Global Economic Research

Caribbean Regional Economic Outlook

Executive Briefing
February 2011

Caribbean Regional Economic Outlook

Executive Briefing February 2011

Caribbean economic recovery in sight Elevated external vulnerability caused by economic imbalances Tourism sector prospects brightening Fragile recovery in the US reflected in Caribbean exports, remittance and FDI inflows Energy price outlook reflected in inflationary pressures

Caribbean economic recovery in sight Global economic recovery is underway, with momentum gradually spilling over to the Caribbean region. The financial crisis adversely affected the Caribbean economies, leading to declining output through a contraction in tourism, financial and business services and goods exports, and a deterioration in government finances. Now, signs of revival in economic activity in the Caribbean are emerging. Nevertheless, while the recovery continues to move forward, growth globally is moving to a weaker, rather than a stronger, performance profile, thereby limiting Caribbean longer-term economic prospects. The US and other developed economies continue to recover, fuelled by a rebound in consumer spending and production activity and the monetary and fiscal stimulus introduced in the last two years. Unemployment in developed economies will likely remain high, while the housing and financial sectors continue to struggle with structural weaknesses, and governments globally face the need to fix their finances by potentially increasing taxes and implementing other austerity measures; therefore, the global recovery in developed economies will likely be relatively gradual, with growth through the decade remaining below levels registered during the previous upturn. As economic ties between the Caribbean region and the US are traditionally strong, the latters economic prospects will greatly influence the Caribbean outlook; we expect the US economy to expand by 3.1% in 2011 and 2.7% in 2012, following an estimated growth of 2.9% in 2010. After expanding by 1.7% in 2010, real GDP growth in the Caribbean (in nominal GDP-weighted average terms) will pick up to over 3% in 2011-12, with the Dominican Republic, Cuba, and Trinidad and Tobago leading the region, while many others expand at a slower pace (i.e. Barbados and Jamaica). Elevated external vulnerability caused by economic imbalances The Caribbean region continues to be vulnerable to changes in global economic and financial market conditions because of limited economic diversification, underdeveloped capital markets, sizable current account deficits and relatively high public debt burdens. Despite the fact that domestic recessionary conditions have generally reduced current account deficits, the shortfalls (as % of GDP) remain in double digits in many cases (particularly among the smaller islands), making the region highly dependent on external financing. Multilateral financing will therefore continue to play a key role in supporting the regional economic recovery as it has constituted a fundamental element aiding some countries to weather effectively the adverse effects of the global recession. Persistently lax monetary conditions in advanced economies will play in the Caribbean regions favour, allowing the countries to access affordable external financing to complement national savings. Similarly, falling tax revenues associated with the recession and rising public spending on the back of fiscal stimulus programs have led to a severe deterioration of fiscal balances throughout the region. Given the Caribbean regions relatively elevated public debt levels, the economic downturn has placed several regional governments in a difficult position at a time of economic and financial distress. With global investor attention continuing to center on fiscal sustainability issues, credible consolidation of public sector balances by regional governments remains imperative to restore investor confidence; within an environment of rapidly changing risk appetite, the possibility of governments facing difficulties in rolling over external debt obligations remains latent. Furthermore, natural disaster preparedness contributes an additional element of potential stress to public finances for the Caribbean region. In the midst of the financial crisis, several Caribbean countries sought multilateral assistance. For instance, Dominica, St. Lucia and St. Vincent and the Grenadines requested aid from the International Monetary Fund under the Exogenous Shocks Facility to help deal with the adverse effects stemming from the global downturn, while Jamaica and the Dominican Republic have received funding on the back of their Stand-By Arrangements with the Fund.

