One of central banks’ key roles is maintaining price stability. This usually means a stable and predictable rate of inflation. Authorities care about the rate of inflation because out of control inflation can cause several problems including erosion of purchasing power, uncertainty of investments for businesses and households, increasing vulnerability of pensioners and others on fixed incomes, higher union demands, less competitive exports and a greater need for the government to spend (often borrow) on social protection programs. To control the rate of inflation, central banks will utilize the tools at their discretion. The use of these tools is what economists call Monetary Policy.

The tools available to central banks can broadly be categorized into two groups, direct and indirect. Direct tools are reserve requirements, direct credit control, direct interest rate control and direct lending. Indirect tools are open market operations (OMOs, the buying and selling of government securities), interbank lending rates and repo rates. The general idea behind direct tools is to increase/decrease the money supply, increase/decrease interest rates, or both. The general idea behind indirect tools is to influence banks to act in a way that achieves a similar result, that is, an increase/decrease in the money supply, an increase/decrease in interest rates, or both. Economist will often talk about monetary policy transmission, which is how successful the tools are in getting banks and the overall economy to positively respond to the central bank’s direction. The selection of a tool or a sub-set of tools is partially dependent on the transmission mechanism.

The regional inflation rate rose to 9.6% in 2022 from 3.0% in 2020 and 6.7% in 2021, and in some regional countries such as Suriname and Jamaica, 2022’s inflation was as high as 52.4% and 10.3% respectively. What’s more, the expectation at the time was that inflation would stick around for a while. Indeed, that turned out to be true as inflation remained stubbornly high in 2023, averaging 7.9% for the region and as high as 51.6% in Suriname and 6.5% in Jamaica. Such inflation required central banks to respond. The common prescription is for central banks to raise interest rates, as was done in the USA, Eurozone and UK, but not all regional central banks raised rates, in fact, Jamaica was the lone major regional economy to do so, though effective August 21st 2024, their policy interest rate was reduced by 25 basis points to 6.75% in response to inflation now comfortably within the Bank of Jamaica (BOJ) target of 4-6%. The other regional economies (Trinidad and Tobago, Barbados, the Organization of Eastern Caribbean States (OECS) and Guyana) kept rates steady. Why?

While central banks try to manage inflation, they have to be wary of being disruptive to economic growth. Raising interest rates tends to cool off economic activity since the cost of borrowing and investing becomes more prohibitive. Additionally, if the central bank raises its policy rate, but banks are flushed with liquidity (essentially, a high level of deposits versus loans) then the monetary policy transmission mechanism will be weak and interest rates in general could remain stagnant or even decline! Central banks in such an economy may choose to use another policy tool such as increasing the reserve requirement (essentially, reducing the amount of liquidity) causing a tightening on credit activity through a lowering of the supply of loans and therefore higher borrowing rates. A further reason for some regional policy interest rates’ immobility could be the extent of capital controls. As the USA and other countries raised their interest rates, the attractiveness of money or capital flowing to those countries is increased unless the domestic economy also responds with rate hikes. However, if foreign currency cannot easily leave a country, such as in Barbados, Trinidad and Tobago and the OECS because of fixed or managed exchange rates and/or availability of foreign exchange, then the pressure to raise domestic interest rates in response is much smaller.

Instead of interest rate adjustments, Trinidad and Tobago, Barbados, Guyana, Suriname and the OECS relied more heavily on fiscal policy and alternative monetary policy tools such as the reserve requirement and OMOs. It is not a one size fit all or use of a single tool when it comes to monetary policy and each central bank would use what is appropriate to its main objectives and conditions at the time.

Regional inflation is expected to decline to average 4.3% in 2024 and 3.6% in 2025. Jamaica and Suriname are expected to see material disinflation over the two years. Achieving the end result of price stability is what matters.

Now that we have a good grasp of what a credit rating is, a sense of the process, and the various terms used in the credit rating language, the final article of our series explores the benefits of obtaining a credit rating for an issuer or a specific debt issue.

Communication of Entity’s Ability to Repay Debts

First and foremost, credit ratings provide a clear and concise snapshot of an entity’s financial health and its ability to repay debt via cashflows. Ratings offer valuable insights into the risk associated with lending money to an entity.  While it is not a recommendation to buy, sell or hold an investment, lenders/investors can make more informed decisions of a rated versus unrated entity.

Access to Borrowings at Lower Interest Rates

A high credit rating can potentially increase access to borrowings at lower interest rates. Lenders tend to be more willing to extend credit to borrowers with a proven track record of sound financial management. Lenders and financial institutions use credit ratings as a gauge of risk.  Borrowers with high credit ratings therefore can potentially qualify for financing at lower interest rates which can result in substantial cost savings over time. Lower interest rates and fees can redound to reduced interest and overall expenses. The relationship between interest rates and ratings in the region is not as clear as in more developed markets. Despite this, entities that are considered higher credit quality will have more negotiating power. With more entities in the region getting rated and further development of regional capital markets, the relationship between ratings and interest rates should become more apparent over time. Apart from interest rates there are a host of other benefits of becoming rated.

