The Bahamas : Request for Purchase Under the Rapid Financing Instrument—Press Release; Staff Report; and Statement by the Executive Director for the Bahamas

Request for Purchase under the Rapid Financing Instrument-Press Release; Staff Report; and Statement by the Executive Director for The Bahamas

Abstract

Request for Purchase under the Rapid Financing Instrument-Press Release; Staff Report; and Statement by the Executive Director for The Bahamas

Recent Developments and Outlook

1. The COVID-19 shock comes on the heels of the devastation caused by Hurricane Dorian. On September 2–3, 2019, Hurricane Dorian, the strongest storm in The Bahamas’ recent history, caused substantial loss of life and severe damage exceeding 25 percent of GDP. About eight months later, just as the economy started showing signs of recovery, the COVID-19 pandemic has led to an unprecedented sudden stop in tourism and a deep contraction in economic activity. While The Bahamas made notable progress in pursuing fiscal consolidation through a rules-based framework, Hurricane Dorian required directing fiscal resources to recovery and reconstruction. The focus has now shifted to public health measures and a stimulus package to protect jobs and the most vulnerable segments of the population.

2. The pandemic is expected to lead to a deep recession in 2020. As of late-May, the number of confirmed cases of COVID-19 reached 100, with 11 fatalities. The government declared a national state of emergency on March 17 and closed air and sea borders to incoming passengers. Curfews on weekdays with full lockdowns during weekends will remain in place at least through the end of June. As a result of these containment efforts and given the damage caused by Hurricane Dorian, the economy is expected to contract by 12.5 percent in 2020, with unemployment climbing from 10.7 percent in 2019 to over 20 percent.1 Even though banks remain well capitalized, with high liquidity ratios, the recession will further increase non-performing loans (NPLs), which stood at 7 percent at end-2019. Consumer price inflation is expected to decline to 2.1 percent in 2020, from 2.5 percent in 2019, due to the collapse in commodity prices.

3. A gradual recovery should take hold in 2021, assuming that the pandemic fades and global containment efforts can be gradually unwound. Tourist arrivals are expected to recover strongly in 2021 but reaching pre-crisis levels will take time. With the removal of domestic containment measures, post-hurricane reconstruction activity is expected to regain momentum. These developments should lead to a rebound in real GDP growth of about 8 percent in 2021, but the recovery will be gradual with the economy reaching its pre-pandemic level only by end-2023. Inflation is expected to increase to 2.5 percent in 2021, along with the economic recovery, and converge towards 2 percent in the long run.

4. The Bahamas faces a pronounced balance-of-payments shock. The current account balance is expected to deteriorate to a deficit of 17 percent in 2020, from a surplus of 0.7 percent in 2019. Although lower international oil prices and reduced imports will help the trade balance, these effects are more than offset by the sudden stop in tourist arrivals. On the financial account, foreign direct investment (FDI) inflows are expected to halve. Gross international reserves have been boosted by hurricane insurance payouts of about 8 percent of GDP in 2019 and 2020. The result is an external financing need of about US$1 billion. It is expected that financial support from the Fund and other international financial institutions (IFIs), notably the Inter-American Development Bank (IDB) and the Caribbean Development Bank (CDB), will be able to bridge about 60 percent of this financing gap, helping contain the still-significant drawdown of international reserves. Reserves are expected to decline to about US$1.3 billion in 2020 and to remain at similar levels thereafter.

The Bahamas: Impact of COVID-19 and Hurricane Dorian on Balance of Payments

(In millions of U.S. dollars)

article image
Sources: The Bahamian authorities; and IMF staff calculations.

Part of the financing by other IFIs that is related to hurricane Dorian has already been disbursed. Staff assumes that a quarter of the commercial loans associated with the World Bank’s Multilateral Investment Guarantee Agency (MIGA) will be externally issued and disbursed in 2020. Of the $320 million of IDB loans under discussion, about 40 percent (of which 20 percent are investment loans recorded above the line) are assumed to be disbursed in 2020.

The change in reserves under the pre-hurricane/pandemic was an increase in the amount of about US$25 million.

