Current economic theory suggests that when a country's public debt exceeds a certain level, financial confidence collapses and rating agencies downgrade the country's credit rating. The result is an increase in borrowing costs (interest rates rise) and the exchange rate falls as market actors lose confidence and there is capital flight. This certainly holds true for economies with sizable foreign debt. This theory is supported by current data and historical experience. So far there has been only one exception, Japan, and its debt is mainly due to Japanese nationals, in yen.
It is generally accepted that deficit financing is an acceptable tool to be used by governments to maintain national income in special circumstances. However, there are two main conditions: first, where a recession is acute, but is a temporary and reversible cyclical condition; second, and more importantly, where the net public debt level is low enough so that the short term stimulus would not crowd out either public or private investment.
The ability to repay the national debt is measured by a country's debt relative to its GDP, referred to as its debt-to-GDP ratio. Crudely translated, it is generally accepted that the debt to GDP ratio should not exceed 70 per cent, as ratios higher than this would make sustainability and viability difficult. One does not have to look to Europe for examples as Caricom contains several countries in this position, where the debt to GDP ratio is in excess of 100 per cent with many negative consequences including debilitating, not restorative, IMF programmes.
In the case of T&T the policy of deficit financing, whilst mitigating the level of economic decline, will not lead to growth. The major share of government expenditure is recurrent; it is spent on goods and services and therefore does not result in permanent capacity creation. In addition, even where such expenditure is on infrastructure creation, as in the case of the Point Fortin highway project, there is substantial leakage of foreign exchange.
Furthermore, domestic manufacturing is largely based on imported raw material and the fillip to that sector is soon lost. The value-added components are in the form of labour and capital and depend on our productivity which has been declining in recent years. The multiplier effect is therefore limited. Further, the structure of the T&T economy is built on exports primarily from the energy sector and it is very difficult to compensate for the decline in revenues for this sector.
Happily, the expansion in the government's expenditure is not strongly supported by the Central Bank's monetary measures. The Central Bank's monetary stance has been mildly accommodating. Lending interest rates are low in historical terms, but not too low.
Deposits rates on the other hand, are very low. This penalises savers and those relying on fixed income investments, particularly pensioners and pension funds. As T&T now has an aging population, the low bond yields raise a significant issue as the rate of return on pension funds are now well below normative actuarial assumptions.
In real terms, this amounts to a redistribution of income away from households to the banking sector in the first instance and the business sector in the second. This policy is acceptable only if it leads to an increase in productive investment and economic activity by the private sector. The evidence is that the profitability of those involved in financial services and the distribution sector has increased, without the investment activity hoped for or anticipated.
Starting with fiscal 2009, we have had budget deficits in every year. The debt to GDP ratio has increased from 23.8 per cent in 2008 at the start of the recession, to 46.7 per cent at September 2012 and is projected to reach 52 per cent (60 per cent if the Clico bond issue is included) at the end of fiscal 2013. The clearly emerging trend is that we are in a structural deficit which has dangerous consequences if not addressed quickly. A structural deficit is defined as a budget deficit that results from a fundamental imbalance in government receipts and expenditures, as opposed to one based on one-off or short-term factors.
The deficit is structural because the economics of the energy sector is rapidly moving against us. International gas prices are likely to fall in the medium term as more competitors enter the market. Revenues are not likely to increase in line with our expenditures on social programmes. The programmes show no sign of becoming more efficient, and have been growing relatively and absolutely. In any event, if we do have more finds of gas or oil, the returns are unlikely to be in the same order of magnitude as experienced previously.
The difficulty is not simply reducing expenditure or increasing revenue by increasing taxes; that is the easy part. The stark reality is that we must deal with some of the structural imbalances in the domestic economy. This means that we must design market reforms that address areas of persistent underunemployment and improve productivity, vitality and competitiveness. It also requires us to increase the export revenue generating capacity of nascent segments of the economy.to compensate for any decline in energy sector incomes.
At the current rates of expenditure, we will breach the 70 per cent limit in two years and that makes 2015 even more important as it is an election year. If we do not begin to address the problem now and do so in a non-partisan way, the period of adjustment in the post 2015 period will be all the more severe, whoever wins.
• Mariano Browne is a former
—Part 1 of this article was published on January 18