Hard Times Gine Lick We: The IMF Sings A Song For Barbados

The IMF has just released the 2009 Article IV Consultation staff report (see link) and the more digestible Public Information Notice (see link) for Barbados. Fund reports can be tricky to fathom because some of the meat is not in the written sandwich. Trying to distill the tea leaves of IMF reports can be fun, especially when they are short. So, here's a take on a message in a bottle to Barbados.

The Fund says all the nice stuff in the opening paragraph:

'Barbados benefits from well-functioning institutions and social and political stability. The country has some of the highest social and competitiveness indicators in the region and enjoys investment-grade rating on its sovereign debt. Its low crime rate, well-educated work force, and attractive natural setting have helped make it a top destination for high-end tourism and a prime location for offshore financial services and real estate investment. While the long-standing peg to the U.S. dollar has provided a positive effect on investment and growth, some vulnerabilities arise from the high level of public debt and continued fiscal imbalances.'

So, well done, chaps, the country has a good basis for going forward.

The Fund does not give too much away about the exchange rate:

'Directors took note of the authorities’ commitment to maintaining the fixed exchange-rate peg. The longstanding peg to the U.S. dollar has been an effective nominal anchor, providing price stability with a positive effect on investment and growth. While various indicators suggest that the actual exchange rate is close to its equilibrium level, Directors observed that the current global shocks have put strains on the country’s economy. In addition, possible changes in tax regulations abroad could adversely affect Barbados’s offshore financial sector, which is an important source of foreign exchange.' [My highlighting in bold here and hereafter.]

What that seems to say is that the exchange rate peg will be under strain. As is always the case, though, Barbados has a choice of whether to maintain the peg or shift or cut it. It's a balancing act. Time will help determine if the 'strains' are heavy enough to warrant a change.

On fiscal policy and public debt, there is a clear warning of where the country is heading:

'Directors encouraged the authorities to develop a credible medium-term fiscal adjustment plan and start with its implementation, as soon as possible. They were of the view that, if left unchecked, the large fiscal deficits, combined with an uncertain foreign financing outlook, could result in a deterioration in investor confidence.'

What the report points out is that things look about manageable during the current fiscal year, but seem very grim in the immediate years beyond that. Deteriorating investor confidence can be taken as potential downgrading of Barbados' borrowing status and/or actual lack of financing from overseas, whether in the form or loans or foreign direct investment.

The Fund conducts its standard debt sustainability analysis and concluded that:

'The mission noted that there was a risk that, under current policies, public debt would gradually grow to unsustainable levels .'

The word 'unsustainable' is a clear red flag. In actual figures, that means debt soaring to over 130% of GDP, the current account deficit remaining stable, and international reserves falling from just over 3 months of imports to only just over 2 months by end FY 2014. The 'adjustment scenario' would see debt rise next year to about 119% of GDP but then taper to 103% bu FY 2014 and reserves would fall next year but then rise to 4.5 months by FY 2014. But that scenario means what? In Fund speak it is simply put:

'...it is assumed that the authorities will tighten fiscal policies in the context of a medium-term fiscal consolidation plan. This will start with a modest effort of 1 percent of GDP in FY 2009/10. While some small improvements are projected in revenue collections, the bulk of the fiscal efforts would take place in moderating and prioritizing expenditures.'

Not 'assumed'. Decisions have yet to be taken. But, the message is clear: get out the pinking shears and start to pare away at public sector spending.

On CLICO, the Fund staff say:

'In this context, the mission encouraged the authorities to develop contingency plans that could be quickly implemented in the event that the current approach is unsuccessful, to mitigate the potential impact on the already high public debt, on financial sector soundness and on investor confidence.'

I read that to say that the government has been dragging its feet and has not really dealt with the downside risks that are apparent (ie need to develop a contingency plan). But, it's not a trivial point to see that the Fund regards a 'bad' CLICO resolution as likely to put another nail in the coffin of public debt but also put the financial sector at risk and worsen the fragile situation of investor confidence.

I wont speculate about where Barbados will go with the IMF report. Countries are always free to do as they choose. The Fund spells out certain outcomes based on current policies and indicate how that can be modified with policy changes. Countries and their politicians then have to decide who to please and who to annoy. Case in point, is money well spent on feting a returning athlete given other social spending needs? It's not about whether something is good or not, but about what else could be done with money.

Politicians have constituents; the Fund does not. The picking and choosing of options is always complicated by political arithmetic--but here, the current government has some latitude because it does not have to head to the polls until 2012. So, time is precious, and if it is not well used, we have a map of how things may look in the near future, and it's not very rosy. Hard time don't lick we...yet.