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Rising oil prices and wider current account and fiscal deficits predicted in ECCU economies

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ECCU-CountriesRising oil prices and the end of the PetroCaribe programme will result in wider current account and fiscal deficits in the economies of St Kitts and Nevis and the other member states of the Eastern Caribbean Currency Union (ECCU).

 

This is according to the British-based Latin America Monitor, a leading publisher of specialist business information on global emerging and frontier markets.

 

In its October analysis, released prior to the devastation of Anguilla, Barbuda and Dominica by Hurricanes Irma and Maria, Latin America Monitor said, while it views it as unlikely, it cannot rule out a balance of payments crisis in the region or a devaluation of the pegged East Caribbean dollar.

 

“The economies of the Eastern Caribbean Currency Union (ECCU) member states will come under pressure from rising fuel prices and the end of the PetroCaribe programme in the years ahead. We expect to see a deterioration of current account and fiscal balances across the union over the next several years due to increasingly expensive fuel imports. This will raise the risk of balance of payments crises by member states and a devaluation of the East Caribbean dollar (XCD), although these are not part of our core view for the region,” Latin America Monitor said.

 

“Additionally, we note that while this piece focuses on the ECCU, the end of PetroCaribe poses risks to all members of the alliance. We highlight Cuba and Nicaragua as other countries that are particularly vulnerable to the end of the programme,” it said.

 

It stated that, given their small size and limited natural resource bases, the countries of the Caribbean are heavily reliant on fuel imports, primarily for electricity generation. This is particularly true for the ECCU, which includes some of the smallest economies in the Americas that have virtually no domestic fuel production.

 

Latin America Monitor disclosed that between 2010 and 2016, fuel imports accounted for an average of 18.9% of total imports in the ECCU, reaching as high as 29.8% in Montserrat.


“Our Oil & Gas team forecasts the price of Brent to average USD54.0/barrel (/bbl) in 2017 compared to USD45.1/bbl in 2016, before gradually trending higher in subsequent years, which will place upside pressure on the import bill in these economies. Moreover, rising oil prices will be compounded by an end to heavily subsidised fuel imports from Venezuela to the majority of the ECCU as part of the PetroCaribe programme. Years of cheap fuel have masked external vulnerabilities in the ECCU,” said Latin America Monitor, which added that “the ongoing political and economic crisis in Venezuela has seen a sharp decline in shipments to the Caribbean and we see little chance that crude exports will recover to previous levels in the foreseeable future.”

 

The spike in energy costs, amid falling support from Venezuela, will challenge ECCU countries’ fiscal and external account positions, potentially pushing the most vulnerable countries towards a crisis point. Specifically, increased prices will have two major effects, larger current account deficits and deteriorating fiscal positions.

 

Rising fuel import prices will see current account deficits widen across the union. The balance of payments positions of most member states are already precarious: members of the ECCU averaged a current account deficit of 9.5% of GDP in 2016, with Anguilla’s 30.4% deficit the largest. Moreover, despite low global oil prices over 2015 and 2016, these countries’ deficits grew by an average of 3.9 percentage points over the two-year period.

 

“As such, we expect current account deficits to continue widening in the years ahead in tandem with oil prices. This dynamic could call into question the ability of the ECCU to maintain the East Caribbean Dollar (XCD) peg, which is currently at XCD2.70/USD. Use of the peg has made external adjustments more challenging, exposing the region to the sudden shock of a sharp rise in fuel costs,” Latin America Monitor stated.

It added however that “we do not expect that the ECCB will be forced to devalue the currency in the near future, barring a much sharper rise in oil prices than we currently expect. In real effective terms, the unit has steadily weakened over recent quarters, and the ECCU maintains an average 4.0 months of import cover, both of which suggest that there is no imminent need to devalue the XCD.

 

“Moreover, despite a history of wide deficits, the ECCU has historically been able to finance these deficits with substantial inflows into the tourism and financial services sectors. As the bulk of these inflows are in the form of direct investment, the risk of capital flight is relatively low. That said, we note that average reserves are down slightly from 4.3 months in 2014, a pace of decline which may accelerate if current account deficits sharply increase.”

 

According to Latin America Monitor, the end of Venezuelan support will also result in wider budget deficits in the ECCU, noting that in addition to subsidised oil, PetroCaribe effectively provides financial assistance to member governments, which is typically put towards various social development programmes.

 

“Recipients often re-export Venezuelan oil at market prices, using the difference to fund their budgets, or use the oil to provide subsidised electricity. Such spending will become more difficult to sustain given our relatively subdued growth outlook for the region and high debt burdens, possibly requiring governments to either acquire outside financing or make cuts to politically popular programmes, such as St Lucia’s recent cuts to capital expenditures. We also see a significant chance that electricity prices will rise in member states, reducing consumers’ disposable incomes.”

 

Latin America Monitor has identified two dynamics that are likely to mitigate the impact of rising fuel import prices moving forward.

 

“First, we hold a positive outlook on tourism in the Caribbean in the years ahead due to robust growth in the region’s primary source markets as well as fading concerns about the zika virus. Foreign arrivals provide a source of hard currency for the countries of the ECCU, with total visitor expenditures typically amounting to roughly one quarter of GDP. This will offset some of the impact of higher fuel costs on the countries’ external accounts.

 

“Second, over the long term, a greater reliance on renewable sources of energy, as well as liquefied natural gas (LNG), has the potential to reduce the union’s reliance on imported oil to meet domestic energy needs. While both renewable and LNG currently play a minor role in the energy mix of member countries, further development of these power sources would substantially reduce the ECCU’s exposure to oil price shocks,” Latin America Monitor said.



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