The Barbados/IMF Article IV Consultation (Sorry This Is A Long Post)

We agree with Barbados Underground’s call for more debate on economic matters, with a view to this … we are going to borrow a phrase here from our friends over at the Push Pull Blog, we are not trained economists but we have read the IMF Article IV report. Article IV reports are useful as they provide an unbiassed (if diplomatically sanitised) view into the quality of the economic management of the country. This year’s article IV makes interesting reading as the bulk of it centres around the Government’s announced plans to liberalise the country’s capital account.

In a nutshell the IMF thinks that the Barbados is relatively well run.

The prospects for economic activity in 2007 are favorable but imbalances
persist. The economy is growing at a solid pace, and inflation is expected to decline.
However, in the absence of further policy tightening, the wider public sector position is set to
weaken, while the external current account deficit is likely to remain sizeable.

Barbados’ real effective exchange rate appears to be broadly in line with
fundamentals. The real appreciation of the past two years has lifted the exchange rate
somewhat above its estimated equilibrium but neither the small measured overvaluation nor
other indicators suggest a current competitiveness problem.

Capital Account Liberalisation

The discussion then turned to the Government’s announced intention to liberalise the capital account. The IMF did not seem to think the liberalisation would have any drastic immediate impact, but there were risks in the medium term. The remainder of the report discusses the ways for government to contain those risks.

The immediate impact of this step—a commitment under the CARICOM
Single Market and Economy (CSME) to enhance regional integration—is not expected to be
large, owing to the credibility of the peg and the fact that the current approval requirements
have not prevented most transactions from taking place. Indeed, removal of the remaining
controls on foreign-currency accounts, purchase and sale of real estate, and cross-border
borrowing and lending, may have a positive impact on the capital account, to the extent that
they have discouraged certain inflows. However, over time, liberalization may expose
Barbados to the danger of sudden capital account reversals, particularly if it permits sizeable
current account deficits to be financed by short-term inflows. In the absence of a larger
reserve cushion, such reversals could challenge the credibility of the peg or force sharp and
disruptive policy adjustments.

The three strategies to reduce and manage these medium term risks are:

1. Fiscal Consolidation

2. Market Based Monetary Policy Instruments

3. Stronger Financial Sector Policing and Regulation.

Fiscal Consolidation

The main point of disagreement between the Government and the IMF occurs here. The IMF would like the Barbados government to commit to a more agressive programme of consolidation than it has. Their argument for this is that it will reduce the vulnerablity of the economy to external shocks. They argue that in the event of another 9/11 the economy would be able to recover far more quickly. They argue quite strongly for the following measures:

• Reduction of quasi-fiscal activities. The government is undertaking a number of
large public projects that will add some 10 percentage points of GDP to public debt.
Reining in such activities in the future will be crucial, and presenting all quasi-fiscal
activities on a consolidated basis in the budget will help rational planning.

• Improvements in tax administration. The planned establishment of a Central
Revenue Authority, bringing different tax offices under one umbrella, should
generate some small savings, while also facilitating a strategic approach to tax
policies.

 

• Increase in VAT rate and reduction in exemptions. With unchanged collection
efficiency, a rate increase from 15 to 17 percent would raise revenues by 1¼ percent
of GDP; curbing exemptions would create additional savings.

 

• Adjustments in the prices of public utilities. Adjustments appear warranted where
prices are below operating costs, including public transportation, natural gas, and
water—possibly combined with targeted support to protect vulnerable groups.

 

 

• Reduction of tax incentives. Tax expenditures arising from various incentive
schemes for foreign investors were estimated at 6 percent of GDP in 2005/06. A
reduction would be most effective if coordinated with other countries in the region
that apply similar practices.

The last point seems more theoretical than realistic to me, as it is lacks a balancing statistic on how much GDP was generated by the foreign investment (that you wouldn’t get without the incentives)

The Government’s response is summed up in the following paragraph:

The authorities reaffirmed their commitment to reduce central government debt
but were not convinced of a pressing need to adopt fiscal measures. They accepted that
fiscal policy would have to adjust in the face of an eroding reserve coverage and were
committed to act in such a situation. However, they were more optimistic than the mission
about future trends, while pointing out that current projects were unavoidable (new prison
and judicial center), had a positive economic impact (highway expansion), or were selffinancing
(multipurpose sugar factory). Regarding the specific measures advanced by the
mission, the authorities highlighted the role of tax incentives in attracting foreign investment
and expressed concerns about the inflationary and social consequences of raising the VAT
rate and the prices of public utilities.

Further the government argues that the IMF has overestimated the risk of it’s debt burden as the bulk of it is local, and a significant portion of the local debt is held by the NIS Scheme.

Market Based Monetary Policy Instruments

There appeared to be agreement on this and the report notes that Government is likely to create additional Government or Central Bank paper instruments which will require funds to be held to back those instruments. It does note there are concerns on the cost of this.

Stronger Financial Sector Policing and Regulation.

Once again there is general agreement on this point, while there is acknowledgment of increasd risk with the open capital accounts the IMF seems to generally approve of the plans that the Government has implemented or is in the process of implementing.

Conclusions

We on the margin read the report to mean that the Barbados economy is on a generally sound footing. The impending liberalisation of the capital account will open new opportunities to Barbados as a financial centre in good times, however should there be hard times or rapid capital outflows there are substantial risks to the Barbados financial system and our fixed exchange rate.

The best defence in hard times is a tightly run economy. The IMF would like it to be more tightly run than it is, Government disagrees with the IMF prescriptions. Admittedly the rating agencies such as Standard & Poors seem to endorse the Government’s view on the risk associated with it’s current debt profile. (mostly local) We on the margin are of the opinion that eventually Government will adjust the VAT rate. However to our minds, the IMF prescription on reduction of incentives to foreign investment makes no commercial sense. Apart from the difference of opinion on strategies for consolidation, there is very little disagreement between the Government and the IMF.

IN the end, at the heart of the IMF report is a difference of opinion. Is the Barbados Government being overly optimistic? or is the IMF being overly conservative? The truth of the matter is, that we will only know the full answer to these questions when they are matters of history.

Marginal