ST. LUCIA 1. RECENT ECONOMIC PERFORMANCE. A. Overview

1. RECENT ECONOMIC PERFORMANCE A. Overview Economic activity in St. Lucia was estimated to have risen by 5% during 2005, led by increased activity in construction and within the hotels and restaurant industry. During the previous year real output was estimated to have increased by 4%. The results obtained from quarterly surveys in the first and second quarter of 2005, indicate that the level of unemployment declined, reflecting sustained moderate increases in economic activity since 2003 following a decline in 2001 and slow growth in 2002. During 2005 the level of inflation as measured by the change in the CPI was 5.2%. The sustained improvement in economic activity in 2004 and 2005 contributed to improved tax receipts which led to higher savings on Central Government fiscal operations. Increased investor and consumer confidence in the economy was reflected in an expansion in credit by the banking system and a tightening of liquidity. A larger deficit on the external current account was estimated for 2005 and was in part financed from a fall in net foreign assets of the banking system. B. Sectoral Performance Agriculture Real value-added from agriculture was estimated to have contracted by 14.5% in 2005. The production of banana the major agricultural product, was estimated to have declined by 29.1% during the year to 30,007 tns. Leaf spot disease affected several farms in the major banana growing areas resulting in a significant quantity of fruits being unsuitable for exports. ST. LUCIA The proliferation of the disease was exacerbated by wet conditions and by cash flow difficulties. The production of non-banana crops was also estimated to have declined as reflected in export volumes and declining purchases by domestic supermarkets. During 2005, the volume of nonbanana crops exported grew by an estimated 21.7%, but this was outweighed by an 18.6% decline in the volume purchased by domestic supermarkets. However, the value of exports of non-banana crops and purchases by domestic supermarkets rose by 2.9%. Tourism The hotels and restaurants industry continued to perform well with real value-added within that industry estimated to have increased by 6.3%, compared with growth of 5.9% estimated for 2004. During 2005, St. Lucia welcomed 317,939 stay-over guests, which was 6.5% more than it received during 2004. Stay-over arrivals during the first half jumped by 14%, however a decline in the third quarter moderated the overall growth over the period. The performance in the third quarter may have in part reflected the early impact of hurricanes in the Caribbean which resulted in negative publicity even for islands not directly affected. Arrivals picked up in the last quarter and forward bookings for the 2005/06 winter season were reported to be good. Stay-over arrivals from all major sources of visitors to St. Lucia grew, while the USA remained the most important market contributing 35.4% of these arrivals. By contrast, cruiseship arrivals dipped by 18% to 394,431 during 2005. Remedial construction work on the cruise berthing facility in the capital Castries was only partly responsible for the decline. Redeployment of ships from the Caribbean to the Mediterranean and Hawaii and the relocation of some home porting activities from Puerto Rico to the USA mainland which impacted call schedules, also adversely affected cruiseship arrivals to St. Lucia. The high cost of fuel and the general growth in home porting activity on the US mainland also influenced the routes of cruiseships thus adversely impacting destinations in the southern Caribbean such as St. Lucia. Of the other categories of visitors to St. Lucia, excursionist arrivals declined by 34% to 7,541, while yacht passengers rose by 21.9% to 27,464. Construction The construction of new hotel rooms was a major factor underlying an estimated 12.8% growth 103

ST. LUCIA in real value-added from construction activity during 2005. Construction activity had grown marginally during 2004 after declining annually since 1999. The growth in construction activity was underpinned by the response of several investors to the attractive fiscal incentives offered by the Government of St. Lucia (GOSL) which was aimed at attracting investments in new accommodation rooms to facilitate the hosting of matches during Cricket World Cup 2007. Public construction activity was also buoyant. Road construction activity related to the World Cup commenced during the period under review, however several other public sector construction projects were ongoing. past trend, wages within the private sector may have increased by between 2% and 3%. D. Fiscal Policy and Debt Operations An increase in recurrent revenue of 4.5% led to higher savings of $26.8 mn (3.4% of GDP) in 2005 compared with savings of $17.5 mn (2.3% of GDP) in 2004. However capital expenditure rose and amounted to $61.6 mn (7.7% of GDP) compared with $43.4 mn (5.7% of GDP) during 2004. Capital grant receipts more than doubled to $5.4 mn. Consequently the overall deficit grew and amounted to $34.7 mn (4.3% of GDP) during 2005 compared with one of $25.6 mn (3.4% of GDP) in 2004. 