Indications of moderate growth but budget troubles may boil over

A review of 2012 gives some hope for an economic recovery this year. But despite modest economic growth, driven by a more buoyant tourism sector and resurging construction activity, the picture in the financial services sector remains mixed. Meanwhile the budget woes of the Cayman Islands government and its appetite for further fee increases pose a real threat to the competitiveness of many businesses. 

 

If last year’s culmination of government financial troubles in an ill-conceived expat tax proposal is an indicator, Cayman will face difficult decisions in the next budget year irrespective of the outcome of the general election in May.  

The 2012/2013 budget relies on a 20 per cent increase in government revenues. Most of the revenue growth will have to come from fee increases in the financial services sector, but government’s ability to collect is far from a sure bet. Very little in the financial services statistics of 2012 points to considerable growth of the sector this year.  

 

Economy 

The number of registered banks, class A insurers and companies continued to decline and fund numbers have also dropped if the newly required registration of master funds is not taken into consideration. Only new partnership registrations, private equity and Eurobond listings on the Cayman Islands Stock Exchange and, to a lesser extent, captive insurers showed positive signs of growth by the third quarter last year. 

As a result, the Cayman Islands economy grew modestly in 2012. The estimated growth of 0.8 per cent and 1.2 per cent in the first two quarters of 2012 was more sluggish than expected and led the government to revise the macroeconomic outlook for the entire year 2012 downward from 1.8 per cent to 1.4 per cent. This may still be optimistic as in 2011 economic growth slowed in the second half of the year. 

Yet overall GDP growth should have improved on 2011, when the economy grew by 1.1 per cent, following a 3.4 per cent contraction in 2010. Most of last year’s growth was driven by a resurging construction industry, transportation and tourism, rather than the financial sector, according to the Economics and Statistics Office report for the first half on 2012.  

Cayman’s tourism industry was a main contributor to the economy with a 4.8 per cent increase in the number of total visitor arrivals, as air arrivals grew by 3.5 per cent and the number of cruise passengers increased by 5.1 per cent despite the number of cruise ships visiting Cayman’s port dropping from 323 to 309. 

For this year many of Cayman’s hotels are reporting advance bookings ahead of last year and a return of industry metrics, such as revenue per available room and average daily rates, to pre-recession levels. The threat to further improvement comes mainly from prevailing economic conditions in key markets, especially North America. 

Cayman’s economy also benefitted from a pick-up in construction activity in 2012. In the commercial construction space, 94 Solaris Avenue building in Camana Bay, Willow House in Cricket Square and the Appleby Tower on Fort Street were completed last year. A large distribution centre for Foster’s Food Fair IGA, the Clifton Hunter High School and the extension of the Esterley Tibbetts Highway were other large scale construction projects. 

Construction activity of condominiums also continued in 2012, for example with WaterColours on Seven Mile Beach, and Oceana and Casa Luna in South Sound. In addition, a number of hotels underwent extensive refurbishments.  

The For Cayman Investment Alliance between the government and Dart alone has the potential to lift Cayman’s economy in the near future with the extension of the Esterley Tibbetts Highway, the development of the former Courtyard Marriott and the closure and remediation of the landfill, which would be followed by the expansion of the residential component of Camana Bay. Dart is already revamping the Cayman Islands Yacht Club and marina facilities. 

The groundbreaking of the Health City Cayman Islands project is another potential driver for Cayman’s economy, not only with regard to the impact of the construction itself but also the emergence of a new medical tourism sector.  

Moreover, Cayman Enterprise City has welcomed the first special economic zone companies and plans the construction of a physical campus once it has signed up a critical mass of tenants.  

 

Population 

An important factor contributing to Cayman’s economy is the size of the working population and the first half of 2012 saw a 1.2 per cent increase in the number of work permits to 20,158. This compared to a 7.5 per cent decline during the same period a year earlier. Cayman’s foreign working population, particularly important for the rental market, has thus returned to growth after work permit numbers bottomed out at just over 19,000 in the fourth quarter of 2011. 