Risks

5. The main risks facing The Bahamas arise from a more severe and long-lasting COVID-19 pandemic and vulnerability to future hurricanes. The impact of the pandemic depends on its propagation and duration, the success of global and local containment measures, and the effectiveness of policy responses. Disruption of international supply chains, tourism, and travel (including within the archipelago) could have deeper effects than currently expected. The human and economic costs of the local outbreak could also be substantial, given limited capacities of the healthcare system. Vulnerability to hurricanes persists, especially as fiscal and financial buffers are used to respond to Hurricane Dorian and the COVID-19 pandemic.

Authorities’ Response to the Crisis

6. As part of a comprehensive pandemic response strategy, the authorities have established Economic Recovery, Tourism Response, and National Food Committees. The Economic Recovery and Tourism Response Committees will guide the country’s COVID-19 response and advise on ways to jumpstart the economy following the crisis, with a focus on job-creation and stimulating small business development, especially in the tourism industry. The Food Committee will enhance the collaboration among public institutions, the private sector and civil society organizations to improve food distribution, especially to the most vulnerable groups.

The Bahamas: COVID-19 Fiscal Stimulus Measures in FY2019/20–FY2020/21

article image
Sources: Ministry of Finance; and IMF staff estimates

Purchase of medical and surgical supplies, ventilators, oxygen tanks, vehicles, and bio waste bins, emergency flights, sanitation of medical facilities, and quarantine site expenses.

7. Fiscal policy has appropriately shifted toward providing economic relief to mitigate the impact of pandemic. The authorities have introduced temporary fiscal measures of about 4 percent of GDP in response to the COVID-19 outbreak to support healthcare infrastructure, employment, small and medium enterprises, and vulnerable groups in the population. These measures come on top of the recovery and reconstruction outlays and tax exemptions following Hurricane Dorian.

8. The fiscal position is expected to deteriorate sharply this fiscal year and next. To accommodate some of the increased fiscal needs, the FY2020/21 budget introduces current spending cuts of 20 percent across ministries, excluding interest expenses and the wage bill, to be achieved through postponing non-priority programs and improving efficiency. State-owned enterprises (SOEs) need to identify savings for FY2020/21 (such as introducing user fees or cutting operating costs). A sin tax may be imposed for one year on items deemed harmful (including alcohol and tobacco). Excise rates on these products could rise by 10 percent and B$5 per gallon, yielding about B$30 million in additional revenues in FY2020/21. Staff estimates that the additional measures could yield total savings of about B$175 million in FY2020/21. As a result, staff projects the overall deficit at 6.7 and 9.5 percent of GDP in FY2019/20 and FY2020/21, respectively.

The Bahamas: Additional Measures for FY2020/21 Budget

(In millions of Bahamian dollars)

article image
Sources: Bahamian authorities; and IMF staff calculation.

Capital expenditure includes capital transfers to public sectors.

9. The increased fiscal needs will be financed by a combination of domestic and external debt issuance, as well as financial support from the Fund and other IFIs. Despite the recent S&P downgrade by one notch to “BB”, The Bahamas is expected to continue to have access to international bond markets albeit at significantly higher rates than before. The authorities plan a long-term external bond issuance in FY2020/21. They are also seeking two guarantees from the World Bank’s Multilateral Investment Guarantee Agency (MIGA) for COVID-19 healthcare expenses and capital spending. The associated guaranteed commercial bank loans would have maturities exceeding 5 years. Discussions are ongoing with the IDB for new credit facilities amounting to $320 million in FY 2020/2021 for policy loans and investment loans, with maturities exceeding 20 years.

10. The authorities have put in place contingency plans to protect priority spending. In addition to the current expenditure cuts and proposed increase in excise taxes in the FY2020/21 budget, they are reviewing public expenditure (including by SOEs) to allow the government to reprioritize spending flexibly and timely should downside risks materialize. The Ministry of Finance is also proposing a temporary tightening of expenditure controls across ministries and agencies in order to reduce non-priority spending. Freezing wages and payroll increments could provide substantial savings, especially over the medium-term.

