By Ravi Kurjah First Citizens Research & Analytics First Citizens Investment Services

Barbados Policy Prescription? By Ravi Kurjah First Citizens Research & Analytics First Citizens Investment Services Review of the Economy The Barbados economy continued a slow but resolute growth trajectory in 2016. Real GDP is estimated to have expanded by 1.6% at the end of the last year. The tradable sector grew by 2.2% on account of the robust performance of the tourism sector which increased by 4.8%. The non-tradable sector grew 1.5% supported primarily by the construction sub-sector which expanded by 2.8 % and the finance and other services sub-sector by 2.5 %. At the end of 2016 the average inflation rate stood at 1.1 % and the unemployment rate fell to 9.0 %, as seen in table 1, compared with 11.3 % at the end of 2015. Per capita GDP (basic prices) declined by an estimated 1.6 % to record BBD28,600. (USD14,300) compared with BBD29, 100 (USD14,500 ) in 2015. The stock of foreign reserves at the end of December 2016 was estimated at BBD681.1 million, representing 10.3 weeks of import cover. This represents a decline of 26.5% when compared to the previous period end of year stock of BBD926.8 million which was previously estimated at 13.6 weeks of import cover. Table 1 2015 2016 Jan-Mar 2016 Jan-Mar 2017 Real Growth (%) 1.0 1.6 2.3 2.0 Tradeables (%) 2.6 2.2 7.3 4.7 Nontradeables (%) 0.5 1.5 0.9 1.5 Inflation (%) -1.1 1.1-1.3 Avg. Unemployment (%) 11.3 9.0 11.3 Foreign Exchange Reserves (BBD Million) 927.0 681.1 940.6 705.4 Foreign Exchange Reserves Cover, Weeks 13.6 10.4 14.2 10.7 Source: Central Bank of Barbados 1 P a g e

% of GDP 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015e 2016e 2017f 2018f 2019f 2020f 2021f Addressing the Fiscal Deficit The most significant challenges facing the Barbadian authorities are the widening fiscal deficit and diminishing foreign exchange reserves. The fiscal deficit as at March 2017of BBD583 million represents 6.3% of GDP. Figure 1 3.0 1.0-1.0-3.0-5.0-7.0-9.0-11.0 Barbados budget balance Source: BMI, Central Bank of Barbados The Minister of Finance and Economic Affairs stated that the 2017-2018 budgetary proposal will address the short term fiscal and financial challenges, while wide ranging discussions across critical sectors will create a short to medium term fiscal and economic plan. To confront medium to longer term growth challenges the minister proposed the National Fiscal, Economic, and Social Development Restructuring and Enhancement Programme. This budgetary proposal key items are: 1. Boosting foreign exchange earnings through creating even more attractive conditions of foreign direct investment: 2. Implementing productive sector reform by reducing the cost of doing business in critical sectors; 3. Instituting a Competitiveness Awareness Commission and Operational Unit to drive implementation of work being conducted by Competitive Action Teams (CAT) such as improving efficiencies and output in: The Grantley Adams International Airport; The Bridgetown Seaport; The Legal System in the Offices of the Chief Parliamentary Counsel (CPC) and the Solicitor General (SG); Registration of Properties; The Court System; 2 P a g e

Physical planning permission - Town and Country Development Planning Office; and Tax Efficiency with respect to the Barbados Revenue Authority (BRA) and the Customs Department. 4. Implementation of a new national energy policy to make Barbados energy independent by 2035 based on extensive use of alternative energy; 5. Implementing fiscal consolidation through: Public Financial Management reform including the passage of the Finance Management and Audit (State Owned Enterprises or SOE ) Act; 6. Reforming SOE s, including: mergers, operational consolidation and divestment; 7. Completing tax policy reform and tax administration upgrade including the transition of Customs to the BRA. 8. Stabilizing debt growth and reduction through fiscal reform, debt management and debt profiling; 9. Reforming key social sectors such as: health, education, sanitation, social care and environmental protection. Government expenditure is dominated by payments for goods and services. Figure 2 Government of Barbados expenditure estimates 2017-2018 in millions Debt Service, $1.67 Wages and salaries, $1.23 Retiring Benefits, $270.00 Good and Services, $419.86 Grants to public institutions, $219.28 Source: Barbados budget statement 2017 3 P a g e