Global Economic Research

Tuuli McCully
tuuli_mccully@scotiacapital.com

Oscar Snchez
oscar_sanchez@scotiacapital.com

Caribbean Regional Economic Outlook

Executive Briefing February 2011

Tourism sector prospects brightening The Caribbean region is vulnerable to fluctuations in external demand, which is correspondingly reflected in volatile economic growth. With over 20 million arrivals and more than US$22 billion in tourism receipts annually, the tourism industry is by far the main employer and foreign exchange generator in many countries in the region. Caribbean tourism receipts are equivalent to 10% of regional GDP, while the sector directly employs at least 600,000 people. As tourist arrivals are linked to all facets of the economy, including such sectors as retail and construction, the real impact of the leisure industry is significantly larger. Nevertheless, the importance of the sector varies widely across the region; in Aruba, tourism receipts are equivalent to 53% of GDP, while in the Bahamas, Barbados and St. Lucia such income amounts to a third of GDP. Meanwhile, in Puerto Ricos manufacturing oriented economy, tourism has less significance, with industry receipts equivalent to less than 6% of GDP. With the United States being the main origin of visitors to the Caribbean (accounting for almost half of total arrivals; in the case of the Bahamas, 80% of the arrivals are from the US), its economic recovery will provide support to the tourism sector over the coming years. Nevertheless, as tourism sector performance depends on employment conditions in source countries which typically lag output recoveries the industry will likely see only modest advancement this year. While a global recovery in consumer spending will be reflected in a pickup in tourist arrivals, ample room capacity and persistent uncertainties regarding the strength of the rebound in activity will likely keep hotel room discounting in place in the near term. The Caribbean regions tourism industry has been recovering since September 2009; according to the World Tourism Organization, visitor arrivals were 3.9% higher in 2010 than in the previous year. Meanwhile, the World Travel and Tourism Council estimates that real GDP growth stemming from the tourism industry will reach an average of 4.1% over the next 10 years. The Caribbean region is well-positioned to take advantage and meet the tourism services needs of the aging US population. Fragile recovery in the US reflected in Caribbean exports, remittance and FDI inflows Remittances contribute substantially to national income across the Caribbean as they support consumption and savings levels of a significant segment of the population. Following substantial declines in remittances (of around 15%) in 2009, the amounts of money sent home started to show improvement across the board in 2010, both on a month-to-month and year-to-year basis. Looking ahead, however, only a slow recovery can be envisaged as the construction and services sectors within the US economy remain laggards in the replenishment of job positions lost during the recession. As the US is a major trading partner for most Caribbean countries, its economic recovery has been reflected in Caribbean exports performance. While foreign sales of manufacturing products continue to recover, any improvements will likely be gradual. In a similar fashion, foreign investment-related activity will respond to improving economic scenarios, albeit with a lag, as risk aversion remains high. Capital and profitability distress in the US continues to push US-based banks to limit credit availability, with some development projects in the Caribbean tourism industry and second home projects remaining on a wait-and-see mode. This has had adverse consequences on employment and economic activity in the construction sector within the Caribbean. Nevertheless, some revival is already evident, as indicated by substantial progress in the Bahamas, for instance. Energy price outlook reflected in inflationary pressures Vulnerabilities with respect to global commodity price fluctuations will continue to dictate the outlook for inflation within the Caribbean region. While relatively elevated oil prices provoked an uptick in fuel prices in some countries in 2010, we anticipate a fairly stable scenario for 2011 as lacklustre economic expansions in advanced economies is compensated with solid recoveries in emerging markets. A benchmark WTI oil price of US$97 per barrel is expected on average for 2011-12. Meanwhile, global food prices are showing signs of a pickup, causing adverse inflationary impacts on many import-dependent Caribbean countries. The exposure of some Caribbean countries (such as Barbados) to arrivals from the European region will likely benefit their economic situation to some extent as the major European currencies, such as the euro, the British pound and the Swiss franc are expected to gain ground vis--vis the US dollar through 2012, making the highly-dollarized Caribbean region more affordable to European travellers.

Global Economic Research

Tuuli McCully
tuuli_mccully@scotiacapital.com

Oscar Snchez
oscar_sanchez@scotiacapital.com

BAHAMAS
Capital Market Dynamics

Caribbean Regional Economic Outlook

Executive Briefing February 2011

Foreign Exchange Monetary authorities remain committed to supporting the fixed parity between the Bahamian and the US dollars. The central banks foreign reserves remain at an elevated level in historical terms of close to US$900 million (equivalent to four months of imports). Sovereign Debt & Credit Ratings The level of public sector debt is increasing as a result of ongoing infrastructure projects; government debt will likely reach 50% of GDP by the end of the ongoing fiscal year 2010/11 (July-June), before returning to a modest downward trajectory by FY2012/13. Nevertheless, public sector external debt remains low at around 9% of GDP as of end-FY2009/10. The outlook for the Bahamas sovereign credit ratings remains stable, with Moodys Investors Service and Standard and Poors assigning the country A3 and BBB+ long-term foreign currency credit ratings, respectively. The rating agencies assess that the country enjoys the benefits of political stability and well established tourism and financial services industries, but note that the Bahamas remains vulnerable to external shocks due to lack of economic diversification and fiscal flexibility.

