Nathan Kowalski, Financial Ramblings from the Rock

Bermuda first-quarter real gross domestic product, as officially reported, climbed 3.7 per cent to $1,339.5 million. The biggest contributor to the acceleration was gross capital formation otherwise known as “investment” which produced a $30.9 million gain.

Shortly after this release we heard several incredulous comments and disparaging remarks. The most common refrain was: “If you strip out the ongoing hospitality projects, Belco, and the airport construction the GDP would look horrible!” So that is what we have attempted to do.

We were unable to get detailed specifics on certain projects, so we have opted to represent this as a more “average” first quarter for investment based on 13 years of first-quarter data. This is by no means 100 per cent accurate but does attempt to revise GDP by removing the larger change in capital investments for the quarter.

In doing so, we have adjusted investment and imported services and goods to average. Imported goods grew 10.7 per cent due “mostly to imports of machinery, fuel and finished equipment” while payments for imported services rose 1.3 per cent due to “construction/engineering services”. The original release and adjustments can be shown in the table shown.

A few points and highlights to consider:

1, By adjusting gross capital formation to a more “normal Q1” and adjusting the associated imported goods and services, GDP would still have grown 1.8 per cent. This is still a fairly strong number as Q1 historic data has exhibited average gains of about 1.1 per cent.

2, Although the gain in investment was a significant amount of the 3.7 per cent increase, end demand seems to be stable. Household final consumption was still positive at 0.5 per cent even if it was slightly weaker than average.

3, International business also looks healthy with a gain of 5 per cent (0.6 per cent better than average) coming from the export of services. IB income may have rebounded after bonuses were impacted by significant storm-related losses in the prior year.

4, A large part of the gain is also due to weaker numbers posted in Q1 2018 overall. If one recalls, Q1 2018 GDP was negative to the tune of 1.4 per cent. Gross capital formation actually fell 11.5 per cent in that prior quarter with machinery and equipment having plummeted 21.4 per cent. Even consumption was down 0.6 per cent. Thus, given our longer-term real GDP forecast of approximately zero for Bermuda, we would not be surprised to see continued oscillations around 0 per cent as a slightly weak quarter is followed by a slightly stronger quarter.

In conclusion, the latest GDP number seems to have been flattered by a weak comparison and some surge in investment, but is not significantly out of line when more normalised historic context is considered. We would not get excessively despondent or excited by the recent GDP release and would continue to focus more on employment figures and the government fiscal situation, which will contain more meaningful data points to indicate the delta of Bermuda’s trajectory.

Government surplus?

The Government is running a surplus ….

We can already hear disbelief and shock. It is true according to data released for the trailing 12-month period up to the second quarter of 2019. The Government began running a primary budget surplus in September 2018, and now it is running an overall budget surplus — which includes the cost of servicing the debt — of $1.7 million. The second quarter is the second time on a trailing 12-month basis that this has happened since the quarter ended March 2007 — the first being Q1 of 2019 (see graph).

The contributions to this change may also be surprising. It is both spending decreases and tax hikes that have led to the surplus. Government expenditures over the trailing 12-month period have fallen 4.2 per cent and revenues have jumped 9.9 per cent.

The biggest contributor to revenues appears to be from land tax which has jumped 25.5 per cent, or $14.9 million, and payroll taxes, which have climbed 3.2 per cent or $14.6 million.

While government wages and salaries and other personnel costs continue to climb, capital expenditures have been curtailed by some $25.8 million, or 31 per cent, over the last 12 months.

Unfortunately, these figures will be impacted by the potential $200 million additional debt from the Caroline Bay guarantee. We estimate that this debt will cost taxpayers approximately $6 million per year if the Government refinances with bonds near current interest rates.

The good news is the existing debt can be refinanced at lower interest rates in the current market. For example, the ten-year Bermuda Government bond issued in November last year with a coupon of 4.75 per cent now yields only 3 per cent. If US rates remain depressed the interest savings should help to offset a portion of the additional Caroline Bay debt.

With the Government’s fiscal position continuing to improve, we hope and strongly suggest they avoid any measures to raise taxes further. In fact, it would be far more beneficial for Bermuda and economic growth generally if they began considering tax breaks — especially for employers with a form of payroll tax reform.

This is a crucial part needed to encourage further employment on the island, which we believe is the paramount economic factor that will drive Bermuda’s economic wellbeing and trajectory.

Lowering the cost of doing business is essential for Bermuda’s future success — in fact it is likely the most important factor. Efforts should be made to focus almost exclusively on this.

Any policies that increase cost or potentially increase cost should be viewed as non-starters and a potential contributor to the island’s chances of economic failure. A sober assessment of the true state of the economy and its weakness is necessary and goes beyond any political gamesmanship.

• Nathan Kowalski CPA, CA, CFA, CIM, FCSI is the chief financial officer of Anchor Investment Management Ltd. and can be contacted at nkowalski@anchor.bm

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