11. The authorities remain committed to fiscal consolidation over the medium term as specified under the Fiscal Responsibility Act (FRA). The government activated the escape clause of the FRA after Hurricane Dorian hit the country. This allows the authorities to postpone the achievement of their fiscal consolidation targets (a fiscal deficit of 0.5 percent of GDP by FY2020/21 and a public debt-to-GDP ratio of 50 percent by FY2024/25) by four years. The COVID-19 crisis will delay reaching these targets further, but the authorities are steadfast to bring the fiscal deficit to 0.5 percent of GDP by FY2026/27 and the debt ratio to 50 percent of GDP by FY2030/31. They will resume various measures when the pandemic fades, including the reviews of SOE governance, investment incentives, and the pension system, enhancements to public financial management (PFM) to increase expenditure control and efficiency, and revenue administration reforms.

The Bahamas: Fiscal Financing. FY19/20 and 20/21

(In millions of U.S. Dollars 1/)

article image
Sources: The Baham is n authorities; and IMF staff calculations

Exchange rate of Bahamian dollar and U.S. dollar is fixed to 1.

"Pre-hurriane/pandemic" refers to the 2019 AIV.

Loans for investment projects are included in "External.net".

12. The authorities plan to follow best practices in procurement and contract awards. The Cabinet recently re-established the Audit Committee to strengthen the implementation of recommendations by internal and external audits. The authorities intend to finalize the Public Procurement Bill—which will modernize the existing procurement system and bring it in line with international best practice—by end-June this year. The new Public Financial Management (PFM) Bill and Public Debt Management Bill are under internal review and will be submitted to Parliament by end-December.

13. The Central Bank of the Bahamas (CBOB) has kept interest rates unchanged and focused on protecting the peg to the U.S. dollar. The CBOB has maintained the policy rate at a historically low level of 4 percent. Recent measures aimed at ensuring liquidity in the foreign exchange market include: (i) suspending dividend payments by domestic and foreign-owned financial institutions; (ii) providing more latitude to commercial banks to supply foreign exchange to the public before approaching the CBOB to replenish such funds2; (iii) suspending access to foreign exchange for international capital market and real estate investments; and (iv) requesting the National Insurance Board (NIB) to repatriate some of its external assets (about $60 million). Measure (ii) is an easing of a capital flow measure (CFM) on inflows and measures (iii) and (iv) are assessed as a tightening of CFMs on outflows under the IMF’s Institutional View (IV).

14. The CBOB has encouraged domestic banks and credit unions to consider loan moratoria. The arrangement provides for a 3-month deferral against repayments on credit facilities that were negatively impacted by the COVID-19 crisis and requires the resumption of payments, with accrued interest, when the financial circumstances of borrowers improve. Some financial institutions have already announced credit support that could extend beyond the 3-month period. The CBOB has provided guidance that loans in good standing before the onset of the pandemic will not be reclassified as a consequence of the deferral against repayments. However, if at the end of the forbearance period loans are not performing, banks will have to reevaluate and reclassify them as needed. Banks have been asked to report monthly on their loan portfolio to enable the CBOB to monitor the impact of the payment deferral on their credit quality.

Debt Sustainability

15. Despite the severe shocks of Hurricane Dorian and COVID-19, public debt remains sustainable. In the baseline scenario, the public debt-to-GDP ratio increases from 61.8 percent in FY2018/19 to 82.6 percent by FY2020/21, and then gradually declines to 79.2 percent over the medium term. The authorities remain committed to pursuing the fiscal targets under the FRA after the pandemic wanes. Nevertheless, considering the expected increase in the debt level, the projected debt path remains vulnerable to substantial downside risks, including from a more severe and long-lasting COVID-19 pandemic and vulnerability to future hurricanes. The authorities have extended maturities through financing support from international financial institutions, limiting the impact on gross financing needs over the medium term but leading to a significant increase in external debt.

Policy Recommendations

16. Staff supports the fiscal measures taken by the authorities to address the fallout from the pandemic. The focus on supporting the health care system, ensuring adequate food supply and protecting employment is appropriate. Transfers in-kind could also be considered to protect undocumented workers. Enhancing transparency by providing a separate reporting mechanism for COVID-19 expenditures, commissioning and publishing an independent, third-party audit, and publishing all public contracts as well as beneficial ownership information on companies that receive pandemic-related procurement contracts, will be critical. Effective implementation of the Public Procurement Bill, Public Financial Management and Public Debt Management Bills will require appropriate staffing of the macro-fiscal and debt management units at the Ministry of Finance. To prevent arrears, expenditure monitoring and reporting should be strengthened through more frequent communication between Ministry of Finance, line ministries and agencies.