Economic Outlook Growth The Bahamian economy remains closely tied to the US business cycle as the bulk of tourist arrivals and foreign direct investment come from the US. With the US economy showing signs of stronger than expected performance, prospects for the Bahamian economic outlook are improving as well. Following a virtually flat performance in 2010, real GDP growth should pick up to around 1% this year and to 2% in 2012. Several sizable tourism related investment projects are moving ahead that will provide a significant boost to the construction sector, being a major engine of output growth in 2012. For instance, the February 21st, 2011 launch of the US$2.6 billion Baha Mar resort project (equivalent to 35% of the countrys GDP) is a welcome development for the construction and tourism sectors, as well as for employment prospects. The important tourism industry (tourism receipts are equivalent to close to 30% of GDP) is showing signs of a rebound; in the first ten months of 2010, tourist arrivals by air were up by 4.3% from the year before. Meanwhile, cruise passenger arrivals increased by 18.2% y/y; nevertheless, economic benefits from sea arrivals tend to be limited. While stopover arrivals from Canada have increased substantially recently, the Bahamas remains dependent on arrival flows from the US (which remain somewhat lacklustre for the time being), with nearly 80% of total visitors being Americans. Inflation & Monetary Context The inflation outlook is promising, with price pressures likely to remain mild in the coming months due to subdued domestic demand conditions. While retail price inflation is currently hovering around 1.5% y/y, rebounding commodities prices will likely take the inflation rate back to around 2% by end-2011. The Central Bank of the Bahamas is committed to promoting balance of payments stability and steady credit conditions to support the fixed parity between the Bahamian and US dollars. Monetary authorities will likely maintain the benchmark discount rate at 5.25% in the foreseeable future. Fiscal & Current Account Balance Government finances remain under pressure due to still-subdued economic conditions and the fiscal cost related to the necessary infrastructure work for the Baha Mar project. In the 2009/10 fiscal year, the budget deficit swelled to 5.8% of GDP. While the FY2010/11 budget calls for expenditure restraint and enhanced revenue measures in order to bring the shortfall to 3.0% of GDP, we expect a more modest reduction to around 4% of GDP. The current account shortfall will be widening gradually through 2012 as higher energy prices and construction materials increase the import bill; at the same time, however, the services surplus broadens as the tourism sector continues to recover. The current account deficit will likely hover around 13% of GDP through 2012.

Institutional Framework & Political Environment Governance The government, led by Prime Minister Hubert Ingrahams Free National Movement Party, has a mandate to govern until May 2012; with its workable (24 out of 41) majority in the lower house, the administration should face no major difficulties in implementing its agenda. Financial Sector Financial sector prospects will remain challenging through 2012, though some early signs of stabilization have recently emerged. While growth in lending to the private sector remains subdued, it has been on a gradual recovery path since mid-2010. Challenging employment conditions are reflected in the private sector non-performing loans (NPL), with the NPL ratio climbing to 10.3% of total loans in November compared with a 4.7% rate in early 2008. Banking sector asset quality will continue to be under pressure in the near term; however, improving labour markets should provide some relief to banks loan portfolios over the forecast period. In terms of the countrys off-shore financial sector, the government has made significant progress in reaching international tax information exchange agreements; the OECD now classifies the Bahamas as a jurisdiction that has substantially implemented the internationally agreed tax standard.

Global Economic Research

Tuuli McCully
tuuli_mccully@scotiacapital.com

BARBADOS
Capital Market Dynamics

Caribbean Regional Economic Outlook

Executive Briefing February 2011

Foreign Exchange The Barbadian dollar (BBD) remains pegged to the US dollar (USD) with an exchange rate of USDBBD2.0. Foreign reserves amounted to BBD1.45 billion in December 2010, equivalent to 18% of GDP and six months of imports. Sovereign Debt & Credit Ratings Barbados continues to have the benefit of investment grade sovereign credit ratings. However, Standard and Poors (S&P) lowered the countrys rating by one notch to BBB- (with a stable outlook) in October 2010 on the back of rising government debt resulting from delays in fiscal consolidation. Meanwhile, Moodys Investors Service rates the Barbadian credit in the Baa3 category. A high public debt burden central government gross debt was equivalent to 99.7% of GDP at the end of 2010 limits the countrys ability to deal with external shocks; nevertheless, the government does not face significant rollover risks, as a large part of the debt is routinely financed by public entities and local banks.

