Category: Economic Commentary

Interview with the New President of the Barbados Economic Society – Shane Lowe

Today’s interview is with the new President of the Barbados Economic Society.

Congrats on becoming the new President of the BES. When was the official start date of your term?

Thank you. December 19, 2017.

I know that you’ve been in the press a bit and I saw the last BES press release on your thoughts about the economy. I think everyone accepts that we’re in a precarious position. One of the things people ask me all of the time, and I assume that they will ask every economist, is should we devalue. What are your thoughts?

No. Why? Because I don’t think it adds any material benefit to us. I think that clearly we’re a very import-dependent economy and devaluation would just increase the cost of those imports because we don’t have the excess capacity to produce what we currently import. Not in any meaningful way, at least. On the export side, it’s not like we have lots of hotels that are empty. The hotels are very much doing well, at least in the tourist season. So, making the currency “cheaper” would not necessarily bring additional benefits to Barbados without improving the current capacity.

People have been talking about going to the IMF. What are your thoughts on that?

Yes, we should go to the IMF, and not because the IMF can solve everything. But simply because we have a balance of payment deficit that is getting worse every year. The reserves have been declining at a faster rate every year since 2013/2014 and part of the reason is that government’s debt has become so high and the credit ratings have become so poor that government has to pay external debt out of reserves. We need to be at least able to match those outflows in order to stabilise the reserves and give us time to make the necessary adjustments on the current account – which would be imports and exports – to stabilise the reserves even further and put them on an upward trajectory.

But if we go with the IMF, the IMF obviously has their prescription, usually involving devaluation.

Sometimes, it might. In 1991/92 we didn’t devalue and we were in an IMF programme then. What it means is that we’d have to make further cuts and adjustments on the fiscal side. Either way, the prescription is going to be to restore the balance between inflows and outflows of foreign exchange. The IMF might suggest devaluation and we might suggest a fiscal adjustment, and I suspect a fiscal adjustment would need to be even greater if we reject devaluation.

So what is the difference then between going to the IMF and what we’re already doing? There are a number of economists that have said that we have our own almost home-grown adjustment programme, so what is the benefit in your view of going to the IMF when we’re already allegedly implementing measures now?

There are two things. The IMF provides the foreign currency that we need right now to stabilise the reserves. It’s all well having a home-grown programme, but we don’t have the time or enough of a buffer from a foreign exchange perspective to allow us to make the adjustments sustainable without running out of reserves first. The IMF provides the FX.

The second thing is that the IMF provides credibility once you’ve passed the tests. Too often we’ve set targets for ourselves and we have failed to reach the targets without any real consequences, so to speak. The IMF puts benchmarks in place, where if you pass the benchmarks, if you meet the standards, then you get financing. So there’s a carrot and stick situation. And that additional credibility is favourable with the credit rating agencies and the international investors, and that might help to restore access to the international financial markets.

The argument of going to the IMF for credibility was used for Jamaica, and Jamaica still missed their deadlines. The programme came to a halt and they had to redo the entire programme and that sent the economy into a further decline. In addition to missing the deadlines and the obvious implications of that, the credibility factor was lost as well. So my fear is that if we’re not doing well at execution now, what makes people believe that the IMF coming will necessarily make us any better at execution?

I think that’s where a credible plan needs to be put in place; not just a plan with quantitative targets, but how are we going to get things done. Part of the reason why there is a Barbados Sustainable Recovery Plan, and this whole process of trying to get the social partnership back together and an oversight committee in place, is to make sure that we have an implementation plan as well as macroeconomic targets. So, I think it involves consultation with other members in the private sector and the unions, which may be in a position to help with the implementation. Many of these issues may require some adjustments to the size of the government’s labour force, and obviously the unions can determine how easy or difficult these adjustments can be achieved.

I remember when the social partnership attempted to meet last year, in the discussions they were very much, on the private sector side, anyway, trying to get the unions on board and agitating for the government and the unions to reach a final position with respect to civil servants’ wages. That to me never happened. And, if it’s not happening in this current environment, where it is fairly obvious why you need an agreement on the way forward, why would the IMF coming change that dynamic? 