17. Staff sees some room for monetary easing, but the policy stance should take into account developments in the foreign exchange market. Against the backdrop of a collapse in economic activity and limited inflation pressures, there is some room to lower interest rates. The benefits of doing so have to be weighed against the potential erosion of international reserves and structural bottlenecks in the monetary transmission mechanism. While the recent CBOB interventions could help ensure an adequate level of international reserves, the repatriation of NIB assets needs to be done in a controlled manner that avoids any potential fire-sale dynamics and preserves the NIB’s financial position. The CFMs are appropriate under the IV but need to be closely monitored and removed as crisis conditions abate.

18. Staff recommends maintaining a balance between supporting economic activity and safeguarding financial stability. Loan moratoria, where considered useful for households and firms to weather liquidity shocks, should be introduced without relaxing current credit risk standards. They need to be targeted to those borrowers affected by the pandemic, to promote transparency and sound risk management, and prevent a potential buildup of financial risks and moral hazard. While moratoria should not lead to automatic reclassification of assets and an increase in loan provisions, the CBOB should provide guidance so banks’ estimates of expected credit losses are robust and timely, and ask for regular loan portfolio reviews and risk assessments by banks to measure the pandemic’s impact on financial conditions and asset quality.

19. Once the present crisis subsides, the focus needs to shift to rebuilding buffers and strengthening resilience:

  • Size and speed of fiscal adjustment. Decisive and significant fiscal measures are needed to bring public debt on a clear downward path and achieve the fiscal targets under the FRA. Staff calculations suggest that to achieve the FRA debt target by 2030/31, an average primary surplus of 4 percent would be needed starting in FY2024/2025, with significantly faster consolidation than in the current baseline already beginning in FY2022/23. The exact speed of this adjustment should be calibrated to the economic outlook, subject to scrutiny by the Fiscal Council and parliament approval.

  • Composition of fiscal measures. The composition of fiscal adjustment should be carefully balanced to achieve inclusive growth, protect key public services and invest in natural disaster preparedness. Actions to achieve these objectives include containing expenditure growth by further rationalizing the wage bill, advancing the pension reform, and accelerating SOE reforms. On the revenue side, there is significant scope to increase revenue collection by accelerating planned revenue administration reforms and streamlining tax expenditures. Increasing revenues from departure taxes, business license fees, and property taxes should be strongly considered. A well-crafted communication strategy will help foster the credibility of the medium-term fiscal framework.

  • Resilience. Introducing mandatory hurricane insurance would strengthen private sector resilience; improving data collection, sharing, and management among agencies would enhance the resilience of the social safety net.

  • FX and monetary policy. The new Central Bank Law should be adopted to strengthen the CBOB’s governance framework. Reducing central bank lending to the government and developing domestic debt markets would help strengthen the transmission mechanism over the medium term.

  • Financial sector policies. The authorities should ensure timely monitoring and resolution of NPLs, especially in already vulnerable financial institutions and reduce credit market asymmetries by moving ahead with an asset registry and real estate price index, while enhancing banking supervision, resolution frameworks, and governance of asset management companies. They should continue to improve the effectiveness of the AML/CFT regime, as agreed with the Financial Action Task Force (FATF), including by focusing on measures to enhance entity transparency and building upon the Register of Beneficial Ownership Act. They should also monitor pressures on correspondent banking relationships.

Modalities of Support

20. The RFI is the appropriate instrument for The Bahamas at this juncture. The Bahamas meets the qualification requirements for support under the RFI.

  • It has an urgent balance of payments need, which, if not addressed promptly, would result in immediate and severe economic disruption.

  • It is not feasible at this stage to put in place an upper-credit-tranche arrangement due to the urgent needs facing The Bahamas and the high degree of uncertainty regarding the duration and scale of the COVID-19 pandemic.

