The Tribune

By NEIL HARTNELL Tribune Business Editor THE Bahamas could end up "paying the price" for failing to employ a balanced countercyclical policy response to the 2007-2009 recession, a former finance minister warning yesterday this nation could find itself at the mercy of rising foreign currency debt servicing costs. James Smith, who ran the Ministry of Finance during the 2002-2007 Christie-led PLP administration, told Tribune Business that the Bahamas had "missed quite an opportunity" by relying 100 per cent on fiscal policy to mitigate the recession's economic impact, turning only to monetary policy last year with the Central Bank of the Bahamas's Prime interest rate cut. Mr Smith was commenting after Tribune Business obtained a recently-released report by the Inter-American Development Bank (IDB), World of Forking Paths - Latin America and the Caribbean Facing Global Economic Risks, which placed the Bahamas in the lowest of three categories measuring 23 Latin American and Caribbean countries for so-called 'fiscal headroom'. That term refers to the ability countries have, given their current fiscal positions, to engage in further government-led action should the world economy suffer further negative shocks. The Bahamas, though, was placed in the bottom 'Restricted Space' category, meaning that based on current debt and deficit indicators it has little to no 'fiscal headroom' to undertake more countercyclical policy actions. Spelling it out, the IDB and the report's author, Andrew Powell, said 'Restricted Space' nations such as the Bahamas were places where "higher fiscal adjustment is required to maintain debt levels" at their current position. And the Bahamas was also listed among those "in worse shape" from a fiscal viewpoint in the recession's aftermath, due to the Ingraham administration using up the 'headroom' that previously existed. "Comparing fiscal space by end-2010 with the pre-crisis fiscal space by end-2007, it appears that most countries are now in worse shape," the report for the IDB said. "The main reason for the deterioration is the widespread reduction in structural primary balances over the three-year period. In fact, of the 23 countries in the sample, only Barbados, Bolivia and Jamaica increased their fiscal balance." This is not surprising, given that the Bahamas' national debt stands at around $4.3 billion, and its debt-to-GDP ratio is now approaching 60 per cent. The International Monetary Fund (IMF) has projected this ratio will rise to 70 per cent by 2016 if nothing is done, with the national debt growing by at least $1.3 billion to hit $5.5 billion. The World of Forking Paths report also compared the policy response of the Bahamas and Barbados to the 'credit crunch' and subsequent recession, given that both employ fixed exchange rate regimes. While Barbados relied heavily on monetary policy, via central bank interest rate cuts, the Bahamas eschewed this approach and went exclusively for fiscal policy via various infrastructure-related capital spending projects. The IDB report said the longstanding capital controls employed by both countries "drive a wedge between domestic and foreign assets and potentially provide some, albeit limited, space for monetary policy. "Barbados used this space actively, as the Central Bank lowered minimum deposit rates from 5.25 per cent to 4.75 per cent in November 2007, lowering them again in April 2008 and October 2008 to reach 4 per cent. The Central Bank also used open market operations, purchasing treasuries held by banks to enhance liquidity in the financial system." The report conceded that Barbados was effectively forced to rely on monetary policy because it had little 'fiscal headroom' at the start of the recession, with a debt-to-GDP ratio of around 100 per cent. Still, its approach contrasted with that of the Bahamas. "On the other hand, the Bahamas, which enjoyed greater fiscal space, chose not to use interest rates to react to the 2008 shock, but rather employed various fiscal tools," the IDB report said. The Central Bank of the Bahamas was critcised by both the Government and various private sector executives for not using interest rates earlier to bring relief to hard-pressed business and consumer borrowers, eventually cutting the Prime rate by 75 basis points in May 2011 - a move also prompted by the high system liquidity. Indicating that the Bahamas should have found a better balance between monetary and fiscal policy responses, Mr Smith told Tribune Business: "We really should have been employing both. We lost quite an opportunity there, and could end up paying the price later. We ended up taking on more foreign debt." US interest rates were currently being held artificially low by the Federal Reserve, Mr Smith suggested, and when they started to rise the Bahamas would face higher interest payments on its foreign currency debt, which stood at $1.391 billion at year-end 2011. Meanwhile, describing the Bahamas' 'Restricted Space' fiscal ranking as "not surprising", Mr Smith said: "It speaks to our, over that period of time, the level of national debt that's built up and our capacity to fund the increase which, in our case, is the revenue growth or lack thereof to fund the higher debt servicing requirements. "I'm quite certain our figures indicate that we've had an increase in direct debt from $2.7-$2.8 billion to over $4 billion, and no appreciable growth in revenue, all things being equal. It means our capacity to deal with new levels of debt servicing are severely strained." With consumer consumption and foreign direct investment "drastically" down, Mr Smith said the Bahamas had "pretty well near maximised out" government spending and its ability to keep the economy afloat. "Using that kind of measure, I'm not surprised we're ranked where we are," he added of the Bahamas' 'Restricted Space' rating, "because we're seeing other countries in the Caribbean emerging in better shape following the recession, which for us might not be entirely over." The former finance minister urged the Bahamas to see the IDB report as "some sort of call to action" when it came to putting this nation's fiscal house in order. "It means that whatever we were doing in the recessionary period is not enough, and we need to look clearly and dispassionately at where we are with the debt build-up, and move quickly on a medium-term strategy to deal with the debt and deficit," he added. Mr Smith said it was "even more critical" for the Bahamas to rebuild fiscal 'headroom' because it was located in the hurricane belt, and therefore exposed to natural disasters as well as economic downturns. "It's only a question of whether we will take heed," he told Tribune Business. "I think it's the first time we've ever been in this position, and both parties need to do something about it. It should be top of the agenda going forward."