I guess the challenge is that the IMF probably won’t change that. We need to change that ourselves, which requires strong leadership on all sides. I don’t think it is an easy fix, but we have to get to a stage where people fear for the Barbados economy’s long-term health enough that they will make the necessary decisions and changes that they need to make. But I don’t think the IMF can force those changes.

Do you think people have a clear understanding of the consequences of the decisions we face? One of the questions that we get asked is what happens if we run out of reserves. We’ve never run out of reserves as a country, so this is not a ‘real’ scenario in most people’s minds. They have never lived through a situation where there are no reserves. So, just to help clarify this issue for the people that will be reading this, in your view, what happens if we run out of reserves, if the reserve cover actually gets to zero?

Two things. The reason why we have a 2:1 peg is because the central bank guarantees that rate if the commercial banks come to the central bank [for foreign exchange]. If the commercial banks go to the central bank and the central bank has no reserves to guarantee the rate, then the rate is set basically by whatever the market determines. So the first thing that would happen is that you may have a devaluation, if commercial banks set the rate at a much higher level than it is today.

The second issue is that sometimes because of the seasonality of foreign exchange inflows and outflows, we have to use the reserves to pay for food and medicine and construction materials and so on. If we run out of reserves and the commercial banks aren’t getting enough FX from tourism and international business, and we have to dip into reserves and we have none, then essentially we go for a period without being able to import food. It is then that the average person would certainly feel the impact of having no reserves.

Part of the challenge that we have in the country is that we’re not earning enough foreign exchange and we have sizeable FX expenses, which is why the reserves are being drawn down. One of the questions that we get asked is what do we need to do to actually earn more foreign exchange. All of the measures that the government has put in place have been along the lines of retaining what little we currently have. What would you suggest the country do to actually earn more foreign exchange?

Earning FX and saving FX are kind of similar. Alternative energy, for example, is not an earner of foreign exchange but it achieves the same thing. So, moving more towards sustainable energy, whether it be wind or solar, would help. I think that back in Q1 2015, the central bank reported that Barbados produced an external current account surplus, which in my lifetime has been a rarity. The reason for the surplus was that oil prices had fallen so low that our inflows of foreign exchange more than matched our outflows of foreign exchange, at least on the current account. If we can replicate that over time, we can have a significant growth in the FX reserves.

The second thing is building out capacity in other areas. For example, we do really well in tourism but I think we can do more. If you look at Aruba, Aruba gets about 1 million stayover arrivals every year and we get about 600,000. Their economy, the size of their population, the size of their country, is much smaller than ours. Is there perhaps room for us to grow significantly more in tourism given what Aruba has been able to accomplish? And then there’s international business. International business is a favourite of mine because it is a weightless export. We have lots of professionals here and I often say, why can’t a Barbadian set up an international business in Barbados, an accounting firm, for example, and offer their accounting services to Canada or the UK, because we do the same professional qualifications and we can probably charge a slightly lower price for the same value. Those are just examples of how we can earn more foreign exchange.

The other area that I think we need to go into over the long term is being able to earn FX from income as opposed to being a net payer of income to other countries. So if you look at the current account, you’d see that we earned as much from exports of goods and services as we paid in imports of goods and services in 2017. The reason why the current account was in deficit is because the income that we earned from non-residents was significantly lower than what we paid. And part of that is because we have to pay dividends to non-residents, people that invest in Barbados, as well as to pay interest on debt. If we can somewhat reverse that so that we’re investing more externally and we’re earning dividends from overseas then we can close that gap in the current account and earn more foreign exchange as well.

To me what you’re pointing to is an opportunity for the private sector.

 Maybe yes, it possibly is.

That is one of my pet peeves. One of the reasons why AE exists it to support the private sector. Economists traditionally have supported governments and society at large and we feel that, while there is more we can do, it is on the right track. So you do have a situation where for big decisions government entities, development banks and certain types of NGOs know to come to an economist for support. They know to ask for help. They know they need forecasts, they need scenarios, they need estimates and so on. But in the private sector a lot of decisions are still based on what essentially boils down to gut. And while that is useful, and I’m completely supportive of the instinct that business people develop for their field and industry, one of the challenges I think we have, and why Barbados is lagging behind some of the other islands with respect to our private sector, is maybe because there isn’t enough information to ground decisions in fact.

