn in 2006, compared with a growth rate of 4.3% in 2005. Both M1 and quasi money recorded positive growth in 2006, refl e ctive of economic developments in the country during the year. M1 grew by 12.7% to $68.3 mn in 2006, compared with a decline of 1.9% in 2005. During 2006, currency in circulation increased by 19% to $29 mn while demand deposits rose by 13.7% to $47.9 mn. During 2005, currency in circulation rose by 8.6% and demand deposits declined by 0.1% over the previous year. Quasi money grew faster by 12.9% to $412.5 mn in 2006 compared with a growth of 5.5% in the previous year. Time and savings deposits rose by 8.5% to $261.9 mn in 2006, compared with 4.8% growth in 2005. Foreign currency deposits grew by 21.2% to $150.7 mn in 2006, compared with 6.8% growth in 2005. Credit developments reflected the general positive economic growth in the country during 2006. Total domestic credit increased by 13.7% to $476.9 mn in 2006 compared with a growth of 14.1% in the previous year. Credit to the private sector increased by 11.8% to $333.1 mn compared with a growth of 7.5% in 2005. Net credit to the Central Government increased by 9.5% to $183.4 mn in 2006 compared with growth of 9.2% in 2005. The net foreign assets of the banking system increased by an estimated 61.2% to $224.9 mn as at end-2006 compared with an increase of 31.1% as at end-2005. The country s imputed share of the Central Bank s net reserves increased by 23.9% to $88.6 mn at end-2006 from $71.5 mn at end-2005. F. External Sector Preliminary estimates indicate a widening of the current account deficit of the balance of payments to $118.1 mn (24.9% of GDP) in 2006 compared with $78.9 mn (18.6% of GDP) in 2005. The current account outturn during 2006 resulted from deterioration in the merchandise trade balanceas well as in net factor income accounts. The merchandise trade deficit increased by 28.2% to $162.9 mn in 2006 on account of higher imports, due mainly to increased prices of petroleum products and increased quantities of construction-related imports. Merchandise imports in 2006 were 19.9% higher at $222 mn as compared with $185.2 mn in 2005. Petroleum imports rose by an estimated 23.5% to $33.9 mn in 2006. Export earnings grew marginally by 1.7% to $59.1 mn in 2006 despite the cessation of sugar production, the bulk of which was exported. The net services account declined by 4.3% to $53.4 mn in 2006. Travel receipts rose by 1.8% to an estimated $102.1 mn, reflecting continued growth in total visitor arrivals. In contrast, the net factor income account registered a larger defi c it of $36.1 mn in 2006 compared with $33.5 mn in 2005, refl e cting higher external debt service payments. The net surplus on the capital and financial accounts is estimated at $118.1 mn (24.9% of GDP) in 2006 compared with $67 mn (15.6% of GDP) in 2005. Net foreign direct investment increased by 7.7% to $92.1 mn in 2006 compared with $85.5 mn in 2005. 2. MAJOR POLICY ISSUES A. Achieving Fiscal and Debt Sustainability The high level of public sector indebtedness and increasing debt service obligations are major concerns for the Government. The country s debt service payments are now the highest among members of the ECCU, and exceeds combined spending on health and education. The Government acknowledges the need to address the situation, and during the year started a programme for both debt management and for a reduction in debt-servicing costs. The programme is operating in conjunction with existing strategies to increase the rate of GDP growth, and includes changing the interest rate profile of existing debt, and the sale of assets, the proceeds of which are to be used to reduce the level of outstanding debt. Prudent fi s cal management will be critical to the success of the programmes.. The management reform programme will also target 76 CDB Annual Economic Review 2006 St. Kitts and Nevis

non-central Government public enterprises, with the objective being substantial improvement in the quality of operational and financial management in these entities. To this end a special enterprise monitoring unit is being established in the Ministry of Finance. The achievement of fiscal sustainability will require the Government to pursue stronger fiscal adjustment to support the return to fi s cal and debt sustainability. Further improvement in fiscal savings will require the implementation of additional changes to taxation and expenditure arrangements, some aspects of which, broadly in line with an OECS-wide reform programme, are currently under study. In additional to tax rate and tax structure changes, and to improvement in the management of expenditure, the authorities have begun to focus on the critical need to address substantial institutional weaknesses in public sector management generally. This area is being approached carefully because of the longer-term implications of effecting organizational changes and for sustaining improvement in the quality of human resources. D. Environmental Sustainability Environmental sustainability is an increasingly important aspect of the development process, particularly in countries which rely heavily on that environment for employment, incomes and growth (as in the case of tourism and St. Kitts and Nevis), and in those countries which are open to adverse natural hazard shocks to social and economic activity (rain- and wind-storms, earthquakes, volcanic activity, landslides, and drought). The tourism industry itself, if not properly managed from an environmental point of view, has the capacity to damage or destroy the very basis for its existence. The situation is now complicated by the likely effects of ongoing climate change. The authorities will need to study the situation carefully, and develop rules and operating practices in order to maintain the parameters on which the development programmes rest. Given the fact that other nearby countries in the region and in the OECS grouping face the same challenges, a regional or subregional approach to dealing with the issues will be more likely to yield affordable solutions; so aspects of the problem do in fact require a global approach. B. Sustaining Economic Growth A key development issue in SKN is sustaining economic growth performance in the medium to long term. The growth performance in SKN in recent years reflects the inherent vulnerability of the economy to exogenous shocks and natural hazards. The challenge of sustaining economic growth would require the The current programme has the Government undertaking structural and economic reforms to create a more investment-friendly social, physical and institutional economic environment; however, an important issue is whether other issues need to be addressed, and the identification of those issues. C. Enhancing Social Development Enhancing human capabilities and social development is