IMF Executive Board Concludes Article IV Consultation with The Bahamas

The Bahamas depends heavily on tourism and financial services. Executive Directors have commended the strong track record of prudent macroeconomic management, but have encouraged the government to broaden the domestic tax base, reduce distortions, increase the resilience of revenues to shocks, and specify contingency measures to reign in the growth in public debt. Greater transparency will underpin the medium-term fiscal strategy, and a higher international reserve coverage will help reduce vulnerabilities. Measures under way to strengthen the financial system have been commended.

Abstract

The Bahamas depends heavily on tourism and financial services. Executive Directors have commended the strong track record of prudent macroeconomic management, but have encouraged the government to broaden the domestic tax base, reduce distortions, increase the resilience of revenues to shocks, and specify contingency measures to reign in the growth in public debt. Greater transparency will underpin the medium-term fiscal strategy, and a higher international reserve coverage will help reduce vulnerabilities. Measures under way to strengthen the financial system have been commended.

On October 27, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with The Bahamas.9

Background

The global crisis had a profound impact on the Bahamian economy. During 2009, tourist arrivals declined by 10 percent and foreign direct investment fell by over 30 percent, leading to a sharp contraction in domestic activity and an increase in unemployment. The lower demand, together with lower import prices, helped reduce inflation and narrow the external current account deficit to about 12.5 percent of GDP. External borrowing and the one-off Special Drawing Rights (SDR) allocation (US$179 million) more than covered the current account deficit, and gross international reserves increased to about 2.5 months of imports.

The downturn deteriorated the fiscal position. Revenues declined, while the authorities maintained spending broadly in line with the budget (strengthening the social safety net and accelerating investment spending) to mitigate the demand shock. As a result, the central government deficit rose by 0.5 percentage points to 5.3 percent of Gross Domestic Product (GDP) in the fiscal year 2009/10. Central government debt also increased, reaching 47 percent of GDP at end June 2010, about 10 percentage points higher than before the crisis.

Although the sharp fall in activity reduced bank lending and weakened the loan portfolio, the banking system remains well capitalized and there is ample liquidity. Non-performing loans have increased, recently more so from commercial loans, but stress tests conducted by the authorities suggest that the banking system has adequate buffers to withstand a further deterioration, while continuing to comply with capital requirements.

While near-term growth prospects remain weak, the medium-term outlook is somewhat more favorable. Real GDP is projected to grow modestly in 2010, as tourist arrivals rebound, but a return to the trend growth rate of about 2.5 percent is likely by 2012 if global conditions improve. The external current account deficit, which will widen somewhat in 2010 and 2011, is expected to narrow over the medium term, from higher tourism receipts and continued foreign direct investment. Nonetheless, the fiscal outlook is of concern, with the ratio of central government debt to GDP projected to continue rising over the medium term.

Executive Board Assessment

Directors noted that a sharp contraction in domestic activity amidst the global downturn has weakened the fiscal position and banks’ balance sheets. Prudent macroeconomic policies have now laid the foundations of a recovery, but the outlook remains exposed to downside risks. In order to boost economic prospects, Directors encouraged the authorities to build adequate buffers against external shocks and address vulnerabilities in the fiscal domain and in the financial sector.

Directors commended the authorities for their commitment to medium-term fiscal adjustment and their strategy to reverse the recent rise in the public debt-to-GDP ratio. They welcomed the revenue and spending measures adopted in the budget, but considered that contingency measures might be needed to achieve the desired reduction in the fiscal deficit. Directors noted that broader reforms to the tax system and public finance management would also be needed over the medium term to sustain improvements in the fiscal position.

Directors considered that the longstanding peg to the U.S. dollar has provided an appropriate nominal anchor and served the country well. They took note of the staff’s assessment that the current level of the exchange rate is broadly in line with long-term fundamentals. To ensure that the peg remains adequately supported, Directors encouraged the authorities to build up foreign exchange reserves over time as needed.

Directors commended the authorities efforts to strengthen the financial system and their close cooperation with supervisors in other jurisdictions. They welcomed recent enhancements in the oversight of the financial sector and in the legal framework for security markets. Directors considered that rising non-performing loans at banks remain a concern, and that close monitoring is warranted. They also encouraged the authorities to continue strengthening the prudential framework of nonbank institutions.

Directors agreed that far-reaching structural reforms are necessary to lift medium-term growth prospects. They welcomed the authorities’ plans to improve business conditions, including for small and medium-sized enterprises, and to strengthen public infrastructure in a manner consistent with the fiscal consolidation strategy.

Public Information Notices (PINs) form part of the IMF’s efforts to promote transparency of the IMF’s views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

The Bahamas: Selected Economic Indicators

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

Revised national accounts data.

2009 figure based on May survey.

In percent of exports of goods and services. The increase in 2009 reflects repayment of internal forex loan of US$185 million to domestic banks.

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Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.

The Bahamas: 2010 Article IV Consultation-Staff Report; and Public Information Notice on the Executive Board Discussion
Author: International Monetary Fund