Download A Preliminary Assessment on Fiscal Insurance for OECS

A Fiscal Insurance Scheme
for the Eastern Caribbean Currency Union
Laura dos Reis
Intergovernmental Group of 24 (G-24)
RES, 10 years
September 17, 2004
Washington, D.C.
Fiscal Insurance
 Important instrument to respond to asymmetric
shocks
 Reinforce the monetary union long-term
sustainability
The Organization of the Eastern
Caribbean States (OECS)
OECS Monetary Union is particularly
vulnerable…
Volatility of TOT Shocks
(%) Median Volatilities
12
10
8
1980s
6
1990s
4
2
0
OECS
Latin America Pacific Islands
Others
Term of Trade shocks are defined as (trade/GDP)*(change in term of trade)
Source: WDI-GDF, World Bank and terms of trade data are from the IMF.
Natural Disasters
Frequency and Cost of natural disasters 1970-2000
Country
Frequency
Antigua
Dominica
Grenada
St Kitts and Nevis
St Lucia/1
St. Vincent and the Grenadines
1/ in 1988 Hurricane Gilbert caused an estimated US$1 billion of damage
Source: World Bank (2002).
6
6
4
7
8
8
Average
Cost/GDP
(in percent)
10.76
29.40
3.93
32.94
143.93
17.13
Natural Disasters
Main Natural Disasters in OECS (1979-2000)
Persons
Damage
Affected US(000s)/1
72,100
44,650
Year
1979
Country (Hazard Type's Name)
Dominica (David and Frederick)
1980
St Lucia (Allen)
80,000
87,990
1989
Montserrat (Hugo)
12,040
240,000
1989
Antigua, St Kitts & Nevis, Montserrat (Luis)
33,790 3,579,000
1995
St Kitts & Nevis (Luis)
1999-2000 Antigua, Dominica, Grenada, St.Lucia (Lenny)
1,800
--
197,000
268,000
1/Damage is valued at the year of the event
Source: World Bank (2002)c. and OFDA/CRED International Disaster Database (EM-DAT) 2002. Hurricane Lenny Recovery
in the Eastern Caribbean.
…which have affected the regional
growth performance and complicated the
management of government finances
OECS Selected Economic Indicators (as percent of GDP).
GDP Growth
(% change)
1998
1999
2000
2001
2002
4.0
4.1
2.8
-1.3
0.2
Central
Government
Deficit
(% GDP)
-1.5
-2.9
-4.4
-6.4
-6.8
Source: Eastern Caribbean Central Bank (ECCB).
Current
Public External
Account Deficit
Debt
(% GDP)
(% GDP)
-14.2
-16.1
-14.8
-14.7
-16.5
42.7
45.8
46.4
52.7
62.7
However, regional asymmetries provide
scope for potential risk-sharing gains
 Low or negative correlation of economic fluctuations
Aggregate output and fiscal revenues are less volatile
than individual member’s volatility
Room for potential gains under a risk-sharing mechanism
Correlation of Economic Fluctuations
Correlation Matrix of Cyclical Revenues (1981-2001)
Antigua and Barbuda
Dominica
Grenada
St. Kitts and Nevis
St. Lucia
St. Vincent and the
Grenadines
Antigua and
Barbuda
1
Dominica
Grenada
St. Kitts and Nevis
St. Lucia
0.3315
(0.3835)
-0.0526
(0.8306)
0.8027(*)
(0.0000)
-0.129
(0.5673)
0.7124(*)
-0.0538
(0.8907)
0.1219
(0.7548)
0.7495(*)
(0.0201)
0.5250
0.3469
(0.1456)
-0.1803
(0.4600)
0.1343
-0.1669
(0.4580)
0.5940(*)
-0.5646(*)
(0.0002)
(0.1467)
(0.5837)
(0.0036)
(0.0062)
St. Vincent and the
Grenadines
1
1
1
1
(*) 5 percent statistical significance level. Standard error in parenthesis.
Source: Own calculations based on ECCB fiscal data. Correlations are calculated with the cyclical revenues in logarithms
1
OECS output less volatile
than for member countries
GDP Growth and Volatility in OECS
(in percent)
Countries
Antigua and Barbuda
Dominica
Grenada
St. Kitts and Nevis
St. Lucia
St. Vincent and the Grenadines
OECS
Growth (%)
1980-90
1991-01
6.1
3.4
5.4
0.8
6.2
3.8
6.6
4.4
7.3
2.0
6.1
3.4
6.4
2.9
Source: Own calculations based on data of the Eastern Caribbean Central Bank (ECCB).
Std Dev (%)
1980-90
1991-01
3.7
3.3
3.6
3.3
3.2
3.4
4.4
2.3
4.8
2.8
3.2
2.6
2.8
1.4
Fiscal Revenues less volatile for
OECS than for member countries
Volatility in OECS Revenues
14.0
Std.Dev 84-92
12.0
Std Dev 93-01
Percent (%)
10.0
8.0
6.0
4.0
(2) It does not include Dominica due to data unavailability for the period 1984-1992
Source: Own calculations based on the Eastern Caribbean Central Bank
OECS(2)
St. Vincent & the
Grenadines
St. Kitts & Nevis
St. Lucia
Grenada
Antigua &
Barbuda
0.0
Dominica
2.0
Fiscal Insurance Proposal
Basic Framework
A buffer fund to be administered by a centralized fiscal
authority or the regional central bank
 A Fiscal insurance scheme that covers for shortfalls in cyclical
revenues owing to natural disasters and terms-of-trade shocks.
The fiscal authority establishes the share of the shortfalls in
revenues attributed to the shocks for each member
The initial fund requirements for this coverage could be
financed through regional savings, market financing or
multilateral loans
The payments to the fund can take the form of a flat premium
or a credit line with charges
Fiscal Insurance Proposal
Benefits
 Help accommodate asymmetric and country-specific shocks
 Reduction in regional volatility
 Long-term sustainability of the union:
- Less incentives to leave the union
- Better fiscal coordination.
Limitations
 Incentives problems:
-Moral Hazard
-Common-pool
Simulation Exercise
The centralized fiscal authority only covers for
cyclical changes in fiscal revenues due to terms-of –
trade shocks and natural disasters
 Monte Carlo simulation of fiscal revenues to test the
performance of the insurance scheme for full and
partial insurance coverage levels
Simulation Results:
Initial OECS Buffer Funds
Simulation for Full –and Partial- Insurance
(100 50-year histories)
Coverage/1
100%
90%
80%
70%
60%
50%
/1The
Bo/GDP
(%)
12.3
6.2
4.6
3.4
2.2
1.7
percentage of coverage is the number of histories the buffer fund is depleted out of a total of 100 histories.
Note: “Bo/GDP” is the share of the initial period buffer fund over GDP trend.
Simulation Results:
Initial OECS Buffer Funds
OECS International Reserves
(percentage of GDP)
Antigua and Barbuda
Dominica
Grenada
St.Kitts and Nevis
St Lucia
St Vincent and The Grenadines
Average
1999
10.7
11.8
13.4
16.3
11.2
12.9
12.7
2000
9.6
11.0
14.2
13.7
11.5
16.4
12.7
Source: IMF, International Financial Statistics (IFS) and World Economic Outlook (WEO) April 2004.
2001
11.4
11.9
16.1
16.4
13.7
17.6
14.5
2002
12.2
17.9
21.2
18.5
14.2
14.7
16.5
Simulation Results:
Risk-Sharing Gains
Self Insurance and Risk-Sharing:
Simulation for Full –and Partial- Insurance
(100 50-years histories)
Bo/GDP (%)
Countries
100%
1- Self-Insurance
Antigua & Barbuda
Grenada
St. Lucia
St. Kitts & Nevis
St. Vincent and the Grenadines
OECS(1)
2- Risk-Sharing
OECS (2)
Total Difference (OECS (2)-(1))
90%
80%
70%
60%
50%
16.3
12.6
28.4
61.8
11.2
24.1
8.2
9.8
14.8
38.0
4.7
13.6
5.6
7.0
11.9
31.1
3.1
10.5
3.3
5.5
8.6
25.6
1.8
7.7
2.3
4.6
7.0
21.9
0.7
6.2
1.3
3.3
4.3
16.1
0.4
4.2
12.3
-11.8
6.2
-7.3
4.6
-5.8
3.4
-4.3
2.2
-4.0
1.7
-2.6
Conclusions
 Volatility in fiscal accounts would be reduced if countries join
a fiscal insurance arrangement
 Asymmetries in regional fluctuations of output and government
revenues can lead to welfare gains.
 Fiscal Insurance would reinforce the countries’ commitment to
the union.
 Partial Insurance can
Moderate incentive problems (i.e. moral hazard)
Easier to implement as it required lower initial resources
 Further steps to implement this policy
Institutional characteristics of the central fiscal authority.
Initial financing conditions.
Re-payment options: premium, credit line.