From CIBC FirstCaribbean

Caribbean Economic Overview

Summary: In its July 2017 update to its World Economic Outlook, the IMF suggested that global economic growth had evolved in line with its initial expectations thus far in 2017. However, economic growth has varied from expectations in major economies as stronger than anticipated performances in Canada, the Euro Area, and Japan erased weaker than expected first quarter economic growth performances in the USA and the UK. Real GDP growth slowed during Q1 2017 in the USA and the UK, but strong domestic demand boosted Canadian real value-added during the same period. And, preliminary estimates point to accelerated growth in economic output during Q2 2017. Finally, while average crude oil prices have increased during H1 2017 relative to the same period one year earlier, increased production from US shale producers continues to counteract lower production from OPEC, and prices have fluctuated around US$50 a barrel for most of 2017. As a result, economic growth in Venezuela – one of the Dutch Caribbean’s closest trading partners – continues to suffer.

The economic developments in advanced economies in 2016 and during the first quarter of 2017 have contributed to the economic dynamics in the Caribbean thus far in 2017. While economic growth remained positive across most markets during Q1 2017, construction activity and cruise tourism contributed noticeably more to the expansion in real GDP than the previously-dominant stay-over tourism sector. Stay-over arrivals increased just 0.7% y/y during 2016 compared to 4.8% during 2015, while initial data for 2017 suggest that growth in arrivals from the UK (where political uncertainty surrounding BREXIT negotiations continues to keep the GBPUSD depressed), Venezuela and the previously-dominant US market slowed relative to previous years. In contrast, Canadian arrivals, which had previously declined after the slump in oil prices slowed Canadian economic growth, rebounded in most countries across the region. In contrast, all but three of fifteen markets benefited from positive growth in cruise arrivals during the first few months of 2017, while, notwithstanding lower public capital expenditure in approximately half of the markets covered, stronger private sector-led construction, particularly in tourism-related investment, boosted construction output throughout the region. Moreover, while the increase in commodity prices has improved the terms of trade in Trinidad and Tobago, and Suriname, weak production in the former and still-low prices continue to limit any expansion in economic growth in those commodity-dependent economies.

Caribbean Market Review

Summary: Emerging market credits continued to gain ground since our last publication despite the normalization in monetary policy hinted or announced by major central banks. Caribbean credits have reacted positively to the timid increase in oil prices so far this year and still solid increases in tourism. The episodes of volatility in the market were limited to political noise, especially in the US, and around the Fed rate increase in June. As the market assesses the impact of a slow process of normalization in rates around the world, and expectations of higher inflation in the US still tamed, we expect investors’ search for yield to benefit countries in the region with improving fiscal balances and/or with government policy moving towards that direction. Moreover, in the absence of a run for safe haven assets due to further global political instability, we expect Caribbean credits to mimic the trend seen since the start of the year, with small, and orderly selling episodes around key dates (i.e., Fed balance sheet normalization in September, US debt ceiling discussions in October, etc.), but slowly gain strength as the element of surprise dissipates.

Following credit rating downgrades, BARBAD bonds recovered the terrain lost with yields dropping 182 bps on average along the curve, as the government announced several measures to adjust its fiscal imbalances in its 2017 Financial Statement and Budgetary proposals. However, as in previous budgets, the measures focus primarily on additional revenue through new or higher tax rates and less so in addressing structural inefficiencies in public expenditure. Despite the gain in BARBAD in the last quarter, we expect volatility to return, as elections approach and liquidity remains thin.

JAMAN bonds have benefited from compliance with the IMF program and significant local demand since Q4 2016. However, as demand diminishes and the market absorbs the repurchase of the bonds in the 2Y-8Y range following the US$ 869 million issuance in JAMAN ‘28s and JAMAN ‘45s, we see room for markets to take a breather.

As mentioned in our previous quarterly release, DOMREP and PANAMA continued to outperform with a fiscal house in order and the highest GDP growth levels in the region. Despite yields dropping between 30-50 bps along the DOMREP curve, we expect DOMREP’s attractiveness in the region to diminish as growth decelerates and positive events/economic news in the pipeline dry-up. On the other hand, despite being one of the richest credits in the region, we expect PANAMA’s to continue to benefit from the Canal’s strong performance and to better perform against episodes of high global volatility.

With the market recognizing the possibility of a slower than anticipated monetary policy normalization by the Fed, we expect Caribbean credits that rely on an improving fiscal picture and the highest pace of growth to benefit from any episodes of volatility in emerging markets. We recognize that despite constant improvement in the credit, we see limited upside on the JAMAN trade as local demand dries up and growth slows down. We remain cautious about BARBAD driven by low liquidity and would expect it to underperform given the uncertain and binary outcome of the next election. Moreover, with growth sharply decelerating in DOMREP, corruption allegations surrounding the Punta Catalina project, and the lack of positive news in the pipeline, we see DOMREP as having limited upside.

In this scenario and with a marginal improvement in Costa Rica’s fiscal picture and still robust growth, relative value plays in favour of COSTAR against DOMREP are becoming increasingly attractive. Our models point to the 44’s sector of the curve as having a reasonable risk-reward profile. In spite of this, risk of further external debt issuance to finance the 2018 Budget remains high in Costa Rica for the moment. Such event could still lead to wider levels and indeed, better entry points. The official party (PAC) has already recognized the need to cut expenses via its fiscal adjustment measures sent to congress at the start of August. Furthermore, the PLN led by Antonio Alvarez-Desanti remains in favour of a comprehensive fiscal adjustment and is currently heading the presidential election polls. Once these conditions materialize, we expect this development to provide an ideal scenario for rapid tightening of the COSTAR and DOMREP long-end relative value spreads.