The Bahamas
2005 Article IV Consultation-Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for The Bahamas

The Bahamas’s 2005 Article IV Consultation reports that the economic slowdown has contributed to deterioration in the fiscal accounts. The Bahamas is a small, open, and relatively wealthy economy, which is highly dependent on tourism from the United States and offshore financial activities. Offshore financial activities have developed rapidly since the early 1990s and account for roughly 15 percent of GDP. This has reduced the economy’s dependence on the tourism sector, which is focused on the higher end of the U.S. market but still accounts for one-fourth of GDP.

Abstract

The Bahamas’s 2005 Article IV Consultation reports that the economic slowdown has contributed to deterioration in the fiscal accounts. The Bahamas is a small, open, and relatively wealthy economy, which is highly dependent on tourism from the United States and offshore financial activities. Offshore financial activities have developed rapidly since the early 1990s and account for roughly 15 percent of GDP. This has reduced the economy’s dependence on the tourism sector, which is focused on the higher end of the U.S. market but still accounts for one-fourth of GDP.

I. Background and Prospects for 2005

A. A Brief Perspective

1. The Bahamas is a small, open, and relatively wealthy economy, which is highly dependent on tourism from the United States and offshore financial activities. Per capita GDP is US$18,000, and other indicators of social development compare favorably with Caribbean averages (Tables 1 and 2). Offshore financial activities have developed rapidly since the early 1990s and now account for roughly 15 percent of GDP. This has reduced the economy’s dependence on the tourism sector, which is focused on the higher end of the U.S. market but still accounts for a quarter of GDP. However, economic activity remains narrowly based, and options for further diversification appear limited.

Table 1.

The Bahamas: Selected Economic Indicators

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Sources: Central Bank of The Bahamas; Department of Statistics; Ministry of Finance; and Fund staff estimates and projections.

Staff projections assuming active scenario.

Corresponds to the fiscal year ending June 30.

In relation to liabilities to the private sector at the beginning of the year.

Weighted by country of origin of tourists.

Liabilities in local currency, including deposits of public corporations.

In percent of exports of goods and services.

Table 2.

The Bahamas: Social Indicators

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Sources: World Bank, World Development Indicators 2005; UNDP, Human Development Report 2004 (for the human development index, and adult literacy); and Kaufmann, Kraay, and Mastruzzi (2005) (for the control of corruption index).

The set of countries covered depends on data availability for each indicator.

Caribbean average refers to 2002, except for Puerto Rico for which 2001 data are used.

Caribbean average refers to 2003, except for Bermuda for which 2002 data are used.

Caribbean average refers to 2003, except for Cuba for which 2002 data are used.

Caribbean average uses data that ranges from 1998 to 2003. This average does not include Cuba (590); with Cuba in the sample the average is 178. Without St. Lucia (518), the average drops to 70.

Caribbean average refers to 2002, except for Aruba, Jamaica, and Suriname for which 2001 data are used, and for Guyana for which 1999 data are used.

Caribbean average refers to 2002, except for Aruba, Guyana, Jamaica, and Suriname for which 2001 data are used.

The control of corruption index measures perceptions of corruption, where corruption is the exercise of public power for private gain. The control of corruption index score reflects the statistical compilation of responses on the control of corruption given by a large number of enterprise, citizen, and expert survey respondents, as reported by survey institutes, think-tanks, non-governmental organizations, and international organizations. The index ranges, with 99 percent probability, between -2.5 (high perceived corruption) to 2.5 (low perceived corruption). For The Bahamas, the index uses two sources.

2. The economy’s external dependence contributed to a marked weakening of the macroeconomic situation in 2001–02. Following average annual growth of 4½ percent during 1996-2000, real GDP growth slowed to an average of about 1 percent in the following two years, owing to the U.S. recession and the impact of the September 2001 terrorist attacks on tourism. However, with the exchange rate pegged to the U.S. dollar, annual inflation remained low at around 2 percent.

Sources of Growth

(Contribution to GDP growth, in percentage points)

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Sources: The Bahamas Department of Statistics; and Fund staff calculations.

