Barbados is facing a major fiscal dilemma.
The International Monetary Fund conceded today that Barbados and other struggling small open economies in the Caribbean risked “adverse effects” should they administer its longstanding and persistent devaluation prescription.
A similar outcome might also be the result if a policy of fiscal consolidation was pursued, the financial institution based in Washington D.C. cautioned today.
But despite the observation, the IMF included the measures among its recommendation of “three main ways to improve competitiveness and reduce relative domestic costs”, something it said countries in this part of the Western Hemisphere needed in the current environment where “high debt and weak competitiveness continue to constrain growth. Devaluation or not, however, the IMF said structural reforms, including improving the effectiveness of public investment and business facilitation, “should be pursued vigorously”.
The latest IMF advice came today when it released its annual Western Hemisphere Regional Economic Outlook in Montevideo, Uruguay.
“The choice between … external and internal devaluation … is difficult, because both may entail adverse macroeconomic effects. Moreover, in small open economies, the balance between the positive and negative effects of the two options differs from those in larger economies, because of their high degree of trade openness,” it noted.
As Government continues preparation on an adapted Medium Term Fiscal Strategy, after both Central Bank of Barbados Governor, Dr. DeLisle Worrell and Minister of Finance Chris Sinckler said it went “off track” last year, the IMF said the prospects for growth in the region were not good, noting that this was especially so for Barbados and other countries dependent on tourism.
It recommended the use of an “internal devaluation”, the “fiscal adjustment to bring domestic inflation below that of major trading partners”, a “nominal depreciation” (external devaluation), and “structural reforms to boost private investment and productivity”.
Having faced major criticism from Worrell and others in the past about the dangers of devaluation for Barbados and economies like it, though, the IMF suggested the choice of devaluation was not a straightforward one.
“For the Caribbean, the choice between internal and external devaluations is made easier because most countries have to undertake significant fiscal adjustments to improve their debt dynamics, which will also help improve competitiveness,” it said in the section of its report in which it offered advice on how the Caribbean could increase its competitiveness.
“Should an additional external adjustment be needed, external devaluations can be used, although they are not expected to be as effective as in larger and less open economies.
“To improve the likelihood that they would have an expansionary effect, external devaluations should be undertaken together with measures to boost confidence that further devaluations would not be needed, such as structural reforms and fiscal adjustment,” it added.
The IMF said its suggestions were made in the context of what it called “a conundrum” Barbados and company faced, which was “how to bolster growth in a weak external environment at a time when fiscal retrenchment has become imperative”.
Acknowledging that “many countries in the region are under fixed exchange rate regimes”, the IMF said based on Barbados’ experience in 1991 with an international devaluation (fiscal adjustment), as well as others in Hong Kong (1997) and Argentina (1998) this was a reasonable option.
“Model-based simulations and case studies provide some evidence that an internal devaluation may be effective in boosting competitiveness in Caribbean economies. Fiscal consolidation produces a real depreciation, which helps correct external imbalances,” it said in this regard. (SC)