Table 2 FY 2017/18 Estimate BDS (Million) % of GDP March 2017 Budget deficit $422.00 4.4 Revised Deficit $537.60 5.6 Domestic & Foreign Amortization $971.00 10.2 Financing Required (net of domestic roll-overs & foreign financing) $814 8.5 Of which Central Bank (Pre-adjustment Financing) $654 6.8 Size of Fiscal Adjustment $542.00 5.7 Adjusted Fiscal Surplus (as result of measures) $4.40 0 Adjusted Primary Surplus 702.4 7.3 Post-adjustment Central Bank Financing $87 0.9 Source: Barbados budget statement Although reforms outlined by the administration will help improve Barbados fiscal standing, elevated debt levels are likely to persist, compounding the deterioration of the country s sovereign credentials. High debt levels have already significantly reduced Barbados financing options and depleted its foreign reserves. Despite mounting pressure, authorities will most likely avoid seeking multilateral assistance in the near term from the International Monetary Fund (IMF). Loans or extended credit from the IMF will likely contain strict austerity stipulations. With elections due in 2018, a tough fiscal stance would likely be off the cards. Foreign Exchange Reserve Snapshot International reserves have declined steadily as current economic conditions continues to place pressures on Barbados foreign exchange reserves, reducing Government s ability to meet its external debt service requirement. As at March 2017, the international reserves stood at BBD705.4 million (seen in figure 1 below), following an increase of BBD24.3 million in the first quarter. However, the import reserve cover declined to 10.7 weeks, falling below the 12-week benchmark, a reflection of larger capital outflows in financial year 2016/2017 as seen in table 3. 4 P a g e

Figure 3 Table 3 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Capital Inflows Private 1,410.9 1,717.3 1,405.1 724.4 536.2 1,110.5 1,343.9 494.6 919.6 834.2 836.2 Public 230.6 136.9 89.5 519.9 808.4 225.8 54.9 393.7 234.2 272.2 111.8 Total 1,641.5 1,854.2 1,494.6 1,244.3 1,344.6 1,336.3 1,398.8 888.3 1,153.8 1,106.4 948.0 Capital Outflows Private 176.7 565.8 452.2 208.1 101.3 119.4 363.6 185.4 287.7 330.7 422.2 Public 163.7 108.0 212.1 111.3 501.8 131.6 139.3 167.8 146.6 344.4 282.1 Total 340.4 673.8 664.3 319.4 603.1 251.0 502.9 353.2 434.3 675.1 704.3 Travel Credits 2,121.2 2,381.6 2,391.8 2,145.6 2,076.5 1,925.3 1,835.7 1,927.9 1,776.7 1,913.8 2,048.1 Source: Barbados budget statement Proposed Revenue Generating and Cost Cutting Measures from 2017/2018 Budget Statement National Social Responsibility Levy (NSRL) The minister proposed effective July 1, 2017 the NSRL rate to increase from 2% to 10% with an intent to finance the cost of health care. The NSRL was implemented in September 1 2016 with the expectation of raising additional annual revenues of BBD142.1 million. It was applied to goods imported into Barbados and on domestically manufactured goods but excludes imported raw materials. The 2% to 10% move is 5 P a g e