Which brings me to another set of questions around the economics profession generally. The BES is probably one of the quietest associations for professionals. Just so that the readers understand, to be a member, do you have to be an economist?

No you don’t. We have members from various industries and professions.

Do you think that we have a situation in Barbados where people do not understand what it is that economists actually do? 

I think it’s possible. People often see economists as related to government, as you implied, and that is why those that are a part of the private sector may not look to economists because they may not be as interested in what is going on in the public sector. I also think that they see economics as very much an academic field. Lots of models, forecasts that aren’t perfect. So from their perspective it is not very practical. I think, as you said, changing that is very important.

I’ve never seen that as a mandate of the BES. To me, the BES has always had a focus on overall macroeconomic development. During your presidency, will you continue to focus on supporting the entire economy and the initiatives that are going on at the national level?

We definitely want to play a role on the macro side, but also on the private sector side. One of the things we’d like to do is to offer training courses to private sector organisations; it could be a simple training course on how to create a regression in Excel, because the average person will not have EViews or Stata or one of the other modelling programmes. So how do you create a simple regression in Excel? How do you interpret the results and how can you use it for forecasting? My experience working in the private sector suggests that there are many questions that people have that can be answered with economics or econometric tools; things like marketing, for example, or how you allocate resources most efficiently, which is central to the area of economics. So that’s what we want to do if we have enough resources and time this year.

Your term is one year only?

Two years.

I know you had said you wanted to support the macro economy; is there a facility right now to allow you to do that?

There are a couple of ways that we can do that. One of the things that we would like to do is to speak in the press and have our various sessions to discuss these issues. Ultimately, the insights do get filtered up to the various politicians and decision-makers. What we’d like to do as well is, given that we have so many consultations on the sustainable recovery plan and where do we go from here, whether we go to the IMF or not, we want to have a seat at the table as well. It is something that we have discussed as an executive and certainly it is something I have queried already, maybe as a private sector organisation, because we are not public sector and we’re not a union.

Is there anything that you’d like the private sector to do to support the work of the BES? Is there any support that you need from the private sector?

Data is always important, if that’s available, because making recommendations and estimates without the appropriate data is always quite dangerous and personally I like to have my facts before I go speaking on things. I also find that often our decision-making doesn’t seem grounded in much modelling or fact. It’s like, let’s do this and have this outcome when clearly it seems as a professional looking in from the outside, you’re not going to get the outcome you wanted or there will be issues. So I think the private sector can help in terms of pushing for a rigorous approach and a fact-based approach to policymaking.

Thank you very much Shane for taking the time to talk to me today.

 

A little bit about Shane:

Shane Lowe is the current President of the Barbados Economics Society. He has a keen interest in and working knowledge of Caribbean economies having worked as an Economist at both the Central Bank of Barbados and in the private sector.  He has published both independent and co-authored empirical research papers in the areas of fiscal policy, financial stability, external competitiveness, tourism sustainability and economic development in peer-reviewed journals and as part of the Central Bank of Barbados’ Economic Review and working paper series. More recently, his research has focused on understanding the drivers of consumption volatility in small, open economies as well as on applying optimisation techniques to determining appropriate solutions to existing economic policy problems. Shane is currently a PhD candidate and graduate of the University of Glasgow where he earned his Master of Science in International Financial Economics with distinction. He previously obtained a Bachelor of Science in Economics and Accounting from the University of the West Indies, Cave Hill, and is also a holder of the Global Association of Risk Professionals’ Financial Risk Manager certification.

Are you ready for election year?

Barbados

How economic forecasts and scenarios can strengthen financial planning

It’s already mid-December 2017. Your organisation has already started (or maybe even finalised) your plans for 2018. You have targets and budgets and tactics lined up to take you confidently into the year ahead. But, did you remember that 2018 is an election year in Barbados? Did you factor that in to your organisation’s financial plans?