Investor Confidence

For businesses and governments, credit ratings influence investor confidence. A strong credit rating signals stability and reliability and thus attracts investors seeking worthwhile investment opportunities. Most investors find independent assessments useful and use them to support their own analysis.

Commitment to High Standards of Corporate Governance

A credit rating conveys a company’s willingness to be transparent and speaks well of overall corporate governance. It enhances the company’s emphasis on transparency and alignment to best practices in the region.

Market Competitiveness

Companies with high credit ratings may enjoy a competitive advantage in the marketplace as suppliers, vendors, and other counterparties may be more inclined to engage in business relationships with entities that demonstrate financial strength and stability.  Companies with high credit ratings may also benefit from increased negotiating power.

Risk Management

Credit ratings may serve as a risk management tool for both borrowers and lenders. By assessing their credit risk upfront, borrowers can identify areas for improvement and take proactive measures to strengthen their financial position. This can result in an upgrade in its credit rating and increased attractiveness for investors. Similarly, lenders can mitigate risk by carefully evaluating the creditworthiness of potential borrowers.

Implementation of Sound Financial Management Practices

The pursuit of a credit rating serves as a catalyst for entities to implement prudent financial management, with the objective of securing a strong rating that reflects their capacity for timely debt servicing.

In addition to the above, obtaining a rating from Caribbean Information & Credit Rating Services (CariCRIS) can result in:

Local Insight and Expertise

CariCRIS offers an in depth understanding of the nuances and characteristics in local and regional market, economic conditions, and regulatory environment.  A regional scale rating from CariCRIS also benchmarks the company or country against regional peers, many of whom are only rated by CariCRIS.

Brand Recognition and Trust in the Caribbean region

A CariCRIS rating can help further strengthen an company’s brand recognition and trust amongst Caribbean consumers and businesses and boost confidence among stakeholders regarding the company’s financial stability and commitment to the region.  A CariCRIS credit rating can increase a company’s visibility and contributes to its brand equity.

In a landmark move to address tax evasion and profit shifting by multinational corporations, the Organisation for Economic Co-operation and Development (OECD) has proposed a global minimum tax rate of 15%. While the intention behind this initiative is to ensure that large corporations pay their fair share of taxes regardless of where they operate, the ripple effects are set to be profound, particularly for small island developing economies (SIDS) like the Cayman Islands and the British Virgin Islands (BVI), which have long relied on offshore business registrations to bolster their fiscal revenues and GDP.

The Global Minimum Tax Rate: An Overview

The OECD’s global minimum tax rate is part of a broader effort to reform international tax rules. This initiative aims to curb the practice of profit shifting, where multinational corporations move profits to low-tax jurisdictions to minimize their tax liabilities. By establishing a floor rate of 15%, the OECD intends to prevent a “race to the bottom” in corporate tax rates and ensure a more equitable distribution of tax revenues.

Under this framework, if a corporation pays less than the minimum tax rate in a particular jurisdiction, its home country would have the right to “top up” its taxes to the 15% rate. This measure is expected to generate significant additional tax revenues for countries around the world and reduce the incentive for corporations to engage in aggressive tax planning.

Impact on Small Island Developing Economies

Small island developing economies such as the Cayman Islands and the BVI have built their economic models around offering low or zero corporate tax rates to attract foreign businesses. These jurisdictions have become global hubs for offshore financial services, contributing substantially to their GDP and fiscal revenues. The implementation of the OECD’s global minimum tax rate poses several challenges to these economies.

Economic Vulnerability

For SIDS, the offshore financial sector is a cornerstone of their economic structure. In the Cayman Islands, for instance, financial services account for over 50% of the GDP. The BVI similarly relies heavily on the sector, with offshore business registrations forming a critical revenue stream. The introduction of the global minimum tax rate threatens to undermine this economic model, as multinational corporations may no longer find these jurisdictions as attractive for tax planning purposes.

Fiscal Revenues

The fiscal revenues of SIDS are at risk of significant decline with the implementation of the global minimum tax rate. The current tax advantages that these jurisdictions offer are a major draw for international businesses. A reduction in the number of new business registrations and a potential exodus of existing companies could lead to a substantial drop in government revenues, affecting public services and investments.

Diversification Challenges

Many small island economies have limited options for economic diversification due to their size, geographic isolation, and vulnerability to external shocks such as natural disasters and global economic downturns. Transitioning away from a dependence on offshore financial services will require significant investment in new sectors, such as tourism, renewable energy, and technology. However, these sectors may not generate sufficient revenue to compensate for the loss of income from the financial services industry in the short to medium term.

