Barbados in a spot
Barbados’ once stellar credit rating that was pegged years ago at “A- minus” has been downgraded again by Moody’s Investors Service. It blamed Barbados’ “lacklustre economic performance” and the escalation of its already high debt for the action it took.
The credit rating fell to Ba1, taking it into junk bond territory, and Moody’s, a giant Wall Street credit rating firm, placed a negative outlook on the rating because it indicated the country’s economic prospects were weak. In effect, the rating can fall even more.
In this week’s Big Interview, Aaron Freedman, a Moody’s vice-president and senior economic analyst, spoke to THE NATION’s North American Correspondent Tony Best about the firm’s decisions and its implications for Barbados.
Why did Moody’s downgrade Barbados’ rating?
Freedman: There are key rationale for the downgrade and they are closely intertwined with one another. The first one is the continued poor economic performance. Growth has been far short of expectations, both the Government’s and even our own modest expectations over the past several years. That in and of itself wouldn’t have merited a downgrade.
We have to look at that on top of what was already a fairly extended history of weak growth that reflects underlying structural problems in the Barbadian economy.
The second and even arguably even more important consideration is the variation of Government’s debt matrix, the increase in the debt levels which has been driven by persistent fiscal deficits.
If you are a rapidly growing economy, that’s something you might be able to get away with or you might have a temporary increase in your debt level but you know you may be able to grow out of it. In Barbados’ case, that is not likely to happen.
What does that mean?
Freedman: What that means is that the island is left with substantially less flexibility in the future than it had in the past to react to additional economic shocks.
It is very vulnerable to these kinds of shocks because it is a very small, open economy that is very dependent upon the outside world, in particular, obviously, tourism from a couple of markets, in particular the United Kingdom (UK) and the United States. Those countries, particularly the UK, right now are having their own economic difficulties.
Tourism is, of course, a discretionary activity and that is one of the first things to go when things are tight. That leaves Barbados in a tough position. The tourism market in general is becoming more competitive and Barbados is losing competitiveness, in part, because of persistent high inflation which is largely imported.
You have a fixed exchange rate so there is really not too much you can do to combat that. I am not arguing that devaluation is the answer in Barbados’ case.
The island is really stuck, in many respects, between a rock and a hard place right now. It doesn’t have a lot of good actions available to it.
What can Barbados do?
Freedman: If the Government does take significant action to close the size of the deficit and try to reduce the rate at which debt increases, it risks putting the economy back into a recession.
Obviously, if it does nothing, debt will continue to rise and flexibility will continue to deteriorate. Some of the proposals that are currently being bandied about to try to stimulate the economy and restore growth, at least in the short term, carry the risk of accelerating the deterioration in the Government’s finances.
Why the negative outlook on the rating?Freedman: We have a negative outlook still on the rating. What that means is we are going to keep an eye on things over the next 12 to 18 months. We are going to look to see if the Government can develop a more credible plan for addressing the situation.
We think it is achievable – [stabilizing] debt levels without really risking putting the economy back into a recession. It’s an uphill battle.
An election is on the horizon. Did you take that fact into consideration?
Freedman: We recognize that there are elections coming up early next year. I don’t think that the outcome of the elections will have a direct impact on the rating. What we will be looking to see is whatever plans whichever party wins develop and we will assess those on their merits at the time.
You referred to a “more credible strategy” being developed. Is it that the current Government’s strategy isn’t working?
Freedman: I think that, certainly last year, the Government achieved its targets but it seems they were able to do so because certain measures were taken that may not be sustainable. During the first six months of this year, there was slippage. We think the deficit could widen further by the end of the year.
The Government has ordered expenditure cuts, cuts in discretionary expenditures but it remains to be seen how effective they are. It is also important to note that a year ago the Government revised the targets and pushed out for two years the date at which it expects to balance the budget.
That was something else that happened in the interim between when we first assigned the negative outlook and on Thursday when the rating was downgraded.
