Caribbean Offshore Financial Centres: Resilient Onshore Economies

Academics and practitioners have long investigated the extent to which residents of small island offshore financial centres (OFCs) receive benefit from hosting offshore business activity. The economic benefit of an offshore sector with predominantly brass plate companies is typically restricted to the government revenue earned from any licencing fees rendered. However, offshore centres that engender a real physical presence of international businesses afford significant economic benefits that extend beyond additional government receipts. Research has showed that even when offshore businesses are legally and operationally separated from local commercial activity, host jurisdictions demonstrate more financially developed domestic financial sectors, greater access to capital, and enhanced employment, all contributing to long-term economic development.

The Offshore-Onshore Relationship

Despite offshore businesses often having minimal physical presence and operating solely to supply goods and services to non-residents, depth in domestic commerce in host jurisdictions and solid onshore economic fundamentals are important for attracting international capital, creating wealth, and managing macroeconomic risks. A symbiotic relationship between the local and offshore economic sectors is evident when examining the performance of multinational companies with presence in both international financial centres and non-offshore jurisdictions.[1] Economically sound OFCs help to increase corporate revenues and improve the efficiency of production of multinational corporations. Further, establishing an affiliate in an international financial centre with strong economic fundamentals is associated with greater sales and investment of affiliates located in non-OFC jurisdictions. [2] 

Even further, close geographic proximity to an economically sound OFC has positive spill-over effects on business activity in neighbouring jurisdictions.[3] In fact, offshore banking influences the financial environment in neighbouring countries by increasing their financial depth, competitiveness, and sophistication. These spatial relationships dissipate the further away an OFC is from non-OFC territories.

Recent Economic Developments

It is the case that growth in international financial activity will be enhanced when domiciled in jurisdictions with strong domestic economic fundamentals. The resilience of Caribbean economies and the strength in underlying fundamentals is evident in their post-Covid economic recovery and performance through the subsequent global monetary policy tightening. In March 2020, when Covid-19 was declared a global pandemic, the restriction in cross-border trade and travel caused global real GDP to decline on average by 3.5 per cent in 2020. The Caribbean was among the hardest hit economically, with a decline in real GDP twice that of the global average due to its high tourism dependency. As small open economies that are heavily dependent on trade, restrictions associated with the pandemic brought about a significant fall in aggregate demand, and declines in the trade of both goods and services. Restrictions on global supply, a war in Ukraine, and spiking food and energy prices resulted in inflation reaching as high as 12 per cent in some countries. Inflation targeting jurisdictions within the Caribbean undertook one of the earliest and most aggressive response to spiking inflation.

However, with the reopening of trade and travel, the economic recovery of the Caribbean has been among the strongest globally. The region has benefitted from a recovery in tourism, as arrivals and spend across most jurisdictions has showed significant growth to date. Broad economic growth has led to a general improvement in labour markets in the region via increased employment.

An Economic Outlook For Caribbean OFCs

Economic activity in much of the Caribbean is still largely concentrated, dependent on tourism, energy or financial services. Global economic growth is expected to be modest over the next 12 to 36 months. This reflects a normalisation from the burst in activity stemming from the post-Covid reopening and spend associated with pent-up consumer demand. Future domestic economic developments will largely be dependent on global liquidity conditions and global demand for services from the region, and to a lesser extent, the global demand for specific goods such as minerals, oil and gas.

The lagged impact of significantly higher consumer prices, a slower increase in personal and business income, and increased borrowing costs, will continue to pass through to economic activity, possibly reducing consumer spending and investment for the next 12 to 18 months. Therefore, despite continued positive global economic growth, external demand is expected to slow as pent-up consumption dissipates and excess savings decline.

The post-Covid inflation spike was met with globally synchronised monetary policy tightening. Despite inflation beginning to normalise within the region, it is expected that monetary policy normalisation will be slow, and set to target only a neutral monetary policy position. Further, the timing of the policy normalisation will be less synchronised globally. As a result, it is expected that short-term interest rates in the Caribbean will change little in the remainder of 2024, with more noticeable decline in 2025.

Government operations across the region generally reflect fiscal deficit positions. The prominence of fixed-rate financing delayed the impact of the higher global interest rate environment. New financing efforts at currently higher rates will create increased dependency on domestic and external support. Notwithstanding, fiscal policy frameworks across the region will continue to be enhanced and strengthened with the support of international multilateral agencies. Hence, broad stability of sovereign credit ratings is expected.

Against the backdrop of lower consumer demand and a steady recovery in global supply, the efforts of policy authorities to reduce inflation have been effective. However, upside risks to regional inflation do persist. Current price trends could easily be influenced by a number of global and local factors. These include:

1. Geopolitical issues resulting in spikes to food and/or energy prices.
2. Fiscal policy in some industrialised nations becoming more protectionist in nature through additional tariffs on import items.
3. Serious or recurring natural environmental events within the region.

The impending effects could include cost pressures on businesses’ performance and a faster than expected shift in consumption away from non-essential spending. Tight global financial conditions created scarcity in international capital inflow to the region. Trade deficits in many jurisdictions continue to widen while foreign direct investment has declined. The outlook is also dependent on the speed of return in larger sums of foreign direct investment and portfolio capital inflows.

Even further, the cumulative effects of higher domestic interest rates and reduced disposable income could significantly dampen the consumption multiplier effect in Caribbean OFCs. These cumulative effects could create stronger than expected contractionary impacts on domestic demand, particularly if there are one-off systemic shocks such as natural disasters or volatilities in global financial markets.

Final Thoughts

The hosting of an offshore financial centre is a competitive market. As competing host jurisdictions continue to use the Caribbean OFC structures as a blueprint for their own development, it is essential for Caribbean OFCs to continue offering competitive advantages beyond cost minimisation, as future growth will depend on more than competitive deregulation. Growth in Caribbean OFC activity will still depend on strong local institutions and a solid reputation.[4] Further, the sector needs to be one of increasing function requiring technical competencies for increasing employment in host jurisdictions. Future growth will also be dependent on the continuous enhancement of legislation and collaboration between regulators and international standard setting bodies.

[1] Dharmapala, D. (2008). What problems and opportunities are created by tax havens? Oxford Review of Economic Policy, 24(4), 661-679.

[2] Desai, M., Foley, C., and Hines, J. (2005). Foreign direct investment and the domestic capital stock. American Economic Review, 95(2), 33-38.

[3] Rose, A., and Spiegel, M. (2006). Offshore financial centers: Parasites or symbionts? (NBER Working Papers No. 12044).

[4] Hudson, A. (1998). Placing trust, trusting place: on the social construction of offshore financial centers. Political Geography, 17 (8), 915-937.

Leo-Rey Gordon
Leo-Rey Gordon is a financial economist and is Head of Economic and Financial Research and Analysis at the National Commercial Bank Jamaica Limited (NCBJ). NCBJ is a subsidiary of the NCB Financial Group, the largest financial services group in Jamaica, with wealth management, life and general insurance, and banking subsidiaries throughout the Caribbean. In his role he provides regional macroeconomic forecasts and supports asset and liability management within the group. Prior to his role at NCBJ, he was a central banker as Head of Macroprudential Policy at the Bank of Jamaica. He has also had an academic career as an Assistant Professor at Wilmington University in the USA. His research focused on banking and economic development with research published in the Journal of Financial Regulation and Compliance, The Banking and Finance Review, and World Development. Leo-Rey Gordon holds PhD and Master’s degrees in economics from the University of Delaware, USA and a Bachelor’s Degree in Mathematics from the University of the Wes Indies, Jamaica. He also holds Financial Risk Management designation from the Global Association of Risk Professionals.