104 Other Sectors Increased production of alcoholic beverages, metal products and electronic items largely led to a 3.9% increase in value-added in Manufacturing, notwithstanding lower output of corrugated paper and paperboard products, as well as lower output of copra and copra derivatives. Value-added from wholesale and retail trade grew by 10.5% with all other sectors recorded growth, largely reflecting the impetus created by the growth in construction and tourism activity and increasing confidence in the economy. C. Prices, Wages and Employment At the end of 2005 the CPI rose by 5.2% over the position at the end of the previous year. By comparison, at the end of 2004, the level of inflation as measured by the change in the CPI was 3.5% relative to the position at the end of 2003. Food prices rose sharply during 2005 as reflected in a 9.4% increase in the sub-index for food which carries the greatest weight. The rise in the level of consumer prices during 2005 was also influenced by increases in international oil prices which were passed on to consumers. Reflecting this, the subindex for fuel and light climbed by 6.1% while that for transportation and communication rose by 5.4%. While the level of unemployment remained high in 2005, preliminary survey results indicated that the level was lower during the second quarter at 17.5%, down from 20.9% recorded during the first quarter and an average of 21% registered in 2004. An increase in construction activity may have contributed to this decline. Wage rates within the public sector remained constant during 2005 as wage negotiations were not concluded. Wages are however expected to increase in 2006 to reflect increases both for 2005 and 2006. Judging from The higher recurrent revenue intake which amounted to $208.1 mn, resulted from increased receipts from taxes on income international trade and transactions. Of taxes on income and profits which grew by 19.9% to $51.7 mn, receipts from corporation tax rose by 36.5% to $22.3 mn. This outturn was attributed to the sustained improvement in economic activity during 2004. Individual income taxes and withholding taxes also increased. The intake on taxes on international trade and transactions rose by 2.6% to $106.7 mn, and was largely attributed to higher collections of custom service charge, excise tax on imports and environmental surcharge. Revenue from taxes on domestic goods and services declined by 4,1% to $33.1 mn, but this outturn largely resulted from a decline in the receipts from licences by more than half, which reflected the extraordinary increase in the yield from that item during the previous year due to the payment of arrears. Recurrent expenditure declined by 0.2% to $181.3 mn. The wages and salaries bill declined by 2.8% to $81.7 mn, but this partly reflected the fact that retroactive payments were made during the previous year and that negotiations for wage and salary increases for 2005 were not concluded. The outlay on goods and services decreased by 5.7% to $33.4 mn. Interest payments rose by 11.4% to $25.5 mn, while transfers increased by 3.7% to $40.7 mn. At the end of September 2005, the disbursed outstanding debt of the Central Government stood at $445.8 mn. By comparison, Central Government debt stood at $437.6 mn at the end of 2004, which was equivalent to 59.9% of GDP at market prices. Central Government external debt rose by $31.3

mn to 328.9 mn at the end of September 2005, while Central Government domestic debt declined by $23 mn to $116.9 mn. Total public sector debt amounted to $528.9 mn at the end of September 2005, compared with $524 mn (71.2% of GDP at market prices) at the end of 2004. E. Financial Sector During 2005, the monetary liabilities of the banking system expanded by $75.1 mn to $634 mn. However, credit extended by commercial banks increased by a greater extent than the expansion in monetary liabilities, and thus led to tighter liquidity. Reflecting this, the loans to deposit ratio rose to 85% at the end of September 2005 compared with 80.7% recorded at the end of 2004. Approximately $160.2 mn growth in net domestic credit to $601.1 mn was largely underpinned by a $99 mn increase in credit to the private sector and a $15.2 mn increase in net credit to Central Government. Increases in credit were recorded within several areas of economic activity including, the distributive trades and tourism, lending to which increased by $12.1 mn and $24.7 mn respectively, while lending for personal use rose by $35 mn. Lending rates remained stable over the period, while the maximum deposit rates on fixed deposits with duration of 12 months or less, declined by between 1.75 and 2.5 percentage points. F. External Sector Net foreign assets within the commercial banking system declined by $85.1 mn to $32.9 mn during 2005, and thus suggested an overall deficit on the external account. St. Lucia s imputed reserves at ECCB declined by $16.6 mn to $113.6 mn. Indications are that the deficit on the external current account grew. During 2005, merchandise imports grew by 8.2% to $410.1 mn. By contrast merchandise exports contracted by 45.1% to $50.9 mn. An improvement on the services account was anticipated based on the improved performance of the tourism industry and notwithstanding the decline in cruiseship passenger arrivals; however the higher merchandise trade deficit was likely to outweigh the improvement on the services account. 