Sunday 17 December, 2017

S&P downgrades Barbados' credit rating to CCC

International credit rating agency, Standard & Poor's (S&P), has dropped Barbados' sovereign credit rating by one notch to CCC.

In a statement issued this afternoon, S&P said:

"We are lowering our long-term local currency rating on Barbados to 'CCC' from 'CCC+'. We are affirming our other ratings on Barbados, including the 'CCC+' long-term foreign currency sovereign rating.

"The negative outlook reflects the risk of a downgrade given difficulty turning around fiscal policy (with parliamentary elections in 2018), a possible domestic debt exchange that could be a default under our criteria, and prospects for a balance-of-payments crisis."

It also noted that Barbados' policy challenges include "high general government debt, deficits, and debt servicing requirements; limited appetite for private-sector financing; and a low level of international reserves raising the risk to sustainability of the peg to the U.S. dollar."

According to the S&P, the CCC rating means that debts are currently vulnerable to nonpayment, and are dependent upon favourable business, financial, and economic conditions for the obligor (owing party) to meet its financial commitment on the obligation. In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation."

The ratings agency said it could revise the negative outlook to stable over the next 12 months "if the government succeeds in balancing its fiscal budget, either from implementation of fiscal measures or a prolonged rebound in growth; improves its access to financing, from private creditors locally and globally; and stabilises the country's external vulnerabilities and bolsters international reserves".

S&P previously downgraded Barbados' credit rating in March 2017, when it lowered the sovereign credit rating to CCC+ from B-.

See the full statement below:

RATING ACTION

On Sept. 27, 2017, S&P Global Ratings lowered its long-term local currency sovereign credit rating on Barbados to 'CCC' from 'CCC+'. We also affirmed our long-term foreign currency sovereign rating at 'CCC+. The outlook on both long-term ratings is negative. We also affirmed the short-term ratings at 'C'.

The transfer and convertibility assessment for Barbados remains 'CCC+'.

OUTLOOK

The negative outlook reflects the potential for a downgrade over the next 12 months should the government fail to advance measures to significantly lower its high fiscal deficit, strengthen its external liquidity, and reverse its low level of international reserves. These scenarios would likely lead to further pressure on availability of deficit financing--be it from official or private creditors--and pose challenges for the fixed exchange rate regime. Any potential local currency debt exchange with commercial creditors, though not currently under consideration by the government, would most likely be considered a distressed debt exchange and constitute a default according to our criteria.

We could revise the outlook to stable over the next 12 months if the government succeeds in balancing its fiscal budget, either from implementation of fiscal measures or a prolonged rebound in growth; improves its access to financing, from private creditors locally and globally; and stabilizes the country's external vulnerabilities and bolsters international reserves.

RATIONALE

Barbados' history of wider fiscal deficits and low growth since 2009 has resulted in a significant increase in general government debt and debt service needs. Limited appetite for government paper in the local market has led to reliance on financing from the National Insurance Scheme (NIS) and the Central Bank of Barbados. Amid high current account deficits and limited external inflows, external liquidity has been weakening. The decline in international reserves reduces Barbados' capacity to defend the currency peg and increases the risk of a balance-of-payments crisis. Our ratings on Barbados reflect our view that its creditworthiness is currently vulnerable and is dependent upon favorable business, financial, and economic conditions to meet its financial commitments.

Flexibility and performance profile: Rising debt and interest burden, limited financing alternatives, and high external vulnerabilities.

As of June 2017, Barbados' gross central government debt represented around 140% of GDP, one of the highest debt levels among Latin American and Caribbean countries. We expect Barbados' net general government debt (which does not include NIS and central bank holdings of government debt and incorporates liquid assets) to rise toward 98% of GDP over the next three years from 95% in 2016. We consider this level of debt a key credit weakness, particularly given Barbados' narrow, open economy (which depends highly on tourism) and fixed exchange-rate regime. In addition, the general government interest to revenue burden is over 15%. We assess Barbados' contingent liabilities as limited, considering our view of the strength of the banking system, with assets around 170% of GDP and being fully foreign-owned.

Financing sources have become increasingly limited over the last five years.

Barbados has not tapped international capital markets since 2010. Financing from bilateral and multilateral lenders has slowed, in part, as Barbados has been slow to satisfy conditions for disbursement and advance projects associated with borrowing.

Historically, local capital markets provided most of Barbados' financing. However, in recent years, the private-sector appetite has dried up on weak policy execution. The government has relied on the central bank and NIS; they met 85% of the financing requirements during 2015 and 2016. Commercial banks have had a limited appetite to finance the central government deficit. During fiscal year 2017/2018 (fiscal years go from April until March), the central bank aims to reduce financing to the central government to only 1% of GDP, from the 6% in 2015/2016 and 8% in 2016/2017.

The NIS has already exceeded its own prudential limits on government paper, and the growth rate of financing provided by the NIS has already decreased.