 

Budget 

This trend was, however, significantly threatened last year when government proposed the introduction of a “community enhancement fee” for expatriates, a de facto direct tax on the payroll of foreign workers.  

Although the plans were abandoned, government now relies on revenue coming from a range of measures that include higher bank and trust licence fees, increased work permit fees for permits costing more than $1,000 per year, an increase in the tourist accommodation tax from 10 per cent to 13 per cent, an increase in the departure tax of $10 per person and across-the-board increases on stamp duty charged on land transfers. Most property purchasers will now pay a higher 7.5 per cent stamp duty rate.  

Other new fees included master fund registration fees, a new licensing system for fund and corporate directors, traffic “regulatory fees”, additional fees on exempted limited partnerships and a luxury tax on non-commercial boats. A number of other fees and licensing charges were planned to be assessed to the local financial services industry.  

Although less toxic than the initial plans for a direct tax, which according to many in the business community would have destroyed the economic model of the Cayman Islands, the consecutive rounds of fee increases, needed to balance the government budget, represent a significant challenge to business operations in Cayman. 

The current budget needs to see a massive 20 per cent increase in government revenues to match planned expenditures. Should revenues fall short or should expenditures increase more than planned, the framework for fiscal responsibility that was passed into law late in 2012, will leave little room for new measures that are not painful.  

The business community has for some time demanded more radical cuts to government expenditures. Government in turn claimed in its Strategic Policy Statement it has been able to reduce the number of employees in the civil service by 5.5 per cent over the past three years, referring to a reduction of 250 employees between 2008 and 2011. 

“A more aggressive reduction was not pursued as the private sector simply did not have the capacity to absorb any sudden influx of workers transitioning from the public sector. With Caymanians representing close to 75 per cent of public sector workers, the result would simply be a transfer from the annual ‘emoluments bill’ to the annual ‘social assistance bill’,” the policy statement said. 

However, by June 2012 the number of civil servants had increased again slightly by 0.6 per cent. Meanwhile statutory authorities and government companies employed more staff in 2012 (2,264) than prior to the financial crisis in 2007/08 (2,220). For 2012/13 the number is expected to increase further to 2,283, according to the government ownership agreements.  

As part of the current budget, the civil service did agree to cost-reduction measures totalling $10 million, including a 3.2 per cent pay cut, and committed to reduce the civil service headcount by 360 during a period of five years. About 145 positions already left unfilled in 2012/13 will count toward that figure. In addition a moratorium on new hires continues and a pay freeze was instituted for the budget year.  

Whether these cost cutting measures can be effectively implemented and whether they are sufficient remains to be seen. More importantly, it is not clear if another round of fee increases, should it be required, will bring in additional revenue or instead result in a decline of business activity, leading to a further deterioration of government finances. 

 

Immigration 

Another important issue for Cayman businesses in 2013 will be immigration reform. In September 2011, former Premier McKeeva Bush announced he would ask Cabinet to suspend the term limits in place for most foreign workers for up to two years to allow for a comprehensive review of the law and its effects since being introduced in 2004. 

A review committee, which completed its report in June 2012, recommended keeping a term limit on foreign nationals, but extending that term limit to 10 years and allowing any foreigner who stayed continuously past seven years the opportunity to apply for permanent residency before their eighth year.  

Both the government and the opposition have indicated Cayman’s term limit policy is in need of reform and both seemed to support a plan of easing the current regime in some way, but no decision was made last year.  

The two year suspension of the rollover will expire in October 2013. During that time about 5,000 foreign workers will have faced the end of their term limit. This means 5,000 workers who have committed seven years of their lives to the Cayman Islands and are very much integrated into its community and economy will have to leave or will have already left.  

For many a decision about immigration reform will come too late. By June 2012 only 23.6 per cent of foreign workers who could have applied for a term limit exemption permit had received one, at an approval rate of 90.6 per cent. If the trend continues between 1,000 and 2,000 foreign workers will face the end of their term limit exemption permit by October 2013. An even larger number will have already left. 

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