Economic Outlook Growth Economic prospects in Barbados are brightening very gradually. According to the central banks preliminary estimates, output contracted by 0.4% in 2010, following a deep decline of 4.7% in 2009. On the back of a gradual recovery in tourism and consequently in the retail and construction sectors we expect real GDP to grow by around 1% through 2012. The tourism industry, which is the main contributor to economic growth with industry receipts equivalent to a third of GDP, is supported by larger airline seating capacity and increased marketing efforts. In fact, stop-over arrival growth rates (y/y) have been positive since May 2010, with visitors in the January-October period being 3.8% above the level a year before. Moreover, the industry outlook is brightening due to recuperating consumer spending in Barbados major markets. A third of total stop-over arrivals to Barbados are from the UK, while the US accounts for a quarter. In terms of quality of infrastructure, security and health care services, the tourism industry of Barbados is well positioned to meet the needs of an aging population in developed economies. Inflation & Monetary Context Price pressures will gradually build through 2012 as Barbados is heavily dependent on imports given its small economy and limited natural resources. We estimate that annual inflation closed the year 2010 at just over 5%, and will likely climb towards 6% by the end of 2011. After easing monetary conditions to stimulate economic activity, the Central Bank of Barbados will likely maintain a neutral monetary policy stance in the near term; the minimum deposit rate has been held at 2.5% since August 2009. Fiscal & Current Account Balance Government finances are being strained by low tax collections and fairly modest fiscal consolidation efforts; the general government fiscal deficit will likely narrow only slightly to 8% of GDP in the current fiscal year (April-March) from 9.4% of GDP in FY2009/10. To improve public finances, the government is committed to the Medium Term Fiscal Strategy, which targets a balanced budget by 2014/15. After narrowing in 2009 in the midst of the global downturn, the countrys current account deficit is widening again on the back of a larger import bill, reaching an estimated shortfall of 7% of GDP in 2010. We expect the current account gap to hover close to 8% of GDP through 2012.

Institutional Framework & Political Environment Governance Political and social stability, policy continuity and institutional strength continue to be Barbados greatest assets, keeping the countrys rankings high on international indices of social development and quality of governance. Despite Prime Minister David Thompsons passing away in October 2010, political stability should be maintained by the ruling Democratic Labour Partys comfortable two-thirds majority in parliament. Freundel Stuart, the former deputy prime minister, has undertaken the role of the head of the government. Next elections are not due until May 2013. Financial Sector The International Monetary Fund assesses that banks in Barbados remain healthy, though it sees further room for strengthening bank oversight. While nonperforming loans (NPL) have increased, solid capital bases provide effective cushions against future losses. The NPL ratio increased to 11% by September 2010 from 5% a year earlier. Nevertheless, the capital adequacy ratio for the Barbadian banking sector was 18% in September, significantly above the 8% minimum requirement. Barbadian offshore international business and financial services sector is relatively well positioned to withstand the synchronized global effort to tackle tax evasion activities connected to offshore financial centers; according to OECD classifications, Barbados is among the jurisdictions that have successfully implemented the internationally agreed tax standard.

Global Economic Research

Tuuli McCully
tuuli_mccully@scotiacapital.com

DOMINICAN REPUBLIC
Capital Market Dynamics

Caribbean Regional Economic Outlook

Executive Briefing February 2011

Foreign Exchange The Dominican peso (DOP) currently trades at 37.68 DOP per US dollar. Following a volatility episode in October, the FX market has stabilized on the back of another disbursement of the International Monetary Fund (IMF) Stand-By Arrangement. International reserves currently stand at US$2.9 billion, fulfilling IMFs requirements for the end of 2010. The country has a significant exposure to currency volatility with external debt at 64.0% of total public sector debt; nevertheless, internal debt participation has been increasing in the last three years reducing FX risks. Interest Rates The central bank tightened monetary policy in September and October 2010 by 100 basis points, responding to economic outperformance; however, since then, the central bank has left its benchmark interest rate unchanged at 5.0%. We expect the monetary authorities to keep the interest rate stable in the coming months; however, the increasing oil and food prices could put more pressure on inflation expectations, pushing authorities to start another hiking cycle. In addition, the risk of economic overheating could force the central bank to react as it did in the last tightening cycle. Sovereign Debt & Credit Ratings Following the latest Stand-By Arrangement review, the IMF informed that the Dominican Republic met its 2010 fiscal and foreign reserves accumulation targets. Moreover, the Fund gave credit to the central banks monetary policies, and acknowledged that inflation was well anchored, leading to another disbursement of US$168.1 million. The 10-year bond auctions have been highly demanded by market participants, despite illiquidity on the secondary market. More actions will likely be held in the first months of 2011. Since Q2 2010, country risk - measured by JP Morgans EMBI sovereign spread - has been declining, reaching levels not seen since the beginning of 2008. In early January, Fitch revised Dominican Republics outlook to positive from stable on the back of macroeconomic consolidation. However, rating agencies highlight vulnerabilities in external and government debt ratios. Current ratings are as follow: Moodys B2, Fitch B, and S&P at B.

