To Borrow or Not to Borrow

Author(s): Central Bank Of Barbados

Created 20 Oct, 2021
Tags CBB 101 CBB Blog
Categories General Press Release
Views: 960

It seems simple. If you’re trying to keep your finances under control, it doesn’t make sense for you to be borrowing money. Then it stands to reason that Barbados, which has set a long-term goal of reducing its debt-to-GDP ratio to 60 percent of GDP by the end of financial year 2034/35, shouldn’t be borrowing either, right?

The situation is more complex than that, explains Central Bank of Barbados Governor Cleviston Haynes.

Why Government Borrows

Government borrows primarily to sure up the country’s international reserves or to help it meet its financing needs.

In the first instance, it is important for the island to maintain an adequate level of international reserves, which are foreign exchange assets that Barbados can use to pay for imports. Having enough international reserves – 12 weeks is generally considered the benchmark, although Governor Haynes says more is better – is key to maintaining our fixed exchange rate.

But even if the level of Barbados’ international reserves is fine now, Government needs to consider future foreign exchange needs. “What you’re looking at is the medium-term prospects,” says Governor Haynes. “What debt service do you have coming due this year? Next year? The following year? You want to be able to look at that. What is the level of economic activity? How is Government’s fiscal programme looking? Does it have a lot of interest payments? The decisions [to borrow] are based around what is happening at a point in time.”

Who Does Government Borrow From

When Government decides to borrow, it can do so domestically or internationally. Domestic borrowing will be in local currency and therefore does not boost the island’s reserves. At the international level, Barbados can borrow either from international financial institutions (IFIs) such as the International Monetary Fund (IMF), the InterAmerican Development Bank (IDB), the World Bank, and other agencies, or from the capital market, international private sector companies.

Governor Haynes says funding from international financial institutions is usually for balance of payments support, as with our current IMF programme, or is project based, and as such is made available in tranches.

The Cost of Borrowing

Should Government need to access a substantial amount of funding, it can offer bonds on the international capital market, where the interest rate it has to pay can determine whether and how much it borrows:

“The interest rate is the cost of borrowing, and the more you borrow, the more your interest costs rise, and therefore even if you don’t have to pay the principal of the loan right now, you always have to be paying interest. So a critical determination in the borrowing decision is going to be the interest cost. Sometimes the need is so great that you end up with very expensive loans.”

Governor Haynes explains that the interest rate Barbados has to pay for loans from private lenders is determined not only by prevailing market conditions, but also by how lenders view the island’s creditworthiness. In short, a country’s credit rating is critical.

Interestingly, one of the factors that impacts a country’s credit rating is the level of international reserves. “As your reserves fall, then there is a concern that you will not be able to service your debts when they become due.”

Controlling Borrowing

For all these reasons, the decision to borrow is not one that is made lightly. While there is no fixed limit on how much the country can borrow, plans to borrow internationally are usually approved by Parliament.

Another guardrail, although not of Government’s choosing, is the market itself, which determines how much it is willing to lend based on the perceived risk. One metric lenders use is the country’s debt-to-GDP ratio, and a debt-to-GDP ratio of 60 percent is considered to be good.

Which brings us back to the initial question: if Barbados is trying to reduce its debt-to-GDP ratio, why would it continue to borrow money?

Sometimes it is necessary for the good of the country and the people. Think of all the spending Government had to do during the COVID pandemic: setting up the Harrison’s Point Isolation Facility and purchasing medical supplies and PPE as well as indirect expenses related to support for families and businesses. COVID is an obvious example, but there are others.

Governor Haynes uses this analogy: “If you wanted to get a mortgage to build your home and you took out a 25-year loan, you carry that loan for the next 25 years. But I don’t think you’d say that was a bad thing because without that mortgage, you would not have been able to get that home.”

Copyright 2021 by Central Bank of Barbados