Sovereign credit ratings have become widely reported and quoted in Barbados and “ratings actions” are now a major news item.
Over the years, whenever there is a credit rating “downgrade” I receive calls from a number of persons from a wide cross section of the society asking, “Is the dollar going to get devalued?” I was again bombarded with the “devaluation” question after the most recent downgrades in August 2018.
Whether or not the currency is devalued is largely driven by confidence in a country’s ability to support the exchange rate peg, which in turn is largely determined by the level of a country’s foreign exchange reserves.
The credit rating does have some linkage to the level of reserves and Barbados’ ability to maintain the current exchange rate peg, in that it affects the ability and the rate at which the country can borrow on the private international capital markets.
Over the years, Barbados has used its credit rating and the ability to borrow on the private international market to boost its foreign reserves and support the foreign exchange peg, without having to deal with the rigours of an International Monetary Fund (IMF) program for example.
However, because of the selective default on Barbados’ foreign commercial debts, the Government has now lost the ability to tap the private international capital markets in order to boost the foreign reserves for the foreseeable future. I should, however, state that because of the very low credit rating, access to private international capital markets was severely limited and very expensive before the selective default. However, an actual selective default means that access is all but gone for the foreseeable future.
The new, post-default reality is that in order to boost its foreign exchange reserves and support the foreign exchange peg, Barbados needs to rely on investment flows and foreign currency funding from what are called “Multilateral Agencies” such as the International Monetary Fund, World Bank, Caribbean Development Bank, Inter-American Development Bank, European Union, and so on.
So to answer the devaluation question, the immediate factor affecting whether or not Barbados devalues, is whether or not, and how quickly Barbados can conclude an agreement with the IMF, in order to access the foreign exchange it badly needs to protect the exchange rate peg.
It is widely known that IMF programs tend to focus heavily on “Debt Sustainability.” In particular, a country needs to demonstrate a credible path to a Debt-of GDP ratio of around 60 per cent in a reasonable time frame (say 15 years). With Barbados’ Debt-to-GDP ratio more than twice this amount, a credible program of “revenue raising measures” and maybe more importantly “expenditure reduction measures” to create a pathway to this target is critical.
The re-profiling of Barbados’ debt and the expected savings on interest payments is one of the key expenditure reduction measures being proposed by the new administration and is also one of what the IMF considers to be “Prior Actions.”
Prior actions are defined as “measures that a country agrees to take before the IMF’s Executive Board approves financing or completes a review”. The negotiations with creditors on a debt re-profiling can be complex and take some time. The foreign exchange and financing challenges Barbados faces means that it does not appear to have the luxury of protracted negotiations with its creditors, because it now needs to conclude an IMF agreement quickly, and completing the debt re-profiling is a key part of concluding the IMF agreement.
An IMF program will generate foreign exchange from the IMF and other multi-laterals which will boost Barbados’ reserves and allow it to maintain the current foreign exchange peg. The lack of access to financing, which has been compounded by the selective debt default, means that Barbados needs to complete these negotiations quickly in order to protect the exchange rate and be able to finance the operations of the Government without reliance on central bank financing.
Successful and speedy negotiations with the IMF will likely depend on successful and speedy negotiations with creditors to expedite the debt re-profiling exercise (which is a “prior action”) as well as crafting a credible set of expenditure reduction measures to support the June 2018 mini-budget.
Now that the new administration has defaulted on Barbados’ foreign commercial debt, has forced a rollover of some domestic debt which is deemed a default by the ratings agencies and announced its intention to re-profile the nation’s debts, it should be no surprise that Barbados has been “downgraded” again and moved to the lowest possible credit rating in one case and “selective default” in the other.
The point is that a “Sovereign Credit Rating” focuses on a particular aspect of the economy – the likelihood that the Government will default on its debts. The reality is that in Barbados’ case, the very thing a rating is supposed to warn investors about (a default) has pretty much happened, or we have been told that it is going to happen, hence the rating agencies actions.
The latest downgrades should therefore not be taken as a judgement on the suitability of the new Government’s policies especially the mini-budget laid in Parliament in June 2018.
As I said in a much criticized article in September 2017, “I think part of the confusion around credit ratings is that we have made them into something they are not. The credit rating is extremely important because it can affect the ability of the Government to borrow and the terms and conditions under which it can borrow. The rating focuses on the ability of the Government to service its debts when they fall due as a way to provide guidance to investors in Government bonds. However, the credit rating is not a pronouncement on the overall health or well-being of the economy or the nature of Government’s economic policies.” You may default as a necessary step to improve your economy’s health, but you will still get downgraded.
Barbados should have some concerns about its credit ratings going forward. The ratings focus on a nation’s “ability to pay” and “its willingness to pay.” Even if Barbados’ “ability to pay” improves, as I expect it to, there will likely be a shadow over the “willingness to pay” aspect in the foreseeable future, which only time and strong economic performance can take care of. Many ratings models suggest that the most likely predictor of whether or not you will default in the future is whether or not you have defaulted before. Observers should, therefore, be realistic about the pace at which its credit rating will improve in the future as they may not improve at the rate of the improvements in “ability to pay.”