Recession and Falling Reserves: 2013Q3 Review

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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.