Pressure mounts for debt exit plan

WEDNESDAY, JUNE 27: Bermuda could face further downgrades if it doesn’t get its financial house in order.

Yesterday Fitch Ratings downgraded Bermuda from AA+ to AA.

It means the cost of Government borrowing will increase.

Santiago Mosquera, a director at Fitch and the primary analyst on the ratings downgrade, told the Bermuda Sun that Bermuda needs higher revenues and cuts in public sector spending. If that does not happen, he said, Bermuda could face further downgrades as its financial position weakens.

Finance Minister and Premier Paula Cox said cutting back would do more harm to the economy than good and Government plans to freeze spending in the 2013 Budget.

Mr Mosquera said after the next general election, the rating agency will expect a clear plan from the Government of the day: “Are there measures to increase Government revenue or to address Government expenditures if revenues are not coming back?

“The revenue base in Bermuda is so narrow there are not many alternatives.”

He said Bermuda needs to “recover economic growth, and even if you have that… you need a plan to cut the deficit.

“The spending has to go down and the revenue has to go up. It’s simple math. In our opinion, one is not enough. Changing the tax system is not feasible for Bermuda because of the tax advantage they have.”

He said that Bermuda’s upcoming bond issue was taken into account for the current downgrade.

In its press release, Fitch Ratings downgraded Bermuda due its weak performance compared to its peers, and “deteriorating fiscal and government debt ratios and lack of a credible fiscal consolidation strategy”.

The downgrade means Bermuda will have to pay a higher interest rate on the money it borrows.

Premier Cox said the downgrade returns Bermuda to the same rating it had from 1994 to 2006 and Bermuda still has comparatively high ratings from Fitch, Moody’s and S&P.

She said: “I remain committed to bringing enhanced efficiency to the civil service, and freezing spending at current levels. I am confident this is the correct fiscal consolidation strategy, as further spending cuts will only serve to weaken the economy during these tough times, putting more strain on Bermudian families.

“The Government is pleased that the adjusted rating remains in the top tier of the ratings. At AA, Bermuda’s sovereign bond rating is only two notches below the highest rating of AAA.”

Craig Simmons, economist at Bermuda College, and Cordell Riley, a former Government statistician and owner of Profiles in Bermuda, said in the short term, Government’s strategy of stimulus over cutbacks is the correct move.

Mr Simmons said what is missing is a plan to emerge from the debt.

“None was provided in the 2012-2013 Budget Statement. I suspect that one reason for the downgrade is the lack of an exit strategy: a plan of how the debt will be managed over the near-term and reduced over the coming decade or so. The lack of a plan feeds into the pervasive uncertainty around the island’s ability to service its debt.

“The social costs associated with following austerity whilst the recession continues are too high a price to pay for fiscal consolidation. Mild stimulus is a sensible way forward over the next year or two.”

But he added that there was  a “critical” need for a medium-term plan to reduce spending and raise taxes to pay down the debt.

Mr Riley said Fitch rating is a fiscal check-up for Bermuda.

“The ratings doctor has effectively stated that they have found some things that are cause for concern which need corrective action. The Government has thus far resisted calls for spending cuts, fearing that sharp cuts to balance the budget may actually make things worse — and there is some truth to that. “Governments that have gone the austerity route, such as Spain, France, Britain and of course Greece, are struggling. Of course, if you spend more than you take in, the deficits can only increase and that is not sustainable over the long run.”

He said raising taxes was not a viable option and suggests that civil servants may have to move to a four-and-a-half day work-week and that Government should commit to a balanced Budget by 2015.

Bermuda Sun Columnist Larry Burchall said the ratings downgrade means Bermuda will pay more to borrow to service its debt: “This increase in the cost to borrow must be set against government’s still-falling revenue.”

Less annual revenue plus steeper borrowing costs translates into more borrowing— or deeper spending cuts. “The hit always goes down to the man-in-the-street,” Mr Burchall said.