Economic Outlook Growth Economic recovery has exceeded expectations. The central bank has recently estimated a real GDP growth of 7.8% for 2010, significantly above the initial 5.5-6.0% forecast. Local demand has been the key driver responding to accommodative monetary and fiscal policies during most part of last year. Authorities have accomplished all the StandBy Arrangement objectives set by the IMF, leading to the approval of another disbursement, bringing the total amount to USD$840.4 million in December, which seems to be building confidence in the country. However, there are still concerns over the low fiscal income and the electricity sector reform. The Dominican Republic is highly dependent on international economic performance with tourism, remittances and exports being the main economic drivers; therefore, the global economic recovery is one of the most important variables for the local outlook. Inflation Inflation for 2010 remained within the central banks objective (6.0-7.0%) at 6.2%; however, it continues to be heavily dependent on the behaviour of oil and food prices, which have increased in the latest months. For this year, inflation target range has been reduced to 5-6.0%; we expect inflation to remain in the upper part of it, as food and oil prices will continue to add to headline price pressures. The central bank will be focusing on a smooth change to an inflation-targeting framework that will come into effect in 2012. To this end, the central bank has published a wide program to build up a strategy, which includes a more transparent monetary policy. Fiscal Balance Reflecting the IMF Stand-By Arrangement, government cut expenditure and increased tax revenues in 2010, leading to a manageable deficit of 3.5% of GDP. The draft of the 2011 budget targets a deficit of 3.0% of GDP, in line with the fiscal consolidation requirements by the Fund. It is estimated that for 2010, public sector non-financial debt was equivalent to 2.9% of GDP, almost the same proportion than in 2009. The current account deficit widened to 7.5% of GDP in 2010 caused by an increase in imports and oil prices; the shortfall is financed by foreign direct investment and capital inflows.

Institutional Framework & Political Environment Governance President Leonel Fernandezs government will face important goals during the last two years of his mandate. On one hand, his efforts to achieve IMFs requirements and build up confidence among international investors will remain under careful scrutiny. The next elections will be held in 2012, and as yet there is no clear evidence of the contenders. In the last legislative elections, Fernandezs party, Partido de la Liberacin Dominicana (PLD), won the majority in both Chambers, highlighting the PLDs popularity. Reforms An energy sector reform is one of the most complex and needed reforms in the country. The Fund has put a lot of pressure on this issue, though it has a high political cost. To support a reduction of the electricity sector deficit and to cover state subsidies, the government increased electricity tariffs by 11% in the last month of 2010, which will put some pressure on the current government.
Daniela Blancas
daniela_blancas@scotiacapital.com

Global Economic Research

JAMAICA
Capital Market Dynamics

Caribbean Regional Economic Outlook

Executive Briefing February 2011

Foreign Exchange The Jamaican dollar (JMD) is showing signs of stabilizing and even appreciation however, bouts of JMD volatility may occur through the forecast horizon due to market participants concerns regarding the governments commitment to fiscal reform. While access to foreign currency from multilateral lenders should provide stability to the JMD, we expect the currency to face a modest depreciation bias vis--vis the US dollar (USD) in the next two years from the current level of 85.2, closing the year 2011 at 88 per USD. Sovereign Debt & Credit Ratings Market metrics indicate an improvement in Jamaicas creditworthiness: the EMBIG sovereign debt spread over US Treasuries declined from 850 basis points (bps) at end-November 2009 to the current level of 380 bps. In mid-January 2011, the International Monetary Fund (IMF) completed the third review of Jamaicas economic performance under the US$1.2 billion Stand-By Arrangement that was reached in February 2010, assessing that the country has met all the quantitative performance criteria. Following last years successful implementation of a domestic debt exchange regarding half of total public debt, Jamaicas sovereign credit ratings have been upgraded from a default category to B- (Standard & Poors), B3 (Moodys) and B- (Fitch) with a stable outlook. Equity Market Jamaican equity securities lagged the recovery evident in other emerging-markets; since reaching a low-point in early-February 2010, the Jamaica Stock Exchange index has increased by around 14%, compared with a 23% gain in the MSCI Emerging Market Equity Index over the same period of time.