The government announced in May 2017 fiscal adjustment measures that are among the most significant to date in an effort to balance its fiscal year 2017-2018 budget. They include raising the National Social Responsibility Levy (NSRL) on imports and domestic manufactured goods to 10% from 2% and a 2% fee on foreign currency transactions and the sale of Barbados National Terminal Corp. Ltd. (BNTCL), which stalled last fiscal year because of the Barbados Fair Trading Commission concerns of possible monopoly practices.

However, a weak track record of execution, the introduction of the measures half way into the fiscal year, the likely overestimation of one-off revenues, and political considerations while moving to an election year in 2018 leads us to assume that the measures will fall short of balancing Barbados' budget this year and next.

Therefore, our base case expects a general government deficit (and change in general government debt) of 4% of GDP during 2017-2020. General government fiscal results include an NIS surplus below 1% of GDP during the same period, down from a 3% in 2011. Lower profitability is attributed to central government arrears on the NIS.

In an additional effort to reduce near-term pressure on the budget and financing requirements, the government also announced it's considering a debt liability management exercise on local currency debt held by the NIS, central bank, and other government-related entities (GREs).

Central bank and NIS holdings represent around 40% of gross central government debt. The government expects to finalize a voluntary debt exchange operation that extends maturities without net present value losses before the current calendar year ends.

A transaction only focused on intragovernmental debt is not a default under our criteria. But it highlights the extent of fiscal stress, and if it's extended to private-sector creditors, it would likely constitute a default under our criteria. The liability management operations being considered by the government do not include foreign-currency-denominated debt. There are not external commercial maturities until 2019, but we estimate a debt service of around US$200 million per year during 2017 and 2018.

Strong receipts from tourism, low private-sector demand, and low oil prices resulted in flat imports, which helped reduce Barbados' current account deficit (CAD) to 5% of GDP as of 2016, below the 10% average of the previous five years. Our base case expects that tourism continues to perform adequately, and that low oil prices and the NSRL further discouraging consumption (and imports) would result in an average CAD of 4% during 2017-2019. Foreign direct investment won't be able to fully finance the CAD, which should keep pressure on the level of international reserves during 2017-2019.

International reserves stood at US$317 million as of June 2017. Usable international reserves, which we consider for assessing external liquidity, are even lower; we subtract the monetary base from international reserves because reserve coverage of the monetary base is critical to maintaining confidence in the exchange-rate regime. Barbados' usable reserves have been negative since 2013, and the position continues to deteriorate, in part because of the central bank's deficit financing, which has expanded the monetary base.

We expect Barbados' gross external financing needs to be above 200% of current account receipts (CAR) plus usable reserves. We expect narrow net external debt to average about 30% of CAR during 2017-2019. Our external assessment also considers that net external liabilities of a projected 140% of CAR during 2017-2018 are substantially higher than narrow net external debt.

Finally, in our view, data on Barbados' international investment position have inconsistencies and are not timely.

In our opinion, monetary financing to the central government is at odds with sustaining Barbados' currency peg to the dollar, and it significantly curtails the central bank's ability to act as a lender of last resort in the financial system. Low inflation is a reflection of global conditions rather than effective monetary policy execution given the fixed exchange-rate regime.

Institutional and economic profile: Subdued economic growth prospects and weakened policy track record. With about US$16,771 per capita GDP projected for 2017, Barbados is still one of the richest countries in the Caribbean. Strong flows of tourists and the expansion of the Sandals hotel helped Barbados to grow 2% in real terms during 2016, the highest rate of growth posted since 2009. This contributed to an improved economic assessment. However, historical growth has been below that of peers with a similar level of economic development, and the economy depends highly on tourism.

Growth over the next several years balances a reduction in length of stay and marginal growth in average tourist expenditure with higher arrivals, especially from the U.S. market. A second source of growth would be two major hotel projects that would open operations on the island in 2019 – the Hyatt and the Sam Lord's Castle project by Wyndham. But growth would be held back by recurrent tourism project delays, higher taxes, low private-sector confidence and consumption, and a significant level of red tape, which weakens Barbados' overall economic profile.

Barbados has a stable, predictable, and mature political system, which has traditionally benefited from consensus on major economic and social issues. The government has alternated between the Democratic Labour Party (DLP) and the Barbados Labour Party (BLP). Parliamentary elections are due by June 2018. Despite the unpopularity of Prime Minister Freundel Stuart (DLP), the election is likely be close given divisions within BLP led by opposition leader Mia Mottley. Both parties have similar priorities: to restore growth and maintain the currency peg with the U.S. dollar.

Despite the fact consensus supports and acknowledges the need for adjustment, there has not been success on this front. Private-sector confidence in the current government has fallen on ineffective and slow policy responses. This includes recurrent delays in many investment projects, the failure to enact a comprehensive fiscal adjustment plan, and declines in international reserves.

Slow actions have weighed on our policy assessment compared with when Barbados was higher-rated. Transparency and timeliness of data publication are also weaker than higher-rated sovereigns.