CARIBBEAN DEVELOPMENT BANK AN EVALUATION OF RECENT HOUSING DEVELOPMENT STRATEGY IN BELIZE

Transcription

1 CARIBBEAN DEVELOPMENT BANK AN EVALUATION OF RECENT HOUSING DEVELOPMENT STRATEGY IN BELIZE This Report was prepared by an official of the Bank. However, the opinions expressed are exclusively those of the Author. Patrick Kendall Economics and Programming Department June 2002

2 ABBREVIATIONS CARICOM - Caribbean Community CBB - Central Bank of Belize CDB - Caribbean Development Bank CPA - Country Poverty Assessment DFC - Development Finance Corporation EU - European Union FY - Fiscal Year GDP - Growth Domestic Product GOB - Government of Belize IMF - International Monetary Fund mn - million Nun - OECD - Organisation for Economic Cooperation and Development PUP - Peoples United Party SSB - Social Security Board UDP - United Democratic Party USA - United States of America WB - World Bank

3 AN EVALUATION OF RECENT HOUSING DEVELOPMENT STRATEGY IN BELIZE INTRODUCTION 1.01 In the context of the difficulties facing the external sector of many Caribbean countries due to trade liberalisation, there is increasing temptation to turn towards the non-traded sector as the source of growth. Increased access to external borrowing with the liberalisation of the financial sector both regionally and internationally also provides a natural inducement towards this strategic perspective. Prospects of increasing levels of poverty and social deprivation across the Region give added impetus to Governments temptation to look inward. In this economic strategy, the stimulation of housing construction is a logical choice for Governments, given its ability to address both economic (growth, employment) and social concerns simultaneously. However, the recent experience of Belize suggests caution in the pursuit of such a strategy. The paper focuses specifically on the experience of the Development Finance Corporation (DFC) because of the leading role that it has played in housing construction in recent years, the rapidity in the expansion of its housing programme, the relative newness of the approach used and the macroeconomic implications of a significantly expanded DFC. By March 2001, DFC s loans outstanding in the construction sector was approximately 50% of that in the commercial banking sector The first section of the paper provides general information on the economic and social setting that motivated the Belizean strategy. The second section details the Government of Belize s (GOB) strategy for the housing sector while the third and fourth sections detail the institutional and macroeconomic consequences of the strategy. The last section discusses the lessons learnt. 2. MACROECONOMIC, SOCIAL AND POLITICAL SETTING 2.01 Belize is situated in Central America between Guatemala and Mexico. It is a member of CARICOM and also of the Central American Common Market. With a geographical area of 23,000 square kilometres, it is the second largest country within CARICOM though just about 11% the size of Guyana, the largest member. Its capital, Belmopan, with a population of approximately 7,000, was established after substantial damage by hurricane Hattie in The main urban centre is Belize City which lies on the coastland and is home to approximately 22% of the population. Belize is a political democracy, independent since It has two main political parties - the Peoples United Party (PUP) and the United Democratic Party (UDP). In 1998, PUP assumed office with a landslide, winning 26 out of 29 seats Belize is a multiethnic, multilingual, though mainly English speaking, country of approximately 250,000 inhabitants. It is estimated that 48% of the population is Mestizo, 27% Creole, 11% Maya, 5% Garifuna, 2% East Indian and 6% of other racial and/or cultural origin (Asian, white etc.) 1/ The Caribbean Development Bank s (CDB) Country Poverty Assessment in 1996 reported that approximately 33% of the population was poor and 13% very poor, that is, unable to meet basic dietary needs. The report indicated that most of this poverty was in the southern districts of Cayo and Toledo where resides the largest concentration of Mayan Indians engaged mainly in subsistence farming. The report estimated the level of poverty in these areas as high as 58%. Substantial poverty was also found in Belize City where youth and female unemployment have been cited as the dominant causative factor. However, urban poverty at 20.6% was less than half of rural poverty which was estimated at 50%. The prevalence of poverty was a major motivator for the scale of GOB s recent intervention in the housing sector. 1/ IBRD, Country Assistance Strategy, August 2000, p.1.