3. The economic slowdown also contributed to a deterioration in the fiscal accounts (Table 3). A boom in tax revenue and expenditure restraint lowered the central government deficit to ½ percent of GDP by FY 2000/01, but the deficit widened to 3¼ percent of GDP in FY 2001/02 and 3½ percent of GDP in FY 2002/03, taking central government debt to 37 percent of GDP (Table 5).1 Two thirds of the deterioration reflected the effects of lower imports and reduced stopover visitors on tax collections, and the remainder was the result of increased current outlays, especially following a wage contract that provided for a substantial increase in 1999 and escalators during 2001–04. Although deficits were almost fully financed by domestic banks, roughly half the bank financing involved U.S. dollar loans from the offshore books of foreign banks, which contributed to a large increase in the net foreign liabilities of the banking system.

Table 3.

The Bahamas: Operations of the Central Government 1/

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Sources: Ministry of Finance; and Fund staff estimates and projections.

Fiscal year begins July 1.

As presented in the Budget Communication May 2005.

Includes receipt of past due import taxes from The Bahamas Electricity company (0.8 percent of GDP) and payment. of previous years’ utility bills (current goods and services, 0.8 percent of GDP).

Includes in FY 2004/05 tax arrears from the sale of the Hotel Corporation equivalent to 0.3 percent of GDP.

Reclassifies central government transfers to the Public Hospitals Authority (PHA), College of The Bahamas, the Public Utilities Commission, and the Ministry of Tourism in wages and purchases of goods and services.

Table 4.

The Bahamas: Operations of Nonfinancial Public Corporations 1/

(In percent of GDP)

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Sources: Ministry of Finance; public corporations; National Insurance Board; and Fund staff estimates and projections.

Staff projections, assuming active scenario.

BTC, Bahamas Electricity, Water and Sewerage, Bahamasair, and Broadcasting Corporation.

Difference between the balance measured from financing data and the balance measured from above the line.

Balance measured from financing data.

Table 5.

The Bahamas: Public Debt

(In percent of GDP)

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Source: Central Bank of The Bahamas.

Staff projections, assuming active scenario.

Debt of The Bahamas Mortgage Corporation and The Bahamas Development Bank, included in the total debt of the public sector.

Table 6.

The Bahamas: Selected Indicators of Tourism

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Sources: Caribbean Tourism Statistical Report, 2002—03, Caribbean Tourism Organization (CTO); and Ministry of Tourism.

For Cancun, Cozumel, and Puerto Rico, data for 2004 concern nonresident hotel registrations only.

Includes Cancun and Cozumel (Mexico).

Commonwealth Caribbean countries and U.S. territories.

Stayover arrivals as estimated by World Tourism Organization.

4. The authorities used credit controls to alleviate pressures on international reserves and the exchange rate. The Bahamas maintains significant restrictions on capital flows and supplements these with direct instruments to control liquidity, including credit ceilings and moral suasion, with interest rates having a secondary role in policymaking. Accordingly, as net international reserves (NIR) declined in the third quarter of 2001 by US$60 million to US$300 million (77 percent of base money) and the peg appeared under threat, the central bank introduced in September a bank-by-bank freeze on domestic currency credit to the private sector. This action helped reverse the decline in NIR in 2002 by restraining household sector demand, which is import-intensive.

B. Recent Developments

5. The Progressive Liberal Party enjoys a strong majority in Parliament. The government’s popularity has been strengthened by the launch of several large-scale tourism projects; general elections are due by August 2007.

6. Economic activity recovered in 2003–04 (Figure 1). Real GDP growth increased to 2 percent in 2003, owing to a rapid pick-up in financial and other services that offset continued weakness in tourism, and reached 3 percent in 2004 as the tourism sector began to turn around. Despite two hurricanes in September 2004, spending by tourists increased by over 6 percent in real terms in 2004, boosted by a continued rapid growth of cruise ship visitors.2 The upturn in economic activity also contributed to a decline in the unemployment rate, to just over 10 percent in 2004.

Figure 1.
Figure 1.

The Bahamas: Developments in the Real Sector

Growth is picking up and tourist arrivals are recovering…

Citation: IMF Staff Country Reports 2005, 223; 10.5089/9781451804713.002.A001

uA01fig01a

…the recovery has been mainly in cruise rather than stayover arrivals…

Citation: IMF Staff Country Reports 2005, 223; 10.5089/9781451804713.002.A001

A01fig01b

¨but stopover visitors spend much more than cruise visitors.

