The Tribune

• Ex-finance minister: ‘Every family’ will feel effects

• Predicts Bahamas to see ‘US-plus inflation’ rates

• Wage pressures could lead to strikes, stoppages

By NEIL HARTNELL

Tribune Business Editor

nhartnell@tribunemedia.net

A former finance minister yesterday warned that “every family can expect hardship” from rising inflation that will exceed the current 7 percent rate in the US.

James Smith, also a former Central Bank governor, told Tribune Business that The Bahamas will likely see “US inflation rates-plus” due to its consumption-based tax system that will exacerbate the impact of a sustained rise in the cost of goods and services imported from the country’s northern neighbour.

And, with the cost of living increasing, and living standards and disposable incomes falling, he warned that an “already depressed” economy could come under further pressure from workers demanding salary increases that keep pace with inflation. Strikes and work stoppages could result if unions fail to get their way, Mr Smith said, with pay rises possibly further fuelling inflation.

The ex-minister of state for finance added that the Government’s already-delicate fiscal position also faces “some serious headwinds ahead” if the Federal Reserve, the US central bank, tightens monetary policy as forecast via a series of three to four short-term interest rate hikes in 2022.

This, Mr Smith said, could result in increased debt servicing costs for any part of The Bahamas’ $4.5bn US dollar-denominated debt, while also increasing the interest burden on any new issuance should the Government need to tap the capital markets again.

Simon Wilson, the Ministry of Finance’s financial secretary, told Tribune Business last week that it was “too early to say” how inflation and the anticipated Federal Reserve response will impact the Government’s financial position and borrowing plans to cover the 2021-2022 and upcoming deficits.

The Davis administration had pushed back the $800m international bond issue left by its predecessor to the second half of the current fiscal year, and Mr Wilson said no decision has yet been take on whether to proceed with it in a climate where The Bahamas (taxpayers) will likely have to pay more for debt capital.

“It’s still under consideration,” he added of the $800m bond. “If market conditions improve we will probably do it. It depends on market conditions and the advice we get.” As for inflation, Mr Wilson said the Government and wider economy would simply have to “adjust” to it was “part of an economic cycle” that The Bahamas has little control over.

“The reality is that we were in a low interest rate environment for the last ten years or more,” the financial secretary said. “We knew that this would come to an end, and we have to adjust to it. The way we adjust to it is by reducing the debt and deficit levels, and that’s part of the plan.”

Mr Smith, meanwhile, reiterated the position outlined by current Central Bank governor, John Rolle, last week that The Bahamas must hope its post-COVID tourism revival and continued economic re-opening offset the impact from inflation and any US monetary policy actions.

“We import inflation because we bring in probably 90 percent of what we consume from the US,” he said. “Price changes there translate into price changes here. Our inflation rate here will be US inflation rate-plus because it’s likely our prices will be pushed up higher than in the US.”

While consumption-based taxes, such as VAT and import tariffs, will exacerbate the problem through being levied on higher-priced imports, Mr Smith said some merchants will also likely use the situation to “add on” and increase their margins.

“This is happening without any changes in disposable income among the local population, so they can expect hardship that every family would experience,” he told Tribune Business. “With what essentially are fixed incomes, people will be able to buy less goods and services because of price increases, and that will have an impact on general output.

“It just compresses the economy a little bit more. You’re paying the same for a lesser amount of goods and services being purchased, and the economy is less efficient because it is not operating at optimum output.”

Mr Smith warned this could translate into worker demands for wage increases to maintain living standards, especially in unionised workplaces, even though companies may not be able to afford this post-COVID.

“Everyone would want their income to increase, so they will be making demands for higher wages and, if those demands are met, there will be more pressure on the economy because you are taking from an economy that is already depressed, so you have a bit of a downward spiral,” he added.

“On the other hand, if you don’t pay them, you have the possibility of strikes or stoppages which affects economic output. From that point of view we need to keep a close watch on what inflation is doing in the US because with a very short time lag we’ll be experiencing it.”

US inflation increased by 7 percent year-over-year in December 2021, marking the fifth consecutive month it has been over 5 percent. The month-over-month increase was 0.5 percent, with economists increasingly suggesting that inflation is not a transitory or temporary phenomenon caused by supply chain and other post-COVID woes.

Mr Smith said US inflation could also reduce travel demand and spending from The Bahamas’ major tourism market, due to the impact on disposable incomes, savings and wealth, although Mr Rolle last week suggested this impact will be more than offset by “pent-up” travel demand.

As for the Federal Reserve’s anticipated interest hike, the ex-finance minister and Central Bank governor said it would likely have little to no effect on the cost of money in The Bahamas as local interest rates seemed to have been decoupled or delinked from their US equivalent during the pandemic.

Bahamian rates “at one time” tended to follow their US counterparts, but have not adjusted in line with the latter’s downward movement in recent years. Mr Smith, though, said that the biggest impact from a US rate hike could be felt by the Government’s foreign debt servicing costs - especially if it has to go back to the international capital markets now.

COVID, coupled with years of creditworthiness downgrades by the international rating agencies, left The Bahamas paying 8-9 percent on its last bond issues. Some 89 percent, or $4.5bn, of The Bahamas’ total $5bn foreign currency debt is denominated in US dollars, and Mr Smith, who heads the Government’s debt advisory committee, was unable to say if all existing issues are fixed rate.

Those that are floating rate, and linked to LIBOR or some other benchmark, would see an immediate rate increase if there is a Federal Reserve adjustment. “If rates go up because of a change in US rates, the cost of debt servicing goes up,” Mr Smith said.

“Potentially that will have a depressing effect on government services, as we have to pay more for debt and that has to come from somewhere. Obviously the cost of new money will take into account the move in interest rates. Clearly there are some serious headwinds ahead for dealing with the Budget deficit in any event.”

As a result, Mr Smith said it was critical that The Bahamas not be seen as a “hot spot” for COVID-19. “I think the impact on the economy and impact of the pandemic are hand in glove at this stage,” he added.

“There’s a possible scenario that, if inflation and interest rates go up and have an adverse impact, if the pandemic stabilises through higher vaccination rates here and in the US, we could have an increase in arrivals to our main industry that could offset. We still ultimately have to pay serious attention to the pandemic and bringing under control. The one constant fear is the unknown.”