expected to increase revenue from this measure to BBD291 million for a full financial year and BBD218 million for the remaining nine months of the current fiscal year. Moreover, the expected breakdown in the contributions is projected to be NSRL- BBD186 million and VAT- BBD32 million. This policy will lead to increased cost for local businesses, which can choose to transfer cost to consumers. Increase in inflation can also be expected and depending on the price elasticity of demand, a reduction in consumer demand can be anticipated. Lower consumer demand will not augur well for domestic economic growth and has the potential to erode the tepid growth registered in the economy. Commission on Foreign Exchange Transactions The minister proposed a broad-based foreign exchange commission be charged on all sales of foreign currency at a rate of 2%. This will extend to all wire transfers, credit card transactions, and over the counter sale of foreign currencies. This measure is also expected to raise an estimated BBD52.5 million over the remainder of the current financial year and BBD140 million over a full financial year. Just like the effect of the NSRL proposal, it is expected that this measure will increase prices on consumer discretionary goods. This can fuel black market trading of foreign currency. Excise Tax on gasoline and diesel Effective June 1 2017 the excise tax on gasoline will be increased by BBD0.25 per litre, from BBD0.74 to BBD0.99 and on diesel by BBD0.24 from BBD0.20 to BBD0.44. The dollar change to fuel prices can be seen in table 4. Table 4 Fuel type Current price per litre New price per litre $ Increase Gasoline BBD3.00 BBD3.05 BBD0.05 Diesel BBD2.15 BBD2.25 BBD0.10 Source: FCIS Research & Analytics, Barbados Budget Statement The increase in fuel prices will increase a factor in the cost of production of local goods and services (transportation cost). It will affect the base cost of agriculture, manufacturing and service sectors and will have an inflationary impact, albeit temporary, until prices normalize Tax amnesty The authorities have implemented an additional period during which taxpayers can benefit from a waiver of penalty and interest on taxes owed to the Barbados Revenue Authority (BRA) for land tax and Value 6 P a g e

Added Tax. The amnesty will run from June 1 2017 until November 30 2017. Preliminary figures from the last amnesty indicate that just over BBD35 million was collected in outstanding taxes and on this occasion the authorities are anticipating that an additional BBD25 million can be realized. This measure should achieve favorable results as taxpayers are given additional time to update filings and standing with BRA. The onus will however be on the government to utilize collections prudently. Divestment of state assets The government of Barbados proposed to raise revenue through a divestment programme which includes sale of the following government assets: 1. Barbados National Terminal Company Ltd. (BNTCL) which is owned by Barbados National Oil Co. Ltd. (BNOCL). Update: The process for the completion of that sale is now awaiting final regulatory approval from the Fair Trading Commission (FTC) of Barbados. It is expected that this transaction should be completed during this financial year and is expected to boost revenue by BBD70 million. 2. Sale of the Hilton Hotel at Needham s Point currently under the portfolio of Needham s Point Holding Ltd. Government expects to receive a minimum of BBD100 million as net proceeds from the sale. It should be noted that the real estate market is not necessarily thriving and therefore determining a favorable market price will be a challenge. The government also has to ensure that these transactions are completed soon since an immediate inflow of revenue and foreign exchange is required. Tax administration The Minister proposed to establish a special task force unit within the Barbados Revenue Authority for the purpose of establishing a national tax administration registration initiative. This policy proposal is aimed at capturing persons operating businesses, self-employed, professionals, sole traders and artisans. This measure will broaden the tax base rather than just simply rely on increasing taxes. The success of the programme will depend on how well it is communicated. A definitive timeline is not provided. VAT factoring The Minister proposes that the Barbados Revenue Authority, Ministry of Finance and Economic Affairs, Treasury Department and Central Bank of Barbados collaborate and design a VAT factoring programme to attend to the issue of arrears in VAT refunds. 7 P a g e