2. MAJOR POLICY ISSUES A. Tourism Development The tourism industry continues to be the most important area of economic activity and appears to hold the most potential for enhancing economic growth and development of St. Lucia. One of the key objectives of GOSL is to establish tourism as a strategic economic development priority. Strong investor confidence in the industry has resurged following some decline that was largely associated with the event of September 11 th 2001. Investments of more than $1 bn in guest accommodation facilities are anticipated over the medium term which is expected to add more than 1,500 rooms. The island s tourism industry competes on quality and on its uniqueness, rather than on price. Thus, it is important to seek to maintain Saint Lucia s image as an upscale destination. This will require consistency between its marketing strategy and its product quality. GOSL has undertaken a number of initiatives to improve the standard and quality of its tourism product and is encouraged to continue making appropriate investments in infrastructure and in the aesthetic appeal of the destination. Preserving the island s environmental integrity and the spread of the benefits of tourism throughout the society are also critical to the sustainability of the islands tourism industry. Given the decline of the banana industry over the last 15 years, tourism has played a critical role in providing employment. Enhancing social cohesion will require continued efforts so as to spread the benefit of tourism particularly in rural areas, especially given the further decline anticipated in the banana industry. Sustaining efforts under the heritage tourism programme are thus important. This programme seeks to strengthen the heritage tourism capacities within communities. B. Agriculture Development The tariff-quota arrangement for the imports of bananas into Europe which favored ACP producers including the St. Lucia and other Windward Islands, has been replaced by a tariff only system which was effective from the beginning of 2006. Under this new system, bananas from the ACP countries enter the EU market free of tariffs within a quota of 775,000 tns, while a tariff of 176 per tn is levied on non-acp bananas. Under the preceding regime, non-acp bananas faced a tariff of 75 per tn within a quota of 2,653,000 while a tariff of 680 per tn was applied to amounts outside of the quota. The new tariff is much lower than the 300 per tn that was thought by some to be the minimum tariff on non- ACP fruit that would enable the Windward Islands banana industry to survive. The new tariff of 176 is also significantly lower than the 230 per tn which ST. LUCIA 105

ST. LUCIA the EU originally proposed and argued would have resulted in an equivalent level of market access as under the tariff/quota arrangement. Over the next 6 to 12 months, the adequacy of the new tariff to protect the Windward Islands banana industry will be tested. However, several Latin American banana producing countries are not pleased with the new EU tariff import regime and contend that the EU is violating multilateral trade laws and regulations by allowing bananas from ACP countries to enter the market tariff free. Several Latin American banana producing countries had announced that they intend to dispute the new banana import regime at the WTO. While attempts at improving the competitiveness of the banana industry should continue, attempts to diversify agriculture must be intensified. Some stakeholders are of the view that a higher degree of organisation and support is needed if nonbanana agriculture is to flourish, especially where there is potential for linkages with the tourism sector and where food security is of importance. GOSL has put in place a new incentive regime to support agri-business development. A key element of this incentive regime is the focus on groupings, association and cooperatives. These grouping are entitled to benefits that are greater than that to which individuals are entitled. The regime makes concessions available through partial or complete waiver of import duties, consumption or excise taxes on a range of items and inputs used in agricultural production and processing. planning for the eventuality of natural hazards and disasters should be a critical element in the pursuit of sustainable growth and development in the Caribbean Region. A greater awareness of this has been driven home to the OECS sub-region by the frequency with which hurricanes has struck the Region within the last two decades. Development and growth and hence attempts to eliminate poverty within the OECS Region have been repeatedly set back by natural disasters through the destruction of productive capacity and its related impacts including the adverse impact on government operations. These disasters have also contributed to