Citation: IMF Staff Country Reports 2005, 223; 10.5089/9781451804713.002.A001

Source: Caribbean Tourism Organization; Ministry of Tourism; and Fund staff estimates.
uA01fig01

The Bahamas’ share of tourism expenditure has risen, at least through 2002, despite a declining share of stopover arrivals.

Citation: IMF Staff Country Reports 2005, 223; 10.5089/9781451804713.002.A001

7. A depreciation of the real effective exchange rate vis-à-vis regional competitors in 2004 suggests an improvement in The Bahamas’ competitiveness (Figure 2).3 However, while the share of Caribbean tourism expenditure rose during 1998–2002, this trend may not have continued in 2003–04, judging by stopover arrivals.

Figure 2.
Figure 2.

The Bahamas: Real Effective Exchange Rates

Citation: IMF Staff Country Reports 2005, 223; 10.5089/9781451804713.002.A001

Source: Fund staff estimates.1/ Weighted by country of origin of tourists (Argentina, Belgium, Brazil, Canada, France, Germany, Italy, Japan, The Netherlands, Spain, Sweden, Switzerland, United Kingtom, United States, and Venezuela).2/ Weighted by share of main competitors in the Caribbean tourism market (Antigua and Barbuda, Barbados, Belize, Dominica, Dominican Republic, Grenada, Guyana, Jamaica, Mexico, Netherlands Antilles, St. Lucia, St. Vincent and The Grenadines, and Trinidad and Tobago).

8. Fiscal performance fell short of budget objectives. Although current outlays on nonwage goods and services and capital expenditure were contained, the fiscal deficit remained above 3 percent of GDP during FY 2003/04 (see Table 3 and Figure 3), compared with the authorities’ target of 2¼ percent of GDP. Tax revenues were depressed, partly as a result of tariff exemptions aimed at stimulating the construction and tourism sectors, and public sector wages rose in line with the escalators established under the 1999 wage agreement.

Figure 3.
Figure 3.

The Bahamas: Fiscal Developments

(In percent of GDP) 1/ Fiscal revenues have fallen markedly as import taxes decreased…

Citation: IMF Staff Country Reports 2005, 223; 10.5089/9781451804713.002.A001

A01fig3a

…while current expenditures remained high under the legacy of the wage agreement signed in 1999 and the wage drift …

Citation: IMF Staff Country Reports 2005, 223; 10.5089/9781451804713.002.A001

A01fig3b

…leading to a sizable fiscal deficit…

Citation: IMF Staff Country Reports 2005, 223; 10.5089/9781451804713.002.A001

A01fig3c

…and a marked increase in the debt-to-GDP ratio.

Citation: IMF Staff Country Reports 2005, 223; 10.5089/9781451804713.002.A001

Source: The Central Bank of the Bahamas; and Fund staff estimates and projections.1/ Central government; fiscal year ending June 30.

9. The government deficit is estimated to have narrowed to 2½ percent of GDP in 2004/05, slightly better than the budget projection. About two thirds of the reduction in the primary deficit of 0.6 percentage point of GDP was attributable to one-time factors, namely, the settlement of tax arrears by a hotel being sold to a large developer and grants for post-hurricane repairs (0.3 percent and 0.1 percent of GDP, respectively). Revenues were boosted by a rapid growth in property tax and stamp tax collections in response to strengthened enforcement efforts. Budget reallocations made room for post-hurricane repairs while keeping outlays within budget limits, and total expenditure remained stable in relation to GDP. Although a new public sector wage agreement had not yet been reached, real wages continued to rise, owing to wage drift, resulting in a cumulative rise in real wages of 23 percent since 1998/99.

10. The increase in public sector debt since 2000 has tended to reflect the rising central government debt (Figure 4 and Table 5). The debt of the rest of the public sector has remained stable at around 10 percent of GDP since the mid-1990s. However, total public sector debt in relation to GDP, at 46 percent at end-2004, was essentially unchanged from the year before, as a modest decline in public enterprise debt—whose balance shifted into surplus, in response to lower capital expenditure—offset an increase in central government debt.

Figure 4.
Figure 4.