Details on the programme should be revealed soon. This programme will aid in alleviating the backlog of VAT refunds and improve business cash flow and government arrears. Figure 4 Revenue and expenditure budgetary measures (BBD' 000) $25.00 $70.00 $82.00 $218.00 Increase in NSRL Commission on the sale of foreign exchange Increase on excise taxes on petroleum fuels Divestment of assets $70.00 $50.00 $52.00 Interest rate savings on domestic debt Reduction on residual expenditure Tax amnesty for 6 months Source: Barbados budget statement Balance of payment outlook. With the budget measures in place, a close eye will be on the effect on debt and economic growth as a wide external current account and fiscal deficit undermine the ability of government to invest in expanding capacity. According to Business Monitor International (BMI) Tourism represents 15% of the Barbadian economy. BMI further estimates that Tourist activity will support a service surplus of 21.3% of GDP in 2017 and will be the primary source of foreign currency. However, a large import bill can offset services strength. A large portion of the import bill, refined petroleum, represents nearly 20% of Barbadian imports, if international oil prices appreciate, BMI says that will lead to imports growing an average of 4.1% in 2017 and 2018. Tourism sector outlook Barbados external current account deficit is set to widen as the tourism driven services surplus remains muted. According to the IMF, the average expenditure per tourist in Barbados has declined in recent years, reflecting lower room rental rates, which may be in response to increased competition from 8 P a g e

nontraditional accommodation sources (including online sharing platforms like HomeAway and Airbnb), and lower costs arising in part from real wage freeze, lower import prices, and lower taxes. IMF has proposed that the authorities need to focus on average spending as well as total spending, while maintaining a relative competitiveness in the high-end tourism market. Credit Ratings On March 3, 2017, S&P Global Ratings lowered its long-term foreign and local currency sovereign ratings on Barbados to 'CCC+' from 'B-'. The outlook is negative. S&P also lowered the short-term ratings to 'C' from 'B.' The downgrade reflected reliance on central bank financing of the still-high government deficit and the fall in international reserves reflected heightened challenges for policy implementation, the sustainability of the peg to the U.S. dollar, and underpin expected weaker growth prospects in Barbados. However, government has since signaled the objective to reduce and ultimately eliminate the Central Bank s participation in new financing. Following S&P, on March 9, 2017, Moody s downgraded Barbados bond and issuer ratings to Caa3 but unlike S&P, Moody s maintained a stable outlook. Moody s decision to downgrade Barbados issuer and bond ratings was summarized into two points: 1. Continued increase in government debt and very limited prospects for fiscal reform 2. Rising domestic and external financing pressures that are very likely to impair the government s ability to service its debt. S&P Credit Rating History Source: Bloomberg 9 P a g e

Moody s Credit Rating History Source: Bloomberg Barbados Investment Risk Barbados external account and ability to finance debt is expected to remain weak. Reforms are critically needed to reverse the current imbalanced on both the fiscal and the external accounts. In the absence of policy-led adjustments, the external current account deficit will widen and this will renew pressure on foreign exchange reserves, and ultimately will place even more pressure on the fixed exchange rate. Given the current account deficit, a dollarization state cannot be ruled out. Despite the burden, Barbados is unlikely to alter its currency policy in the coming years due to potential public dissatisfaction and political fallout before the February 2018 general election. Barbados is expected to remain in a precarious position with regards to its fiscal account. Certainly the government has proposed fiscal remedies, but the administering of this medication is critical to the treatment s success. In the past, government s efforts have been focused on raising revenue via taxation tools but in the coming years the focus will shift to austerity measures as government aims to reduce debt. DISCLAIMER This report has been prepared by First Citizens Investment Services Limited, a subsidiary of First Citizens Bank Limited. It is provided for informational purposes only and without any obligation, whether contractual or otherwise. All information contained herein has been obtained from sources that First Citizens Investment Services believes to be accurate and reliable. All opinions and estimates constitute the author s judgment as at the date of the report. First Citizens Investment Services does not warrant the accuracy, timeliness, completeness of the information given or the assessments made. Opinions expressed may change without notice. This report does not constitute an offer or solicitation to buy or sell any securities discussed herein. The securities discussed in this report may not be suitable to all investors, therefore Investors wishing to purchase any of the securities mentioned should consult an investment adviser. 10 P a g e