Caribbean economies in the midst of a global economic storm

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Anna Lee Ali's picture

The Caribbean islands[i] while very diverse share numerous similarities. By conventional standards, these islands are small and are prone to natural disasters because of their location in the tropics. Although storms occasionally wreak havoc, the region’s fundamental challenges remain economic and political.

After the independence wave during the 1960s and 1970s, most of these small island nations have experienced low growth (commodity exporters are the exception) and have remained dependent on niche sectors such as tourism, financial services, agriculture and fisheries and natural resources and minerals. Due to their small size, these open economies are forced to import most of their basic necessities and as a result are vulnerable to terms of trade shocks. They are also highly uncompetitive as reflected by sustained current account deficits in their balance of payments.

Figure 1

Source: World Economic Outlook (WEO)

Caribbean economies are generally stable democratic states and they have a relatively highly skilled workforce due to their investments in education. Brain drain, however, remains an acute problem albeit a significant source of private remittances in the region.

High public spending on social programmes, employment and education over the decades have saddled these countries with a mountain of debt. In the aftermath of the financial crisis, the tourism industry suffered a major blow prompting many Caribbean countries to spend their way out of stagnation ultimately resulting in unsustainable debt levels. This caused a string of sovereign defaults across the region. As a result, some countries were forced to undergo debt restructuring exercises. Despite several such restructurings, debt levels still remain extremely high as most countries are unwilling to endanger their local financial systems and by extension their economies. This is because the majority of public debt is held by domestic investors such as banks and other financial institutions.

Figure 2

Source: WEO[ii]

The Caribbean’s failure to utilize periods of higher growth to diversify its economies and increase competitiveness coupled with high debt levels continues to inhibit growth. Additionally, the region remains especially susceptible to global developments, some of which are discussed below.   

Recovery in US growth and Europe’s economic stagnation

As the world’s largest economy-the United States (US) continues to gain economic momentum, the Caribbean stands to benefit from an increase in export earnings. This is because the US is a major trading partner for the larger Caribbean islands such as Trinidad and Tobago and Jamaica.

Additionally, it is expected that the region will record greater tourist numbers as the US economic recovery strengthens. There was a significant drop in visitor numbers from the US and Europe (the two most important markets for the region) following the global financial crisis. As the US economy continues to improve, the Caribbean tourism sector is likely to continue to recover as the number of US visitors increases. However, given Europe’s economic stagnation, it is highly improbable that the same trend will be observed for visitors from that region.

Figure 3

Source:  Caribbean Tourism Organisation (CTO)[iii]

Figure 4

Source: CTO  

Figure 5

 Source: CTO

In early 2015, the US relaxed its tourism restrictions with Cuba after both countries announced a rapprochement in December 2014 marking the end of five decades of hostility. This move is expected to result in a notable increase in the number of US tourists visiting Cuba. Since tourism is often a zero sum game, this could result in a decline in tourism market share for other Caribbean countries.

Moreover, the improvement in the US economy has led to a sharp appreciation of the US dollar against its major trading partners. In the Caribbean, most economies have either a managed or fixed exchange rate system to the US dollar. The recent rise in the US dollar has eroded these countries competitiveness as the anchor to the US dollar has also caused a rise in the value of these small islands’ currencies.

Softening of commodity prices

In December 2014, the Bloomberg Commodity Index, which tracks twenty commodity prices, fell to 109.4-the lowest level seen in more than four and a half years. Plummeting prices for metals, oil and agriculture products are as a result of a number of different factors ranging from slowing growth in China to bumper harvests for some agricultural commodities.

Figure 6

Source: Bloomberg

This has been a mixed blessing for the Caribbean region since some countries are commodity exporters and will be negatively impacted. For others, falling commodity prices will translate into higher real incomes and will improve growth prospects.

Declining oil prices, however, has been the exception. The collapse in oil prices threatens the present economic recovery of these small island states and could jeopardise countries involved in economic adjustment programmes if Venezuela is forced to review its PetroCaribe subsidized oil arrangement. Under the PetroCaribe agreement[iv], some Caribbean countries can import a set daily quota of oil from Venezuela at preferential payment terms and conditions. Imported oil remains the dominant energy source in much of the Caribbean region and high energy costs continue to be the main driver of many countries’ trade deficit even with the programme. At low prices, the present agreement is now under threat as Venezuela’s economy is in a tailspin and political pressures mount.