The Bahamas: Public and Central Government Debt, 1992–2005

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 223; 10.5089/9781451804713.002.A001

Sources: Minister of Finance; and Fund staff estimates and projections.
uA01fig02

Central Government Real Wages

Citation: IMF Staff Country Reports 2005, 223; 10.5089/9781451804713.002.A001

Source: Ministry of Finance.

11. The balance of payments strengthened markedly in 2004, and net international reserves (NIR) rose substantially (Table 7). The trade deficit widened, largely owing to the higher oil import bill, but this was offset by an expansion of tourism receipts and reinsurance-related inflows following the hurricanes that hit The Bahamas in September. As a result, the current account deficit narrowed to 5½ percent of GDP, from 8 percent in 2003. Coupled with an increase in direct investment, which boosted the financial account surplus, NIR—already buoyed by a government bond issue in 2003—rose further in 2004, reaching 105 percent of base money at end-2004.

Table 7.

The Bahamas: Balance of Payments

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Sources: Central Bank; Department of Statistics; and Fund staff estimates and projections.

Staff projections, assuming active scenario.

12. The central bank responded to the strengthening of net international reserves by relaxing credit controls in August 2004. The bank-by-bank credit freeze—which had been introduced in 2001—was lifted, and was replaced by prudential guidelines for consumer loans and mortgages that were designed to contain the growth of household debt. Bank credit to the private sector grew by only 6 percent in 2004, after having stagnated during 2003, and credit growth remained subdued in first quarter of 2005, suggesting the lack of pent-up demand for credit by the private sector. Net international reserves have also continued to strengthen, reaching 117 percent of base money at end-March 2005.

13. High and persistent excess bank liquidity has led interest rates to fall. Domestic interest rates have tended to move independently from international interest rates, reflecting the autonomy gained from capital controls, and their recent decline contrasts with the firming of international rates. However, bank liquidity rose sharply in late 2004 and early 2005, with excess bank reserves reaching the equivalent of 6 percent of M3 at end-March 2005; consequently, the interest rate on treasury bills fell to close to nil, and commercial bank deposit and lending rates and the intermediation margin fell (Figures 5 and 6). A reduction in the central bank discount rate of 50 basis points in February 2005 consolidated this trend by leading commercial banks to lower the prime lending rate by an equivalent amount, to 5.5 percent.

Figure 5.
Figure 5.

The Bahamas: Bank Credit, Liquidity and International Reserves, 1999-2005 1/

Citation: IMF Staff Country Reports 2005, 223; 10.5089/9781451804713.002.A001

Source: Central Bank of The Bahamas.1/ Broad money in this figure includes deposits of public agencies.2/ Net international reserves of the central bank.3/ Cash-in-vault and deposits at the central bank.
Figure 6.
Figure 6.

The Bahamas: Selected Interest Rates, and Bank Liquidity 1999–2004

(Quarterly average; in percent per annum)

Citation: IMF Staff Country Reports 2005, 223; 10.5089/9781451804713.002.A001

Sources: Central Bank of The Bahamas.1/ Lending rate less deposit rate.2/ In percent, end-of-period.

14. The regulation and supervision of the domestic and offshore financial sectors have strengthened over the last two years. The Module 2 assessment of the offshore financial center (OFC) report was generally favorable, including with regard to compliance with the Basel core principles for bank supervision.4 Steps were taken in 2003–04 to implement the report’s recommendations, including the closure by mid-2004 of all banks without a meaningful physical presence, and an ongoing study of how best to consolidate regulatory functions. Anti-money laundering legislation was reconciled with current best international practices; processes were streamlined; and legislation prohibiting the financing of terrorism was approved in December 2004. Bank soundness indicators improved somewhat in 2004, as nonperforming loans fell to just under 5 percent and provisioning increased (Tables 8 and 9).

Table 8.

The Bahamas: Summary Accounts of the Central Bank and the Financial System

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Sources: Central Bank of The Bahamas; and Fund staff estimates and projections.

Staff projections, assuming active scenario.

Table 9.

The Bahamas: Commercial Bank Performance Indicators, 2000-04

(In percent at end-period, unless otherwise noted)

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Source: Central Bank of The Bahamas.
Table 10.

The Bahamas: Indicators of External and Financial Vulnerability

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Sources: Central Bank of The Bahamas; and Fund staff estimates and projections.

Staff projections, assuming active scenario.

Includes errors and omissions.

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