Efforts to Protest and Adapt

The proposed global minimum tax rate has not gone unchallenged. Several SIDS have voiced their concerns and opposition through various international forums. These jurisdictions argue that the tax reform disproportionately impacts their economies and undermines their sovereign right to determine their tax policies.

Diplomatic Engagement

The governments of the Cayman Islands and the BVI, among others, have engaged in diplomatic efforts to mitigate the potential adverse effects of the global minimum tax rate. They have lobbied through regional organizations, such as the Caribbean Community (CARICOM), and international platforms like the United Nations, to advocate for special considerations or exemptions for small island economies. These efforts aim to highlight the unique vulnerabilities of SIDS and seek more balanced solutions that do not jeopardize their economic stability.

Economic Reforms and Diversification

In response to the impending changes, some small island economies have begun exploring strategies to diversify their economic base. The Cayman Islands, for instance, is investing in sectors like tourism, technology, and healthcare to reduce its dependency on offshore financial services. Similarly, the BVI is looking at enhancing its tourism product and developing a more robust regulatory framework to attract legitimate business activities beyond mere tax advantages.

Regional Cooperation

There is also an increasing push for regional cooperation among SIDS to create a unified front in addressing the challenges posed by the global minimum tax rate. By collaborating on economic reforms, sharing best practices, and developing joint strategies for economic diversification, these countries aim to strengthen their collective resilience against external economic pressures.

Conclusion

The OECD’s global minimum tax rate represents a significant shift in international tax policy with far-reaching implications. For small island developing economies like the Cayman Islands and the British Virgin Islands, the reform poses a substantial challenge to their current economic models. While these jurisdictions are actively protesting the implementation of the tax rate and seeking diplomatic solutions, the need for economic diversification and adaptation is evident. The transition may be fraught with difficulties, but it also presents an opportunity for SIDS to build more resilient and sustainable economies in the long term.

In the second part of credit rating definitions, we delve a little more deeply and explain rating sensitivity factors (RSFs), outlooks, and the concept of a rating watch.  Similar to Part 1 published last week, these definitions are specific to Caribbean Information & Credit Rating Services (CariCRIS).

Rating Sensitivity Factors (RSFs)

RSFs are factors that can trigger an upgrade or a downgrade.

Here’s a closer look at these factors:

– Rating Upgrade: An upward revision of a rating following a review.

– Rating Downgrade: A downward revision of a rating following a review.

– Rating Reaffirmation: No change in the rating following a review.

RSFs are determined after projections are performed to ascertain the variables/conditions under which the financial health of a company would be severely impacted such that a rating change may be warranted.  CariCRIS’ projections incorporate a base case (scenario if existing trends continue) as well as stressed scenarios.  Projections are completed based on client budgets, strategic plans as well as conversations with the executive team on the company’s plans.

Outlooks

The meaning of a credit rating is more commonly understood than its outlook.  For example, “CariAA” is widely understood to mean that the rating corresponds to a high credit quality and a low probability of default.  In rating reports, investors often see the terms, stable, positive or negative outlooks.  Outlooks are an essential feature on most long-term debt ratings and give CariCRIS’ perspective of the assigned credit ratings over the next twelve to fifteen months.

– Stable Outlook: Indicates that a rating change is unlikely.

– Positive Outlook: Signals at least a one-in-three chance that a rating upgrade could occur if certain RSFs are met.

– Negative Outlook: Signals at least a one-in-three chance that a rating downgrade could occur if certain RSFs are met.

CariCRIS utilizes projections to assign both a rating and an outlook. Therefore, if there is at least a one in three chance that the base case projections would not materialize, either a positive or negative outlook would be assigned.  CariCRIS also compares the client’s current and projected performance against its industry peers as well as benchmarks when determining the rating and the outlook.

Example:

ABC Limited has just acquired a smaller competitor and the post-acquisition has been going smoothly; key management has been retained, brand integration has gone well, and systems integration has been successful, inter alia. ABC Limited’s performance in the last twelve months has increased above its long-term trend as a result.

Revenue and profitability growth are expected to moderate in the medium-term – base case scenario but there is also at least a one in three chance that the stronger growth continues from gained synergies.  This may therefore warrant a positive outlook.

A positive or negative outlook therefore means assumptions used in base case projections have a one in three chance of not materializing.

Rating Watch

In cases where a rating cannot be determined with reasonable certainty, a rating watch can be assigned. A rating watch is suitably assigned when a unique situation occurs where the effect of future events is so uncertain that the rating could either be raised, lowered or re-affirmed. A rating watch typically lasts no more than three months. During this period the outlook and rating are temporarily deferred.