Wednesday, March 22, 2017
Latest Barbados Bond Downgrade Re- ignites Talk Of Devaluation
Currency devaluation would turn Barbados from a still desirable tourist destination replete with sun and sand, into a crime-ridden gang fiefdom.
In a post from May 3rd last year, after returning from Barbados, I wrote:
"This year's headaches commenced with the Moody's downgrade of Barbados' government bonds to Caa1+, or even worse junk than the previous (BB) level. It means higher interest due on any new gov't loans taken out, Currency devaluation would turn Barbados from a still desirable tourist destination replete with sun and sand, into a crime-ridden gang fiefdom and let me point out the island's debt is already estimated to be nearly 55% of GDP "
"The word also circulating around the island is that ever more money is being printed."
Now, there's been yet another Moody's bond downgrade, down to Caaa3+, and Barbados is once again being swept by rumors of currency devaluation. As the latest Moody's report puts the matter:
Moody's decision to downgrade Barbados' issuer and bond ratings to Caa3 was driven by the following factors:
1. The continued increase in government debt and very limited prospects of fiscal reform
2. In consequence, rising domestic and external financing pressures that are very likely to impair the government's ability to service its debt
Despite the government's efforts to contain the fiscal deficit and alleviate pressures on foreign exchange reserves, the fiscal deficit remains large and credit risks have increased in Barbados. The debt burden has risen in recent years and will continue to do so for the next few. Domestic and external liquidity pressures on the sovereign have increased. We assess the likelihood of a credit event in the near-term as very high, given lack of fiscal adjustment and increasingly limited financing options.
First Driver: The continued increase in government debt and very limited prospects of fiscal reform
Although macroeconomic conditions in Barbados have stabilized with a pick-up in growth, driven by rebound in tourism and investment in the sector, the fiscal deficit remains high.
The economy grew by 1.6% in 2016 after reporting anemic growth of less than 1.0% since 2010. The drop in oil prices and an increase in tourist arrivals temporarily alleviated some of the mounting pressures on foreign exchange reserves. However, reform efforts to address persistently large fiscal deficits since 2014 have not achieved a meaningful turnaround in fiscal performance, leading to what we consider to be an unsustainable increase in the government's debt burden.
The government debt burden reached 111% of GDP at end-2016, and the authorities have accumulated a large stock of arrears to the private sector and the National Insurance Scheme, estimated at a further 11% of GDP at end-FY2015/16. Large refinancing requirements and the high interest burden, which consumes around 27% of government revenues, pose increasingly severe credit risks.
Second Driver: In consequence, rising domestic and external financing pressures that are very likely to impair the government's ability to service short-term debt
With commercial banks having reduced their exposure to the sovereign, the government has become increasingly reliant on short-term debt issuance, financed by the Central Bank of Barbados, to meet the rising refinancing and interest costs. The rapid increase in short-term debt since 2013, allied with the large financing gap, imply mounting concerns about rollover risk. In 2016, the central bank was the only source of new financing for the government. As of end-2016, the central bank's holdings amounted to 34% of outstanding short-term T-bills, equivalent to 13.2% of GDP. The central bank's unwillingness to increase its exposure to the government would trigger a credit event.
The stable outlook on the Caa3 rating reflects the high probability of a credit event in the next 2-3 years, and reflects a balance of risks between lower and higher levels of loss given default.
According to former IADB (Inter-American Development Bank) senior economic advisor Charles Skeete "Devaluation must be on the table". This was after both Moody's and S&P complained about Barbados' declining credit rating and raised the specter of the factors that might bring forth the need to devalue. But former Governor of the Central Bank Winston Cox rejects devaluation as any practical solution, asserting it will merely address the symptoms not the causes. As Cox put it in a recent issue of the NATION (Mar. 19):
"Devaluation would not reduce government spending. Also, it doesn't address the possible credit default mentioned by Moody's. It will also lead to inflation which in turn will lead to higher government spending."
Skeete, on the other hand, is convinced no tool can be taken off the table, especially when the ratings agencies are pretty well 'screaming' that it ought to be seriously considered given the island nation's balance of payments situation and a debt 111% of GDP.
How did things get this bad? Well, a nation living beyond its means, and unwise government fiscal policy, namely using the Central Bank as the lender of first and last resort which ultimately means printing tons of new Bajan dollar bills. Minister of Finance Chris Sinckler has evidently embraced this policy and when DeLisle Worrell (former Central Bank Governor) took exception, he was shown the door, replaced,
Here is where Skeete may be very perceptive, as he told the Barbados Business Authority in the wake of the credit downgrade:
"You cannot have a fiscal deficit that is a multiple of the rate of economic growth and then not face the prospect of devaluation. In addition, you cannot print money at the pace at which we were printing it. I believe, I don’t know this for sure, that when DeLisle couldn’t get the Minister of Finance to understand that he was staring a devaluation in the face, he had no choice” but to state his disagreement with the policy."
My own first hand experience of a place in the maw of currency devaluation was in August, 1978 while on a brief visit to Guyana, South America, to deliver a 3 -day astronomy workshop. While staying at the Park Hotel in the center of Georgetown -- the capital- I was told to never venture onto the streets after dark, and certainly not while wearing my (gold) wedding ring. Roaming thieves would hack my ring finger off with a machete to get the gold. At that time, the Guyana dollar was worth maybe 10 cents on the U.S dollar. Since then the value has plummeted to hundredths of U.S. dollar value and Guyanese are hard pressed to survive.
This is the way devaluation of currency rolls: downward! Look at all the nations of the Caribbean that have devalued since the 1960s: Guyana, Trinidad and Tobago, Jamaica - all have been on a downward slide, their populations growing ever more poverty stricken and restive as their respective dollars have continued sliding downward relative to currencies to which they originally had been pegged.
THREE DEVALUATION OPTIONS have been presented to Barbados by the Inter-American Development Bank, since 2013. These include: external, internal and fiscal devaluation, as the main choices in the face of reduced competitiveness and a sustained current account deficit. The internal one was last applied, at the behest of the IMF, in 1991 and entailed an eight percent cut across the board in civil servants' wages. That was also the one that drove wifey and myself back to the States.
The one being pressed now is the fiscal or full currency devaluation. However, the betting by most of those in the know is that the DLP government wouldn't dare implement it before the next general election- likely within 2 years. That doesn't mean such devaluation couldn't happen if fiscal pressures continue to increase and getting more loan money demands it.
We will be looking at the situation critically, also talking to family and friends, when we make our next trip back to Bim.