  • The Bahamas is assessed as having sustainable debt (see Annex I). The Bahamas’s capacity to repay the Fund remains adequate. Obligations to the Fund will peak in 2021—when the recovery is underway—and decline steadily to below 1 percent of GDP over the medium term. The relatively high share of credit outstanding as percent of debt service reflects The Bahamas’ low level of external indebtedness. Downside risks to the capacity to repay the Fund include a more severe and longer-lasting COVID-19 pandemic and vulnerability to future hurricanes.

  • Staff is confident that the authorities will cooperate with the Fund and pursue the economic policies appropriate for addressing the impact of the pandemic, based on the country’s track record of economic policies and relations with the Fund.

21. Staff considers access of 100 percent of quota under the RFI to be appropriate. The Bahamas does not currently have an IMF arrangement, and access of 100 percent of quota is within the applicable access limits under the GRA.

  • The access of 100 percent of quota (SDR 182.4 million or about US$252 million), together with financial assistance from other IFIs, would provide relief to the sizable BOP and fiscal needs facing The Bahamas, which is facing temporary difficulties in accessing the international capital markets, thereby supporting the country’s policy response to the COVID-19 shock. Remaining external financing needs are expected to be filled through other official and private sources and a significant drawdown of international reserves. Overall, gross reserves are expected to remain slightly above both the Fund’s reserve adequacy metric and CBOB’s statutory minimum of 3 months’ imports coverage in 2020.

  • The purchase will be channeled to the Ministry of Finance for budget support. In their Letter of Intent, the authorities confirm that a Memorandum of Understanding between the CBOB and the Ministry of Finance related to the obligation of repayment to the Fund will be signed before the purchase. The authorities commit to undertake a safeguards assessment that would need to be completed before the Executive Board approval of any subsequent arrangement to which the safeguards policy applies. The authorities agree to provide Fund staff with the necessary central bank audit reports and to authorize the external auditors of the CBOB to hold discussions with staff.

Authorities’ Views

22. The authorities broadly agree with staff on the economic outlook, which remains subject to significant risks and uncertainty. They foresee a deep recession in 2020 with real GDP contracting between 9 and 15 percent, depending on when the economy reopens and tourism demand from advanced economies resumes. Unemployment could climb to as high as 35 percent. The authorities hope to lift the domestic lockdown measures and reopen air and sea borders by July 1. Post-Hurricane Dorian reconstruction efforts—delayed because of the pandemic—should gain pace in the second half of 2020, as domestic containment measures are relaxed. While real GDP is expected to reach pre-crisis levels in 2023 in line with staff projections, the authorities are projecting significantly lower growth in 2021 and higher growth in 2022/2023. They expect the lingering effects of the global COVID-19 travel restrictions and consumer hesitancy to temper the pace of the recovery in tourism demand through the first half of 2021.

23. The COVID-19 pandemic will have a profound impact on public finances, including through an unprecedented loss in revenues. The authorities highlighted the severe revenue shortfalls they are experiencing, with April revenues being 50 percent lower than last year. This— together with the measures taken to save lives and livelihoods—will significantly increase budget deficits this fiscal year and next. The authorities are currently targeting a deficit of B$1326 million for FY2020/21, somewhat higher than staff’s projection, given their different recovery profile.

24. The authorities share staff’s views on the importance of advancing structural fiscal and governance reforms and safeguarding debt sustainability. They confirmed that the COVID-19 measures will be audited within 9 months of the end of the fiscal year, and results will be published on the government’s website, ensuring efficiency and transparency of relevant spending. The government will continue to finalize the new PFM-related laws. These—together with the Fiscal Council—will further enhance fiscal management and discipline. The authorities are also committed to medium-term debt sustainability targets and view the reform of SOEs as particularly promising in generating savings over the medium-term.

25. The CBOB sees an urgent need to maintain an adequate level of international reserves. While there are no significant capital outflows at this stage, the CBOB views the recent foreign exchange measures as necessary to preserve reserve adequacy. Repatriating some of the NIB’s external assets, representing a small portion of its portfolio, and allowing domestic banks greater latitude in open positions to purchase funds in the interbank market should contribute to foreign exchange liquidity. The CBOB argues that it has adequate systems to monitor the effects on the banking system of these interventions. The CBOB also highlighted their temporary nature and that they will not jeopardize recent progress in exchange control liberalization. The CBOB does not consider expansionary monetary policies to be appropriate at the current juncture. The CBOB agreed that the new central bank law should be adopted without delay.

26. The CBOB views recent financial sector measures as appropriate and in line with international best practice. The central bank is in constant consultation with international regulatory bodies and agrees on the need to carefully monitor asset quality and compliance with the regulatory regime in the financial system. The CBOB will also conduct stress tests of the banking sector to better assess the strategies, processes and risk resilience of individual institutions.

Staff Appraisal

27. The Covid-19 pandemic comes on the heels of Hurricane Dorian that caused significant economic damage in the fall of 2019. These are significant external shocks to The Bahamas’ tourism and related sectors, which account for about 40 percent of GDP and represent the major source of income and employment. Coupled with domestic containment measures, the collapse in tourism will cause a deep recession and an urgent balance-of-payments need. The economic outlook remains subject to an unusually high degree of uncertainty.

28. The authorities’ response to the pandemic is appropriate. The authorities have introduced fiscal measures to support public health, protect the most vulnerable and cushion the impact of the pandemic on employment. These measures come on top of the recovery and reconstruction measures that were put in place in response to Hurricane Dorian. Staff supports the CBOB’s measures to mitigate the impact of the pandemic on the banking sector, but also highlights the need to safeguard financial stability. The temporary relaxation of prudential regulations should be accompanied by close monitoring of NPL classification and prudent risk management practices.

29. Once the present crisis subsides, the focus needs to shift to rebuilding buffers and strengthening resilience. Significant and determined fiscal effort will be needed to bring debt on a clear downward path and achieve the long-term targets under the FRA. Actions to achieve this objective could include increasing revenue collection, especially through property taxation, streamlining tax expenditures as well as containing the wage bill and reducing transfers to SOEs. Steps should also be taken to enhance resilience to natural disasters by putting in place mandatory hurricane insurance and strengthening the social safety net. Timely resolution of NPLs is a key objective, while legislative reforms of crisis management and resolution need to be completed.

30. Staff supports the authorities’ request for an RFI in the amount of SDR 182.4 million (100 percent of quota). The unprecedented economic fallout from the COVID-19 pandemic and the urgent balance-of-payments needs justify the authorities’ request for emergency financial assistance from the Fund through an RFI. The authorities have reiterated their commitment to prudent policies through the Fiscal Responsibility Act, which is designed to ensure debt sustainability over the long term. Staff assessed The Bahamas’ capacity to repay the Fund as adequate.

Table 1.

The Bahamas: Selected Social and Economic Indicators

article image
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.

Net International Reserves.

Table 2a.

The Bahamas: Operations of the Central Government

(In millions of Bahamian dollars)

article image
Sources: Ministry of Finance; and Fund staff projections.

Fiscal year ends June 30.

Excludes payment arrears and promissory notes for the resolution of Bank of The Bahamas.

Table 2b.

The Bahamas: Operations of the Central Government

(In percent of GDP)

article image
Sources: Ministry of Finance; and IMF staff projections.

Fiscal year ends June 30.

Excludes payment arrears and promissory notes for the resolution of Bank of The Bahamas.

Table 3.

The Bahamas: Balance of Payments

article image
Sources: Central Bank of The Bahamas; Department of Statistics; and IMF staff projections.

Includes errors and omissions.

Staff assumes that a quarter of the $350 million of commercial loans associated with the World Bank’s Multilateral Investment Guarantee Agency (MIGA) will be externally issued and disbursed in 2020. Of the $320 million of IDB loans under discussion, $125 million (of which $25 million are investment loans recorded above the line) are assumed to be disbursed in 2020.

Reserves as percent of ARA metric amount to 77.4 percent without external support.

Table 4.

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

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

Under the assumption that reserves are used to sterilize the monetary impact of government drawing down on its deposits at the central bank.

Table 5.

The Bahamas: Financial Soundness Indicators for the Banking System

(In percent, unless otherwise indicated)

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

In percent of total credit.

Includes the two largest credit unions.

2018 & 2019 data does not include Credit Union data for Asset Quality

Short-term liabilities are defined as resident deposits.