Economic Outlook Growth Jamaicas economic conditions will continue to be arduous in the foreseeable future, particularly due to cyclical and structural domestic challenges; nevertheless, some signs of improving prospects are emerging. Activity remained below year-earlier levels in the first three quarters of 2010; we estimate that the countrys output recorded a small decline of around % in 2010 following a 3.0% contraction in 2009. In 2011, the mining and tourism industries will help economic growth to rebound from a low base to just over 1%, followed by a 1% expansion in 2012. Fiscal consolidation is the key factor limiting growth prospects. While labour market conditions remain challenging, a gradual recovery in remittances (equivalent to 15% of GDP) that contribute substantially to disposable income will provide some support to consumer spending. The mining industry is recovering along with improving capacity utilization rates; nevertheless, export performance remains subdued by historical standards. Jamaicas tourism industry continues to perform well compared with many of its regional peers. In the first eight months of 2010, stop-over visitor arrivals were 4.2% higher than in the year before. Inflation & Monetary Context Moderate price pressures may start rebuilding as demand recovers and global commodity prices increase. Annual inflation closed the year 2010 at 11.8%; we expect inflation to remain relatively elevated, hovering in the 9-10% y/y range through 2012. Monetary conditions will continue to be accommodative on the back of weak demand conditions. In February 2011, the Bank of Jamaica (BoJ) reduced the 30-day benchmark interest rate to a record low of 7.25%, taking total cumulative reductions to 975 bps since July 2009; the BoJ may have fairly limited room for further easing in the context of elevated investor risk aversion and negative real interest rates. In January 2010, the BoJ removed all tenors over 30 days from its open market operations, facilitating the creation of a yield curve following the debt exchange. Fiscal & Current Account Balance Jamaicas public finances remain challenging with low tax revenues and an onerous debt servicing burden. Nevertheless, the debt exchange program conducted a year ago brought some relief to fiscal pressures; during the first nine months of the FY2010/11 (April-March), 39% of government revenues went to public debt interest payments, while in the FY2009/10 the corresponding ratio was 63%. Public debt is scheduled to decrease gradually, reaching the 120% of GDP mark in 2012. Planned austerity measures will lower the budget gap from 10.9% of GDP in FY2009/10 to around 4% of GDP in FY2011/12. The current account deficit will continue to hover around 10% of GDP through 2012, representing a significant improvement from the pre-crisis levels of around 20% of GDP.

Institutional Framework & Political Environment Governance The administration, led by Prime Minister Bruce Golding of the Jamaica Labour Party (JLP), continues to be challenged by weak economic conditions, austerity measures and high crime. A victory in a December by-election supports our view that the JLP will likely remain in power in the foreseeable future, despite its slim 32-28 majority and the difficult tasks it is facing. The next general election is due by September 2012. Financial Sector The IMF assesses that financial sector reforms aimed at strengthening the overall supervisory framework are broadly on track. The Jamaican authorities are planning to gradually wind down the Financial System Support Fund this year. Credit to the private sector started to pick up in the third quarter of 2010. Meanwhile, the private sector non-performing loans ratio decreased marginally from 6.4% in June to 6.0% in September 2010. Lending to the private sector accounts for only 38% of commercial banks total assets.
Tuuli McCully
tuuli_mccully@scotiacapital.com

Global Economic Research

PUERTO RICO
Capital Market Dynamics

Caribbean Regional Economic Outlook

Executive Briefing February 2011

Sovereign Debt & Credit Ratings The Commonwealths creditworthiness has been turned around reaching the highest level in over 35 years as the administration of Mr. Luis Fortuo has pressed for fiscal austerity. Having ranked as the municipality with the worst fiscal revenue outlook in FY2009, Puerto Ricos budgeted deficit as a share of total revenues for FY2011 (July 2010-June 2011) climbed up the ranks to 26th place among all US provinces. This has reflected in Puerto Rican sales tax revenue bond spreads over corresponding U.S. Treasury securities compressing over 150 basis points in the past two years. The spread peaked at 393 basis points in November 2008. Two of the main international ratings agencies have either improved their outlook or raised their rating of the islands credit during the past six months. Fitch upgraded Puerto Ricos government bonds to a BBB+ rating with a stable outlook on January 19th, 2011, while Standard & Poors affirmed last November the BBB- rating, but revised the outlook to positive on the basis of balanced budget progress. Moodys retains an A3 rating with a negative outlook.

