NEW YORK, USA -- Last Friday, the government of Grenada indicated that it will default on its US dollar and Eastern Caribbean (EC) dollar bonds due 2025 because it has been unable to secure financing to make a coupon payment on March 15.
According to Moody’s Investors Service, the liquidity crisis leading to the default is credit negative for Grenada and elevates the risk of distress spilling over to its peers in the Eastern Caribbean Currency Union (ECCU).
In Moody’s view, Grenada’s default has systemic implications for the ECCU through two channels, financial and institutional:
• Financial. Grenada’s default will elevate short term financing costs for its peers that issue local currency (EC dollar) bonds and treasury bills on the ECCU’s Regional Government Securities Market (RGSM). Sovereign defaults have also weakened the balance sheets of banks and institutional bondholders in the region.
• Institutional. Pre-emptive debt restructuring (primarily targeting external, foreign currency bonds) has become a more acceptable option for policymakers in the region, indicating a diminished willingness to service sovereign debt.
The default will be Grenada’s second since 2004 and mirrors wider distress in the ECCU: St. Kitts and Nevis defaulted on its debt in 2011, and Antigua and Barbuda restructured its debt in 2010. Both countries have active IMF stand-by programs with embedded conditionality and structural reform requirements, while all six ECCU members (which also include St Vincent, St Lucia and Dominica) rely on emergency IMF credit facilities for financing reconstruction following the impact of hurricanes.
Government debt in the ECCU is high – the regional average was 94% of GDP in 2012, on par with distressed euro area sovereigns – and regional GDP contracted at an average rate of 2.1% between 2009 and 2012, and we expect only a modest recovery in 2013 (Exhibit 1). In addition to the debt overhang, ECCU sovereigns face elevated risks stemming from twin current account and fiscal deficits (Exhibit 2).
Absent a currency devaluation or exit from the union, which are both unlikely options at this time, policy levers for addressing these imbalances and repairing sovereign balance sheets are limited to a severe domestic adjustment through fiscal consolidation and structural reforms to stimulate growth. For a number of sovereigns in the region, these reforms may not materialize fast enough to arrest rising sovereign financing needs, leading to liquidity crunches.
A sustained reduction in debt in the region over the next decade will require some combination of aggressive fiscal consolidation and an improvement in growth. However, both of these goals are increasingly out of reach. Budgets are largely inflexible, limited by high and rising interest costs and expenditure on wages and social benefits. And diminishing returns to the Caribbean tourism-centered growth model, combined with depressed public sector investment in infrastructure, have resulted in a ratcheting down of trend growth that will be difficult to reverse. Moreover, growth in the ECCU is acutely vulnerable to volatility in external demand and weather-related shocks.
Moody’s also views more indirect approaches to reducing the debt burden as less feasible in the ECCU: monetizing domestic currency debt through inflation is not a viable option under the current quasi-currency board arrangement; the ECCU lacks the fiscal firepower to finance an emergency lending facility along the lines of the European Stability Mechanism and IMF financing remains the sole source of emergency external liquidity support; debt mutualization within the currency union – a potential long-term solution to the liquidity pressures facing issuers in the euro area – is far from becoming an economic reality in the ECCU since all of the sovereign member states currently carry unsustainable debt loads; and the region’s upper middle-income status disqualifies it from multilateral and Paris Club debt relief that is afforded to over-indebted but poor countries.
This dearth of options has elevated debt restructuring as a tool for reducing government debt. However, the history of sovereign default in the Caribbean is instructive: to date, restructurings in the region have done little to address the threat of insolvency posed by unmanageable debt burdens; instead, most countries have received only temporary liquidity relief, which has only increased the frequency of sovereign default (Exhibit 3).