THE FUTURE OF DEBT – PART II




Despite our desires, objectively, the task ahead is largely an uphill climb and requires us to accept some truths along the way. Why is there a seemingly lack of congruency between the country and the credit market? There appears to be many countries, peers, with debt-to-GDP that is much worse than The Bahamas, lover per capita income, less stable socio-economic realities, but are paying much less for borrowing. Focusing on these comparisons does not make for sound analysis. While the measures hold importance it is the perceived ability of the country to repay its debt that is most important, based on the current fiscal policies in play and economic outturn. The extent of the country's credit worthiness is not simply a function of the size of the economy but rather how much the government takes, its fiscal space. The Bahamas currently has very limited fiscal space with reasonable capacity to change that. We are mindful however of the important tensions at play.


The amount of borrowing which took place over a short period had an adverse effect on the country. The performance of the economy was weak with very limited foreign exchange coming in. There was an acute need to support the peg. This spate of borrowing was not followed by any real fiscal adjustments but understandably, we were in the midst of the pandemic. The most recent budget made some adjustments but with more focus on enforcement and collections. Effectively therefore the additional borrowings in recent times tipped the total stock of debt into "unaffordable" regions, $10B plus attracting annual interest cost of over $500M, from a budget of $2.5B in revenue, with no attendant source of revenue changes.


Currently debt is projected to go beyond $12B and will therefore attract interest tending well over $500M from a budget of $2.8B. This in circumstance where there is very high yields on our foreign currency bonds, as stated above, and a local domestic market that appears not to have a very vigorous appetite for sovereign debt. The main issue here is that the other countries we often compare ourselves to may have made adjustments or have circumstances which render them better able to demonstrate their ability to pay. The Bahamas current position in this regard is clinically focused on fiscal consolidation and the extent to which we can get back to or close to pre-pandemic levels. The question is whether this is enough to change market sentiment and the extent to which it can be sustained.


The debt discussion has many twists and turns but I believe that proper analysis should force us to look at it through the eyes of the creditor with a view of convincing the market that it has concluded wrongly on the fundamentals of the country. I hope that Rothschild will be successful in this regard. It is imperative that this happens quickly or we accept that the market has gotten it right, we accept things for what they are and adjust accordingly.


NEED FOR OPTIMISTIC REALISM


No one can fault any policymaker for being optimistic. However, there is also a place for positive realism. In this regard, I believe that if the tables are going to turn The Bahamas must shift its gaze from what was to what is and what needs to be. The country recently had two of the best market makers run a loan campaign. It becomes difficult to accept that in that process the market was not given the best quality information about the country. We have to stop and accept that when the market asks for a high premium it is seeing some things that it does not like but enough that it likes to take the risk. I believe we should accept what the market is saying and move to resolve the issues that are adverse to our position. The 10% plus premium on US Treasury reference rate for Bahamian debt landed us on one distressed listing by a market maker, Bloomberg.


The outcome of the most recent market access evidences the fact that personnel at the Ministry of Finance is working very hard work with a refreshing level of creativity. The most recent transaction was creative and beneficial but unfortunately, it cannot be replicated, at least not to the tune of country’s current borrowing needs of $1.8B, subject to any carry over of deficiencies from fiscal 2022. Everything about the Bahamas debt at this point turns on the market’s perception or agreement of its credit worthiness. Whether we feel it is real or not the market is asking for distress levels premium. Nothing changes until that perception or reality is fixed and borrowing at these levels will be both imprudent and untenable. Herein lies the potential value of Rothschild. If working with government they can get the market to see the country in a different light then the upside could be significant.


Is the credit market wrong or have we withheld critical information which would put the country in a better light? The recent listing of the Bahamas as a distressed sovereign, by Bloomberg, puts us together with some countries which when assessed on non-credit basis we do not seem to fit. That is a natural defensive urge where we are thinking about the best interest of the country. However to seek to rationalize the situation on bases other than what the credit market is taking into consideration could prove detrimental. I am convinced that if tomorrow the government announces certain fiscal measures which increases potential revenue intake we would almost immediately fall off these listing.


