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Why island nations are less likely to default

Islands enjoy higher credit ratings and richer and more open economies than their landlocked counterparts, Standard & Poor's (S&P) said on Thursday.

Thirty-one of the 131 sovereigns rated by the ratings agency are islands and have a median rating of "BBB+", trumping "BB+" for those nations attached to a mainland.

Bermuda's GDP per capita is over $93,000.
Photo: Michael Turek | Getty Images
Bermuda's GDP per capita is over $93,000.

"Throughout the centuries, islands have benefited economically from their openness to trade — increasingly in services —with the rest of the world," S&P credit analyst, Frank Gill, said in a report forwarded on Thursday.

"But with trade populism and fiscal nationalism on the rise globally, external currents may yet again become treacherous, perhaps causing another island storm."

Island facts

  • S&P rates 31 island states
  • Populations range from 4,900 for Montserrat to 250 million for Indonesia
  • Four island states are rated AAA — Australia, Hong Kong, Singapore and the U.K.
  • Per capita GDP ranges from $2,400 for Papua New Guinea to over $93,000 for Bermuda
  • The average island is rated BBB+ by S&P versus BB+ for other sovereigns

The islands covered by S&P have median per capita gross domestic product (GDP) — a measure that adjusts economic output for the size of a population — of $23,000, or 2.7 times that of rated non-islands.

S&P said that islands' higher ratings reflected strong institutional frameworks as well as high wealth. In addition, island economies have generally adjusted more quickly to globalization and are almost twice as likely as mainland countries to be part of free trade areas that also guarantee free movement of labor.

Shortcomings

The average island economy is only one-fifth the size of a mainland state, making them vulnerable to overreliance on a particular industry. Notably, a bankruptcy filing of a single mega-resort in the Bahamas weighed enough on its economy to result in a negative sovereign credit outlook from S&P.

Heavy reliance on tourism can prove doubly problematic in regions vulnerable to climate change.

"Coral bleaching, which reflects rising sea temperatures, appears to be causing a decline in fishing activity in the South Pacific, including in the Fiji islands. Temperature changes are also leading to a redistribution of tuna resources out of islands in the Pacific into higher latitudes, with serious economic consequences," Gill said.

Due to their typically small size, islands may also be more vulnerable from a military or geopolitical perspective. The island of Cyprus, for instance, remains divided, although reunification could generate extra GDP growth.

Cyprus, harbor at Kyrenia.
Steve Allen | The Image Bank | Getty Images
Cyprus, harbor at Kyrenia.

Tax havens

S&P said that smaller island sovereigns were generally more willing to promote their competitiveness by lowering tax rates to below mainland countries.

"Islands generally offer lower corporate income tax rates, and significant exemptions for intellectual property rights, on top of low withholding taxes and generous tax deductibility on depreciation of fixed assets. In most cases, islands, especially financial centers, have negotiated bilateral double taxation agreements with important trading partners. This has been one of the attractions for large FDI (foreign direct investment) as well as other capital inflows into Aruba, The Bahamas, Barbados, Cape Verde, Fiji, and Ireland," Gill said.

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