A crisis that will rum-ble on

Date first published: 12/06/2018

Key sectors: all

Key risks: sovereign default; domestic default; financial sector stability

On 1 June Mia Mottley, Barbados’ newly elected prime minister, announced an immediate suspension on payments to its external commercial creditors. Less than a week later Barbados failed to make an interest payment on a 6.625 per cent note due in 2035. Barbados will almost certainly default on two other international bonds that have coupon payments due this month. While the government promised to continue servicing its domestic creditors, it requested that they roll over principal maturities and plans to negotiate a comprehensive restructuring agreement involving both domestic and external creditors. Barbados’ remedial action over the past two weeks appears broadly prudent, unlike neighbouring Venezuela’s, but the extent of its problems means that it could be plunged into a devastating economic crisis.

Barbados’ economic difficulties partly reflect a broader malaise in the Caribbean. Since 2010, Antigua and Barbuda, Belize, St Kitts and Nevis, Grenada and Jamaica have all defaulted on their debts. The entire region has suffered from a decrease in tourist revenue since the global financial crisis, and slowly accumulated huge debts. Barbados has traditionally been thought of as one of the better managed Caribbean economies, but that image just allowed it to delay the inevitable crisis. In reality, Barbados’s fiscal discipline weakened after the financial crisis, it lacked fiscal institutions to control the deficit, state-owned enterprises were chronically mismanaged, and its real-estate bubble was unsustainable.

Mottley’s government is attempting to repair the country’s deficit, and her attempts to revive the economy appear prudent. On 11 June, the government announced a series of new taxes to help repair Barbados’ precarious fiscal position. Amongst the reforms, the government introduced a fuel tax, created a new 40 per cent upper income tax band, and increased corporation tax. The measures are forecast to raise around BD$300m (US$150m) for the next fiscal year. However, debt is around 175 per cent of GDP, the fourth-highest debt-to-GDP ratio in the world after Japan, Greece and Sudan and above Venezuela’s. Barbados will require further budget cuts and taxes, state-owned enterprise reform, and substantial support from the IMF and other international donors.

Barbados also requires its creditors to come to the table to negotiate a restructuring. Debt restructuring will be complicated. External debt is less than 30 percentage points of the country’s total debt burden. While servicing that debt is difficult, particularly given Barbados’ limited foreign reserves, the IMF noted last month that external debt does not ‘pose of solvency risk’. Even if Barbados can secure advantageous renegotiated terms from its external creditors, a successful restructuring will have to focus on domestic debt. The majority of that debt is held by local banks and investors, which implies that the required tough restructuring could threaten the solvency of domestic financial institutions. It is unclear whether Barbados can find a way to reduce its debt sufficiently while protecting the domestic economy from extensive harm.

Barbados’ debt crisis is unlikely to have serious consequences for those outside of the region. However, one surprising aspect of Barbados’ difficulties is the extent of its debt. The Finance Ministry claimed upon entering office that it discovered substantial arrears that went unaccounted. The result is that its estimate of Barbados’ total liabilities are over 30 percentage points higher than previously released figures. Mozambique and Zambia too have reportedly found largely divergences between reported and actual debt. Prime Minister Mahathir Mohamad’s newly elected administration in Malaysia founds that his country’s debt was almost 15 percentage points higher than previously disclosed. Barbados’ difficulties therefore serve as a reminder of the fragility of emerging market credits and their government’s propensity to underreport debt.