4 The economy is essentially agriculture-based (crops, forestry, fishing). Agriculture accounted directly for approximately 19% of real gross domestic product (GDP) over the last five years. The main crops are sugar, citrus and bananas. Belize is considered one of the more competitive sugar producers in the CARICOM Region. Sugar exports reached approximately 120,000 tons in Sugar is exported mainly to the European Union (EU) under preferential arrangement with a relatively smaller proportion being sold under quota to the United States of America (USA). A very small percentage is sold on the world market. Cultivation of sugar cane is currently undertaken mainly by peasants. Belize is also one of the largest producers of citrus in CARICOM with exports of processed fruit (citrus juice) destined mainly to the USA but some to the EU and recently Japan. Unlike sugar, citrus production is undertaken by a combination of small and large farms. Raw fruit production reached 7 mn boxes (40 pounds each) in During the last decade, there has also been a substantial increase in banana production destined for the EU. Production reached close to 70,000 tonnes in The industry is targeting 100,000 tonnes for the medium term. Quite unlike the other two crops, banana production for export is undertaken by 16 large farms. The harvesting is done mainly by immigrant labour from Guatemala There is also a variety of other crops, such as beans and papayas, exports of which have been expanding quite rapidly. With the help of Brazil, Belize has recently embarked on soya bean production. The last five years have also witnessed substantial growth in farmed shrimp which has been exported mainly to the USA. Production is done by a handful of large shrimp farms. Shrimp exports reached approximately 5 mn pounds in Belize also exports fish and lobster. Per annum exports of the latter averaged 0.6 mn pounds over the last five years. Overall, Belize can be said to have a fairly vibrant agriculture sector, and is one of the countries in the Region with the highest level of self sufficiency in food production. Nevertheless, substantial poverty subsists in the rural area with the prospect of further impoverishment with the imminent removal of trade preferences for major export commodities The other major sector is tourism which accounts directly for about 17% of real GDP. Tourism activity is centered mainly in the cays off the Caribbean coast and is the largest single earner of foreign exchange. Substantial effort is in train to develop mainland tourism. The current year is likely to see substantial growth in cruiseship tourism. Belize also has an offshore finance sector which, however, is still in its fledgling stage and, like offshore finance jurisdictions elsewhere in the Region, has had to deal with the pressures of the OECD s harmful tax competition initiative As indicated in Table 1, during the period , economic performance deteriorated substantially as compared with the previous six years. Real GDP growth slowed from an average of 9.0% per annum during 1986 to 1992 to 2.7% during 1993 to Contributors to the slowing of real income growth included: (i) the deceleration in growth of the major export industries (sugar, bananas, garments, citrus), and (ii) the substantial downturn in export prices for major commodity exports as the pace of trade liberalisation accelerated internationally and competition intensified. Growth in commodity export revenue fell from 9.9% per annum during 1986 to 1992 to 4% during 1993 to The withdrawal of British troops in 1994 also led to a substantial decline in service exports. The export of goods and non-factor services fell from an average of almost 60.0% of GDP to 52.6% of GDP during 1993 to International reserves tumbled to approximately one month of import cover as compared with an average of four months in the previous period. The drop in real income growth was reflected in the deterioration in fiscal performance. Central Government current account savings fell from an average of almost 6.0% of GDP during 1986 to 1992 to 2.1% of GDP during 1993 to The overall budgetary deficit averaged 4.1% of GDP as compared with 1.3% of GDP during the former period. In support of the exchange rate parity, inadequate fiscal adjustment was compensated for by tight monetary policy which had a depressive effect on productive sector activity.

5 - 3 - Average lending rates in the commercial banking sector rose from 14.1% in the first period to 15.9% in the second. Unemployment, a major cause of poverty, remained high. When the current PUP administration assumed office in 1998, reversing the trend in economic performance and the deterioration in social welfare were priorities. In fact, the new PUP administration titled its first budget Getting the Economic Train Moving Again. It was in this context that the housing sector assumed substantial importance. With the challenges facing the external sector, GOB sought to stimulate growth at least in the short to medium term through an increase in non-traded sector activity and particularly housing. The new administration also viewed it as an important part of its response to poverty. Below is a set of major macroeconomic indicators for the period 1986 to TABLE 1: LIST OF MAJOR ESTIMATED AND PROJECTED ECONOMIC INDICATORS Variable e 2002 p Real GDP Growth (%) Unemployment Rate (%) n.a Inflation Rate (%) Interest Rate (Lending) (%)* Exports of Goods and Non-factor Services/GDP (%) Balance of Payments Current Account Balance/GDP (%) Gross Reserves in months of imports Fiscal Current Account** Balance/GDP (%) Overall Budgetary Balance/ GDP (%)** * Weighted average **Fiscal Years e=estimate p = projected Source: Ministry of Finance, Central Bank of Belize, International Monetary Fund (IMF), World Bank, CDB 3. HOUSING DEVELOPMENT STRATEGY 3.01 GOB committed itself to building 10,000 houses over five years. The cost of building 10,000 homes was estimated at US$150 mn to US$200 mn or between 20% to 30% of GDP. 2/ GOB s strategy for funding housing development was essentially twofold. The first was to borrow externally, the initial target as reported by the IMF being US$50 mn. However, this figure was eventually substantially surpassed. In the 2/ IMF Staff Report for the 2000 Article IV Consultation, p.11. Financial figures are in Belize dollars unless otherwise specified.