Economic Outlook Growth Puerto Rican economic activity is in line to rebound this fiscal year from a four year recession. The Commonwealth entered into a recovery path earlier in the year inking the first sequential quarterly output expansion during the April-June period. Although activity lapsed in July-September, at the outset of the new fiscal year, figures through November display revived momentum. The annual growth rate of the economic activity index calculated by the Global Development Bank of Puerto Rico is at the strongest level in four years, with the current rate of expansion in line to record positive 1% q/q (4% annualized) growth in the December quarter. The break from a long recession is being supported by consumer spending and manufacturing activity, underpinned by upticks in international trade and labour market conditions. Although retail sales activity slowed in September, they picked up by 6.5% y/y during the first-half of 2010, with the rise in spending backed by swelling payrolls as a result of net gain in manufacturing positions. While public payrolls have diminished, private sector job growth has been on a recovery path since the outset of 2010, with the services sector leading the gains. We continue to expect 2.5% y/y GDP growth forecast for FY2011. Inflation & Monetary Context Inflationary pressures are set to build up in 2011. Price pressures picked up to 1.5% y/ y in October, breaking a path of disinflation that brought yearly price growth all the way down to 1% in September. Higher energy demand is underpinning the rebound of inflationary pressures, with gasoline consumption during the first five months of FY2011 up with respect to FY2010. While we expect yearly inflation to remain in the single-digits in 2011, relatively high oil prices will maintain energy costs elevated in the island. Fiscal & Current Account Balance The nascent recovery is being supported by an aggressive fiscal plan backed by the stabilization package instituted last year in the U.S. Latest evidence points to continued improvement in the public accounts profile as government revenues in October-November lie more than 12% higher than year earlier flows. Public receipts expanded in FY2010, having surpassed budgeted estimates for the second fiscal year in a row, after at least four years of persistent shortfalls. Merchandise export receipts have been on an upward trend, with sales to the U.S. inking an 8% y/y advance in the first two months of FY2011. Exports to non-US destinations expanded at an 11% y/y in the 12 months to August 2010. They have been supported by the strategic geographical position of the island and the US-CAFTA (Central American Free Trade Agreement of which Puerto Rico is a beneficiary as a US municipality). The trade deficit fell in 2010 on the back of improving foreign sales and still sluggish import volumes.

Institutional Framework & Political Environment Governance The governor Luis Fortuo of the pro-statehood Partido Nuevo Progresista (PNP) continues to face public dissatisfaction as policies to jump-start the economy have failed to trickle down thoroughly to the majority of the population. Most of the results so far have remained within the government accounts as fiscal progress has put the public balance on a more solid footing with austerity measures a key element of the results. Although Mr. Fortuo has been able to push through key economic reforms in the PNP-dominated legislature, general discontent due to unemployment stuck at an elevated level will continue to instil challenges from the opposition. Financial Sector Financial sector consolidation will remain conditioned on the outlook for the islands real estate sector. With about US$6 billion in portfolio exposure to the local housing market, the combination of falling real estate values and high joblessness remains a key threat to bank balance sheets. An accommodative monetary stance in the U.S. will continue to contribute to alleviate the burden of high debt levels. Lending conditions have hit historical lows both in terms of interest rate levels as well as credit channeled to the private sector. Subdued investment demand within the context of an incipient domestic recovery will bring interest rates even lower in coming months. Cement sales have been solid during the past seven months hinting at stabilization in the real estate sector.
Oscar Snchez
oscar_sanchez@scotiacapital.com

Global Economic Research

TRINIDAD AND TOBAGO

Capital Market Dynamics

Caribbean Regional Economic Outlook

Executive Briefing February 2011

Foreign Exchange The central bank will likely keep the Trinidad and Tobago dollar (TTD) in a narrow trading range against the US dollar (around USDTTD6.30) over the coming quarters, with sizable international reserves (US$9.1 billion in September 2010) supporting the exchange rate policy. The International Monetary Fund has stressed the need for greater exchange rate flexibility; however, a fundamental shift is unlikely to take place in the near-term. Sovereign Debt & Credit Ratings Trinidad and Tobago continues to benefit from investment grade sovereign credit ratings, with Standard and Poors and Moodys Investors Service rating the countrys credit as A and Baa1, respectively, with a stable outlook. While Moodys highlights the countrys economic and fiscal vulnerability to volatile energy prices, it assesses that a sizable fiscal stabilization fund of around US$3 billion, 10% of GDP, provides protection against external shocks. The level of public debt has increased in recent years, being equivalent to around 40% of GDP.

