Notes From The Margin

September 18, 2007

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

Advertisements

16 Comments »

  1. I see nothing wrong with devaluing the Barbados dollar.

    Comment by Anonymous — September 18, 2007 @ 10:45 am | Reply

  2. […] Notes From The Margin weighs in on the Barbados/IMF Article IV Consultation: “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?” Share This […]

    Pingback by Global Voices Online » Barbados: IMF Recommendations — September 18, 2007 @ 1:11 pm | Reply

  3. Anonymous,

    What benefit would you see to a devaluation? I can see many negatives.

    Comment by notesfromthemargin — September 18, 2007 @ 5:59 pm | Reply

  4. For one, our exports would be able to penetrate markets where they are now shut out due to their high costs, thus leading to increase corporate profits, less expensive products lead to more demand and sales
    for another, as a tourist destination we would be far more compettive than we are, increase tourist revenues, increase business for bars, restaurants which are frequented by tourists,
    for another, it would drive down the sky high cost of living,
    For another, the GDP will improve.

    Comment by Anonymous — September 18, 2007 @ 10:08 pm | Reply

  5. Therein lies the problem “I can see many negatives”, we have been brainwashed for so many years about the negatives that we can not see the benfits, even though they are right there in front of our very noses.
    All systems have positive and negatives but we somehow only focus on the negatives.
    Let me ask you a question, since you can see negatives so clearly, since you know the positives of tying the Barbados dollar to the US at roughly two to one, what are the negatives of this so-called strong Barbados dollar? Just give me four.

    Comment by Anonymous — September 18, 2007 @ 10:28 pm | Reply

  6. Anonymous,

    The arguments presented for are generally those advanced for a devaluation in larger markets. However in a small open market like Barbados, with the exception of labour and perhaps Sugar, all of the inputs for our exports are imported. What this means is that their cost (from a local point of view) simply goes up by the factor of the devaluation. This means that the benefits as far as an exporter are greatly diluted.

    From the services point of view, there is an argument that the cost of those will reduce somewhat, however the costs of inputs rise because of the same reason cited above.

    In terms of the experience of the Caribbean, the reductions in the costs of labour have always turned out to be temporary. The devaluation results in demands by Trade Unions for pay increases which ultimately return the country to it’s pre-devaluation state of competitiveness, hence leading to another devaluation. This is what (in previous years)resulted in the repetitive cycle of devaluations seen in Guyana and Jamaica.

    I think based on the above arguements you can see what the effect on the cost of living would be. You would have to remember that for your cost of living to go down you would have to be paid in US dollars or some other currency. If you are paid in Barbados dollars your cost of living will go down but so will your income.

    Marginal Comments: Okay Okay OKAY…. We accept that these are pretty lame….,
    For your second post (assuming we are dealing with the same poster)four negatives of a strong Barbados dollar would be:

    1. The strong dollar results in a high cost of exports, hence the reason why Barbados is a service economy which allows us to earn a better return for our dollar.

    2. The Barbados dollar being tied to the US dollar, floats with the US dollar. Which can result in variations in imports as we import many things from other countries. For example imports from the Euro zone are now increasingly expensive because of the relative strength of the Euro to the US dollar. A similar effect can be seen in the price of cars.

    3. From a Caribbean perspective, our competitiveness vis a vis our neighbours is weak.

    4. Being a fixed currency, the Barbados dollar is not tradable, this results in the US dollar being the de-facto currency for many businesses.

    Perhaps you would like to post some other negatives of the currency peg.

    Marginal

    Comment by notesfromthemargin — September 19, 2007 @ 12:26 pm | Reply

  7. Marginal, you could have summed it all up by stating that as a political commodity, devaluation is not saleable.

    Of the four reasons you gave, #1 seems to be based on the mistaken distinction between visible exports (goods) and invisibles (services)which, incidentally, are also exports.

    There seems to be some confusion in your suggestion that the B’dos dollar is strong because it is tied to the US dollar, since you recognise that the latter’s value has been declining in comparison with the Euro, thus making imports from that source relatively more expensive.

    The issue of the competitiveness of Barbados’ products is not simply a matter of currency parities.

    I can’t figure out what you mean by your point #4.

    Even to economists the arguments for “real” as opposed to “nominal” changes in currency parities (devaluation) are complex. However, it is usually seen as a tool to “stabilise” economies, which for many persons generate the negative welfare effects to which you allude. I have to give you credit for trying to present the view of the man in the street.

    Comment by Linchh — September 20, 2007 @ 6:45 pm | Reply

  8. Linchh

    Well at least I have stated my reasons for being against a currency devaluation. The four points on the end were my attempt to take up our anonymous poster’s challenge for four disadvantages of a strong dollar. I will admit they were not terribly convincing.

