Bermuda credit rating cut imminent
After reading through the Budget release and attending the Bermuda Chamber of Commerces Budget Breakfast it is my opinion that Bermudas economic challenges are both enormous and wide ranging. In which case balancing the Budget will be a significant and difficult task requiring patience and time. What follows are a few negative and positive takeaways from the current situation:
1) Rating Cut is Imminent. There is no doubt in my mind that at this stage Bermudas Sovereign Credit Rating will be cut further. The real question is by how much? After reviewing the numbers and running various projection paths and scenarios it is highly likely that a credit downgrade is on its way. Bermudas current net debt to GDP ratio is approximately 28 percent and will likely approach 34 percent by the end of fiscal 2013. The Government aspires to achieve a net debt to revenue ratio below 80 percent, however, it is currently an eye-popping 202 percent. The only ameliorating factor is that the seriousness of the debt situation has been confronted; the Government is committed to tackling it and plans to begin lowering the debt burden in its fifth year. Jamaicas recent default offers a stark backdrop on what happens when debt levels are allowed to escalate unchecked.
2) Demographic Hurdles. Peter Everson, a Chamber of Commerce Board member, briefly went through the numbers with regards to Bermudas demographic challenges. Specifically, he noted that there is approximately $1.5 billion in off-balance sheet liabilities associated with underfunded Government entitlement costs and this debt costs the Government $154 million per year, but is not reflected in the statement of consolidated accounts. Bermudas ageing population is pushing the country closer towards a position where there will be more dependents on entitlement programs than contributors. This milestone may happen as soon as 2025. This escalating burden is another obligation that needs to be funded and addressed in some form. It may eventually result in reduced benefits and/or curtailment of current programmes.
3) Short On Concrete Growth Initiatives. The Government has indicated it is focused on a two-pronged strategy to fix the budget imbalances: pro-growth initiatives and expense controls. In my opinion the budget statement contained limited pro-growth initiatives. I acknowledge that the government is focused on increasing the speed and a quality of service in order to make Bermuda more attractive as a business destination. They hope to do this by eliminating excessive red tape and making it cheaper and more attractive for businesses based in Bermuda to employ more people. To that end, the removal of term limits is a positive step towards removing the uncertainty of employers and key employees, making investment in Bermuda more attractive. However, I would have liked to see more extensive and bolder policies like the implementation of gambling. I also worry that the current payroll concessions will at some point need to be removed as the budget is starved of revenues. What is really required is demand creation. You can make labour cheaper and cheaper but there is no business that will hire unless there is sufficient demand. Gambling offers an entire new industry that can create demand for a new product. I understand this is being addressed with the new Tourism Authority that is conducting a full analysis before any recommendation or implementation takes place but I still feel it would have been a positive potential aspect to note. It would have also been nice to have seen more details on how Bermuda expects to expand its asset management industry and further support/encourage its success in the Insurance Linked Securities market.
4) Shared Sacrifice. There was a pervasive call for unity and shared sacrifice. This is important because it is very unlikely that Bermuda will overcome the escalating costs that are driving decreased global competitiveness without lowering various cost structures of both labour and capital. The key here is that both labour and capital will need to, in some form or another, make concessions. It is far too easy to point at Unions as the cause of Bermudas uncompetitive cost structure. But it is by no means entirely their fault. There are numerous examples of where capital in Bermuda has been grossly malinvested and used in an inefficient manner. Lower input costs, from energy to rent, are also necessary to adjust the cost basis on the island toward a completive position. As the budget statement says, there will need to be teamwork for Bermudians in every sphere.
5) Conservative & Prudent. Say what you want about the scary figures and anticipated higher debt levels but the projections look prudent and conservative to me. This is critical as it brings into focus Bermudas escalating debt and engages the nation with a goal of slowly turning the ship. It also provides some credibility to the budgeting process so, hopefully, any future negative revisions will be eliminated. The first step in solving a problem is recognising that it is a problem and quantifying it. The budget statement clearly accepts this responsibility: Bermudas prolonged recession was due to structural Bermudian issues, issues that we are compelled to address ourselves.
6) No Drastic Austerity. Dramatic austerity measures at this stage would be counterproductive and would likely tip Bermuda further into recession. A recent paper published by the IMF Economic Counselor Olivier Blanchard, noted that recent efforts among wealthy countries to shrink their deficits — through tax hikes and spending cuts — have been causing far more economic damage than experts had assumed. In fact every dollar cut or saved has resulted in a $1.50 reduction in growth. Harsh fiscal austerity has shown to lead to a viscous spiral of lower economic growth and lower tax revenue. A large part of next years deficit is uncontrollable at this stage. The new government has inherited many capital projects and a run-rate cost basis that will take time to adjust. It is heartening to see that the problem is acknowledged but that drastic austerity, which would likely cause undue economic hardship, has not been implemented.
7) Future Debt Raise. It is clear that more debt issuance will need to be done. These future issuances, in my opinion, should be focused on locally sourced Bermuda dollar debt issues that are held by domestic companies and residents, not foreign entities. This improves the stability of the debt profile for Bermuda by placing the debt in the hands of interested parties, and reduces the need for increasing foreign reliance. It would also be worth considering local public and private debt financing options through local debt issuances for capital projects such as the hospital. With significant capital already raised and a guaranteed income stream from this monopoly, a bond offering is very likely to attract investment.
8) Inclusive. The budget also includes steps to make Bermuda more inclusive. We have often noted that population growth directly impacts GDP growth. Policies like the removal of term limits and making property more affordable for foreign owners may help to stabilise the islands population loss and may even help with growth. Property ownership has been proven to foster a greater sense of community and unity.
I commend the government for not shying away from Bermudas fiscal issues. The road to redemption will be challenging and, at this junction, does seem a bit daunting.
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