The war on tax havens

With the recent G20 crackdown on tax havens, many countries stand to lose business as investors move their capital to other tax havens such as Delaware. It is expected that as greater transparency and double taxation agreements are implemented, Caribbean economies which are dependent on offshore financial centres will continue to experience a decline in their financial services sector which will weigh heavily on economic growth in future years.

Ebola Fear factor

While there have been no reported cases of Ebola in the region, one case of the disease has the potential to cripple the entire tourism industry placing addition stress on economies that already are in a vulnerable position. Given the fragile nature of the healthcare system across the region and the lack of infrastructure to deal with any possible cases of the disease, avoiding Ebola will be essential to ensure the region’s economic survival.

Federal Reserve normalisation & immigration policy changes

If US interest rates were to rise more quickly than expected, there is a high probability that financial market volatility could occur and capital outflow pressures would materialize.

President Obama’s changes in immigration policy will also affect the Caribbean. Undocumented Caribbean immigrants who qualify to apply for citizenship should be able to find jobs better suited to their skill set. Consequently, they ought to be paid more appropriate salaries and benefits allowing them to send more remittances to the region.

It is highly unlikely that current immigration policy at this point will significantly deter Caribbean workers from migrating to the US. This is because US immigration policy is primarily focused on tightening border security as a way of preventing illegal immigrants from entering the US, while most undocumented Caribbean immigrants arrived legally, later overstaying their visitor visas.

Moving forward  

While a more flexible exchange rate system generally enables countries to better absorb some macroeconomic shocks, some smaller Caribbean countries are members of the Eastern Caribbean Currency Union (ECCU)[v] and as a result cannot devalue their currency. In addition, research has shown that while an external devaluation may prove beneficial to some countries around the world, expenditure switching can be difficult to achieve in the Caribbean region (Worrell 2003) and can adversely affect real incomes instead. In order to restore competitiveness and spur growth, a fiscal devaluation should be considered as an alternative.

High energy costs continue to be a major issue for most Caribbean countries. As a result, it is in their best interest to consider other options to reduce costs as there is a high probability that there will be some policy adjustments to PetroCaribe in light of Venezuela’s situation. One such option would be to assess whether a similar agreement could be reached for the US to supply natural gas to the region. In barrels of oil equivalent, the cost will be significantly less and natural gas being a cleaner fuel can be used as a bridge towards the use of renewable sources of energy. Of course a cost benefit analysis will have to be undertaken and any net benefits accrued will have to be compared to that in the existing agreement before any decisions are made.

The region stands to benefit from creating trade relations with new countries especially developing middle income countries since their rapid growth can filter to these small island states. Through these new relationships, Caribbean economies can becomes less dependent on developed countries and hence less vulnerable to external shocks created in these economies.  

Generally speaking, the region lacks the fiscal and external buffers necessary to shield their economies from international shocks. As a result, complementary stabilization and structural policies are needed and deeper relations should be developed both within and outside the Caribbean region to help weather any economic storm that may occur in the future.   

 

[i] For the purpose of this analysis, fifteen small island territories are covered namely: Haiti, Trinidad and Tobago, Suriname, Guyana, The Bahamas, Dominica, Belize, St Vincent and the Grenadines, St. Lucia, St. Kitts and Nevis, Antigua and Barbuda, Barbados, Monsterrat, Grenada and Jamaica.

[ii] e represents an estimate.

[iii] Non-tourism based economies namely Guyana, Haiti, Suriname and Trinidad and Tobago are excluded from this part of the analysis.

[iv] All countries included in this analysis are members of this energy union with the exception of Trinidad and Tobago, Montserrat and Barbados.

[v]ECCU member countries include Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia and St. Vincent and the Grenadines.

 

References: 
  • The Caribbean: A darkening debt storm, The Financial Times, Robin Wigglesworth and Benedict Mander, April 28th 2013.
  • A New Caribbean Outlook: Looking beyond Petrocaribe & Gasifying the Caribbean, Caribbean Petroleum Update, September 2014.
  • The Caribbean: Haircuts on the Beach, Roubini Global Economics, Nouriel Roubini and Joao Ribiero, November 12th 2014.
  • The border is not the problem, The Economist, D.K, November 21st 2014
  • A currency union for the Caribbean, International Monetary Fund, DeLisle Worrell, 2003.
  • Crackdown on Offshore Finance to leave Island economies scarred, Business Monitor International, May 8th 2013.
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