Economic Background

Barbados’ economy is expected to grow very mildly in 2011, strengthening only to a modest pace over the medium term. In particular, the increase in non-traded sector activity should cushion a negative contribution from traded production in the current period, with net foreign exchange earnings compressed due to slightly decreased real tourism receipts and an elevated oil imports bill. Meanwhile, despite successful efforts to narrow the fiscal deficit to a projected 5.1 percent of GDP from just above 8.0 percent in both 2009 and 2010, the debt will rise further. In the protracted weakness in the private sector, retrenchments have led to an increase in the jobless rate, even as the social partnership led by the public sector’s initiative has been a source of significant stability. As the recovery strengthens, risks will remain elevated, with tourism hindered by cautious consumer behavior in the advanced economies, and the international businesses sector’s momentum slowed by the evolving regulatory environment. FDI flows are also likely to recover at a tempered pace. The upswing should nevertheless have a favorable impact on the banking system, reversing a largely cyclical deterioration in credit quality.

Monetary and Financial Sector Polices

As the staff report acknowledges, the scope for monetary policy easing is limited in an economy such as Barbados’ because domestic demand is not sustainable in isolation from the strength of the foreign earning exchange sectors. The authorities therefore agree that further relaxation of interest rates would not be appropriate at this time. The Central Bank of Barbados (CBB) however decided that it was appropriate to take measures to remedy information asymmetries and resuscitate the operations of the foreign exchange market. This explains the August 2011 decision to impose a 5 percent surrender requirement on gross purchases by authorized dealers. Contrary to the staff’s interpretation, this policy was not intended to send a negative signal to the private sector, either as a rollback of earlier liberalization or to spark concerns about the credibility of the peg. Both this measure and the reduction in the margin on foreign exchange sales by dealers have been followed up by heightened monitoring of the foreign exchange markets and increased communication between the CBB and authorized dealers. In particular, the CBB began circulating daily reports to dealers on the volume and breakdown of foreign exchange transactions and has further stepped up its internal analysis to monitor the impact of the policy changes.

In the meantime, financial sector supervision and regulation continue to be enhanced. In the banking sector, oversight remains heightened given elevated NPLs and credit risks. In this regard, commercial banks enjoy strong capital buffers even under CBB imposed stress tests. The enhanced banking sector surveillance will be further spotlighted, as the central bank begins regular publication of a financial stability report in December 2011. For non-banks, efforts to consolidate the regulatory regime are now more advanced following the April 2011 startup of the Financial Services Commission (FSC). Supervisory capacity will be built up in this institution over the medium term, aided by technical assistance from CARTAC and other external partners. In addition, the authorities remain focused on implementing the 2008 FSAP Update recommendations, with the Anti-Money Laundering Act approved by Parliament on November 11, 2011.

Barbados is also moving closer to a resolution of the failed CLICO and BAICO insurance operations, with a view to keeping resulting fiscal costs to a minimum. The contingent exposure is expected to be negligible for BAICO, where the judicial management process has already been concluded. In contrast, more substantial liabilities are a potential for CLICO. The judicial management process for CLICO has been set in motion in collaboration with governments in the OECS. This should clear the way for a regionally coordinated plan on restructured as opposed to liquidated operations under private ownership. The judicial managers are expected to present their final reports to the courts in the regional jurisdictions, including Barbados, in December. The Barbadian government then expects to conclude the sale of CLICO’s operations in 2012.

Fiscal Policies

The authorities believe that prudent fiscal policies are essential for the sustainability of the exchange rate peg and that buffers have to be restored to weather future external shocks. Larger primary balances meanwhile should also sustain the government’s ability to effectively sustain pro-growth public sector investments. In this regard, the medium-term fiscal strategy is still focused on reducing the debt-to-GDP ratio to near 70 percent. Since the pace of the recovery is lagging expectations, the time frame for achieving the target is being reviewed in the context of further adjustments to the MTFS. Nevertheless, the authorities are cognizant of the need to balance the required adjustment against fiscal support to growing the economy.

