Trade policy review

(2)Fiscal Policy

1.Fiscal policy is the responsibility of the Ministry of Finance. Fiscal policy is the main macroeconomic instrument actively used by the authorities to affect output, as Grenada, like all other OECS-WTO Members, has no independent monetary and exchange rate policy (see section (3) below). As a result, the national authorities may only resort to fiscal policy to act on the economy as the main income stabilizer and counter the effect of external shocks. As in other OECS countries, and due to the high dependency on taxes on foreign trade for revenue, fiscal policy has a strong link with trade policy.

2.During the period under review, Grenada has been conducting a programme of fiscal policy adjustment. Several important tax reforms have been introduced. The goal of the fiscal reform programme is to obtain a primary surplus of 2.5% of GDP for 2008. A valued added tax will be implemented in 2008 to replace the general consumption tax, motor vehicle purchase tax, and the airline ticket tax (see also Chapter III(1)(v)). Petrol taxes were also increased, and the subsidy provided by the State eliminated.

3.The current balance of the fiscal account has been in surplus during most of the review period, with the exception of 2004, when Hurricane Ivan hit Grenada. However, the overall balance was in deficit through 2000-04. After increasing dramatically, to 19% of GDP in 2002, the overall deficit (after grants) narrowed to 2.9% of GDP in 2004, reflecting primarily a reduction in capital expenditure. The overall deficit has been financed by external financing and foreign grants. An overall fiscal surplus was posted in 2005, but an overall deficit equivalent to 7% of GDP was posted in 2006, mainly due to an increase of 65.8% in capital expenditure, partly as a result of preparations for the Cricket World Cup 2007.

4.Revenues increased substantially in 2005, partly reflecting one-off factors, such as the collection of arrears and higher trade taxes from increased imports of construction material. To finance the reconstruction effort, the Government introduced a 3% national reconstruction levy in January 2006, on taxable income in excess of EC$1,000 per month. Receipts from this levy are expected to average EC$10 million annually for 3 years. Starting 1 October 2005, the Government raised domestic fuel prices by over 45%, taking steps to eliminate the subsidy that had resulted in a build-up of liabilities to oil importing companies of about 2% of GDP. A new pricing mechanism was introduced, with total tax fixed at EC$3 per gallon as of October 2006. Improvements in the collection of non-tax revenues, such as land registry fees, have also been introduced.

5.Expenditure was curtailed as the adjustment of petroleum prices helped eliminate the subsidy, and primary expenditures were kept below the allocation in the budget. In the first nine months of 2006, fiscal operations deteriorated, and an overall deficit of EC$75.9 million was posted. This shift resulted from a fall in current grants and an increase in capital expenditure. Spending reform has also included wage negotiations with public service unions and a review of investment programmes. Other measures include subjecting government procurement to competitive bidding, and redesigning the policy of transfers and subsidies to target social safety nets.

6.Additionally, the Government has initiated reforms to the system of tax incentives (Chapter III(3)(ii)). The Government estimates revenue forgone from import duty and consumption tax concessions during 2000-02, at nearly 11% of GDP.⁵ In 2003-04, the Government took steps to curtail concessions and, since June 2006, publishes all new concessions granted on a quarterly basis. Effective 1 January 2006, no new income tax holidays are granted nor are expiring ones renewed; incentives are now provided in the form of tax write-offs for investment after 30 June 2006 through accelerated depreciation with loss carry-forward provisions. The Government is also considering trimming the import duty concession regime.

7.Grenada engaged in a process of debt restructuring in 2005; it had been incurring arrears on most of its commercial debt after the authorities declared public debt to be unsustainable after Hurricane Ivan struck in 2004.⁶ Almost a year after Ivan, Grenada launched an exchange offer for its commercial debt, which covered about half of the country’s total public sector debt. The exchange of commercial debt was successfully completed on 15 November 2005. Overall participation reached 91% of eligible claims, or about US$237 million. Creditors accepted a substantial net present-value reduction, but the debt exchange did not involve any write-down of principal, and past-due interest was fully capitalized.⁷ The exchange of debt provides an 83% reduction in Grenada’s commercial debt service costs between 2005 and 2008 and a reduction of 73% between 2009 and 2012.

(3)Monetary and Exchange Rate Policy

1.Grenada is a member of the Eastern Caribbean Currency Union (ECCU). Monetary and exchange rate policy is determined by the Monetary Council of the Eastern Caribbean Central Bank (ECCB), which keeps the EC dollar pegged to the U.S. dollar at a rate of EC$2.70/US$1. Movements in the real effective exchange rate of the EC dollar are related largely to changes in the value of the U.S. dollar vis-à-vis other major currencies.

2.Narrow money (M1) and broad money (M2) have been expanding since the economy resumed growth; however, after particularly strong growth in 2004, both aggregates declined in 2005, mainly due to a reduction in demand deposits, and a decline in net foreign assets.⁸ Domestic credit resumed growth in 2005, after declining by 9% in 2004; credit to the public sector was particularly dynamic in 2005. The composition of credit by economic activity showed substantial increases in 2005 for construction and, to a lesser extent, tourism and personal use, but decreases for manufacturing, agriculture, and distribution. Liquidity in the commercial banking system decreased in 2005 but remained at a high level during 2005 and 2006 (the ratio of loans and advances to total deposits was 66% in 2005).

3.Commercial bank interest rates were largely unchanged during 2005 and 2006: rates on savings deposits ranged from 3% to 4.25% and rates on time deposits from 1% to 5.5%. Prime lending rates remained within the 8.5-10.5% range.

4.The increase in the consumer price index (CPI) has been moderate, averaging 2.5% during the period 2000-05. Due to higher oil prices, and the reduction in the subsidy provided by the Government, the CPI rose by 5.8% in 2005. However, consumer prices rose by only 1.7% during 2006.