a significant proportion of the debt burden of the countries directly through the need to borrow to replace damaged or destroyed infrastructure, and indirectly through the impact of reduced economic activity on Government revenue. St. Lucia s geographic location exposes it to a very high probability of being affected by natural disasters including tropical storms and volcanoes. A substantial proportion of the population live on slopes that are susceptible to landslides. The Black Mallet landslide demonstrated the extent of human and financial costs that may result form such events. Given limitations in physical size, the narrowness of its economic base and the openness of the economy, natural disasters pose a particularly serious threat to sustained economic growth in St. Lucia. Of strategic importance therefore, are measures to minimise the impact of natural disasters and the need Tourist Arrivals in St. Lucia 500 400 300 200 100 Stayover arrivals ('000) Cruise Ship arrivals ('000) 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 106 C. Hazard Mitigation Within most, if not all countries of the Caribbean Region, the incidence of hurricanes and tropical storms are seen as a crisis despite the fact that their occurrence can be established within some level of statistical precision that warrants planning (where free market responses are inadequate) rather than crisis management. Comprehensive to build capacity and put in place mechanisms to efficiently manage recovery efforts in their aftermath. Several disaster mitigation projects have been implemented since 1995. These include the desalting and river training, construction of drainage channels, river walls and reservoirs, slope stabilisation works, flood protection works, coastal protection works, institutional strengthening,

Banana Production in St. Lucia 80000 70000 60000 50000 40000 30000 20000 10000 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 training and capacity building, communication and warning systems strengthening. Further interventions are to be implemented under the St. Lucia Disaster Management Project Phase two being financed by GOSL and WB. This project will include coastal protection works, the rehabilitation and construction of three bridges, drainage works, the construction of river walls, slope stabilisation, retrofitting of schools and health Centres, as well as the strengthening of emergency preparedness and response and institutional strengthening. D. Poverty Reduction Efforts to reduce poverty and to share the benefit of growth broadly are necessary elements toward sustaining higher growth levels, promoting social cohesion and fostering an improved security environment. Promoting sustainable economic growth has been the single most important tool employed in the fight against poverty. Without economic growth, efforts at redistribution will be more difficult and social cohesion and economic growth could be undermined. St. Lucia has therefore had good success over the three decades up to 2000, creating employment and in raising per capita income especially through its support for agriculture, manufacturing and tourism. In 1995, CDB, in conjunction with CIDA, and the UK Department for International Development (DFID), funded a CPA for St. Lucia. The poverty assessment indicated that based on their inability to satisfy basic food and non-food requirements, 25.1% of the population (18.7% of households) were classified as being poor. Moreover, 7.1% of the population (5.3% of households) was considered as being extremely poor, their expenditure being below that required to satisfy basic food needs. The CPA identified a number of factors which contributed to the incidence of poverty, including declines in the banana industry and Production (tonnes) the manufacturing sector which increased unemployment. Poverty was also exacerbated by the absence of safety nets, ineffective targeting of social assistance programmes and weakness in critical social infrastructure. While decline in the banana industry has continued to be a major influencing factor on the incidence of poverty, decline in the vital tourism industry during the period 2000-02 has also contributed. Since 2003 there has been recovery in the tourism industry and sustained economic activity resumed following the downturn in 2001 and slow growth in 2002. Prospects for growth are good and provide the desirable foundation for reducing poverty. Several other factors contributed towards poverty in St. Lucia, including, the ability of poor people to secure their livelihoods and enhance their access to social services, social and cultural factors such as low levels of social cohesion; weak social institutions; inadequate organisation at the community level; crime (which is both a cause and a symptom); a weak tradition of entrepreneurship and a culture of dependence; and lifestyles, as well as demographic factors including age, gender, illness, and disability. Environmental factors also contributed to poverty on the island including land degradation, coastal and marine habitat degradation, which influenced the productivity of resources on which the livelihood of many depend, including small farmers and fishermen. Further, the impact of natural hazards (especially hurricanes, floods and landslides) contributed to, and intensified poverty. Thus, there remains a significant challenge to eradicate extreme poverty, reduce the vulnerability of the poor and prevent persons at the margin from declining into poverty. GOSL has had a number of programmes in place aimed at redistributing income, reducing poverty 107 ST. LUCIA