I think going forward the Medium Term Fiscal Strategy relies upon some optimistic assumptions. They are expecting to keep the expenditures basically flat in nominal terms over the next four or five years.
Given high inflation and the pressures it creates for the citizens of Barbados and civil servants in particular, we think there are going to be demands for salary increases. We think the Government is going to be challenged to keep expenditures flat.
Persistently high inflation . . . obviously exacerbates those pressures which I just mentioned and in general that doesn’t bode well for Barbados’ competitiveness.
You mentioned the election. Should the Democratic Labour Party be returned to office, what do you expect? What about the Opposition’s proposals?
Freedman: We think that if the current Government is re-elected, there is a strong possibility that it will propose either an alternative to or some revisions to the Medium Term Fiscal Strategy.
And the Opposition’s proposals, what’s your assessment?
Freedman: We expect that after the elections are over, should the Opposition win, there will be some greater clarity regarding some of those proposals.
What we have heard so far, while some of those proposals definitely point in the right direction – at least in the short term – some of the other proposals could result in fiscal deterioration. In the longer term, if they are successful, they could stimulate economic growth. But that, of course, remains to be seen.
Which Opposition proposals could lead to fiscal deterioration or improvement?
Freedman: One proposal they have made, they seem to be strong proponents of privatization. In theory, that should lead to improvement. But that is much easier said than done. They have proposed as well, I believe, some sort of higher education levy.
From a fiscal perspective that can help reduce the payments the Government has to make to the University of the West Indies which are a significant drain on its finances.
On the other hand, they have proposed some off-setting tax incentives to try to move the economy. As I understand it, they support the rolling back of the VAT increase and a number of incentives. They argue that those measures have limited economic activity. There could be something to that argument.
This year’s revenues are down modestly while last year they increased substantially as a result of those tax increases. Rolling them back will likely result, at least in the short term, in a net reduction in revenues.
Inflation and employment have risen in recent times. What’s your take on those two key indicators? Can we expect rises in both unemployment and inflation?
Freedman: We are not very optimistic regarding Barbados’ growth prospects. Unemployment levels are going to be tied closely to that. I don’t know that we see unemployment necessarily rising, but we don’t see what’s going to happen that will bring unemployment levels down significantly either. They are quite elevated right now, certainly by recent historical standards.
Inflation is a tricky issue because Barbados is dependent on imports and therefore a lot of inflation is imported. And because of a fixed exchange rate the Government [has very little ability] really to control inflation, except arguably by decreasing Government spending or increasing taxes and therefore withdrawing some fiscal stimulation from the economy.
The issue that we see is that inflation in Barbados, for reasons that are not entirely clear to us, seems to be persistently higher than it is in its trading partners and in many of its competitors. That obviously causes Barbados’ own competitiveness to deteriorate.
What is Moody’s view of the fixed exchange rate in Barbados? Should it be changed?
Freedman: In order to defend the exchange rate, an internal devaluation of some sort is likely to be required. An internal devaluation really generally means a reduction in real wages, the nominal wages, [so that] wage increases wouldn’t keep pace with inflation.
Would devaluation solve the problem Barbados is facing? Are Barbadians living beyond their means?
Freedman: We understand that devaluation is a four-letter word in Barbados. We recognize the arguments that are made in favour of maintaining the exchange rate, in terms of the anchor it provides for the economy as well as the fact that because of Barbados’ high dependence on imports, any gains from devaluation are likely to be short-lived. Those arguments do seem to be reasonable.
Furthermore, devaluation could very well be the start of a slippery slope, not just a one-time thing. But once you go down that road, there may be no turning back. We recognize all of those arguments. We don’t propose or recommend any particular policy path for the Government to take.
That said, yes, the country runs persistent current account deficits and the Government runs a persistent fiscal deficit. That does suggest some kind of adjustments would probably need to be undertaken in order to ensure the sustainability of both the economy and the Government’s finances.