Friday, May 10, 2013

Pulling Together in the Eastern Caribbean

The Eastern Caribbean Economic and Currency Union (OECS/ECCU) is one of four currency unions in the world. 

As in other parts of the world in the aftermath of the global economic and financial crisis, the region is at a crossroads, facing the major challenges of creating jobs, making growth more inclusive, reforming the banking system, and managing volatility, while grappling with high public debt and persistent low economic growth. Policymakers have the critical task of implementing strong reforms to strengthen the monetary union while also laying the foundation for accelerating growth. 

A new handbook provides a comprehensive analysis of the key issues in the OECS/ECCU, including its organization and economic and financial sector linkages, and provides policy recommendations to foster economic growth.

In an interview with IMF Survey magazine, economist Alfred Schipke, who is one of the authors, points out that, while the recent global financial crisis exposed significant weaknesses in the ECCU, it also provides a unique opportunity to move forward with needed reforms to strengthen the union.

Schipke recently co-edited The Eastern Caribbean Economic and Currency Union: Macroeconomics and Financial Systems, which was launched at IMF Headquarters in Washington, DC. IMF Deputy Managing Director Min Zhu, in his opening remarks, reflected on the challenges facing small island economies, particularly with loss of market share in the tourism industry, the mainstay of the economy in most of the island states. 

He said that the IMF and its partners can do a better job in helping the region to further push macroeconomic, as well as structural, reforms, and noted that the new book would help in providing a framework for developing solutions to the ECCU’s financial sector problems and stimulating economic growth.

IMF Survey: What are the benefits of this currency arrangement for member states in the Eastern Caribbean?

Schipke: It is important to highlight that the countries have many similarities—they speak the same language and have the same history.

In terms of the benefits, the small size of these countries means that the currency arrangement allows them to take advantage of scale economies. It also allows them to diversify risk. This means that if one country gets hit by an external shock or natural disaster, the other countries can pool resources and deal with the shock more effectively.

Again, because of their size, these islands can provide, at the regional level, more cost-effective public services. So that is a major benefit. What also matters a great deal is when the union speaks with one voice the countries can be better represented at the global level.

IMF Survey: What were some of the weaknesses exposed by the 2008–2009 global crisis?

Interestingly enough, the ECCU is actually a microcosm of the European Economic and Monetary Union, since the ECCU has also faced rising fiscal deficits, unsustainable debt levels in a number of states, a lack of fiscal integration, and challenges in parts of the financial sector that can undermine the stability of this union. As illustrated by the European experience, overcoming these challenges is particularly difficult in monetary unions.

Looking again at the European Economic and Monetary Union, I believe that sometimes a crisis is needed to implement reforms, and there is a general feeling in the Eastern Caribbean region that further integration is needed to ensure the viability of the ECCU. However, like Europe, in order to do that there has to be a willingness by governments to use political capital to implement the reforms.

IMF Survey: Following on the point you just made, what are some of the policy recommendations for long-term growth in the region?

Generating conditions for strong, sustainable growth is paramount in the Eastern Caribbean. In fact, the Eastern Caribbean experienced strong growth periods in the years after independence, but since the 1990s—that is, even prior to the financial crisis—growth slowed down significantly. This could be attributed in part to a number of shocks, including the erosion of trade preferences from which the countries benefited, as well as terms of trade shocks and a reduction in foreign aid.

Our work confirms that indeed tourism has been a main driver of economic growth, and there is some potential for future growth in this particular area as well as in other service areas.

One other aspect that might require a paradigm change is that the new growth model will have to rely more on the private sector. In the past, the role of the public sector was very dominant, but given the high debt levels, the room for public participation will be more limited, so it has to be more private sector driven.

IMF Survey: You drew some comparisons with Europe. There are a lot of mixed feelings among people about that common currency. What is the feeling on the ground in the Eastern Caribbean about the common currency there?

I think within the Eastern Caribbean there is no question that having a common currency is a smart and important strategy. So, the need for a common currency has never been questioned. Given the small size of these countries, there is no better alternative.

In addition, the Eastern Caribbean has had a long history of a currency board arrangement. Initially pegged to the British pound, since 1976 the Eastern Caribbean dollar has been pegged to the U.S. dollar. This has not only resulted in relatively low rates of inflation, but also facilitated the development of the financial sector.

Although there is no question as to the advantages of a common currency, this still needs to be supplemented with other elements, including a sound framework for the financial sector at the regional level, as well as fiscal coordination. So, the question is not whether further coordination needs to take place, but rather at what speed.

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