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News

Bermuda 'A plus' Ratings Affirmed On Return Of Real GDP Growth And Improving Fiscal Deficits; Outlook Stable

Industry News

Overview

  • We are affirming our 'A+' long-term sovereign credit and senior unsecured debt ratings on Bermuda.
  • We are also affirming our 'A-1' short-term rating on the territory.
  • The ratings reflect our view of Bermuda's net external creditor status, moderate and improving fiscal deficits and low debt burden, effective and predictable policymaking, high GDP per capita, and lack of monetary flexibility.
  • We are lowering our transfer and convertibility assessment to 'AA+' from 'AAA'.
  • The stable outlook reflects our expectations that real GDP annual growth will be 2% or more in 2016 and 2017, assisting the government in returning to fiscal balance by fiscal year 2017 or 2018.

Rating Action

On April 28, 2016, Standard & Poor's Ratings Services affirmed its 'A+' long-term issuer credit and senior unsecured debt ratings on Bermuda. At the same time, Standard & Poor's affirmed its 'A-1' short-term rating on the territory. The outlook is stable. Standard & Poor's also lowered its transfer and convertibility (T&C) assessment on Bermuda to 'AA+' from 'AAA'. However, this has no effect on the 'A+' rating because the T&C assessment is above the sovereign credit rating.

Rationale

The ratings reflect Bermuda's status as a net external creditor, its moderate and improving fiscal deficits and low debt burden, effective and predictable policymaking, high GDP per capita, and lack of monetary flexibility.

Bermuda's six-year long economic contraction has come to an end. According to our estimates, real GDP increased about 0.4% in 2015 and nominal GDP 3.5%, the highest annual nominal growth rate since 2008. The return of positive real GDP growth ends six years of consecutive annual declines: From 2008 to 2014, real GDP declined 19% and nominal GDP 8%. Nevertheless, until a positive trend is established, our view that economic trend growth is below-average still tempers our assessment. GDP per capita was US$94,700 in 2015, up from US$91,500 the previous year. Labor market results also improved in 2015: The unemployment rate dropped to 7.0% from 9.0%. For 2016 and 2017, we expect real growth of 2.0% and 3.0%, respectively. Growth should come from the construction and tourism sectors. GDP per capita should be about US$98,300, up 4% from 2015. We expect per capita trend growth of about 1% for the 2016-2019 period. However, the international financial services sector dominates Bermuda's economy, which we view as very concentrated.

GDP growth will help the territory return to fiscal balance. Bermuda generated a general government (GG) deficit of 4.0% of GDP in fiscal 2015, which was up slightly from 3.3% the previous year. Deficits have been shrinking since their most recent peak in fiscal 2013. The current and former governments have made some progress toward reducing expenditures: GG spending fell about 3% in the 2015 fiscal. The government is implementing a number of revenue measures in the 2016-2017 budget, including an increase to the payroll tax, a review of "notional" salaries (which applies to professionals and the self-employed primarily), and a broadening of the tax base to include services (2017 or 2018 at the earliest). The government target is to increase revenues by BM$150 million in the 2016-2018 fiscal period. Despite these measures, we still view the government's ability to raise GG revenue is limited by both pressure from competing jurisdictions and domestic political preferences and the need to retain and attract employers and jobs. By our estimates, the GG deficit will be 3.6% of projected GDP in fiscal 2016, falling to 1.8% in fiscal 2017 and 0.2% in fiscal 2018. The change in GG debt will average 1.1% of GDP for 2016-2018 period. The government's large pool of liquid assets (about 40% of GDP) bolsters our fiscal assessment.

Bermuda's gross GG debt stood at 40% of GDP at the end of fiscal 2015, a level we consider low. Owing to substantial GG assets, we estimate the territory to be a net GG creditor, of about 6% of GDP in fiscal 2015. Both gross and net GG debt ratios were almost unchanged from the previous fiscal year. We expect that GG debt will be just below 40% of projected GDP (gross) and negative 9% (net) by fiscal 2018. In our opinion, a low debt level is important in providing fiscal flexibility, because the government can use debt to cushion the impact of unexpected fiscal shocks, such as the 2008-2009 financial crisis. Despite the slow pace of fiscal recovery, we still expect Bermuda to remain a net GG creditor by the end of 2019. Gross interest expense represented 10.9% of GG revenues in fiscal 2015 or about 7% net. We expect GG interest to represent just under 11% of gross projected GG revenues in the 2016-2018 period and about 7% net.

As with all sovereigns, we consider the local banking sector the principal contingent risk to the government. We place Bermuda's banking sector in group '5', on our Banking Industry Country Risk Assessment scale from '1' to '10', '1' being the best. We believe the sector poses a limited contingent liability to the government because certain aspects of the territory's banking sector have a lower risk profile (in total) than in a number of other jurisdictions and the sector remains well-capitalized.

We view Bermuda's external flexibility as very strong. The territory's gross external financing needs are very high, averaging more than 335% of current accounts receivable (CAR) plus useable reserves for the 2016-2018 period. Bermuda's position as a substantial narrow net external creditor (close to 150% of CAR), however, offset high external financing needs. Bermuda consistently records a large trade deficit through its very low merchandise exports and large merchandise imports -- the country depends almost entirely on imported goods. The trade deficit represented about 15% of GDP in 2015. Foreign earnings from financial services and tourism more than offset trade deficits and consistently generate substantial current account surpluses. The current account surplus was 15% of GDP in 2015 and will average 14% of GDP for the 2016-2018 period by our estimates. We view Bermuda's international investment position estimates as incomplete because it does not include the position of Bermudian households, which tempers our assessment of the territory's external flexibility.

We view Bermuda's institutional effectiveness as very strong, overall. The territory's policymaking is largely effective, predictable, and proactive; and its political institutions stable. We believe Bermuda has the ability and willingness to implement reforms to ensure the long-term sustainability of public finances. As in many other British Overseas Territories, the island's constitutional law retains some powers for the U.K., generally exercised through the U.K.-appointed Governor.

Bermuda lacks monetary flexibility. It has a hard peg exchange rate regime. The Bermudian dollar is pegged to U.S. dollar 1-to-1, which effectively cedes monetary policy decisions to the U.S. Federal Reserve. Dollarization is high: 85% of the assets and liabilities of Bermudian banks are denominated in a foreign currency, predominantly in U.S. dollars. Both circumstances mean that external factors beyond the control of local authorities mostly determine Bermudian monetary conditions.

We have revised our T&C assessment of Bermuda to 'AA+' from 'AAA', reflecting the absence of restrictions on access to foreign exchange, requirements for repatriation or surrender of foreign exchange, the island's outward looking economic policies, and our three-notch cap above the foreign currency rating on the territory.

Outlook

The stable outlook reflects our expectation that real GDP annual growth will be 2% or more in 2016 and 2017, which will assist the government in returning to fiscal balance by fiscal year 2017 or 2018. We also expect Bermuda to remain a narrow net external creditor and maintain its large pool of GG assets. Gross GG debt should stabilize at about 40% of projected GDP during our two-year outlook period.

A return to economic contraction that leads to a resumption of large GG deficits and increasing debt and interest burdens or negative banking-sector outcomes could cause us to lower our ratings.

A sustained return to healthy real GDP growth, balanced fiscal results that persist, and declining debt and interest burdens coupled with banking-system stability, might lead to upward pressure on ratings.

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