Understanding the National Debt Flap
By Ralph Massey, The Nassau Institute
Over the past month or so Government fiscal policy has gone from a largely ignored but informed discussion of credit and capital controls appearing in the Letters to the Editor columns of the daily newspapers to the front page lead article. Fiscal balance, government pay raises and International Monetary Fund guidelines suddenly dominate Parliamentary debate and labour/management relations. It is a major policy flap that merits serious discussion.
The William C Allen - Richard Coulson Exchange
In late April there was an exchange of letters in the media between Sir William C Allen and Mr. Richard Coulson regarding the credit and capital controls of the Central Bank.
Mr. Coulson and others criticized "the cap as a restraint on economic growth". Sir William, the former Minister of Finance, stated the logic of and the need for these controls in maintaining the parity of the Bahamian dollar with the U.S. dollar. "The balance of payments is clearly under pressure" and the maintenance of parity comes before "growth, high employment and rising incomes".
Sir William recognized that foreign investment is "the only sustainable economic growth stimulus"; but any outflow of Bahamian dollar savings was a national danger. He noted the strong desire of the portfolio managers of the National Insurance and other pension funds to reduce their portfolio risks by investing in foreign assets; but such diversification would dangerously reduce the Central Bank's foreign exchange reserves. Prime Minister Perry G. Christie stated in Parliament that "further capital liberalization" could not be justified. (See Google: bahamas.gov.bs, "About the Bahamas", "2003-2004 Budget Communication" of the Hon. Perry G. Christie, page 44.)
Mr. Coulson argued for "more imaginative economic guidance than simply defending the stale status quo of exchange control."
The Budget Debate
The truth of the matter is that the fiscal deficit and the national debt have recently soared like never before. This is readily apparent in the graph of national debt outstanding. In 1966 the national debt was a miniscule $44,400, virtually non-existent. It increased steadily by the mid 1980s to $600 million level and then accelerated to $2.2 billion in 2002-03 and the Prime Minister expects it to reach $2.4 Billion in 2003-04.
National debt is now a big issue. Prime Minister Perry Christie cited critical International Monetary Fund ratios in his Budget Communication; and The Tribune quoted the PM as saying that a GFS deficit of 3.3 percent of the Gross Domestic Product is "dangerous" and it "should not go above 2.2 percent" and total National Debt is approaching the 40% barrier.
Referring to the Table, the improvement in the first ratio, "GFS" Deficit as % of GDP, that is shown in the Communication is misleading since the improvement in the "Total Deficit" ratio, the one that includes Debt Redemption, is not shown and is much less favourable. In addition, Total Debt including contingent liabilities clearly has gone through the 40% barrier.
Whether the budget is fiscally prudent is, of course, a matter of opinion. Revenues are projected as increasing 3.4% while expenditures go up 1.5%; and the Government's continent liabilities can easily become its Direct Liabilities.
The Prime Minister states that unless we are able to "manage efficiently and have the political will, we have a problem".
This raises valid questions.
· How was this situation created?
· What is "the problem"?
· What are the risks of a failure to resolve it?
Dr. Alvin Rabushka
To really understand the problem it is helpful to go back to the work of Dr. Alvin Rabushka, a Senior Fellow at the Hoover Institution, Stanford University. From January 1995 to early 1997 he was an economic advisor to the Securities Market Task Force; and he presented his work to Government, the Ernest & Young Bahamas Business Outlook '97 and the Bankers Association. In his presentations he described public finance as it worked during the colonial period, the Bahamas Monetary Authority of 1968-1974 and the present Central Bank system 1974 to date.
The colonial period featured balanced budgets, a currency board, no central bank and no capital exchange controls on transactions within the Sterling block. With majority rule and independence "the balanced-budget requirement embedded in the colonial regulations" was eliminated; and, with the Central Bank and the ability to place Government debt with the Banks, the "Government was now free to spend beyond its means and make up the difference through public borrowing." And so it did.
The important point made by Dr. Rabushka at that time was that the macro economic stability associated with the country's financial history was tenuous. The growth in the national debt did create a financial asset conversion risk that could only be contained with capital exchange controls on Bahamian citizens and pension fund managers. He defined "the problem" very simply:
"The entire structure of Bahamian dollar financial instruments, and the ultimate value of real domestic assets, rests on a precariously small foundation of U.S. dollar reserves, which are essential to pay import bills. The reserves are too small to both pay import bills and accommodate large-scale conversion of Bahamian assets into foreign currency." (See Google: nassauinstitute.org, Rabushka, "Restructuring the Bahamian economy for the 21st Century", page 6.)
The Tourism Taskforce Report
The tourism industry commissioned a report on the Free Trade Area of the Americas for its members that has had limited distribution outside of Government. It initially looked at the history of international trade starting in the 18th century, the more recent free trade movement, theories of economic growth and the realities of Bahamian society.
When the study turned its attention to the capacity and financial performance of Bahamian hotels, "the problem" became defined in a different way. The profit data of a typical Bahamian hotel versus hotels in other countries "connected the dots" so that one could see the adverse impact of various "societal" factors on business profitably and ultimately on job creation.
What it showed is –
· The Bahamian presence in the global tourist market is declining despite the huge investment made in the 1990s.
· Operating costs are high and the rate of return is relatively low in all areas of tourism thus reducing the incentive to invest and making government incentives a more important factor in investment decisions.
· The high operating costs in the Bahamas can be attributed solely to societal factors or what economists identify as the "Institutional Setting" for economic development.
· The Bahamian Institutional Setting is a mix of a poor work ethic, a low level of education and skills, "tiefing", rent taking, pubic sector over-staffing, grossly inefficient public utilities, a legal system that frustrates the rule of law, a poorly-structured tax system and unions that follow in the foot steps of their European counterparts.
The Report concluded that whether the Bahamas continues in FTAA or not, the tasks at hand are the following --
1. Secure a sustained flow of foreign direct and domestic investment.
2. Sharply reduce the fiscal deficit.
3. Take concrete steps to reduce the country's high operating costs that limit its development options and endanger tourism.
4. Change the "Institutional Setting".
5. Reform the educational system so that Bahamian school leavers become the "Best in the Caribbean".
6. Create a more favourable business environment.
Dr. Rabushka's analysis produced a similar set of prescriptions in 1997.
Problems and Dangers
1. The failure to restore fiscal balance and take concrete steps to reduce the high cost of doing business could lead to the devaluation of the currency.
Devaluation is a highly undesirable event. It is a de facto tax on savings and income; and it produces an immediate forced reduction in the standard of living. Over time the effects of a devaluation may be ameliorated; but a lack of fiscal discipline and an Institutional Setting hostile to job creation can produce recurring cycles of devaluation and recovery. The Taskforce Report cites the example of Mexico where in the last 27 years the Peso has gone from 12.5 per dollar to over 10,000 when it is restated in 1975 equivalents.
Both Dr. Rabushka in 1997 and the Taskforce Report of 2003 provide a "road map" whereby devaluation, an economic catastrophe, can be avoided.
2. The Government will take only short-term measures to solve the balance of payments crisis.
The economic prosperity produced by the investment in Atlantis in the 1990s allowed politicians to avoid addressing and resolving the basic problems identified in 1997. And…the recently announced new foreign investments may allow the present government to do likewise without ever developing a National Recovery Plan as envisioned in the Report, a plan that the tourism industry considers essential for its financial health and for job creation. The Budget Communication suggests some initiatives such as Public Sector Modernization, investment in roads and ports, etc.; but its comments on education reform, privatization and law and order are not satisfactory.
3. Such political short-sightedness is the sure path to recurring crises and lost opportunities.