important to sustaining economic growth in St. Kitts and Nevis. There is a high correlation between low educational attainment, low wages and poverty in the country, as in the rest of the region; so that focused attention on education in all its aspects will be a critically important component in any sustainable programme for poverty reduction and social development that looks beyond the short term. The authorities will need to pay careful attention to the development of a detailed programme to address the issues as an essential part of the ongoing strategy for sustained economic growth over the medium and longer term. 3. PUBLIC SECTOR INVESTMENT PROGRAMME A. Development Objectives The objectives of the programme of economic restructuring and transformation include protecting the economic and social gains of the past; re-orienting the economy to enhance competitivness; and promoting sustainable economic development. The strategic policy focus in the medium term will aim at reducing vulnerability and encourage and facilitate investment; improving competitiveness in the production and export of goods and services; social policies to support economic development and protecting the most vulnerable in society; and ensuring an environmentally sustainable development agenda. It is incumbent on the Government to create a more enabling macroeconomic environment for attracting private investment; supporting key productive sectors for sustained growth; promoting greater economic diversification; and continued emphasis on social development, particularly poverty reduction, education, health, public safety and housing. Continued improvement in fiscal performance and achieving debt sustainability will be fundamental to enhancing the growth prospects and creating the fi s cal policy space necessary to respond effectively to economic shocks. St. Kitts and Nevis CDB Annual Economic Review 2006 77

B. Review of PSIP: 2006 Expenditure on the PSIP is categorised under four broad categories: economic services (agriculture/ environment, tourism, manufacturing and culture); economic infrastructure (transportation and communication, energy, water and sewerage); social services (education, health, community affairs, lands and housing) and general administration. Total spending on the PSIP for 2006 was estimated at $31 mn, 3.5% lower than the level in 2005. Expenditure on economic services was $2.8 mn in 2006 compared with $1 mn in 2005, with the main focus being on beach protection. Expenditure under economic infrastructure totaled $8.3 mn, 22.5% lower than in the previous year. The major projects under this category included natural disaster management, electricity and water improvement, and road infrastructure. Capital expenditure under social services totalled $15.7 mn in 2006, 9% lower than in the previous year; the focus was on sports facilitiues development, a multipurpose centre, and community development. The implementation ratio of the PSIP in 2006 was 89.2%, which was slightly lower than the 91.4% achieved in the previous year. The financing of the PSIP in 2006 was as follows: loans $13.3 mn (43.4% of total financing); grants $12.7 mn (41.1% of total fi n ancing) and general revenue $5.2 mn (15.5% of total fi n ancing). C. Review of PSIP: 2007-08 Spending on the PSIP is projected at $64.5 mn during 2007-08. Economic infrastructure is expected to continue to be the dominant sector accounting for 41.2% of the programme. The main projects proposed under economic infrastructure include improvement to water supplies, electricity, and road infrastructure. Spending on the social services is expected to account for 33% of the programme, with the major items including a World Bank-funded secondary education development Project, the construction of a new education building, and an IT-based training and management project. The health sector projects will include the provision and improvement of health clinics, an HIV/AIDS prevention and control programme, and the reconstruction of the Pogson Hospital. Other social services projects will involve the provision of facilities to support the development of children and youth, including sports facilities and community centres. Spending on general administration is expected to amount to 13.4% of the programme with the main project focused on security, with the construction of police stations at Dieppe Bay, Tabernacle and Frigate Bay. Spending on economic services is expected to account for 14.7% of the programme, and will focus on fisheries development. The financing of the PSIP during the period 2007-09 is expected to be largely through grants. External loans are expected to account for approximately 38% of the programme s financing requirements, with grants accounting for about 48%; the remaining 14% is to come from domestic revenue. D. Implementation Issues The institutional framework for the PSIP continues to be weak resulting in inadequate co-ordination between the various operating units. The planning framework needs to be strengthened to improve the link between investment programming and the capital and current budget processes and debt management. Project implementation has emerged as an area of major concern as significant implementation delays are being experienced in a number of projects, with the delays contributing to cost overruns. In addition, manpower shortages remain a serious issue, adversely affecting the management of both the PSIP and project implementation. 4. MEDIUM-TERM ECONOMIC PROSPECTS Medium-term economic prospects in St Kitts and Nevis are reasonably good, despite the many challenges which need to be addressed. Real GDP growth is projected to grow at an annual average rate of 5% over the period 2007-09, mainly based on the expected performance of tourism and construction, and, to a lesser extent, agriculture. The outlook for tourism and construction is based on current activities to expand accommodation, and on derived demand for residential construction.. Expanded tourism industry and construction sector activity will feed through to other areas of the economy. These growth projections emphasise the dependence of the economy on, and its vulnerability to, the fortunes of a single industry. The medium-term economic policy framework is likely to be dominated by fiscal and debt management improvement measures and public sector reforms ito achieve and enhance fiscal and debt sustainability. Fiscal performance will improve with economic growth if the ongoing reform programme is adhered to and enhanced to take account of the issues raised earlier in this review. The proper management of asset sales, particularly land sales, and the utilisation of the proceeds to reduce outstanding debt, will be absolutely crucial to the success of the debt management programme. 78 CDB Annual Economic Review 2006 St. Kitts and Nevis