Expansionary Fiscal Policies Could Heighten Credit Risk In ECCU

BMI View: We continue to highlight that the eight countries that make up the East Caribbean Currency Union face an elevated risk of fiscal and balance of payment crises in the coming quarters, particularly in light of a recent uptick in government spending. Indeed, should expansionary fiscal policies continue through 2014, the resulting economic imbalances may necessitate further debt restructurings in the region.

The Caribbean region continues to face significant challenges stemming from unsustainable external positions and heavy external public debt loads. As we have previously noted, countries in the East Caribbean Currency Union (ECCU), which use a fixed exchange rate, remain in a particularly difficult bind with regards to rebalancing their economies ( see 'Additional Credit Events Only A Question Of Time', June 4 2013). With the central bank having taken a competitive devaluation of the East Caribbean Dollar off the table as a policy option for the time being, much of the burden for an economic rebalancing has fallen on domestic demand, which has prevented a substantial recovery in economic growth and required governments to expend political capital in pursuing lower public spending and unpopular wage cuts. Contractionary fiscal policies, along with a subdued outlook for tourism, help to inform our forecast for real GDP growth to come in between 0.9-2.0% in all eight ECCU countries in 2014.

However, while significant improvement had been seen on the fiscal front in the ECCU late in 2012 through the first half of 2013, with several governments implementing substantial tax reforms and cutting back on current expenditures, that progress began to unravel towards the end of the year ( see chart above). Some of the uptick in spending is attributable to domestic political resistance to ongoing reforms, as we have highlighted in St. Kitts and Nevis, for example, where current expenditures contracted by 3.9% year-on-year (y-o-y) in H113, but ticked up slightly to 0.8% y-o-y in H213 ( see 'Uncertain Election Calendar To Exacerbate Political And Economic Risks', November 21 2013). Moreover, in Grenada, where debt restructuring negotiations remain ongoing, the potential political costs of agreeing to further cutbacks in public spending in exchange for bondholders taking a significant haircut have seen the ruling party chart an uncertain course forward ( see 'Rocky Road Ahead For Debt Restructuring', February 11). In Antigua & Barbuda, we recently revised our forecast for the country's budget balance in 2014 to reflect a much wider fiscal deficit than initially anticipated, due to the weaker-than-expected fiscal picture in 2013, as well as a sizeable debt payment due this year ( see 'Principal Payments Lead To Weaker Fiscal Position In 2014', February 10).

Spending Ticking Up
ECCU - Current Revenue & Expenditure, % chg y-o-y 12mma (LHS) & Current Budget Balance, XCDmn 12-Month Rolling (RHS)

BMI View: We continue to highlight that the eight countries that make up the East Caribbean Currency Union face an elevated risk of fiscal and balance of payment crises in the coming quarters, particularly in light of a recent uptick in government spending. Indeed, should expansionary fiscal policies continue through 2014, the resulting economic imbalances may necessitate further debt restructurings in the region.

The Caribbean region continues to face significant challenges stemming from unsustainable external positions and heavy external public debt loads. As we have previously noted, countries in the East Caribbean Currency Union (ECCU), which use a fixed exchange rate, remain in a particularly difficult bind with regards to rebalancing their economies ( see 'Additional Credit Events Only A Question Of Time', June 4 2013). With the central bank having taken a competitive devaluation of the East Caribbean Dollar off the table as a policy option for the time being, much of the burden for an economic rebalancing has fallen on domestic demand, which has prevented a substantial recovery in economic growth and required governments to expend political capital in pursuing lower public spending and unpopular wage cuts. Contractionary fiscal policies, along with a subdued outlook for tourism, help to inform our forecast for real GDP growth to come in between 0.9-2.0% in all eight ECCU countries in 2014.

Spending Ticking Up
ECCU - Current Revenue & Expenditure, % chg y-o-y 12mma (LHS) & Current Budget Balance, XCDmn 12-Month Rolling (RHS)

However, while significant improvement had been seen on the fiscal front in the ECCU late in 2012 through the first half of 2013, with several governments implementing substantial tax reforms and cutting back on current expenditures, that progress began to unravel towards the end of the year ( see chart above). Some of the uptick in spending is attributable to domestic political resistance to ongoing reforms, as we have highlighted in St. Kitts and Nevis, for example, where current expenditures contracted by 3.9% year-on-year (y-o-y) in H113, but ticked up slightly to 0.8% y-o-y in H213 ( see 'Uncertain Election Calendar To Exacerbate Political And Economic Risks', November 21 2013). Moreover, in Grenada, where debt restructuring negotiations remain ongoing, the potential political costs of agreeing to further cutbacks in public spending in exchange for bondholders taking a significant haircut have seen the ruling party chart an uncertain course forward ( see 'Rocky Road Ahead For Debt Restructuring', February 11). In Antigua & Barbuda, we recently revised our forecast for the country's budget balance in 2014 to reflect a much wider fiscal deficit than initially anticipated, due to the weaker-than-expected fiscal picture in 2013, as well as a sizeable debt payment due this year ( see 'Principal Payments Lead To Weaker Fiscal Position In 2014', February 10).