6 - 4 - first round of construction, these loans were to be disbursed through the DFC which was to spearhead GOB s housing drive. GOB was able to obtain a soft loan from Taiwan of US$50 mn but supplemented this with borrowing on the international financial market (commercial banks). Some of this was borrowed directly by GOB. Some external borrowing was also undertaken by CBB and passed on to the DFC. Additionally, the DFC borrowed on its own behalf with GOB guarantees. It is estimated that more than US$100 mn was borrowed for DFC operations both by the DFC itself and also by GOB and CBB. The majority of this funding went towards housing development The second round of construction was to be financed through the securitisation and sale of mortgages from the first round which would be sold on the secondary market in the Caribbean. 3/ Four tranches of securitised mortgages and other financial assets were placed in the regional market by the DFC and the Social Security Board (SSB). Most of these assets were in the form of mortgages belonging to the DFC. As at the end of 2001, securitisation proceeds amounted to US$102.2 mn. The transactions involved the assignment of income flows from mortgages and other financial assets to the Royal Merchant Bank of Trinidad and Tobago. To independent observers, the securitisation and sale of mortgages and other assets, were more in the nature of a loan with the pledged income streams constituting the repayment of interest and the sinking funds that have been attached to at least three of the four transactions, providing the repayment of principal. 4/ The income streams were guaranteed by DFC and SSB with GOB providing an additional guarantee. CBB guaranteed the convertibility of the income streams into US dollars. 5/ In addition to the rise in the cost of funds which have had consequences for the DFC s performance, it was also noted that in these transactions, the DFC and the SSB in fact bear the major risks. 6/ The DFC is currently engaged in a similar transaction in the USA market. While it is difficult to argue against the use of securitisation per se as a source of mortgage financing, given its widespread use elsewhere, as for example in the USA, the difficulty lay more in the terms that the DFC and the SSB were able to negotiate. This arguably was a reflection of their own limited knowledge and skills in transacting in such a market In terms of the distribution of housing loans, the DFC engaged in several strategies in an attempt to accelerate housing development. There were essentially three strategies used. The first was direct lending to customers. The DFC, however, also engaged in other strategies. One such strategy was the purchase of houses from developers, the latter having obtained financing from commercial banks. Alternatively, the DFC itself would provide finance to developers and undertake sale of the completed units. In either case, the DFC bore a substantial portion of the risk. In addition to small contracts of up to 10 houses, the DFC has been engaged in the development of several large housing estates as, for example, at la Democracia and Los Lagos. The DFC is estimated to have funded 925 houses in 2000 in addition to 634 units in the 1998/99 period. 3/ 4/ 5/ 6/ It should be pointed out that both funding strategies have been used simultaneously in 2000 and Richard W. Nun, Review and Assessment of the DFC of Belize, July 2001, p.8; CDB, Supervision Report on the DFC, Belize, July 2001, p.26. IMF Staff Report for 2001 Article IV Consultation, p.8. Nun (2001) estimated the interest cost of the securitisation transactions at between 16.0% and 18.0% as compared with maximum mortgage rates of 12.0%. Nun (2001), p.9.

