Ah, the Caribbean. White beaches, blue-green waters, coconuts, rum. A steel drum rings and chimes off in the distance, and sea turtles nip at your toes. Delightful as the thought of a jaunt down south might be, it’s important to remember that the pleasures of the region come in many cases from lagging — even moribund! — economies. One of them, in fact, offers an investment with seemingly little downside. Specifically, a short against the Barbados dollar.
This may seem drastic. There is much to recommend Barbados. The island nation enjoys a high ranking from Transparency International on questions of government and governance. Long dependent economically on the growth and export of sugarcane — the crop that made it the target of successive European colonizations — it managed in the 1970’s to diversify its economy somewhat, with a focus on tourism (now its economic mainstay) and the offshore industry. Barbados is reasonably well off compared to the rest of the world — it ranks 53rd in global GDP, for example, and its population enjoys high education levels that make it more attractive than some other emerging markets as an investment destination.
The country’s path to economic semi-modernity, however, has always been rocky. It suffered, as a big importer like many island nations, a deep recession in the early 1990’s on the back of the oil price shock resulting from the first Gulf War. The early Oughts saw its tourism industry hammered by blowback from 9/11. There was another serious thump dealt by the outbreak of Zika. But by far the worst economic blow came after the global financial crisis: the country’s growth rate hit -4.1 percent year on year at the bottom. Indeed, the island nation seemed stuck in the doldrums until very recently, when its GDP growth climbed back up to its pre-crisis levels.
These modest green shoots, however, belie the fact that on the fundamentals Barbados is caught, due to its U.S. dollar peg, between an economic rock and a monetary hard place. The Barbadian dollar is pegged 2-1 to the U.S. dollar. As Barbados entered this tailspin, the strengthening of the U.S. dollar against the pound and the euro post-Brexit brought with it very unwelcome currency appreciation. British and European tourists form a significant percentage of annual visitors to Barbados, and with the Barbadian dollar tethered to the greenback the island became much more expensive as a vacation spot.
There’s also the fact that Barbados is carrying a significant debt overhang. It’s not at Puerto Rico levels, of course, but it was still (as of the end of 2016) at 110 percent of GDP. Barbados also has the second-highest fiscal deficits in the region after Jamaica. This is coupled with the fact that the country’s foreign reserves are at the lowest they have been since 2009, with $329 million as of February 2017. They have has been below the favored benchmark of international monetary monitors, a three-month cushion, since April 2016. That diminution represents a shocking 21 straight months of decline.
So the the recent saga of DeLisle Worrell, a veteran central banker — he helped navigate Barbados through its recession in the early 90’s, and until February of 2017 he served as the governor of its central bank — coming against this grim backdrop should be no surprise despite its ugliness. Worrell was forced out of the bank by the government of Freundel Stuart, effectively, for refusing to print money to pay for the wage demands of the government. This precipitated a downgrade of Barbados debt from Moody’s to junk. Given all this, it is no surprise that Barbadian bond yields have been soaring ever since Trump came into office and the markets went off on a tear: Bloomberg inducted it into their ultra-high-yield club — a dubious honor reserved for countries whose dollar bonds yield more than 10 percent. Its five year bonds trade as of press time at 84.5, yielding 11.3 percent.
Yet there may be opportunity to be had here. We recommend, as noted, shorting the currency itself. The rationale is simple: the country is facing a wall of maturities and it is running out of reserves. If current trends in Barbados continue, the government will hit that wall in the next few years, when approximately $900 million of debt will require service, including a Credit Suisse loan for $225 million that will come due in 2018. Another $400 million of debt will come due in 2021 and 2022. So how will the Stuart government respond? One traditional path would be austerity, of course — reducing spending, raising taxes, or both. There are, however, likely minimal gains to be had from the second course given the overall stagnant economy. For the first, let’s just say that given the furore that surrounded the departure of Worrell and the general attitude of those in government in charge of fixing fiscal policy that spending reductions sufficient to avoid a default are outside the scope of this administration’s political will. All the more so given that one of the biggest line items in the country’s fiscal spending is public sector wages. The economic problems besetting Barbados are tied to this thorny political one, which does not look to be solved any time soon.
That leaves as a cure monetary magic, which Barbados has so far engaged in a large amount of. RBS economist Marla Dukharan pointed out in an April 2017 analysis that the country has inflated its monetary base by on average 26 percent per month since September 2014 and now a monetary base of some BBD2.34 billion. (This represents a ratio of 7:1 against the country’s foreign reserves.) The ceaseless whirring of the presses in Bridgetown has not only failed to fix the country’s problem’s so far, it may even have exacerbated them. So while we cannot say with certainty that a break of the peg and the concomitant default are coming down the pike, they look likely enough to warrant serious consideration — especially since, as noted, going short Barbadian dollars and long U.S. is a seemingly low-risk game. Depegging that would solve a lot of the macro problems facing Barbados. Argentina, another country lurching into the modern economic world, depegged a decade and a half ago and is now issuing 100-year bonds which investors are snapping up.
The timing, as always with political events of this kind, will be hard to get right. As we mentioned, some obvious potential catalysts are coming up soon: that looming debt maturity in 2018 being one. Andrews Stanners, of Aberdeen, said in a report that he does not expect a credit event in 2017 but that the government will “muddle through” until 2018. Should it survive beyond that, the 2021-22 period would likely be the next big trigger.
How to play it? Bonds are one option. Though longer bonds are down, shorter maturities are trading at higher levels — the two year, for example, is above 96 — so a short might make sense there. Equities are murky: while there are Barbados-based companies that hold assets in USD and liabilities in local currency, its hard to find one that offers a pure play against the peg. We think the best move here is likely the most direct. If and when the peg breaks, people short BBD against USD are going to make major gains. (Although it is, admittedly, hard to trade directly in Barbadian dollars.) Given the continuing swirl of fog that seems to surround once rock-solid geopolitical certainties, this looks like a good bet to us.
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