Election years are typically characterised by increased government spending (which is often accompanied by increased consumer spending) and greater economic confidence. All of the campaigning and promise-making usually puts everyone in an optimistic frame of mind. Given the state of fiscal affairs in Barbados and the generally depressed economic confidence levels, however, maybe 2018 will buck this trend and it will be more or less business as usual. Or maybe the pessimists amongst us will win the day and 2018 will be the worst year, from an economic standpoint, that Barbados has ever experienced. Has your organisation considered the impact of any of these scenarios?

It has been my experience that the economic forecasts included in corporate financial planning exercises are only baseline forecasts. What do I mean by ‘baseline’? Baseline forecasts typically assume that the future will continue more or less in the same fashion as the recent past. In the case of Barbados, therefore, the next 3 to 5 years – i.e. the usual planning period for corporate budgets – will be characterised by:

  • low levels of inflation
  • a fixed 2:1 exchange rate with the U.S. Dollar
  • economic growth rates around 1%
  • unemployment around 10%
  • debt levels over 100%, and,
  • fiscal deficits over 5% of GDP.
But what if one or more of these assumptions no longer holds?

What if the deficit worsens? What if the exchange rate is adjusted? What if the economy slips back into a recession? What if the country is forced into a programme with the International Monetary Fund? What if 2018 is not business as usual and it’s not a typical election year? What impact will these scenarios have on your organisational plans?

And did you consider how economic policy may change depending on which party is elected?

Each party has different ideas on how the country should be run and where emphasis should be placed. Therefore, depending on which government wins the elections, your plans may no longer be relevant.

Including economic forecasts and scenarios into corporate financial budgeting exercises can help you plan for various plausible futures. Not only will you feel better prepared, whichever outcome, but you will also have a better understanding of the likelihood of each scenario, which would allow you to adjust your resources accordingly. Antilles Economics offers a comprehensive range of economic advisory services – for example, workshops, customised forecasts/scenarios and internal stakeholder briefings – that can provide forecasts and scenarios. And, there are various government agencies that publish their expectations about the future, as well as IMF reports and advisories from the international rating agencies. Once you’re confident that you can translate that information into meaningful intelligence for your organisation, they are reliable and trusted sources of economic data.

I’m looking forward to 2018. I think it will be a very interesting year from an economic standpoint. But what may be interesting for us economists, may be devastating for profit-making enterprises. Make sure you’re prepared.

What Next for the Barbados Economy

Barbados

The current state of the Barbados economy

The latest review of the economy from the Central Bank of Barbados (CBB) stated that real GDP in Barbados rose by 1.6% in 2016, compared to 0.9% in 2015, on the back of the tourism industry – long-stay arrivals rose by 6.3% for the year up to December 29. Industries connected to tourism – reflected in sectors such as transport, distribution, utilities, construction and other services – all performed modestly, and these performances contributed to a decline in the unemployment rate to 10.2% at the end of September 2016 from 11.3% at the same point of 2015. The story from the renewable energy industry was also quite promising, with the addition of a 10 megawatt solar photovoltaic farm. As a result of the improvement in economic activity and moderate growth in goods and services exports, the external current account balance improved.

Despite 2016 being the third consecutive year of real GDP growth according to the CBB, the Barbadian economy is still not out of the woods. In fact, it is probably in one of its most dangerous phases since the downturn began back in 2009. The foreign exchange reserves have dropped to 10.3 weeks of imports of goods and services – almost two weeks below the internationally accepted floor of 12 weeks – and the fiscal deficit remains high at a provisional 8.2% of GDP. The drain on the reserves has been caused by a severe reduction in net capital inflows – from $371.8 million in 2015 to $136.1 million in 2016 – while the government seems incapable of reigning in its current expenditure in line with the lower revenue collections. The CBB has been placed in the difficult position of printing money to finance the government’s operations, which has not helped the current low-confidence environment that is at least partially responsible for the fall in net capital inflows.