ST. LUCIA and the vulnerability of the poor, and promoting social cohesion. Direct redistribution of income has taken several forms including monthly allowances paid directly to particular groups of poor persons, the school feeding programme, subsidised provision of health services and housing programmes. GOSL has also been implementing or supporting a number of special intervention projects and institutions that are primarily dedicated to poverty reduction. These include the implementation of BNTF projects, the BELfund, NCF, the PRF, and the National Conservation Authority, among others. The PRF which was established in 1998 seeks to provide assistance to alleviate socio-economic problems; to establish a mechanism for delivering basic services and infrastructure to the poor and the needy; to finance small-scale projects in selected areas to improve living conditions; to promote community participation in development projects; and to provide for related matters. The objective of the BNTF is to assist low-income communities to improve their access to public services through the provision of social and economic infrastructure and the development of skills to enhance employability. The remaining programmes provide additional support including access to finance, short-term employment and skills development. The demand for assistance under the programmes is high and additional resources are required for sustainability. 3. PUBLIC SECTOR INVESTMENT PROGRAMME A. Development Objectives There has been sustained recovery in economic activity over the past three years following the downturn in 2001 and slow growth in 2002. Sustaining growth over the medium to long term is important for continued progress towards reducing unemployment and poverty, and for maintaining and enhancing gains made in provision of social services including education and health care, and improving security. Economic advancement hangs heavily on the continued viability and success of the tourism industry which has performed extremely well over the last two decades during which period there was much decline in the banana industry, the single most important industry to the island, during the 1980s. Stimulating growth in the tourism industry, sustaining its competitiveness, and reducing its vulnerability remain critical challenges given the pivotal importance of the industry to the economy. While it is recognised that due to small size, opportunities for economic diversification may be limited, diversifying the economy to the greatest extent possible remains an important strategy of the Government. Thus the GOSL has continued to provide much support for other areas of economic activity including agriculture and offshore business. Given the potential for natural hazards to reverse several years of economic progress, reducing vulnerability to these hazards is an important area that GOSL has paid attention to in the past and will require further action. GOSL has also shown commitment to alleviate and reduce poverty, directly by targeting groups at risk and indirectly through its social and economic sector policies. Maintaining the gains made in education and health, and improving the security environment are important to sustaining the quality of life of citizens and as a basis for sustaining output growth. B. Composition of the PSIP Planned capital spending for FY 2005/06 amounted to $124.3 mn. The economic sector (agriculture, trade and industry, tourism) accounted for 13.3% of planned investment spending during the year, of which, more than 50% was ear-marked for tourism promotion and marketing. Planned investment spending within the agriculture sector accounted for 6% of the capital budget, and largely envisaged outlays towards the continuation of programmes and projects aimed at improving efficiency in the production of bananas, but also focused on funding for programmes and projects intended to facilitate the diversification of agriculture. Economic infrastructure (transport and communications, water and sanitation, and energy and power) continued to account for a significant share of planned investment spending, and amounted to 18.1% for FY 2005/06, much of which was expected to be expended on the reconstruction and rehabilitation and improvement of roads. Significant expenditure on drainage works and the development of water infrastructure was also planned. The social sector (education, health, and housing and community services) accounted for 26.9% of the planned capital spending during FY 05/06. Continued focus was thus placed in the budget on human resource development and on social protection. Planned outlay for education included the construction of two new secondary schools aimed at facilitation of 108