Economic Outlook Growth The outlook for Trinidad and Tobagos economic conditions is gradually brightening. The economy emerged from recession in the final quarter of 2009 but temporarily dipped back into negative growth territory in the second quarter of 2010. Supported by energy sector activities (that account for nearly 40% of the countrys total output), the economy continues to recover progressively, with domestic demand gradually picking up as it responds to loose monetary conditions and further fiscal stimulus measures. We estimate that real GDP was virtually flat in 2010; output growth will likely pick up to 2-3% in 2011-12. For now, however, domestic demand remains subdued and the private sectors appetite for credit low, as labour market conditions continue to be uncertain. Government expenditure particularly in infrastructure will boost economic activity. Inflation & Monetary Context Monetary conditions will remain accommodative in the near-term as domestic demand continues to be sluggish. However, we expect that the monetary easing cycle in nearing its end; the most recent benchmark interest rate reduction by 25 basis points (bps) to 3.50% in January 2011 took accumulated monetary easing to 525 bps since March 2009. Inflationary pressures have started to rebuild since October 2010, driven by increasing food prices; headline consumer price inflation reached 13.4% y/y at end-2010, continuing to exceed the central banks target of 5-6% by a wide margin. Nevertheless, inflationary pressures at the core level remain somewhat stable, hovering just below 5% y/y. We expect headline inflation to stabilize to around 8-9% in 2011-2012. Fiscal & Current Account Balance The fiscal outlook continues to be somewhat challenging. Nevertheless, on the back of conservative underlying price projections for oil, the fiscal year 2009/2010 (October-September) budget deficit narrowed significantly to an estimated 2.8% of GDP following a shortfall of 4.9% of GDP the year earlier. However, in the context of persistently weak domestic demand conditions, the 2011 budget will provide another round of fiscal stimulus, including transfers to households and incentives to promote activities in both the energy and non-energy sectors. The fiscal gap will likely widen to close to 4% of GDP (less than the targeted deficit of 5.1% of GDP in the 2011 budget that is based on an average WTI oil price forecast of US$65 per barrel), with public debt rising to around 42% of GDP. A large government non-oil budget deficit (around 18% of GDP) will continue to be a key challenge facing the country through the remainder of the decade. Trinidad and Tobagos external position will remain strong through 2012; after dipping to 9% of GDP in 2009, the current account surplus will widen again over the forecast period, averaging 16% of GDP through 2012.

Institutional Framework & Political Environment Governance Snap general elections took place in May 2010, leading to a change in leadership. The Peoples Partnership Alliance formed by five parties won 70% of the seats in the National Assembly, leaving the Peoples National Movement Party in opposition. The new government is led by Prime Minister Kamla Persad-Bissessar of the United National Congress. As the political parties in Trinidad and Tobago enjoy strong policy consensus, no major changes in economic management are expected. Financial Sector The government intervention in early 2009 was successful in preventing a major financial contagion following a large financial conglomerates economic difficulties. Nevertheless, the events underscore the need for improvement of regulation and supervision of the financial sector. According to monetary authorities, the banking system remains well capitalized. Weak demand conditions are reflected in lending indicators; private sector credit declined for the fifteenth consecutive month in November 2010, with the exception of credit for real estate.

Global Economic Research

Tuuli McCully
tuuli_mccully@scotiacapital.com

Global Economic Research

INTERNATIONAL RESEARCH GROUP

Pablo F.G. Brard, Head 1 (416) 862-3876 pablo_breard@scotiacapital.com Daniela Blancas 1 (416) 862-3908 daniela_blancas@scotiacapital.com Tuuli McCully 1 (416) 863-2859 tuuli_mccully@scotiacapital.com Estela Ramrez 1 (416) 862-3199 estela_ramirez@scotiacapital.com Oscar Snchez 1 (416) 862-3174 oscar_sanchez@scotiacapital.com

Scotia Economics
Scotia Plaza 40 King Street West, 63rd Floor Toronto, Ontario Canada M5H 1H1 Tel: (416) 866-6253 Fax: (416) 866-2829 Email: scotia_economics@scotiacapital.com
This Report is prepared by Scotia Economics as a resource for the clients of Scotiabank and Scotia Capital. While the information is from sources believed reliable, neither the information nor the forecast shall be taken as a representation for which The Bank of Nova Scotia or Scotia Capital Inc. or any of their employees incur any responsibility.

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