Policy Options

Policy debates have so far centred on devaluation of the Barbados dollar and/or entering into a financing agreement with the International Monetary Fund (IMF). Our view is that neither of these options would work without the supporting structural changes. Barbados is a net-importer of goods and has limited capacity to substitute imports for locally produced goods should the currency be devalued and imported goods become relatively more expensive. Devaluing the currency would simply make consumption more expensive in an environment where the population has little room to cut back. Already the levels of both personal consumption per capita and personal savings at banks and credit unions have remained relatively unchanged since 2014. For devaluation to work in this economy, the local production capacity would have to increase to such a degree that it seems almost impossible, even in the medium-term; at present, exports of goods represent a mere 16% of retained imports. Concessionary financing appears attractive, but when you consider that the IMF has been advocating for devaluation as one of its policy reforms, the luster starts to fade. Furthermore, the success of IMF programmes, when well-designed, hinges on timely and effective execution, and Barbados does not have a good track record in recent times when it comes to policy execution.

Barbados has to make some difficult decisions and commit to long-term structural change that is sustained beyond political cycles. Many of these changes are in the hands of the private sector. Yes, the government can improve business processes and take its role as a facilitator of business more seriously. We would all welcome more streamlined and transparent processes, with predictable turnaround times and efficient, productive staff. But the economy is the sum of the production of mainly businesses. If the economy is struggling, it’s because businesses are struggling.

Some have argued that Barbados is too tourism-dependent, so when arrivals are down, it affects too large a proportion of businesses in the country and makes the economy too vulnerable. Though there are some large, successful producers, the manufacturing sector is too fragmented, which does not lead to the economies of scale required to produce efficiently in most sub-industries. Agriculture has tremendous room for growth, but once again it may be too fragmented, which contributes to the acres and acres of idle land and inefficiencies that prevent strong, sustainable linkages with other large industries. Renewable energy has great potential for both reducing the amount of imported fuel as well as lowering the overall cost of energy, but the ability of this industry to propel the country out of its woes will hinge on the timing of investments. And the cultural industries, long lauded as the future of economies all across the Caribbean, are still too disorganized to even facilitate a reliable estimate of its size.

The short-term policy options can be boiled down to two interconnected themes: create some breathing room and raise confidence. In the public sector, government can reduce its deficit by reducing both the expenditure of state-owned enterprises and the government’s wage bill. Doing so should provide the government with the financial space to tackle its arrears and reform the entire public sector, both of which would go a long way to improving the public’s trust. Demonstrating that it is committed to fiscal responsibility would also assist with negotiations to gain low interest rates on any future debt.

The private sector is willing to lend its support and demonstrated this by its recently called for a return to active dialogue and cooperation under the Social Partnership. The Social Partnership is a series of protocols that commits the Government of Barbados, labour (represented by the Congress of Trade Unions and Staff Associations of Barbados) and business (represented by the Barbados Private Sector Association) to cooperating to develop the economy in the long-term interests of the country. The last protocol expired in 2013. A return of the Social Partnership would not only raise the confidence of residents, but could also assist the government with tackling arrears and ensuring a smooth adjustment of its wage bill.

But the devil is in the details and that’s where all planning discussions start to fall apart.

Barbados Economic Recovery: Framing the Discussion

Last week on a popular radio show in Barbados, two leading economists and a former head of a large company in Barbados discussed and took calls from the public on the Barbados economic recovery. I found the discussion extremely interesting and I commend all of the panelists for their insights. At the same time, however, I found myself wondering if the discussion was framed correctly.

Be careful what questions you ask, you may just get answers

I believe that you only get answers to the questions you ask. So, for example, if I asked you if you thought that an umbrella would help reduce the heat from the sun, we could have a long discussion on the usefulness of umbrellas, their design, the materials they are made out of, when they are most effective, etc. We may not discuss if the temperature was actually high enough that day to warrant a solution in the first place. We may not discuss if there were other solutions to reducing the impact of the sun’s heat. We may not discuss the benefits of exposing oneself to the sun’s rays. We would focus our discussion on answering the question asked: would an umbrella work.

So, when we ask panelists whether Barbados is in a crisis, they respond with their opinions on what defines a crisis and therefore whether they believe we are in one. When we ask them if the government or the private sector should be the one to get us out, they debate the effectiveness of each option as a means to solving the current problems. When we ask them for specific examples of what we should do to get out of the current crisis, they list suggestions from strengthening tourism, cutting government expenditure, and retraining the labour force.