It is not that the country has no resources but rather that there is limited space created by its current policies. Based on the current debt burden and performance that is not weighing positively enough on credit worthiness for us to see the shifts we desire. There is valuable insights to be gained by deconstructing the latest debt transaction. Firstly, the administration worked with the high-powered Goldman Sachs to demonstrate its ability to access the market. The outcome in this regard was very was successful. Let us assume that the IDB’s contribution (guarantee) is replaced by a policy change, which creates the same or similar effect on market sentiment. If we assume a similar gain, taking into account the then indicative pricing of 13.5% and compare it to the final pricing of the debt, immediately the country’s premium drops below that 10% benchmark to around 6%. With the guarantee, the rate normalized to around 9%, still high but a significant change nonetheless.


From a purely credit perspective the IDB’s guarantee did one thing and one thing only, it signaled to the market that the ability to repay was near certain and the market responded accordingly. This provides us with a window into what the market believes and is thinking. Clearly, going forward any changes creating a similar credit value will have a positive impact on the market sentiment. One cannot reasonably expect that the IDB will guarantee all borrowings for the next fiscal and therefore if the credit worthiness of the country does not improve significantly there will be continued pressure to secure debt at reasonable cost. To secure real solutions we cannot simply second-guess the evidence but rather we must ask what actions are needed to engender such a response on a sustainable basis. Protecting the trajectory of deficits reduction is critical to The Bahamas but ultimately will not be sufficient. Growth in government fiscal revenue is needed. I believe that to change market perception of its credit worthiness The Bahamas at this point has one main problem to solve, demonstrate improved quality revenue and deeper commitment to reforms. Rothschild working together with the government and the Debt Management Committee is likely to conclude likewise and this will therefore form a central part of the new messaging.


THE URGENCY OF NOW


The evidence is clear. Global output is declining. The US economy has reduced over the last two quarter. Inflation continues unabated at historical highs and interest rate is increasing to highest levels in decades. The implications from these creates a complex layer of uncertainties with serious implications for tourism and the continued performance of the economy. It means that The Bahamas will continue to be very challenged in borrowing and without fundamental changes continue to attract debt at significant premium. The sovereign rating will continue to be a drag on the ability to borrow. It is critical that the country becomes maniacally focused on how to create sustained traction on the current debt challenges.


The fundamental question is what can we do to reverse that situation? Well here are some important things already done. The government projected an 8% deficit for 2022 and brought it in that position at a narrower 6%, 2% better. For 2023, the deficit is projected lower at 4% and for subsequent years projected a reduction in deficits until a surplus is secured in 2025/6. Having done that we had the credit rating agency Moody’s opining that such is a credit positive but not sufficient for them to changing their rating because of three main risks. These are dependency on collection and enforcement rather than new tax measures; projections for cost of debt may be understated and could broaden he deficit; and spending measures kept in the narrow band as projected may stifle the growth.


The net take away is that the market is saying that while it loves the direction the country is heading it does not believe that its credit worthiness has improved. This is the fact we must accept and the factors we can influence and change. The work in “creating more headroom for the country to be able to move ahead” must see these issues as its epicenter, the source of greatest damage and the solutions must be clinically focused accordingly. There is an unrelenting urgency for action now. Action with the potency to create and convey a new messaging, action that will shift the credit market sentiment in favour of The Bahamas. There is a clear need to cause there to be significant changes that will positively influence the future, the long-term future of debt.

Hubert Edwards is the Principal of Next Level Solutions Limited (NLS), a management consultancy firm. He can be reached at info@nlsolustionsbahamas.com. Hubert specializes in governance, risk and compliance (GRC), Accounting and Finance. NLS provides services in the areas of enterprise risk management, internal audit and policy and procedures development, regulatory consulting, anti-money laundering, accounting and strategic planning. He also chairs the Organization for Responsible Governance’s (ORG) Economic Development Committee. This and other articles are available at www.nlsolutionsbahamas.com.

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