He also pointed to Bermuda’s declining population, which means less economic activity, which in turn means less Government revenue: “Cuts will happen. The question is, will the cut be a controlled cut in best conditions or a cut forced by a sudden steep rise in borrowing costs coupling with still decreasing revenues?”

(For full Fitch report, see link).

In their own words — views from the experts

Santiago Mosquera: It’s simple math – you need to earn more and spend less

If that does not happen, Bermuda could be in position to suffer further downgrades as its financial position weakens.

He said that Bermuda’s new bond issue is taken into account in these ratings.

“We were expecting a placement for this year — the Government was very clear about that.

“In addition, the Government already has some short term facilities with the financial system in Bermuda that they need to address.  

“It’s very difficult to manage an economy with overdraft facilities with banks. If they raise funds they will have the chance to address this short-term liability and they will have some money to cover the deficit they expect for this year.

“It’s not going to change our numbers because we’ve already factored those in.”

Mr Mosquera said that after the next general election: “What we expect from a new administration is a clear plan for fiscal consolidation. Are there measures to increase Government revenue or to address Government expenditures if revenues are not coming back?

“The revenue base in Bermuda is so narrow there are not many alternatives.”

He said Bermuda needs to “recover economic growth, and even if you have that — and we’re not even sure about that for Bermuda in the short term — you need a plan to cut the deficit.

“The spending has to go down and the revenue has to go up. It’s simple math. In our opinion, one is not enough. Changing the tax system is not feasible for Bermuda because of the tax advantage they have.”

Mr Mosquera said Fitch is not as “optimistic” about Bermuda’s near term future as the Government is.

He stressed that after the election, the Government should “provide a concrete plan on how they are going to close the deficit in the future. For that, the only remedy is to generate primary surpluses.”

He said based on Government having a plan to reduce the deficit, it expects no growth for 2013 and the economy could bounce back with some growth in 2014, but even then, it would be low.

“We understand how the system operates in Bermuda, but we are not that optimistic about the future. We want to see some economic growth or better perspectives for economic growth and at the same time plans for fiscal consolidation.”

He said there were structural issues affecting the Bermuda economy.

“It is still an expensive place for doing business in spite of some corrections in the rental prices and wage adjustments, there are other measures that need to be implemented to help Bermuda become more competitive and more attractive for business.

“The main objectives should be, ‘how does Bermuda maintain the business strategy you have and remain attractive for the international business sector?’

“The Government has been working in the right path with immigration reform in the last year. That’s a small step in the right direction. There are additional steps that can be taken.”

He said an increase in tourism would help and the newly announced Southlands for Morgan’s Point land swap is positive news.

“They finally have a long term plan that may put Bermuda in tourist’s radar worldwide.

“These two initiatives are going to support economic growth, but not in the short-term.

“We have to wait and see what happens.

“Other sources of GDP growth must be discovered. They are talking about registration for boats and aircraft but more needs to be done.”

He said the planned new hotel would have to break ground in order for it to help the economy; it can’t be all talk and announcements.

“Construction has been affected for such a long time, so even if you have a couple of big projects, that is going to help that sector and get things rolling again. When things start moving, that is going to help business confidence and consumers’ confidence that things are improving.”

The Ministry of Finance says it anticipated that the continued turmoil in the global economic environment and tough conditions at home could put Bermuda’s sovereign rating at risk of an adjustment.

Premier and Minister of Finance Paula Cox said: “While today’s ratings adjustment is not positive, it sees Bermuda return to an AA rating, which Bermuda held from 1994 to 2006. In 2006, Fitch raised Bermuda’s rating to AA+. Today’s adjustment returns us to pre-2006 ratings. It is important to note that Bermuda continues to receive high Ratings from all 3 major Ratings Agencies.”

 “The Government will continue to balance the needs of all citizens during these tough times. We will continue press ahead with important investments in infrastructure which will bring jobs, income, and new opportunity to Bermudians.