These are all valid points. Very few people would have any major disagreements. Furthermore, all of their suggestions could work. Unfortunately, this leaves us with no clear idea of what to do next and what I consider to be the ‘too much choice’ dilemma: when faced with too many options we opt to choose none.

We need to frame our discussion around solving our long-term or structural problems first before we can identify the best short-term actions. Policy decisions, probably more than most other types of decision-making, is about long-term planning because timing is the most critical factor in macroeconomic policy. The ‘right’ policy implemented at the wrong time will not work just like the ‘wrong’ policy implemented at the right time will not work. The only combination that works is the ‘right’ policy at the right time.

We created our structural problems by answering the wrong questions before. When government needed more revenue, it added the Value Added Tax (VAT), which did not address the underlying problem of insufficient production in the economy. When the VAT was raised, it did not address the underlying problem of declining production and consumption. When unions demanded pay increases, it did not address the challenge of falling corporate revenue and labour productivity. When companies cut marketing budgets and raised prices, they ignored the fact that consumer demand was falling. All of these solutions were aimed at fixing some short-term challenge. But in the end, they deepened structural weaknesses and contributed to yet another round of problems.

Solving our structural challenges requires us to ask the right questions. What if instead we had asked the panelists for their view of the ‘ideal’ economy of Barbados before we asked any other question? Maybe they would say that it was less dependent on tourism; the government was smaller; the labour force was more flexible; the exports were more diversified; the infrastructure and institutions were stronger; or some other goal or combination of goals. Whatever the goal, we can then debate how we achieve it.

All other questions, and their answers, should be framed with our long-term goals in mind. Suppose we determine that a smaller government was critical to our vision of the ‘ideal’ Barbados economy. Maybe we would be much more supportive of cutting the size of the civil service, embracing technology for standardised government services and divesting of government-owned companies.

The same thinking applies to becoming less dependent on tourism, for example. With this as our goal, maybe we would be hesitant to grant additional subsidies and more financial resources to the hoteliers. Maybe we would revisit our legislation for our international financial services sector to encourage growth in this industry. Maybe we would embrace science and technology more in our agricultural sector to compensate for the physical challenges the industry faces.

As highlighted with these two very different goals, the solutions presented not only shift the economy closer to becoming our ‘ideal’ economy, but they could also help solve the current problems. By having the goal in mind, we also have removed some options from the discussion because they do not help us to achieve our goal.

I believe that asking the right questions is key to solving Barbados’ structural problems so let’s start the discussion. What is your vision for the ‘ideal’ economy of Barbados?

 

What level of international reserves is enough?

Over the last few months we have all listened to the robust debate between our politicians and other interested observers regarding whether Barbados is holding an adequate level of foreign exchange reserves. While the debate has been useful, there is an implicit assumption that the international benchmark of an adequate level of international reserves is a good indicator. That may not be the case.

francsforeuros-32858304

Why do we care about the reserves?

Before we can debate the benchmark, we need to understand why we even care about the level of the reserves. A simple way to think of the reserves is as a backup foreign currency savings account. Consider this simple example:

  • Barbados receives money from selling its goods and services to other countries or when other countries invest in Barbados (foreign exchange inflows);
  • Barbados has to spend money on goods and services it purchases from other countries or when it invests in other countries (foreign exchange outflows);
  • If it spends more than it earns, it needs to make up the difference with savings (reserves).
  • If you run out of savings, how will you pay your foreign currency bills?

In fixed exchange rate economies like Barbados, international reserves allow the central bank to make the implicit guarantee that it will be able to convert local currency to foreign currency on demand.  Think about what would happen if the Central Bank of Barbados could no longer fulfil its promise to exchange two Barbados dollars for one United States dollar.  This would mean that in order to purchase materials from abroad, you would have to obtain foreign exchange from a foreign exchange dealer and pay whatever price the dealer demands for foreign currency.  In these circumstances, the market exchange rate would deviate from the pegged rate – i.e. the market exchange rate would no longer be 2:1 – forcing the authorities to abandon the peg. When you consider that we import almost all of what we consume, instability in the foreign exchange market would have wide-reaching consequences.