    As far as devaluation goes, other than saying that it is usually seen as a tool to stabilise economies by economists, you would have to admit it has not been an effective tool in the Caribbean context. Given its dismal failure in the Guyana, Jamaica and indeed some would argue the Trinidad economies. The stabilisation of the last one could be attributed to the petroleum resources of Trinidad which in turn subsidise its manufacturing sector and the overall economy’s energy cost. Which by the way would remove Trinidad from the group of economies that my reason would apply to, by virtue of the fact that it has internal inputs to it’s industries.

    Marginal
    PS: I will admit #4 was lame but I was reaching 😛

    Comment by notesfromthemargin — September 20, 2007 @ 9:25 pm | Reply

  9. NFTM, in the popular view of Caribbean people devaluation has not been seen as bringing any benefits to the Jamaican and Guyanese economies. But, given the imbalances that these economies faced, particularly their very high debt burdens there may have been no alternative to devaluation.

    In the case of the Trinidad and Tobago economy there has been significant growth in the non-oil sector. Many people see the T&T economy as the most competitive in CARICOM.

    Economists will tell you that a focus on the nominal strength of a country’s currency can be misleading if its “economic fundamentals” are unbalanced. In this context we need to look carefully at the costs and benefits of a particular set of economic policies that a country chooses to adopt.

    Comment by Linchh — September 21, 2007 @ 3:53 pm | Reply

  10. “Economists will tell you that a focus on the nominal strength of a country’s currency can be misleading if its “economic fundamentals” are unbalanced.”

    I would agree with you on that point. and as such the IMF would have done better to focus on those fundamentals. To argue that Jamaica and Guyana are improved economically while the quality of life of their citizens has been effectively destroyed makes no sense to me. It smacks very much of the concept of economics before Keynes said “In the long run we are all dead”.

    A large part of the competitiveness of the Trinidad economy rests on the ability of the economy to access oil at a cost that is less than world prices. This reduces the cost of the energy inputs which improves the level of competitiveness of the entire economy. There is absolutely nothing wrong with this, the Trinidadians have effectively leveraged their strengths.

    However I believe that we both agree that the truth is that good management of the economy is the first and most important requirement in any context.

    Interesting discussion.

    Marginal

    Comment by notesfromthemargin — September 21, 2007 @ 4:08 pm | Reply

  11. NFTM, I certainly agree that good management by its decision-makers is a critical factor in the performance of an economy. What is also important is the ability to learn from past mistakes. The economic difficulties of Guyana and Jamaica are immense, and sustained recovery is probably al long way off.

    Trinidad and Tobago does have a natural resource advantage over the other CARICOM members, but petroleum revenues did not prevent that economy from experiencing significant crises in the 1980s. I think that the decision-makers learned something from their mistakes of that period which has been a factor in the current performance of the T&T economy.

    Comment by Linchh — September 22, 2007 @ 7:39 pm | Reply

  12. Well said, I do believe that as we go further into the post independence period in the West Indies, we have observed sufficient examples of the consequences that stem from economic mismanagement. We can only hope our politicians are paying attention.

    Marginal

    Comment by notesfromthemargin — September 23, 2007 @ 1:18 am | Reply

  13. So do I, but we shall see!

    Comment by Linchh — September 23, 2007 @ 4:02 pm | Reply

  14. I see that the Govt. is moving to lift exchange controls. This is wonderful. However I think a devaluing of the Barbados dollar would work much better.

    Comment by Anonymous — October 3, 2007 @ 3:43 pm | Reply

  15. Currency Devaluation is not so much beneficial in a country’s economy and has so many negatives but devaluation could be if handled properly for long term advantages.

    No doubt that Barbados beaches are truly some of the most beautiful in the whole Caribbean, and few in the top ten best beaches in the world.

    Barbados has immense potential in Real Estate industry. Huge foreign investments could be attracted by the currency devaluation.

    Luxury villas of Barbados, Best hotels and resorts, plantation houses, royal churches are the trademarks of Barbados. Tourism is the next to real estate industry, I’m sure by little bit reduction in currency value tourism may also boom.

    John Doe

    Comment by merricks resort — September 6, 2008 @ 4:24 am | Reply

  16. Thanks and i know that there are many hotels Luxury villas of Barbados but if you see that they are constructed by very beautiful and i think that well know company’s construct that places like merricksresort(http://www.merricksresortandspa.co.uk) i think that the company is well know and bright future.and the new company comes to Barbados and devaluing of the currency could be better if Govt. can think strongly.

    Regards

    Shaun.

    Comment by merricksresort — September 9, 2008 @ 2:56 am | Reply


RSS feed for comments on this post. TrackBack URI

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Blog at WordPress.com.

%d bloggers like this: