The Bahamas: Staff Report for the 2018 Article IV Consultation
Author: International Monetary Fund. Western Hemisphere Dept.
Publication Date:
14 May 2018
eISBN:
9781484355084
Language:
English
Keywords:
ISCR; CR; central bank; cart AC; consumer price index; deficit; GDP; current account; Bahamian authorities; broad money; credit bureau; financial system
Download PDF (1.4 MB)

2018 Article IV Consultation-Press Release and Staff Report

Abstract

2018 Article IV Consultation-Press Release and Staff Report

Economic and Political Context

1. The Bahamian economy has turned the corner, although significant challenges remain. After a steady decline in real GDP over 2013–2015, economic activity is picking up. Near-term growth performance is improving on the back of the much-awaited opening of the mega tourist resort Baha Mar1 and a stronger U.S. economy. But without bold action to tackle longstanding structural bottlenecks, medium-term growth would remain subdued. Commercial banks remain well capitalized and liquid, but are cautious to lend in an environment with poor borrower quality, a legacy of the prolonged recession. Public debt ratios have improved due to major upward revisions to GDP, but fiscal deficits remain above debt-stabilizing levels.

2. The Minnis’ administration has committed to tackle fiscal and structural challenges. Prime Minister Hubert Minnis’ political party, The Free National Movement (FNM), received a strong mandate in the May 2017 general election to change the economic course, securing 35 of the 39 seats in the lower house of Parliament. The administration has announced fiscal austerity measures and intends to table fiscal responsibility legislation. However, Mr. Minnis has also promised introducing a zero-rate VAT for some food items, which would have to be weighed against fiscal sustainability objectives. The administration is also embarking on governance reforms, and is taking steps to liberalize the economy, including by modestly relaxing capital flow management measures (CFM) and committing to seek WTO accession by 2019.

Recent Developments

3. Real GDP is estimated to have expanded by 1.3 percent in 2017. Economic activity has been supported by the completion of Baha Mar, new FDI-financed projects, and post-hurricane reconstruction activity. However, air tourist arrivals declined 4 percent in 2017, as 50 percent of hotel room capacity in the Grand Bahama Island remains out of commission after the passage of Hurricane Matthew in 2016. Baha Mar created about 4,000 jobs by March 2018, which helped reduce the unemployment rate to 10.1 percent in November 2017, from 11.6 percent one year earlier (Figure 1). The decline took place despite a sharp increase in labor force participation to 81 percent, up from 76 percent. The fall in unemployment has been more pronounced among the young with the youth unemployment rate falling to 22 percent, from 26 percent. The national accounts have been substantially revised due mainly to improved coverage, resulting in a 27-percent increase in the level of nominal GDP. 2

Figure 1.
Figure 1.

The Bahamas: Growth, Inflation, and Labor Markets

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Sources: The Bahamian authorities, IMF World Economic Outlook, and IMF staff calculations.
uA01fig01

Construction Activity and Imports

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Source: Central Sank of The Bahamas.

4. Inflation remains low despite higher oil prices. Headline year-on-year inflation reached 1.8 percent in December 2017, up from 0.8 percent in December 2016, driven by an increase in housing and transportation services—which include components sensitive to fuel prices.

uA01fig02

Inflation

(Year on year, percent)

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Sources: Department of Statistics, and IMF staff calculations.

5. The fiscal deficit is declining due mainly to lower capital spending. In FY2017, ending in June, the central government fiscal deficit reached 5.8 percent of GDP, up from 2.8 percent of GDP a year earlier, due to post-hurricane cleanup and reconstruction and lax spending control in the run-up to the general elections. Central government debt reached 57 percent of GDP in FY2017 (Figure 2). Last August, the new administration announced across-the-board spending cuts, the nonrenewal of some temporary workers’ contracts, and a hiring freeze. Data for the first 7 months of FY2018 show a decline in the deficit to 1.6 percent of GDP, 1.2 percentage points of GDP lower than a year earlier, excluding the one-off purchase of promissory notes issued by Resolve.3 The Bahamas avoided a new sovereign rating downgrade and successfully placed an external bond.4 5

Figure 2.
Figure 2.

The Bahamas: Fiscal Developments 1/

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Sources: The Bahamian authorities; and IMF staff calculations.1/ Central government fiscal year ending June 30.

6. Commercial banks remain liquid and well capitalized. Financial system assets are concentrated in the offshore sector, with strict firewalls between the domestic and offshore banking sectors (Figure 3). Seven commercial banks, four of which are subsidiaries of foreign banks, dominate the domestic financial sector, and their balance sheets appear sound. As of December 2017, the average capital adequacy ratio stood at 33.3 percent, well above the regulatory requirement of 17 percent and liquid assets represented 29 percent of total assets, and more than double the statutory minimum. The stock of nonperforming loans (NPLs)—concentrated in mortgages—declined to 9.2 percent of total loans, from 11.4 percent at end-2016. The decline followed mainly from a large disposal of NPLs by the Bank of The Bahamas (BOB), a majority state-owned commercial bank.6 The disposal allowed BOB to strengthen its capital adequacy ratio to 42 percent.

Figure 3.
Figure 3.

The Bahamas: Financial System Structure

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Sources: Central Bank of The Bahamas; Insurance Commission of The Bahamas; and Fund staff calculations.1/ Investment Funds’ data refers to 2016.2/ Includes only domestic banks and subsidiaries of foreign banks.

Financial Soundness Indicators

(Domestic commercial banks)

article image
Sources: Central Bank of The Bahamas; and IMF staff calculations.

Minimum requirement is 17 percent.

In percent of statutory minimum requirement.

End of September 2017.

7. Despite ample balance sheet space, banks are cautious in making new loans. Persistent weakness in economic activity coupled with a debt overhang problem has strained households’ debt-servicing capacity, constraining their access to credit. A central bank survey of bank lending conditions consistently shows an excessively high debt-service-to-income ratio as the most common reason for rejecting loan applications. At the same time, weak economic activity has also affected businesses’ profitability.7 Therefore, banks have been reluctant to lend in an environment where the absence of a credit bureau and book-keeping tradition, combined with a prolonged recession, make it more challenging to screen borrowers. Large intermediation spreads—which in addition to limited competition also reflect a risk premium on lending—have widened significantly since the global financial crisis (Figure 4). These factors have kept credit to the private sector, excluding NPLs, broadly flat. Pressures on correspondent banking relationships (CBR) have not resulted in major disruptions so far.8

Figure 4.
Figure 4.

The Bahamas: Monetary and Financial Developments

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Sources: Central Bank of The Bahamas; Insurance Commission of The Bahamas; and IMF staff calculations.
uA01fig03

Reasons for Turning Down Loan Applications

(In percent of total number of applications)

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Source: Central Bank of The Bahamas, and IMF staff calculations.
uA01fig04

The Bahamas: Credit to the Private Sector

(In percent of GDP, unless otherwise indicated)

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

8. The external sector position is weaker than suggested by fundamentals and desirable policy settings. The current account deficit is estimated to have widened to 16.4 percent of GDP in 2017, from 7.7 percent of GDP in 2016 (Figure 5). The increase is due to a surge in imports of goods and services related to the completion of Baha Mar, the recovery in oil prices, and lower tourism receipts due to the impact of Hurricane Matthew on hotel infrastructure. The 2017 cyclically-adjusted current account deficit, after deducting FDI-related imports, is estimated to be 2.2 percentage points of GDP above the level consistent with fundamentals and desirable policy settings (Annex I). As of end-2017, the Bahamian dollar depreciated 4.3 percent in real effective terms relative to the 2017 average as the U.S. dollar weakened vis-a-vis other major currencies. In staff’s view, the currency is overvalued by about 0–10 percent. Foreign reserves strengthened to US$1.4 billion by end-2017, equivalent to 3.6 months of imports of goods and services, boosted by the sovereign external bond placement in November. The current level of reserves is adequate under traditional benchmarks.

Figure 5.
Figure 5.

The Bahamas: External Sector Developments

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Sources: The Bahamian authorities, IMF International Financial Statistics, the World Bank’s Doing Business Database, and IMF staff calculations.
uA01fig05

Trade Deficit and Commodity Prices

(In percent of GDP, unless otherwise indicated)

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Sources: Central Bank of The Bahamas, INS, WEO, and IMF staff calculations.
uA01fig06

Real Effective Exchange Rates (REER)

(Index 2010=100)

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

9. The authorities have tabled legislation to strengthen governance and the rule of law. This legislation includes i) a constitutional amendment, passed by Parliament in 2017, to create an independent Office of the Director of Public Prosecutions; ii) a bill to create the Office of the Ombudsman; and iii) a bill to set up a new code of conduct for public officials, establish an Integrity Commission to investigate alleged cases of corruption, and deepen the financial disclosure responsibilities of public officials. The Integrity Commission Bill and the Ombudsman Bill were tabled in 2017 and are expected to be debated this year.

Outlook and Risk

10. Real GDP growth is projected to pick up to 2¼ – 2½ percent in 2018–2019 and to stabilize at 1½ percent over the medium term. The baseline scenario is predicated on stronger global growth, particularly in the United States;9 the full opening of Baha Mar; and a pickup in foreign direct investment. Baha Mar is projected to contribute 2¼ percentage points to real GDP growth, cumulatively, over 2017–2019, through higher investment, tourism activity, and employment. Medium-term growth is projected to remain at 1½ percent, reflecting significant structural impediments. The current account deficit is projected to narrow over the medium term, on the back of larger tourism receipts and lower imports due to the completion of Baha Mar and fiscal consolidation.

uA01fig07

Real GDP Growth

(In percent)

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Sources: The Bahamian authorities, World Economic Outlook, and IMF staff calculations.
uA01fig08

External Outlook

(In percent of GDP unless otherwise indicated)

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

11. The flow of bank credit to the private sector is expected to improve gradually. Stronger economic activity and further declines in unemployment should improve households’ access to credit. Commercial banks have the balance sheet space to support a pickup in credit demand. Improving economic conditions should also support a faster reduction in banks’ NPLs and further support the recovery. Under the baseline scenario, bank credit to the private sector would slowly pick up to grow at annual rates of around 2.5–3.0 percent by 2021–2023, leading to a gradual closing of the credit gap.

uA01fig09

Output and Credit Gaps

(In percent of potential GDP)

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Source: IMF staff calculations.

12. Risks to the outlook are skewed to the downside (Annex II). Weaker-than-projected U.S. growth or tourism activity would lead to lower economic activity. A tightening of global financial conditions could lead to lower-than-projected foreign investment inflows. Natural disasters and the intensification of pressures on CBR are additional near- and medium-term risks. On the domestic side, failure to implement fiscal consolidation or structural reforms could undermine investor confidence and reduce projected foreign investment flows. On the upside, lower oil prices, higher-than-projected U.S. growth and FDI flows, or bigger-than-expected boost from Baha Mar would lead to stronger growth (Annex III).

Authorities’ Views

13. The authorities broadly agreed with staff’s projections and risk assessment. The authorities underscored the commitment of the administration to tackle fiscal imbalances and structural impediments. They also agreed with the external position assessment.

Key Policy Issues

A. Fiscal Policy

14. Sharp increases in public debt call for decisive fiscal consolidation efforts to rebuild fiscal buffers and maintain market confidence. Under staff’s baseline scenario, expenditure restraint would reduce the fiscal deficit from 5.8 percent of GDP in FY2017 to 2.7 percent of GDP in FY2018, and to about 1½ percent of GDP in the medium term. Central government debt would peak at 57.4 percent of GDP in FY2018 and would gradually decline to stabilize at around 55 percent of GDP by FY2023. Under this baseline, the debt sustainability heat map points to low to moderate risks to debt sustainability. However, sizable contingent liabilities10 and exposure to natural disasters pose significant downside risks to the fiscal outlook with a combination of adverse shocks putting the debt-to-GDP ratio on an upward trajectory (Annex IV).

15. Strong adherence to the announced fiscal consolidation plan would put public indebtedness on a firmly downward trajectory. The authorities’ fiscal consolidation targets, announced last June in the FY2018 budget, envisage a reduction in the fiscal deficit to 2.7 percent of GDP in FY2018, and to 1.8 percent and 0.8 percent of GDP for FY2019 and FY2020, respectively. For FY2018, the budget included an increase in tax collection and lower spending due to ongoing revenue administration reforms and dissipation of one-off effects from Hurricane Matthew and the elections. The fiscal target for FY2018 is within reach, despite the unbudgeted purchase of Resolve promissory notes, although at the expense of lower-than-budgeted capital spending. During the mid-year budget review in March, the authorities reiterated their commitment to meet the FY2018 deficit target. Staff recommended an additional adjustment of 2 ¼ percent of GDP to bring the deficit to ½ percent of GDP by FY2021—the medium-term target under the proposed fiscal rule (para. 17)—to put the public debt-to-GDP ratio on a firmly downward trajectory. Staff urged the authorities to identify measures to undertake this adjustment with a strong focus on reducing current spending and avoid an undue compression of capital spending. Staff emphasized the following areas:

  • Trimming the wage bill, through a gradual rationalization of public sector jobs—as private sector job creation strengthens—and wage restraint.

  • Turning SOE’s self-sufficient, by ensuring that the price for their services allow recovery of costs and by restructuring these corporations and other public entities to improve their efficiency and reduce their dependence on transfers from the central government. A first essential step is the establishment of effective financial oversight over these entities.

  • Reforming the civil servants’ pension system, by moving to a contributory regime in the near term and to a defined-contribution scheme in the medium term.11 Addressing also imbalances at the National Insurance Board (NIB)12 by adopting the recommendations included in the last actuarial report should reduce fiscal contingent liabilities.

uA01fig10

Current Public Expenditure

(In percent of GDP)

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Sources: Ministry of Finance; and IMF staff calculations.

16. Setting up a savings fund for natural disasters, as part of a multilayer disaster risk-financing strategy, should strengthen fiscal and economic resilience. A multilayer approach to disaster risk financing is considered appropriate and cost effective. As part of this approach, and in line with Fund advice to other Caribbean economies, staff recommended setting up, over the medium term, a natural disasters savings fund of a target size between 2–4 percent of GDP, with annual inflows for ½ percent of GDP (Box 1). In addition, insuring public assets and encouraging the broader use of private insurance, including through financial literacy training and targeted subsidies, would reduce fiscal contingent liabilities. Investing in resilient infrastructure and maintaining up-to-date building codes, land use, and zoning guidelines are also critical elements of an adequate disaster risk management strategy.

Strengthening Natural Disaster Resilience: A Savings Fund Proposal

The exposure of The Bahamas to recurrent natural disasters calls for a multilayer disaster risk financing strategy. As part of this approach, staff proposes the creation of a savings fund of target size ranging 2– 4 percent of GDP.

Motivation. Over the last 30 years, The Bahamas has recorded annual average damages from natural disasters (NDs), including both to public and private sector assets, at close to 1.5 percent of GDP, higher than the Caribbean regional average of 1.2 percent of GDP. Four out of the eight hurricanes that hit The Bahamas since 1990 resulted in estimated total damages—public and private—of at least 5 percent of GDP, implying a probability of a disaster of that magnitude of close to 15 percent in any given year. The Bahamas has traditionally absorbed the fiscal consequences of these shocks through re-prioritization of spending and/or worsening fiscal deficits, often forcing a rapid accumulation of debt. However, increased reliance on risk reduction and preparedness policies are preferable than relying entirely on ex post intervention as financing can be made available immediately and likely at more affordable costs.1

uA01fig11

The Bahamas: Natural Disaster Damage, 1990–2016

(Total damages in percent of GDP)

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Sources: EM-DAT adjusted for 2017 GDP revision, WEO, and IMF Staff calculations.

Methodology. To determine the target size of the savings fund, staff estimated a vector auto-regression (VAR) model over 1985–2016, including the cyclical components of government revenues, primary expenditure, and real GDP (see Selected Issues Paper for details). To isolate fluctuations in these variables not driven by natural disasters, the system included US real GDP, US REER, oil prices, and dummy variables to account for specific events such as the introduction of the VAT, electoral years, and September 2001. After controlling for these sources of shocks, outliers in the distribution of residuals are assumed to be driven by natural disasters. Using a Monte Carlo experiment, staff simulated possible fiscal outcomes and focused on events with a probability of occurrence of 15 percent or less, under the premise that contingent funds in the budget would be the first line of defense for smaller, higher-frequency events.

uA01fig12

Probability of Fund depletion

(In percent)

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Source: IMF staff calculations.

Results. A savings fund of size between 2 and 4 percent of GDP to cover the fiscal impact of natural disasters would be depleted only with 11 percent probability or less. The fund would require annual inflows for ½ percent of GDP during normal years.

uA01fig13

Risk Layering Strategy for Disaster Risk Financing

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Sources: GFDI Sources: GFDRR and World Bank Group (2014).

A tiered approach to disaster risk financing—an approach including different financial instruments for different layers of risk—is appropriate and cost effective (GFDRR and World Bank, 2014). Self-insurance or risk retention, including through contingent funds in the budget, the proposed savings fund, and the recently requested contingent loan from the IDB for US$100 million, should be used to confront the more frequent, less severe shocks. Risk transfer through the Caribbean Catastrophe Risk Insurance Facility (CCRIF), of which The Bahamas is a member, and insurance of public sector assets should be used to confront more severe events. Catastrophe bonds could also help to insure against the most severe disasters.

1 Small States’ Resilience to Natural Disasters and Climate Change – Role for the IMF (2016)

17. Staff welcomed the authorities’ plans to table fiscal responsibility legislation. Draft legislation is currently being prepared with Fund technical assistance and is expected to be tabled in Parliament in May together with the FY2019 budget. The fiscal rule should include a permanent ceiling on the fiscal deficit no larger than 1 percent of GDP with annual deficit targets set at ½ percent of GDP to allow space for automatic stabilizers to operate.13 These targets, binding from FY2021 on, would allow space to accumulate savings in the proposed natural disasters fund. To further avoid procyclicality, the rule should also i) cap the growth rate of current expenditure at the estimated long-run growth of nominal GDP; and ii) include exceptional circumstances clauses to be triggered only when confronted with significant negative shocks. In addition to the rule, the framework should mandate incorporating in the budget process an assessment of near and medium-term fiscal risks and mitigating policies; and it should include enhanced reporting requirements. Staff noted that completing ongoing reforms to the public financial management system, as recommended through the Fund’s technical assistance, is critical for the effectiveness of a medium-term fiscal framework.

Calibrating a Fiscal Rule for The Bahamas

Well-designed fiscal frameworks are structured around two elements: a medium-term anchor and one (or several) operational target(s) to guide annual budgets. A natural anchor is the central government debt ratio, which helps guide expectations and (if prudently calibrated) ensures the sustainability of public finances. Debt anchors need to be complemented with operational targets, such as deficit and spending ceilings, that guide fiscal policy towards the medium-term fiscal anchor.

Staff proposed a debt anchor of 50 percent of GDP. This level of debt is the lower bound among three approaches. The first approach corresponds to the median debt level among emerging markets with investment grade sovereign rating across the three major rating agencies. The second approach identified an initial debt level such that negative shocks would increase debt to above 70 percent of GDP—the DSA critical debt level for emerging markets—only with a small probability. The third approach looks at the highest level of debt that could be sustained under a prolonged economic slowdown without requiring a primary surplus above 2 percent of GDP, (Escolano and others, 2014). These three approaches yielded a range between 50–71 percent of GDP. Staff favors an anchor at the lower end of this range due to the sizable contingent liabilities of the central government; the need to keep a prudent debt level under an exchange rate peg; and to put the debt-to-GDP ratio on a downward trajectory from the current level of 58 percent of GDP.1

Staff proposed a deficit ceiling of 1 percent of GDP and a cap on current expenditure growth of 3 percent as operational targets. Allowing for a transition period of three years covering FY2018–FY2020, a deficit target of 1 percent of GDP from FY2021 onwards would ensure convergence to the debt anchor by FY2028. The target fiscal deficit is backed out from a debt dynamics equation relating the initial stock of debt, the target fiscal deficit, expected long-term nominal GDP growth, an assumed convergence horizon, and the debt target (see Selected Issues Paper for details). To create space for the accumulation of savings in staff’s proposed fund for natural disasters, the target should be reduced to ½ percent of GDP. To limit procyclicality, setting the permanent ceiling at a somewhat higher level, 1 percent of GDP, would allow accommodating real GDP growth shocks of up to 1 standard deviation without breaching the deficit ceiling. The exceptional circumstances clause would provide the option of additional flexibility when confronted with more significant negative shocks. The cap on growth of current spending consistent with the proposed ceiling—assuming revenues remain constant as a share of GDP—is equal to the expected potential nominal GDP growth. Under the staff’s baseline scenario, this growth rate would imply setting a cap of 3 percent.

1 The 2012 World Economic Outlook presents evidence suggesting stronger growth performance over the subsequent 15 years among countries where debt is falling compared to countries where debt is rising, controlling for the initial level of debt.

18. Strengthening tax revenues is critical to protect social and infrastructure spending. Laudable efforts to strengthen fiscal revenues, including through the introduction of the VAT in 2015 and revenue administration reforms,14 helped lift tax revenues from 11.6 percent of GDP in FY2014 to 16 percent of GDP in FY2017. The recently revised national accounts—revealing an economy much larger than previously thought—show significant scope to further increase tax revenues. Staff advised the authorities to continue strengthening tax revenues with the intention to make the tax system more progressive; protect infrastructure and social spending; and to offset a reduction in import duties under an eventual WTO accession. Staff recommended the authorities to consider better-targeted tools than introducing a zero-rate VAT on some food items to help low-income households.

Authorities’ Views

19. The authorities agreed on the need to reduce current expenditure and to strengthen tax revenues. They are taking steps to gradually trim the wage bill and have asked SOE’s to prepare plans to become self-sufficient. They also acknowledged the need to reform the pension system. The authorities highlighted that the reduction in capital spending is temporary and in response to their ongoing efforts to identify priorities. In addition, they expect to rely more on Public Private Partnership (PPP) in the future to fund infrastructure investment. They will continue their efforts to strengthen tax revenues, particularly as they seek WTO accession. They are carefully reviewing the potential impact of a zero-VAT rate on some food items and noted that this option may be easier to administer than conditional cash transfer programs, which have been difficult to manage in the past.

20. The authorities agreed with staff’s proposed fiscal rule targets. They welcomed staff’s proposed calibration of the fiscal rule, which they plan to include in the draft fiscal responsibility legislation. The bill is expected to be sent to Parliament in late May.

21. The authorities welcomed staff’s recommendation on the savings fund. They also highlighted other efforts in improving preparedness and risk reduction, including seeking a contingent credit line from the IDB for US$100 million; their membership with CCRIF; planned investments in sea walls and in enhancing coastal protection; and updating the building code following a Caribbean-wide study on best-practices.

B. Structural Policies

22. Long-standing structural impediments continue to constrain private investment and growth. The Bahamas continues to lag most Caribbean peers in terms of distance to the frontier in the World Bank’s ease of doing business index (DBI),15 particularly due to onerous administrative processes, high costs of trading across borders, lack of reliable and affordable electricity, and low access to credit. The strength of the currency in real effective terms and real wages growing faster than productivity have further eroded cost competitiveness (Figures 6 and 7). Moreover, skill gaps stop many young graduates from entering or remaining in the labor market, which together with increasing labor costs and the narrow economic structure have kept unemployment levels high.

Figure 6.
Figure 6.

The Bahamas: Doing Business Indicators

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

1/ Index for Mexico City.Sources: The World Bank’s Doing Business Database and IMF staff calculations.
Figure 7.
Figure 7.

The Bahamas: Cost Competitiveness Indicators

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Sources: The Bahamian authorities, Caribbean Tourism Organization, Doing Business database (World Bank), Direction of Trade database (IMF), US Energy Information Administration (EIA), Mexico’s Federal Electricity Commission (CFE), and IMF staff calculations.1/ Average rates reported by EIA, CFE, and countries’ electricity companies in 2017.2/ Includes Grenada, Jamaica, St. Kitts and Nevis, St. Lucia, and The Bahamas.
uA01fig14

The Bahamas Doing Business Indicators

(Distance to Frontier, from 0 to 100, where 0: lowest and 100: best)

Citation: IMF Staff Country Reports 2018, 118; 10.5089/9781484355084.002.A001

Source: The World Bank.

23. Decisive structural reforms are needed to unlock growth, particularly as a gradual liberalization of the economy advances. The authorities announced a partial relaxation of exchange controls, effective since last February, to ease the administrative burden on private sector transactions, particularly for small and medium-size enterprises; the Parliament passed the Commercial Enterprise Act, which facilitates the issuance of work permits to foreign workers of enterprises facing a shortage of domestic skilled workers; and the authorities have committed to seek WTO accession by end-2019. Staff stressed that these efforts should be complemented with bold action to put the public debt-to-GDP ratio on a downward trajectory and to alleviate structural impediments to reap the full benefits from greater integration with the global economy. A more competitive economy would also facilitate a further strengthening of foreign reserve buffers. Staff emphasized the following priorities:

  • Advancing energy sector reforms should improve the reliability of the electricity grid and reduce costs. These reforms should aim at i) upgrading infrastructure in electricity generation, transmission, and distribution; ii) improving energy efficiency among users; and iii) exploiting the potential for cleaner energy sources, including wind and solar power.16 Increasing private sector participation in the electricity sector, with adequate regulatory oversight; moving forward with the issuance of the rate-reduction bond;17 and continue improving governance at the state-owned electricity company are necessary steps to advance energy sector reforms. Unifying the planning and implementation of energy policy in one institution would facilitate interagency coordination.

  • Streamlining administrative processes to improve the ease of doing business. Modernizing government registration/filing processes and establishing intra agency information exchange systems will improve efficiency and are necessary to establish a “one-stop shop” for businesses; Streamlining the review and approval processes at The Bahamas Investment Authority; and rationalizing regulatory requirements for starting a business. Ongoing efforts to improve governance and stepping up efforts to fight crime should further enhance the business environment.18

  • Expanding vocational and apprenticeship programs to help reduce skills mismatches and youth unemployment. Staff recommended moving forward with the implementation of the National Apprenticeship Program (NAP),19 to increase the skill set of the young and reduce youth unemployment. More broadly, improving the quality of education should boost human capital and support long-term employment. Finally, improving and disseminating online skills databases and job placement services should help facilitate the matching process between employers and job seekers.

  • Steadfast implementation of the credit bureau to improve access to credit in the medium term. Staff commended the authorities for tabling legislation to create the country’s first credit bureau, in line with past Fund advice. Parliament passed the bill in early 2018. Staff recommended the authorities to move swiftly with the implementation of the credit bureau as it will take time to populate its database.

uA01fig15
Sources: World Bank, US Energy Information Administration (EIA), Mexico’s Federal Electricity Commission (CFE), countries’ electricity companies, and IMF staff calculations.1/ Energy efficiency is the ratio between real GDP (in US dollars, adjusted for purchasing power parity) and total energy consumption (mega joules, MJ).2/ Average rates reported by EIA, CFE, and countries’ electricity companies in 2017.

Authorities’ Views

24. The authorities agreed with the recommended priorities as they are in line with the National Development Plan.

  • On the energy front, they noted that they have appointed a new board and management at the state-owned Bahamas Power and Light (BPL). In addition, a tender has been held to sign an agreement with a private entity to build a new power plant with capacity to generate 80 MW. Finally, BPL is planning on issuing the rate reduction bond in early 2019 to refinance its legacy debt and fund additional infrastructure.

  • On enhancing the business environment, the cabinet is currently reviewing specific recommendations issued by the Ease of Doing Business Committee, appointed last summer, some of which have already been implemented. They also noted that the anticorruption reform package will strengthen governance and the rule of law, and stressed their commitment to fight crime.

  • On strategies to reduce youth unemployment, the National Training Agency has put in place a pre-apprenticeship program to train young people. In addition, the Department of Labor has revamped the online skills and vacancies database, and has increased the outreach activities, including by conducting 4 successful job fairs since last summer, which attracted 4,000 participants, mostly unemployed young people, 900 of which were hired. The authorities are preparing draft amendments to update the National Apprenticeship Act, which is a necessary step to implement the National Apprenticeship Program. The Ministry of Education was cognizant of skill gaps among the young and noted that they are emphasizing vocational training within the high-school curriculum and plan also to increase teacher training to improve the quality of teaching.

  • On the credit bureau, the bill is expected to be signed into law soon and the central bank is now requesting updated proposals from potential operators. The authorities expect to grant a license to the chosen operator by end-2018.

C. Monetary and Financial Sector Polices

25. The monetary stance remains appropriate. The Bahamian dollar is pegged to the U.S. dollar, helping preserve price stability. In addition, the country maintains a capital flow management (CFM) system that allows the central bank some room to control domestic liquidity, mainly through cash reserve requirements. Under the current environment of negative output and credit gaps, staff noted that the current accommodative monetary stance remains appropriate.

26. Moving forward with the planned amendments to the central bank law would bring it closer to international best practices and strengthen the peg’s credibility. A steady increase in central bank lending to the government led to a breach of statutory limits in early 2017. The external sovereign bond placement from last year helped to reduce the central bank’s exposure to the government to levels below the statutory limits. Staff welcomed this reduction and recommended moving forward with the planned amendments to the central bank law, as recommended in the Fund’s technical assistance. These amendments include provisions to improve central bank governance; clarify its objectives; and tighten limits to central bank lending to the government.

27. A more proactive approach to accelerate the resolution of NPLs should support the economic recovery. The central bank’s intensified monitoring of NPLs is welcome as it will encourage a faster resolution of these loans, particularly as economic conditions improve. Developing real estate price indices would further facilitate the determination of fair value and the resolution of NPLs. The Bank of The Bahamas has strengthened its capital position, but it still requires a sustainable business model, free from political interference, to keep fiscal contingent liabilities contained.

28. Strong compliance with AML/CFT and tax transparency standards should help mitigate the withdrawal of CBR and safeguard the integrity of the financial sector. The authorities are taking steps to strengthen their AML/CFT framework for domestic and offshore institutions. They have amended legislation to subject general insurance companies to some of the AML/CFT requirements, and have created a separate Analytics Unit at the central bank to perform risk-focused assessments, request annual reporting, and support more targeted examinations. Staff noted that it is critical to work closely with the CFATF and the FATF to promptly address the strategic deficiencies in the AML/CFT regime identified in the 2017 Mutual Evaluation Report (MER). The authorities have also committed to implement the OECD’s international standards on tax transparency for the automatic exchange of financial account information. The authorities have also committed to implement the Base Erosion and Profit Shifting (BEPS) minimum standards to tackle BEPS.20

29. Staff welcomed progress in implementing FSAP recommendations (Box 2, Annex VI). The Central Bank of The Bahamas (CBOB) has continued strengthening its regulatory and supervisory framework and making progress in implementing the Basel II and III frameworks. CBOB’s stress tests continue to show resilience of the banking system to large shocks.

Financial Sector Regulation and Supervision: Update

  • Risk-based supervisory framework. The CBOB has continued to improve its risk-based supervisory framework. CBOB introduced the concept of “evergreening” to enhance the risk assessment process, intended to map the risk outlook of financial institutions and establish triggers for supervisory action.

  • Crisis management. The CBOB has prepared draft amendments to various laws to align The Bahamas’ framework with recommended international standards, which are pending to be sent to Parliament.

  • Banks’ stress tests. The most recent credit stress tests conducted by the CBOB continue to suggest that, even under the most severe scenario of a 200-percent increase in the level of nonperforming loans over a period of 3 years, the banking system’s capital adequacy ratio would remain well above the 17 percent regulatory minimum requirement. Liquidity stress tests show no material impact on banks’ balance sheets because of the continued excess liquidity in the banking system.

  • Basel II/III. The CBOB has completed implementation of Basel II and the capital component of Basel III. Commercial banks are subject to Basel III capital reporting since 2013. CBOB is now focused on completing the remaining elements of Basel III, the countercyclical capital buffer, and liquidity coverage ratios. CBOB is also simplifying its Basel II (Minimum Disclosure requirements) and Basel III regulatory framework, consistent with the proportionality principle set out by the Basel Committee.

  • Insurance sector risk-based capital regime. The Insurance Commission (IC) has strengthened onsite inspections and introduced a risk-based capital regime for long-term insurance companies. The IC plans to conduct a 3-year pilot program to also include general insurance companies in their risk-based capital regime.

Authorities’ Views

30. The authorities agreed that the monetary stance remains appropriate and with the need to move forward with modernizing the central bank law. The central bank agreed that there was no need to modify cash reserve requirements at this juncture. Moreover, the central bank plans to further reduce its exposure to the government in the near term by selling government advances to commercial banks, which will help mop up some of the excess liquidity in the system. The draft amendments to the central bank law are ready and the public consultation process is expected to begin in the coming weeks.

31. The authorities are confident that their increased monitoring of NPLs will lead to a faster resolution of these loans. The central bank has mandated banks to report on a quarterly basis the status of the top 20 NPLs. The authorities expect that this approach will encourage banks to resolve NPLs faster, with visible results expected by end-2018. Reforms to the property tax system, and automation of transfer taxes, offer opportunities to develop property value databases. They noted that the Bank of The Bahamas now has a sound balance sheet, which should improve its institutional brand and future prospects.

32. Addressing deficiencies in the AML/CFT framework is a top priority for the authorities. The authorities noted that, in addition to creating a new AML/CFT Analytics Unit, they have increased outreach and capacity building activities; they are preparing guidance notes on “Financial Crimes Risk Management” and “Proliferation and Proliferation Financing”; and an AML penalties framework and related guidelines. They expect that all domestic banks will reduce to zero the level of unverified and active accounts by end-March. In coordination with other financial sector regulators, the central bank plans to issue an annual report on AML/CFT risks.

33. The authorities reiterated their commitment to tackle BEPS. The authorities noted that legislation is currently being drafted to give effect to the implementation of the BEPS minimum standards and to address gaps in their current regulatory regime identified by the EU Code of Conduct Group (COCG). The authorities expect to table this legislation in Parliament by end-April 2018, which includes provisions to mandate financial reporting to large multinational corporations operating in The Bahamas.