It is therefore not difficult to understand why so much emphasis is placed the international reserves in fixed exchange rate economies.  It indicates to investors (both local and foreign) whether the peg is sustainable, and therefore the risk of exchange rate-related losses if they were to invest in the country.

gold-bars

 Why it is important to have the right benchmark level?

I like to think of the current reserves debate as similar to steering a ship while tracking the development of a hurricane. We rely on our meteorologists to keep a close eye on every patch of cloud in the sky and watch how it develops. We expect to get warnings long before a harmless cloud becomes a hurricane. We expect to be told how quickly it was developing and when and where to expect it to hit. We may not fully understand how they do it, but we assume meteorologists have thresholds that they compare developing storms to.

But what if their thresholds are wrong? Or, what if their thresholds only signalled an approaching hurricane when we were already in the midst of it? There is nothing wrong with having thresholds. The challenge is obviously if the thresholds are adequate and give us enough time to prepare. That is the concern I have about the internationally accepted benchmark of an adequate level of reserves. I think we all accept that the country’s external position is at a very vulnerable point, but is it too late now to do anything about it?

The current benchmarks

So what level of reserves is needed to maintain the peg and support investor confidence? Economists have two popular indicative rules of thumb.  One of the most quoted in local debates is 3 month or 12 weeks rule: reserves should be able to cover 12 weeks or 3 months of projected imports.  It is important to know that there is no statistical justification for this ratio; it is just a figure that has become a focal point for economists.  It is also subject to criticism as it ignores financial flows and focuses solely on the flow of goods and services. In a country like Barbados, this is an important failing, because while we import more goods and services than we export, we have historically attracted more capital than we have been sending abroad.

Another widely used indicator is the ratio of reserves to broad money (or the amount of printed currency as well as checking and savings deposits in a country). Consider the basic commercial banking model. Banks accept deposits from people that have surplus funds and then lend these funds to people that are in deficit and need to finance their activities.  Banks therefore never have all of the deposits that they have collected in their vaults. The model works, since only a fraction of depositors would demand access to their funds on any given day.  The same thing applies with reserves. If you think of the amount of money in a country as the deposits, only a fraction of these ‘depositors’ or holders of local currency would want to convert their local currency into foreign currency on any given day.  The benchmark considered adequate in this instance is that reserves should be around 20 percent of broad money, i.e. only 20 percent of the money supply would need to be converted into foreign currency in the short- to medium-term, whether it is for goods purchases or investment purposes.

 An alternative benchmark level

While I think that these two ratios are useful, I disagree with the benchmark levels that have been treated as sacrosanct in local debates because they ignore the many other factors that need to be considered when determining the benchmark in the first place. It’s similar to if we are only informed of an approaching hurricane when rain has already started to fall and winds are already creating 20-foot waves. Our international reserves benchmarks are far too low to be meaningful as a signal of distress.

Now let’s go back to the question we raised in the beginning: are the level of reserves Barbados currently holds adequate?

Looking at the benchmark indicators, you could conclude that the level of reserves appears to be adequate.  The reserves currently cover 13.3 weeks of imports of goods and services and at March 2013 were 22% of broad money. In both cases the country is above the benchmark levels so we should be in the clear. However, the story is a bit more complicated.

Consider these three facts:

  1. Small states are more vulnerable to natural disasters and therefor require larger amounts of foreign currency to finance recovery efforts;
  2. Foreign currency flows quite freely in and out of the country and we have limited ways to control it;
  3. We have a very large public sector that drives a large proportion of the country’s foreign currency consumption.

Hurricane

This would imply that we would need to have a larger cushion than countries that do not have these characteristics. We have derived an ideal target of 22 weeks for the ratio of reserves to imports (see the recent paper where we determined the optimal level of reserves based on a statistical cost benefit analysis for more information)[1]. This is almost twice the rule-of-thumb of 12 weeks and is a direct result of the high probability of natural disasters in small states.