universal secondary education. Within the health sector planned spending included provision for preliminary works and site preparation for the construction of a new mental health facility and the new national hospital. Significant expenditure was also envisaged under the HIV/AIDS Prevention and Programme. Modest spending (3.5% of the capital budget) on direct poverty-reduction programmes was also planned. More than 7% of budget allocation for FY 05/06 was for disaster mitigation and response, solid waste management, and other environmental projects. Approximately 17% of the capital budget was allocated towards development projects directly related to the hosting of ICC World Cup Cricket 2007. The investments discussed above were consistent with Government s development objectives and social and economic development strategies. C. Financing of the PSIP 2005-06 Financing for the capital programme for FY 05/06 was anticipated largely from Grants (22.9%), bonds (56.5%) and other external project loans (20.3%). Most of the bonds were expected to be floated in the OECS on the Regional Government Securities Market, while a significant portion was expected to be taken up directly by a domestically registered commercial bank. Bond proceeds were expected to be used to fund road and other infrastructure projects as well as developments related to the hosting of the ICC Cricket World Cup 2007. Bonds proceeds were also expected to be used for a wide variety of smaller projects. Other loan financing was expected to be received principally from CDB and the World Bank. Just over 75% of grant proceeds were expected to be received from the EU and were largely to finance agriculture and economic diversification programmes as part of assistance to cushion the effects of the reduction in the level of protection of bananas exports to the EU. D. Implementation Issues A boom in construction activity started during 2005 and is expected to continue over the medium term. This boom in construction activity has been largely occasioned by preparations for the hosting of the ICC Cricket World Cup 2007. A special regime of incentives offered by the GOSL has resulted in a number of private accommodation project proposals and as a result private sector construction spending in excess of $1 bn is anticipated over the medium term. At the same time significant public sector spending is envisaged. Construction booms are occurring simultaneously in some other neighboring islands occasioned by preparation for the hosting of ICC Cricket World Cup 2007 or by post-hurricane recovery. The boom in construction activity could lead to shortages of skilled labour as well as shortages of some supplies. As a result wages in the construction sector could increase, while delay could occur if vacancies cannot be filled on a timely basis. Intermittent shortages of some construction materials such as cement could be further exacerbated. Appropriate steps need to be taken to avert the occurrence of these possibilities or to minimise their impacts. 4. MEDIUM-TERM ECONOMIC PROSPECTS Based on prospects for the tourism industry and the construction industry, the medium term economic outlook for St. Lucia is good notwithstanding the threat of reduced protection for the export of bananas to Europe. Strong growth in construction activity is likely to continue in 2006. While a significant number of new hotel rooms will come on stream by the time of hosting ICC Cricket World Cup during the first half of 2007, many of the large projects involving the construction of guest accommodation will not be completed by then. Construction activity is therefore likely to remain buoyant well beyond 2006. Continued efforts at marketing St. Lucia as a tourism destination and the availability of new accommodation rooms will fuel increased tourist arrivals over the medium term, with a spike occurring in 2007 associated with the hosting of ICC Cricket World Cup. Growth in economic activity is expected to fuel increased intake of tax receipts by the Central Government and thus result in improved savings. Higher capital expenditure by Central Government in 2006 is however anticipated as preparations are made for the hosting of the ICC World Cup. The overall deficit on Central Government operations may therefore decline in 2006, but is likely to improve subsequently. Commercial bank credit to the private sector is expected to expand to finance investments that will be spurred by expected benefits from the hosting of the ICC Cricket World Cup. Liquidity may therefore further tighten in 2006, before easing in 2007 as a result of faster growth in deposits associated with guest spending, and slower growth in investments after the conclusion of the ICC Cricket World Cup 2007. A larger deficit on the external current account is likely to result, namely, from increased construction ST. LUCIA 109

ST. LUCIA imports during 2006, and will be financed largely by increased foreign direct investments and debt proceeds to the public sector. The external current account deficit is likely to decline in 2007. 110