7 INSTITUTIONAL CONCERNS 4.01 Concerns were expressed initially over the lack particularly of demand data to guide policy. While there was agreement on the substantial need for housing, given the level of poverty, there was scepticism about the level of effective demand. As it turned out, concerns about the possible oversupply of housing and rising delinquencies were fully borne out. At the end of 2001, it was estimated that DFC had some $100 mn of unsold housing assets and the rate of delinquencies in the housing sector was on the increase, compromising substantially current income flows. Nun (2001) and CDB (2001) both reported nonperforming loans as high as 20% of the total loan portfolio with housing accounting for between 25% and 30% of the delinquencies. 7/ The DFC has had to borrow to meet liquidity needs (onlending, debt service, operating expenses) GOB in the budget speech for FY 2001/02 reported that securitisation proceeds had enabled the DFC to expand its mortgage and other lending from $60 mn to $250 mn in two years, and that it had been able to do so in an efficient, affordable and sustainable manner. 8/ However, a recent review of the operations of the DFC questioned the management of its mortgage portfolio on all three counts. 9/ The report indicated that securitisation had led to considerable increase in DFC s cost of funds and a worsening of DFC s portfolio, since the better performing assets in its housing portfolio had been sold on the secondary market. The report also questioned the sustainability of securitisation as the mode of supply for mortgage financing, given the squeeze on profits due to the increase in cost and GOB s desire to repress mortgage rates. The report recommended that a new company be formed to handle the mortgage operations of the DFC and that the DFC manage the company on an agency basis for a fee. This may be an attractive but simplistic solution since it assumes the viability of the current housing operations without addressing major issues such as the sale of housing stock possibly at a loss, the substantial debt overhang and GOB policy with respect to mortgage rates Overall, while the DFC was able to accelerate housing development, this came at a significant cost to the institution. There has been deterioration in both profitability and asset quality. Liquidity problems have surfaced, and indications are that these may not be short term in nature. The institution has been seriously decapitalised. The debt equity ratio moved from 2.7:1 at the end of 1998 to 9.3:1 in June Full recapitalisation would now require an estimated $30 mn. 10/ In the absence of substantial restructuring, the long-term viability of the institution is now in question. 5. MACROECONOMIC CONCERNS 5.01 The use of housing construction as the impetus to growth is an interesting but risky strategy and from the very beginning was open to criticism. The rapid accumulation of public sector external debt which the strategy has entailed in a sector that is not a foreign exchange earner is worrisome. This is also particularly worrisome at a time when the external sector itself faces various challenges and needs financial 7/ 8/ 9/ 10/ Nun (2001), p.11; CDB (2001), p.11. Budget Speech, 2001, p.13. MCT and Associates Ltd., A Strategic Review of the DFC of Belize, December CDB (2001), p.35.

8 - 6 - resources for restructuring to meet those challenges. In the context of trade liberalisation and the struggle to maintain growth in export earnings, GOB has engaged in a strategy that is highly vulnerable to sudden drops in foreign exchange earnings. Also, the housing drive began at a time when reserves were already quite low with import cover of approximately only one month. The rapid accumulation in external debt and of repayment obligations also have implications for the stability of the exchange rate parity Belize s emphasis on housing construction is a case of orthodox Keynesianism. In small open economies, however, such as Belize where there is a high propensity to import, the Keynesian model has limited applicability because of the foreign exchange constraint which soon becomes binding. While GOB has been able to postpone the day of reckoning through foreign exchange receipts via privatisation and external borrowing, the opportunity for so doing has become increasingly limited because of the scarcity of public sector assets for sale and the ratcheting up of external debt. The accumulation of the external debt stock has become more costly as financial markets have increased their risk premium. As indicated by the debt service ratio in Table 2, external debt payments are placing increasing burdens on foreign exchange availability. TABLE 2: EXTERNAL PUBLIC AND PUBLIC GUARANTEED DEBT (US$ mn) e 2002 p Debt Outstanding Central Government Rest of Public Sector Financial Public Sector Publicly Guaranteed In Percent of GDP External Debt Debt Service Amortisation Interest In percent of Export of Goods and Non-factor Services Debt service Amortisation Interest Source: CBB e = estimate p = projected 1 Includes securitisation proceeds and publicly guaranteed debt of privatised state enterprises 2 Public and publicly guaranteed debt 3 Service on public debt

9 - 7 - While according to Belizean law, exporters are required to surrender domestically their foreign exchange earnings, a considerable portion of foreign exchange earnings is left abroad. The foreign exchange shortage in the official market has also been made worse by a thriving unofficial market which reportedly siphons off foreign exchange from the tourist sector. GOB attempted to ease the foreign exchange constraint by requiring the surrender of foreign exchange earnings of the sugar industry. However, this has not resolved the foreign exchange shortage which in 2001 and 2002 has been intense according to reports from some of the commercial banks Other concerns about GOB s housing strategy have included the possible crowding out of commercial banks from housing construction and the overextension of government activity in a single sector resulting in lesser financial flows to other areas in the social sector (health, education) and elsewhere (sugar, citrus) that might have been in greater need of attention. The concern about crowding out of the commercial banks arose from GOB s declared strategy of using the DFC to compete with the banks through lower interest rates, given its concern about the level of interest rates in the commercial banking system. However, the empirical evidence on commercial bank lending so far suggests otherwise, a conclusion that supports the view that the banks and the DFC are operating in separate markets. In any case, while the concern about high lending rates in the commercial banking sector is warranted, the solution arguably lies elsewhere in a more balanced macroeconomic policy and specifically in the use of fiscal adjustments to facilitate the easing of monetary policy The accumulation of liquidity in the banking system as a result of substantial external inflows related to housing development has been another area of concern. In one case, at least, CBB has not been able to draw down on an external loan but nevertheless passed on the local currency equivalent to the DFC for onlending. Increased pressure on reserves was being placed by CBB acting foremost as a development agency rather than the guardian of price and exchange rate stability. The diversion of CBB attention to nonmonetary issues while serious monetary issues such as high interest rates, the threat to exchange rate stability and inadequate supervision of the financial sector were left unattended, was an additional result of the overemphasis on housing Additionally, there has been increasing apprehension about the DFC as a source of risk to general macroeconomic stability. Because of the slow rate of sales of housing assets and also rising delinquencies, the DFC soon found itself facing liquidity shortages and turned to the Ministry of Finance for help. However, this occurred at a time when GOB s resources were already quite stretched and its own debt burden quite high. As indicated in Table 1, GOB s current account savings had not improved and there has been a substantial increase in the overall budgetary deficits. Concerns consequently have emerged about the possibility of delinquency on the part of the DFC, about the signal this would send to international financial markets and possible repercussions on the Belize exchange rate. 6. MAIN LESSONS LEARNT 6.01 The lessons learnt from the Belize experience are many. The first and perhaps the most important is the danger of an overdependence on the stimulation of growth in the non-traded sector, given the foreign exchange constraint. Also, very importantly, the Belize experience suggests that while such an approach may bring short-term gains in terms of real GDP growth and increased employment, this outcome needs to be weighed against the possible loss of growth and employment foregone in the long run as a result of redirection of resources away from the external sector which is the engine of growth and which is in serious need of restructuring to meet the new competitive challenges. For example, it has been argued that had the

