Ensure proper debt ratios

About five years ago I was a member of the Chamber of Commerce Constitution Review Task Force.

One of my suggestions to the Task Force was that the revised constitution includes prescribed debt ratio limits.

I pointed out that there was precedent for this in Hong Kong’s Basic Law (a constitutional document). By having such restrictions on government debt enshrined in the constitution, Cayman would be forced to maintain a prudent fiscal policy and avoid following several other Caribbean territories into a quagmire of debt. My suggestion gained no traction.

Fast forward five years to post-Ivan.

Following Hurricane Ivan, Cayman’s government debt will unavoidably increase significantly, a situation exacerbated by the large haircut the Government took on its insurance claim with Cayman General. Fortunately, the situation is not dire.

Thanks for this must go to the likes of Norman Bodden, Benson Ebanks, Sir Vassel Johnson, Capt. Charles Kirkconnell, and prior members of Exco who believed that Cayman should save for the inevitable rainy day and regularly ran budget surpluses.

Grenada on the other hand was not so fortunate. Their debt to GDP ratio was much higher than Cayman’s prior to Hurricane Ivan. At the end of last year, Grenada was forced to suspend payments on most of its debt. Recently Grenada’s government announced the restructuring of its debt. A fund manger who owns Grenada’s 9.375 per cent US$ bonds maturing in 2012 tells me that Bear Stearns has assisted Grenada in restructuring its debt and are proposing that these bonds be exchanged for new US$ bonds maturing in 2025 that have coupons that increase over time from 0.85 per cent to 8 per cent.

The proposed slashing of the coupon (interest rate) and extension of the term of the bonds will result in a huge devaluation of these bonds in the secondary market. The fund manager told me that he never appreciated that a hurricane could cause a government to default on the original terms of its debt. He is now considering selling all his Caribbean government debt. Other investors are likely to do the same. As a result, the cost of future borrowing by Caribbean governments is likely to increase.

A similar thing happened in the U.S. after Hurricane Katrina. Rumours abound of municipalities in Louisiana and Mississippi defaulting on their bonds. Credit rating agencies have put many of these municipal bonds on watch with a negative outlook as they try to gather information. A lesson of both hurricanes is that governments in the hurricane belt, be they islands or municipalities, can not afford to carry the same debt service ratios as larger countries which are not prone to these large one-off hits. They need to carry much lower levels of debt, build a rainy day fund, or both, so that there is some buffer to deal with the catastrophe of a hurricane. If we are to maintain Cayman’s status as the Singapore of the Caribbean for our children, enshrining conservative debt ratios in our new constitution would be a good start.

Desmond Kinch

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