D. Data

34. The authorities should step up efforts to improve the quality and ensure a timely dissemination of statistics. Staff welcomed recent improvements to the national accounts statistics as well as the commitment to adopt the International Public Sector Accounting Standards (IPSAS) on an accrual basis by 2022. Efforts should also include moving forward with the production of quarterly GDP statistics; publishing and adhering to a data release calendar; improving labor market data, including by conducting unemployment surveys more frequently; and developing an estimate of the International Investment Position.

Staff Appraisal

35. The Bahamian economy has turned the corner but significant challenges remain. Near-term economic prospects are improving, with real GDP growth projected to reach 2½ percent in 2018, on the back of the phased opening of Baha Mar, a stronger U.S. economy, and a pickup in FDI. However, significant structural impediments require bold policy action to unlock medium-term growth. Public debt ratios have declined on the back of a sizable upward revision to nominal GDP, but fiscal deficits remain above debt-stabilizing levels. External reserve buffers have improved; however, the external position is weaker than the level suggested by fundamentals and desirable policy settings.

36. Fiscal consolidation, with a focus on reducing current expenditure, is critical to maintain market confidence and reverse the upward trend in the public debt-to-GDP ratio. The FY2018 target is within reach. However, measures still need to be identified to bring the deficit down to desirable levels while avoiding an undue compression of capital spending. The authorities should focus on i) trimming the wage bill; ii) turning SOE’s self-sufficient; and iii) reforming the unsustainable civil servants’ pension system. Addressing also imbalances at the National Insurance Board (NIB) should reduce fiscal contingent liabilities. The Bank of The Bahamas has strengthened its capital position, but it still requires a sustainable business model, free from political interference, to keep fiscal contingent liabilities contained.

37. Increased reliance on preparedness and risk reduction policies, including by setting up a natural disasters savings fund, should enhance fiscal and economic resilience. The Bahamas should create a savings fund with a target size between 2–4 percent of GDP, by setting aside ½ percentage point of GDP annually during non-disaster years. In addition, insuring public assets and encouraging the broader use of private insurance, including through financial literacy training and targeted subsidies, would reduce fiscal contingent liabilities. Investing in resilient infrastructure and maintaining up-to-date building codes, land use, and zoning guidelines are also critical elements of an adequate disaster risk management strategy.

38. The planned fiscal responsibility legislation is welcome. The framework should include a permanent ceiling of 1 percent of GDP on the fiscal deficit and a cap on the growth rate of current expenditure equal to the estimated long-run growth of nominal GDP. To allow space for automatic stabilizers to operate, annual budgets should target a deficit of ½ percent of GDP. Strong adherence to these targets over the medium term would keep debt on a firmly downward trajectory and would allow accumulating savings into a natural disasters fund. Completing ongoing reforms to the public financial management system is critical for the effectiveness of a medium-term fiscal framework.

39. The authorities should continue strengthening fiscal revenues with the intention to make the tax system more progressive; protect infrastructure and social spending; and offset a reduction in import duties under an eventual WTO accession. Introducing a zero-rate VAT for some items should be avoided as there can be better-targeted tools to assist low-income households.

40. Lifting growth in the medium term requires resolute implementation of structural reforms. Priorities include advancing energy sector reforms to improve the reliability of the electricity grid and reduce costs; streamlining administrative processes to improve the ease of doing business; expanding vocational and apprenticeship programs to help reduce skills mismatches and youth unemployment; and steadfast implementation of the credit bureau to improve access to credit.

41. Moving forward with the planned amendments to the central bank law would bring it closer to international best practices and would strengthen the peg’s credibility. The reduction in central bank lending to the government is welcome. The planned amendments, which include provisions to improve central bank governance; clarify its objectives; and tighten limits to central bank lending to the government, should lead to a more robust legislation.

42. Strong compliance with AML/CFT and tax transparency standards should help mitigate the withdrawal of CBR and safeguard the integrity of the financial sector. Steps to strengthen the AML/CFT framework and to comply with tax transparency standards, including by committing to implement the OECD’s international standards on tax transparency, are welcome. It is critical to work closely with the CFATF and the FATF to swiftly address the strategic deficiencies in the AML/CFT regime identified in the 2017 Mutual Evaluation Report (MER).

43. It is proposed that the next Article IV consultation take place on the standard 12-month cycle.

Table 1.

The Bahamas: Selected Social and Economic Indicators

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

The data refer to fiscal years ending on June 30.

Table 2.

The Bahamas: Operations of the Central Government 1/

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Sources: Ministry of Finance; and Fund staff projections.

Fiscal year ends June 30.

Includes a reclassification of capital transfers to public entities for about 1 percent of GDP into current transfers.

Table 3.

The Bahamas: Outstanding Stock of Public Debt (In percent of GDP) 1/

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Source: Central Bank of The Bahamas.

Calendar year basis.

Excludes central government debt holdings by public corporations.

Table 4.

The Bahamas: Balance of Payments

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

Includes errors and omissions.

Table 5.

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 projections.