10 - 8 - external funding to a large extent been used in the citrus or sugar industries for retooling or the insertion of new technologies, the resulting effects would most likely have been more stable long-term growth and employment which would have benefitted the poor and made available resources on a sustained basis for housing and other development in support of welfare enhancement. Alternatively, the funding could have been used in support of the development of new areas of competitive advantage through the provision of physical or other infrastructure Overall, a major lesson is that the first priority ought to be restructuring of the external sector without which real income growth in the long run will likely be reduced with all of the negative social implications attendant thereto. The proposed approach does not imply a total neglect by governments of the housing sector. It does imply, however, the need to ensure: (i) that such involvement takes place ideally only where there is market failure; and (ii) that housing construction activity is not undertaken on a scale that leads to the neglect of major economic priorities and deprivation in other social sectors. Thus an important lesson is that good macroeconomic management is very much a balancing act involving not only the identification of economic and social priorities but also a judicious allocation of resources Also, there is clearly need to base Government s intervention on some estimate of effective demand rather than of need so as to minimise the risk of default. Particularly in the absence of such an estimate, the Belize experience suggests use of the sell then build model rather than the reverse. Furthermore, while there is need to keep lending rates low so as to ensure access to low income families, the long-term financial viability of the institutions tasked with housing development must not be compromised. Accordingly, in the absence of subsidies, minimisation of the cost of funds should be a primary strategic objective. The need for adequate training in new financing strategies for the sector cannot be overemphasised. Obviously, there is need to pursue, where possible, strategies that also minimise the cost of construction through appropriate design, community labour etc. Pursuit of cost reduction strategies can ultimately enhance effective demand for housing in low income communities and also, through increased affordability and reduced delinquencies, minimise the risk to financing institutions. Finally, there needs to be a thorough evaluation of the foreign exchange implications of the proposed housing programme and strategy so as to ensure that there is not undue pressure on the balance of payments. 7. CONCLUSION 7.01 In the current fiscal year, GOB will have to make substantial demand adjustment (fiscal and monetary) in order to correct the external imbalance resulting from its pursuit of a short-term, high risk growth strategy in which housing construction has played a significant role. The foreign reserves situation is weak and there has been substantial rationing of foreign exchange. The external debt situation has become burdensome and there are fears about the possibility of default. The premium on the official exchange rate in the unofficial market has been relatively high for a sustained period and the cost of external borrowing has increased with the reassessment by international financial markets of credit risk. Indications are that unless external sector performance improves in the short to medium term, Belize in the adjustment process will have to surrender at least some of the short-term gains obtained through economic stimulation.

11 - 9 - BIBLIOGRAPHY Caribbean Development Bank, Country Poverty Assessment, Belize, 1996 Caribbean Development Bank, Supervision Report on the Development Finance Corporation, Belize, July IBRD, Country Assistance Strategy, IMF, Staff Report for the 2000 Article IV Consultation. IMF, Staff Report for the 2001 Article IV Consultation MCT Associates Ltd., A Strategic Review of the Development Finance Corporation of Belize, December Nun, Richard W., Review and Assessment of the Development Finance Corporation of Belize, July 2001.