IMF Staff Analysis of Barbados Economy Sees Possible Risk to Neighbours

Mark Lee

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It reads like a good cop bad cop interrogation of the Barbados economy, the latest International Monetary Fund (IMF) Country Report issued Wednesday (Feb 12) at a news conference from the Fund’s headquarters in Washington DC.

Staff analysts following a round of consultations with government and other officials that ended Monday (Feb 10) see a worst case scenario with the economy expected to show a final decline of 0.7 percent in 2013 and a deeper slippage in 2014, with further slides in tourism arrivals and low foreign investment dollars tied to the poor state of the global economy and finance.

They speculate that a deeper crisis in Barbados, where at least 3,500 public sector workers are being retrenched as part of cost saving measures, could spread to affect the neighbouring member states of the East Caribbean Currency Union (ECCU).

On the other hand, Thomas Hockin, Executive Director for Barbados, and Kelvin Dalrymple, Advisor to Executive Director, disagree with some key statements on external sector developments and on fiscal policy in a country struggling with 11.7 per cent unemployment while it struggles to maintain a fixed exchange rate of two to one $US via Central Bank props to the government.

“We believe that staff exaggerates Barbados’ vulnerability to global financial market volatility,” said Hockin and Dalrymple in their statement included in the Country Report. “By its own calculations, Barbados does not need to access international capital markets during the forecast period in order to maintain foreign reserves at the equivalent of 3 months’ cover, provided private capital flows return to normal levels.

“The link between Barbados’ tourism receipts and growth rates in its main tourist markets, emphasized in the Staff report, is not immutable. Sophisticated marketing and market diversification strategies, now being implemented, are specifically designed to break these links.”

Hockin and Dalrymple were equally divergent from staff on fiscal policy.

“In our view, the staff statement that the government ‘first applied countercyclical policies to offset the impact of the global recession’ is inaccurate because Barbados’ import propensity is so high, countercyclical fiscal policies always result in a decline of foreign exchange reserves. The country’s foreign reserves increased in 2009, and remained above 2008 levels until April of 2013, which provides prima facie evidence that there was no countercyclical fiscal expansion.”

Notwithstanding these disagreements, the figures on the Barbados economy are stark. The economy has declined (the government reports -0.2 percent, the IMF estimates -0.7), and is projected to slide further by 1.2 per cent in 2014. The national debt has grown from BDS$8.54 billion in 2010 and expected to reach $11.27-billion in 2014/15.

$2.47-billion is foreign debt and $8.79-billion domestic,with the single largest portion owed to the National Insurance Scheme (NIS).

According to the staff analysts, the banks operating in Barbados aren’t eager to lend more to the government.

“..[W]hile there appears to be sufficient liquidity in the system, most of the banks are not willing to raise their exposure to the sovereign much further, balance-sheet constraints limit more government debt purchases by the NIS, and the central bank may itself need to sell government bonds into the market to raise interest rates and tighten monetary policy. Overall, risks appear manageable in the short term.”

The good news is that the bad news of what could have an impact on Barbados’s Caribbean Community (CARICOM) neighbours—especially those in the Organization of Eastern Caribbean States currency union—is speculation.

“Materialization of adverse risks in Barbados could have important spillovers in the region, particularly in the ECCU,” the IMF staff said. “In the event of a disorderly adjustment or credit event, the effects could spread to the region through both the trade and financial channels. The region absorbs about 26 percent of Barbados’ exports and accounts for 11 percent of tourist arrivals. Countries in the ECCU are considered to have an exchange rate that is over-valued, and financial sectors are fragile due to capital shortfalls and high [non-performing loans]. Instability originating in Barbados could spread via inter-connected financial systems, including via two large Barbados-based financial entities. Materialization of sovereign risks in Barbados would likely have financial implications for these conglomerates, with direct effects on policy holders (and shareholders) who are widely dispersed across the Caribbean.”

The interrelatedness is also highlighted in tourism, the sector that has become the new monoculture of most of the 14 CARICOM states. On Monday the Caribbean Tourism Organization (CTO), which is headquartered in Barbados, released figures showing that the Commonwealth Caribbean, which are all CARICOM member states, had seen a 0.5 percent decline in overall visitor arrivals in 2013, when most of the other CTO members saw increases. The CTO saw continuing pressures resulting from the global economic climate.

During the period January-November 2013, long stay tourist arrivals to Barbados fell by 5.5 percent.

The IMF report takes a swipe at Barbados and its neighbours with regards the generous incentives to the tourism sector that the writers say transfers wealth away from locals towards tourists.

“Barbados is not contributing to reducing tax competition in the Caribbean. Fiscal incentives in the tourism sector, including subsidies to airlines, have proliferated as governments in the region are drawn into the practice of offering generous tax concessions to tour operators to encourage their foreign direct investment and to secure long term contracts to operate facilities. In aggregate, the most productive sector in the region may be benefitting from the lowest effective tax rates, implying a wealth transfer away from residents towards tourists and foreign tourism operators. Countries would benefit from a regional approach to reduce or limit the trend. The Fund plans to do some research into the issue for the next Caribbean conference.”

It just shows the difficulty a natural resource-scrapped administration faces when it must decide which areas to incentivize when faced with economic danger. Barbados’s main options are tourism and the offshore financial sector, since the report itself notes that the areas in which Barbados is least competitive in the Caribbean and Central America are market size and the macroeconomic environment.

This leads to a confusing situation where the country must invest more and incentivize in the areas in which it is competitive at the same time the Fund is recommending that it curtails spending while increasing tax revenues from tourism.

Barbados is fortunate that unlike some of its CARICOM neighbours, such as Jamaica, it has no loan or financing agreement with the IMF but simply listens to or implements advice the Fund may give following consultations. Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

In all of this, the irony is that the Single Market and Economy agreed on by CARICOM for ages and implemented among some members since 2006, aims at creating the market size and macroeconomic environment that Barbados and its sister territories need to expand and build competitiveness but it seems the IMF staff is identifying hazards rather than opportunities from cross border financial activities.

Immediate Policy Priorities

In view of existing macro pressures, staff discussed with the authorities immediate priorities aimed at supporting the peg by reducing domestic absorption and raising confidence in fiscal and monetary policies:

1. Implement some significant spending cuts and/or tariff increases in the coming weeks.

2. Cease central bank financing of the fiscal deficit, which aggravates pressures on foreign reserves.

3. Raise interest rates to align monetary policy with the exchange rate anchor and raise confidence.

4. Ensure that regulations on capital outflows would be effective in the event of an emergency.

5. Work with labor unions to develop wage arrangements that lower real labor costs over time.

6. Announce plans to design a credible medium-term fiscal strategy, anchored by a gross debt target.