The government of Barbados has already adopted significant revenue enhancing measures and tightened controls on spending. As to further revenue enhancements, the emphasis will remain on administrative improvements. Just in November 2011, the Central Revenue Authority (CRA) was established with a mandate to consolidate tax administration services. Over the medium term, the CRA will achieve the merger of scarce capacity still located in separate agencies and facilitate one-stop provision of taxpayer services. Looking ahead, the government has also requested the Fund to assist with a comprehensive review of the tax framework, with a view to defining a strategy on further revenue enhancements. The authorities already agree that additional streamlining of tax concessions merits consideration and that the applications and approvals process for exemptions could benefit from more transparency. Notwithstanding staffs advice, they are hesitant, however, to impose higher corporate taxes on offshore operations as this could reduce the sector’s competitiveness, particularly in comparison to zero-tax jurisdictions.

Staff rightly observes that even more significant expenditure savings are needed, which will require reforms to social entitlements and more targeted subsidies and transfers. Such initiatives will have to be approached through strong consensus among the social partners. The authorities, though, appreciate the importance of keeping the wage bill under strict control. A wage freeze has existed in government for the last three years, and is likely to continue in the near term as there is no evidence of labor market pressures for changes. The Government further intends to maintain a moratorium on hiring, and expects service delivery reforms to reduce staffing in some public sector operations over time. For the state-owned enterprises (SOEs), there is concurrence that operations have to be kept in line with the MTFS. Subsidies and transfer provisions for SOEs have either been capped or reduced in the current budget, and agencies have been required to identify compensating savings, as part of a medium-term plan to steadily reduce subventions. It will take time to reduce support for education, although the solution might involve a better alignment of subsidies with development objectives. On health sector reforms, steps are already being taken to cap the cost of some programs and eliminate indiscriminate benefits for non-nationals. Costs of supporting the public transportation sector are also being scrutinized, although no policy decision has been taken yet.

Our authorities are also making progress to enhance the debt management capacity, by strengthening the coordination framework between the Ministry of Finance and the CBB. As to vulnerabilities related to the current profile of the debt, they believe these are less heightened than implied from the staff report (Appendix I). The debt is concentrated in domestic currency, mostly at fixed rates, and with limited roll-over risk. In the meantime, most of the external stock is in denominated US dollars, consistent with the currency profile of Barbados’ trade, and with a smooth amortization schedule.

The Barbadian authorities noted the staffs assessment that the public sector financing is too reliant on the National Insurance Scheme (NIS) and that the NIS exposure exceeds a prudentially recommended portfolio limit of 51 percent. However, they stress that, in the current environment, reducing the exposure to government would leave a void of investment opportunities for the portfolio. While cognizant of risks, the authorities maintain that the NIS still has an obligation to maximize the return on its portfolio. Opportunities to invest in public sector securities will naturally decline as fiscal consolidation takes hold. This should coincide with greater scope for portfolio diversification into external investments, when more vibrant foreign exchange flows are available to sustain such transactions. Even still, the authorities believe that the NIS should also play an important direct role in supporting private sector developments, within a prudent risk management framework.

Growth

Barbados is committed both to enhancing and diversifying its medium-term growth prospects. Continued public sector investments in infrastructure are critical to this objective, as well as exploiting further efficiencies in the provision of government services and other direct measures to improve the business environment. Efforts are ongoing to bolster the international business sector, by ensuring that the regulatory environment evolves in keeping with global standards. In tourism, new initiatives are underway to increase business from non-traditional sources in emerging markets, such as Latin America. Policies to enhance external competitiveness are also targeting increases in workforce productivity and reductions in the cost of energy. In the case of the latter, the authorities are promoting increased reliance on renewable energy sources, such as wind and solar.

Conclusion

In summary, the Barbadian authorities remain committed to rebuilding the policy buffers exhausted during the global recession. Pursuing reforms in the context of both the medium-term development and fiscal strategies are consistent with this objective. A more resilient and robust financial sector also accords with this strategy, hence sustained initiatives to enhance and consolidate the regulatory framework. Its is also important to strengthen Barbados’ medium-term growth prospects, and this is being advanced through measures to further improve the business environment, increase workforce productivity, and aggressive policies to diversify the base of the economy. These initiatives will capitalize on Barbados’ highly skilled labor force. The policy dialogue with the Fund as well as TA will remain highly valued in this process.