“As the Premier and Minister of Finance, I remain committed to bringing enhanced efficiency to the Civil Service, and freezing spending at current levels. I am confident this is the correct fiscal consolidation strategy, as further spending cuts will only serve to weaken the economy during these tough times, putting more strain on Bermudian families.”

Premier Cox concluded by saying: “The Government is pleased that the adjusted rating remains in the top tier of the ratings. At AA, Bermuda’s sovereign bond rating is only two notches below the highest rating of AAA. I am also pleased that Fitch has maintained a stable outlook to the AA rating.”

The Ministry of Finance noted that, according to Fitch, “Bermuda ratings are supported by Bermudians’ wealth, the fourth highest GDP per capita among Fitch-rated sovereigns, and the high savings rate relative to its peers in the ‘AA’ rating category.

“Bermuda’s competitive advantage as a domicile of choice for insurance, reinsurance and financial services companies remains intact due to its sophisticated legal system, strong regulatory framework, simple tax regime, proximity to the US market and highly-skilled human Capital.”

Cordell Riley: We should commit to a balanced budget by 2015

Cordell Riley, a former Government statistician and owner of Profiles in Bermuda, told us:

“The latest Fitch economic rating on Bermuda is akin to a fiscal checkup (pun intended). The ratings doctor has effectively stated that they have found some things that are cause for concern which need corrective action. The proscribed medicine is a 'credible fiscal consolidation strategy.'
There are usually two components to such a strategy in recessionary times:  cutting spending and reducing the deficit. A third is to raise taxes. The Government has thus far resisted calls for spending cuts fearing that sharp cuts to balance the budget may actually make things worse — and there is some truth to that.

Governments that have gone the austerity route, such as Spain, France, Britain and of course Greece, are struggling both financially and some politically. The United States, which went the stimulus route, is faring much better although it is still not out of the woods with its 8% unemployment rate only marginally down since Obama took office in 2008.

Europe's unemployment rate by comparison, is in the double digits. Many pundits believe that Obama has a good chance of securing re-elecition.
Of course if you spend more than you take in, the deficits can only increase and that is not sustainable over the long run.

And raising taxes is not really an option as this measure is fraught with many risks, not the least of which are political. So what should the Government do?
I actually don't know what the Government should do but here's what I'd do. First, commit to a balanced budget by 2015. This method would allow the patients, in this case the people of Bermuda, to adjust to the medication. Spending cuts will have to be a feature.  I stated two years ago in my response to the budget that non-essential civil servants may have to go on a 4-and-a-half day work-week. That looks more likely now.  Other spending cuts will have to be found. Some of the 'savings' realized could be used to top up the Sinking Fund, which Government uses to service it debt. Having more funds in the debt-servicing kitty would send the signal to the ratings houses that Bermuda's debt is in fact manageable.  These measures, if implemented now, could have us back on firmer footing in the next couple of years with a much more favourable report from the economic doctors.

Craig Simmons: Lack of a debt exit plan fuels uncertainty

Craig Simmons, an economics lecturer at Bermuda College, said the comments of both Mr Mosquera and the Premier are consistent with each other. He told us: “Mr Mosquera expects that, at some point in time over the next year or two or three, the government’s current account should show a surplus.  

That would require incoming tax revenues to exceed current spending, that is, capital spending on infrastructure would not be included in the current account budget balance.   

The Premier could thus achieve a budget surplus without reducing total government spending (current plus capital spending).  

What I’ve just described is a near-term (1-3 years) solution to appease government bondholders, who are all foreign or at least the debt is denominated in foreign currency and provide a much-needed injection of spending into the local economy.

What is missing from the consolidation effort is what the Pre-Budget Report (see attached, p 6) called a ‘Medium Term Expenditure Framework (MTEF) and a Multi-Year Fiscal Consolidation Strategy’.  