Spending Intended To Boost Domestic Demand And Combat Deflation
ECCU - Consumer Price Inflation & Current Expenditures

In addition to political considerations, we highlight that the uptick in spending has also been a policy response to deflationary conditions, as weak domestic demand, in tandem with falling food import prices, have driven negative consumer price growth in recent months. Concerned that sustained deflation could lead to higher unemployment and spur a recession, governments have ramped up public expenditures in order to stimulate domestic demand. On the monetary policy front, the ECCB also has loosened monetary conditions, growing the money supply in order to spur higher inflation.

Monetary Policy Loosening As Well
ECCU - Consumer Price Inflation & M2 Money Supply

If this trend continues in the ECCU in 2014, the resulting pressures would magnify the likelihood of additional debt restructurings in the coming months, and could lead to more painful measures of economic rebalancing down the line. We forecast public external debt burdens in excess of 20.0% of GDP in 2014 for the five ECCU countries (Dominica, St Vincent, St Kitts and Nevis, Saint Lucia, Grenada) for which we currently forecast this metric.

Little Room To Absorb Expansionary Fiscal Policies
ECCU - Overall Budget Balance, % of GDP

Balance Of Payments Also Under Pressure

East Caribbean governments have little room to absorb expansionary fiscal policies, given that the aggregate nominal fiscal deficit came in at almost 6.0% of GDP in 2013 (before external grants), and ECCU countries continue to rely on foreign capital inflows to fund current account deficits that, in most cases, remain in the double-digits as a percentage of GDP. While weaker domestic demand, and by extension weaker imports, have helped to narrow trade and current account deficits slightly in recent years, the aggregate current account deficit in the ECCU still came in at 19.2% of GDP in 2013. Stronger imports in the coming months could put increased pressures on already overstretched external accounts, while a lack of commitment to constraining spending could exacerbate investor concerns and lead to a higher cost of borrowing, or even halt much needed capital inflows. As such, ECCU governments may face a stark policy choice in the coming months: reduce expenditures again, and continue to face tepid economic growth and deflation, or continue spending and increase the likelihood of a credit event.

Stronger Imports Would Exacerbate External Imbalances
ECCU - Total Exports And Imports, % chg y-o-y 12mma (LHS) & Current Account Balances (RHS)

As we have previously noted, four of the economies in the Caribbean with the largest current account deficits are ECCU members (Dominica, St Lucia, St Vincent and the Grenadines, and Grenada). Although all four possess import cover of above 4.0 months, foreign reserve positions in these countries could be wiped out if capital inflows slow at a time of wide current account deficits ( see 'Rising Risks To Exchange Rate Regimes', June 28 2013). In that light, in addition to the possibility that efforts to boost domestic demand might strengthen imports, the dismantling of Petrocaribe, which could see import costs soar for a number of ECCU countries (in particular, Antigua & Barbuda, Dominica, St Kitts and Nevis, and St Vincent), or weaker-than-anticipated economic growth in the US, which could hurt tourist arrivals, could tip these countries into balance of payments and debt crises ( see 'End Of Petrocaribe Would Elevate Systemic Risk', August 2 2013). We also continue to highlight Dominica as being acutely vulnerable to a debt restructuring in the coming months given double-digit fiscal and current account deficits, with any major economic shock likely to significantly increase the odds of a credit event ( see 'Cautious Economic Outlook Remains Warranted', November 20 2013).

Read the full article

This article is tagged to:
Related sectors of this article: Economy, Balance of Payments, Debt Policy, Investment Climate, Exchange Rate Policy, Fiscal Policy, External Debt
Geography: Caribbean, Antigua and Barbuda, Anguilla, Dominica, Grenada, Saint Kitts and Nevis, Saint Lucia, Montserrat, St Vincent
×

Enter your details to read the full article

By submitting this form you are acknowledging that you have read and understood our Privacy Policy.