The International Monetary Fund (IMF) says that Barbados is facing a "severe" economic recession.

It said that the island's output is contracting, as the global financial crisis has "depressed tourism, brought Foreign Direct Investment (FDI) to a sudden stop, and weakened public finances".

"Consequently, unemployment has risen to double-digit level," the Washington-based financial institution said.

"While the underlying balance of payments is expected to remain weak, international reserves are expected to increase marginally in 2009, on account of the SDR (Special Drawing Rights) allocations and the large government bond issue abroad," it added.

The IMF said while various indicators suggest that the actual exchange rate is close to its equilibrium level, the current global shocks have put strains on the country's economy.

In addition, it warned that possible changes in tax regulations abroad could adversely affect Barbados's offshore financial sector, an important source of foreign exchange.

Fiscal adjustment plan

The IMF, therefore, urged the David Thompson administration to develop a "credible" medium-term fiscal adjustment plan "and start with its implementation, as soon as possible" and cautioned that, if left unchecked, the large fiscal deficits combined with an uncertain foreign financing outlook could result in "a deterioration in investor confidence".

"A concerted adjustment effort was, therefore, crucial to countering such a risk, by reducing fiscal financing needs, supporting the balance of payments, and placing public debt on a firm downward path.

"This would also enhance growth, including by strengthening confidence and attracting higher investment," it added.

The IMF called on the Barbados government to "commit early on to decisive fiscal measures," particularly in expenditure restraint, adding that it would also be important to develop contingency plans, "in the event that the economic recovery was delayed and fiscal pressures persisted".

However, it said that Barbados was well placed to take such bold action, given its "established social partnership with a proven track record of reaching social consensus, particularly at difficult times".

It urged that monetary policy be geared to ensuring price stability and protecting foreign reserves, noting that existing capital controls have given the country some protection against 'disruptive and volatile capital movements, thereby providing the authorities some room to independently set interest rates".

Monitor developments

In light of recent decline in foreign reserves, the IMF also urged the government to monitor developments closely before further easing monetary policy.

"Directors considered that Barbados' banks appeared to be well capitalised. Prudential indicators remained favourable, and directors advised the authorities to carefully monitor the incipient rise in nonperforming loans, although they were still at a relatively low level," the statement said.

It lauded the administration for moving ahead with implementing the recommendations of the 2008 Financial Sector Assessment Program Update, adding that "quick and decisive action" should be taken to resolve the problems of CLICO-Barbados.

The IMF also said that there was a need to deve-lop contingency plans, should the current approach of selling the subsidiaries of CLICO-Barbados to private investors prove unsuccessful.

"This would be important in order to mitigate any impact on the public finances, and protect the financial system and investor confidence," it added.