None was provided in the 2012-2013 Budget Statement. I suspect that one reason for the downgrade is the lack of an exit strategy: a plan of how the debt will be managed over the near-term and reduced over the coming decade or so.

The lack of a plan feeds into the pervasive uncertainty around the island’s ability to service its debt.  

The social costs associated with following austerity whilst the recession continues are too high a price to pay for fiscal consolidation.  

Mild stimulus is a sensible way forward over the next year or two.  Having said that, it is critical that a medium term plan is shared with stakeholders: bondholders, taxpayers, business community.  The medium term plan would sketch how the government will reduce (total) spending and raise taxes to pay down the debt.

Larry Burchall: The pain will be felt by the man-in-the-street

Mr Burchall, a Bermuda Sun columnist and consistent critic of Government’s handling of the economy, draws comparisons between the period 1994-2006 — when Bermuda’s Fitch rating was last at AA — to the current economic picture in 2012:
a.  Bermuda's resident population was growing. Now it is falling
b.  Bermuda's economy was growing. Now it is declining
c.  Bermuda was adding IB companies and their Bermuda footprint was growing. Now the footprint of IB companies is declining.
d.  National Debt ran between 20% and 22% of Government revenue. Now Debt is 150% of revenue
e.  National Debt was around 3% of GDP. Now National Debt is 24% of GDP

Mr Burchall told us:  “[The question] is not ‘who is right’ [between Fitch saying we need a balanced Budget and the Premier saying she will ‘freeze’ spending but not make cuts as it would weaken the economy] — it’s ‘when will the borrowing force cuts anyhow?’

Bermuda is now forced to spend $0.13 out of every dollar of revenue on Debt Service costs. This downgrade will push that higher.

If borrowing continues, Bermuda will soon spend $0.14, then $0.15, then $0.16 of every revenue dollar on Debt Service.

This means that Bermuda either lives on the $0.87 left (or $0.86, or $0.85 and so on…) or Bermuda keeps borrowing until successive downgrades see us spending $0.20 on Debt and trying to get by on an $0.80 dollar in a world in which prices are still rising.

At some point, lenders will only lend at a very high rate. That's when we'll be forced to cut. Premier Cox has been delaying far too long.

 We could have had 10 per cent cuts back in 2009, 15 per cent in 2010. Now, well into 2012, we're staring at a need for at least 25 per cent cuts in personnel costs — and that's where the cuts will have to go.

Government is already cutting back on routine maintenance and other costs. These are insufficient. Since we don't print our own money we have to do what the Greeks and Spaniards must ultimately do. 

The 'Fitch' man says that. I've been saying it for a year. 

Declining population = declining economic activity = declining government revenue = EITHER cuts in spending OR more borrowing. The cost of borrowing has just risen.

There is an inevitable mathematic result coming towards us.

Cuts will happen. The question is, ‘will the cut be a controlled cut in best conditions or a cut forced by a sudden steep rise in borrowing costs coupling with still decreasing revenues’?

The downgrade means an interest rate increase. A minimum 0.25 per cent increase means $250,000 EXTRA on a borrow of $100m and $500,000 on $200m.

The Ministry of Finance will be seeking/is seeking to borrow $200m on this foray. The man-in-the-street must provide this extra. Of course, the increase could be 0.50 per cent — or more. Just do the Middle school maths.

This increase in the cost to borrow must be set against government still falling revenue. So $1m - or $10m — less in total annual revenue + at least $500,000 increase in borrowing costs is a double hit; which translates into more borrowing - or deeper spending cuts. The hit always goes down to the man-in-the-street.”

Bob Richards: It’s a serious blow to Bermuda

The OBA’s Shadow Finance Minister said: “[The] downgrade of Bermuda by Fitch Ratings is a serious blow to Bermuda. It casts doubt on the Government’s credibility to properly manage the public purse and reveals the Island performing poorly relative to other jurisdictions.”

See the OBA's full statement here.