Even this target, however, should not be viewed as sacrosanct. We found that small states that were able to implement a prudent government expenditure management framework would be able to hold a smaller stock of reserves, without leading to a disruption of normal import and export activities or any negative impact on short- to medium-term growth. Though the latest Central Bank of Barbados press release showed declining expenditure levels, the fiscal deficit was still estimated at a relatively high 8% for the 2012/13 fiscal year.

In short, it is important that we monitor the level of international reserves in countries such as Barbados. It is equally important that we independently determine what level is the minimum that we need to comfortably meet our obligations.

 


[1] Moore, W. and Glean, A. (2013), Optimal Foreign Exchange Reserve Holdings in Small-Island Developing States, presented at the Central Bank of Barbados’ Annual Economic Review, Bridgetown.

Recession and Falling Reserves: 2013Q3 Review

Central_Bank_Barbados_Building

The Central Bank of Barbados (CBB) released their review of the economic performance of Barbados for the first nine months of 2013. As expected, the country slid deeper into recession and the CBB estimates that economic activity declined by 0.7% so far for the year. The key drivers of economic activity – tourism and construction activity – continued to struggle, the unemployment rate remains high and the level of reserves continued to plummet. The only good sign is the continued ease in inflation, though one could argue that the low inflation rate (2.1% at July 2013) may partially reflect low demand, especially in an import-dependent country, such as Barbados, where high levels of consumer confidence are often accompanied by a rising inflation rate.

Confidence and the Foreign Exchange Reserves

Perhaps the most worrying trend is the continued leakage in the foreign exchange reserves, which fell by Bds$220.2 million in the third quarter of 2013 and is now at its lowest since 2000. To be prudent, countries with fixed exchange rates are encouraged to maintain foreign exchange reserves equivalent to at least 12 weeks of imports of goods and services. This level is believed to provide sufficient foreign exchange coverage to successfully defend the exchange rate and thus provides a signal to international investors of the strength of the Balance of Payments position and, by extension, the entire economy. At 13.3 weeks, Barbados is only 1.3 weeks above this international benchmark. Unlike the last period of significant drain on the reserves, the reduction in the reserves is not due to a fast-growing import bill. In fact, retained imports have grown by a mere 0.05% so far for the year since domestic demand is quite weak.

The main obstacle to arresting the slide in the reserves has been attracting capital inflows. The CBB estimates that net capital inflows at the end of the third quarter are roughly one-quarter of what was recorded by the same point in time in 2012. Capital inflows, especially foreign direct investment, are good indicators of the level of confidence in an economy. In times where confidence is high, inward investment grows, as both domestic and foreign investors are comfortable making the long-term investments that attract capital inflows, such as major construction projects, buying real estate and starting/expanding companies. On the flip side, when confidence is low, not only do foreign investors become increasingly reluctant to make long-term commitments, but domestic investors also go into a holding pattern, since low confidence in the future of the economy increases the risk of these types of investments.

The CBB believes that 2014 should be better year for foreign direct investment due to the construction of a cruise pier and the implementation of government infrastructure and tourism-related projects. Furthermore, it anticipates that capital inflows will strengthen even further in 2015. This outlook hinges on major projects coming fully on stream and the success of initiatives to strengthen Barbados’ international competitiveness.

There are clear downside risks to this outlook. Private-sector projects have been subject to above-average financing constraints in recent years, partially due to the uncertainty surrounding long-term investing in Barbados. The government is also in the middle of a major fiscal contraction, which could prevent or significant slow the implementation of major infrastructural projects. There are signs that confidence may returning, however, with the major commitment recently made by Sandals Resorts International and the addition of another Jet Blue flight to Barbados.

Operating with Economic Uncertainty

Operating with this level of economic uncertainty is a major challenge for businesses operating in Barbados and presents a catch twenty-two situation for the country. Without investment and confidence in the future of the country, it would be difficult for the economy to rise out of recession. On the flip side, it is risky to invest in a country that has been in recession for a prolonged period of time, especially when the economic outlook is somewhat unclear. Nevertheless, we may be at a turning point in the country’s history where the timing may be right for the private sector to firmly take the reigns of the economy and lead Barbados to sustainable growth.