The Bahamas: Staff Concluding Statement of the 2019 Article IV Mission
April 15, 2019
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
The Bahamas delivered strong economic performance in 2018, supported by sound macroeconomic policies and progress on fiscal reforms. With downside risks prevailing, maintaining this positive momentum requires broad-based reforms to strengthen institutions, improve competitiveness and external accounts, and bring public debt on a downward path. The 2019 Financial Sector Assessment Program (FSAP) found the financial system to be resilient to current stability threats, but action is needed to safeguard against potential weaknesses and respond to future stress events.
Recent Performance and Outlook
Growth in 2018 was backed by buoyant tourism and construction activity. Real GDP is estimated to have grown by 2.3 percent in 2018, and growth is projected to steady at 2.1 percent in 2019, underpinned by continued growth in the tourism sector. Despite positive jobs growth, however, the unemployment rate remains high and is projected to decline only gradually. Inflation increased to an average of 2.2 percent in 2018 but is projected to fall to 1.6 percent in 2019 as the temporary effect of the VAT rate increase fades.
The medium-term outlook is positive, but risk factors could weigh on growth. Economic growth is projected to converge to its potential of 1½ percent in the medium term as tourism growth normalizes. A significant slowdown in the U.S. and other advanced economies would, however, adversely affect the tourism-dependent Bahamian economy. Reputational risks in the offshore sector remain even as the government has strengthened regulatory and transparency standards, and existing business models could be challenged. Vulnerability to hurricanes and climate change is high. Against this backdrop, continued commitment to fiscal responsibility and sound macro-financial policies is welcome and indispensable.
Maintaining the Momentum on Fiscal Reforms
The effective implementation of the Fiscal Responsibility Law (FRL) will bolster policy credibility and ensure durable gains from fiscal consolidation. The commitment to maintaining the pace of fiscal adjustment in line with FRL targets—which will bring public debt towards the anchor of 50 percent of GDP—is welcome. While the budget deficit has narrowed, recognition of sizeable arrears highlights the need for stronger public financial management (PFM) systems to address weaknesses in expenditure control and budget preparation. Enacting the Public Financial Management, Public Debt Management, and Procurement Acts and operationalizing the Fiscal Council should be prioritized to ensure permanent advances in budgeting, transparency, and accountability.
In the near term, however, there is need for expenditure restraint to deliver the FY2018/19 target. Available data point to weaker-than-expected revenue performance, partly due to grace periods granted for the implementation of revenue measures and legal disputes. The fiscal deficit is therefore projected to narrow to 2.1 percent of GDP, bringing the outturn close to the 1.8 percent target. This consolidation is broadly in line with the transition path towards the FRL targets established in the budget. To demonstrate steadfast commitment to the new policy framework and safeguard public investment, the government should further rein in current expenditures. Over the medium term, decisive measures are needed to reduce debt, including in the areas of public pensions and health, while carefully balancing priorities for inclusive growth and disaster preparedness.
Fiscal policy should play a greater medium-term role in achieving public policy objectives, including greater income equality. The Bahamas does not levy income or capital gains taxes, relying mostly on VAT, business license fees, and international trade taxes. Global tax trends and the prospective accession to the WTO thus present an opportunity for a comprehensive review of the Bahamian tax regime with a view to achieving a more equitable and less distortionary tax system. To strengthen transparency and inform future policies, a quantitative review of existing tax and other investment incentives is recommended.
Important steps have been taken to increase resilience to natural disasters. The government has secured a contingent credit line with the Inter-American Development Bank and re-subscribed to disaster insurance through the Caribbean Catastrophe Risk Insurance Facility (CCRIF). Speedy establishment of the Natural Disaster Fund will complement the financial tools currently available to effectively respond to disasters. Investing in physically resilient infrastructure, including through building code enforcement and coastal management, is equally critical.
Strengthening the Financial Sector
The banking sector remains sound, but credit growth is hampered by non-performing loans (NPLs) and lack of information about potential borrowers. The 2019 FSAP found that the banking sector enjoys healthy profits and maintains high capital and liquidity ratios. Further progress in supervision of credit underwriting and timely resolution of NPLs remain key objectives. A local real estate price index should be introduced to increase visibility into the residential housing market and improve NPL valuations. The credit bureau, once operational, should strengthen the quality and pace of credit activity and improve assessment of lending standards.
Strengthening the central bank’s recovery and resolution powers will enhance banking sector resilience. The recapitalizations of the Bank of The Bahamas highlight the need to complete planned legislative reform and enhance governance of public asset management companies. Governance arrangements for state-controlled financial institutions should be strengthened to ensure their continued effective and independent supervision.
Swift implementation of the new framework for the international sector will demonstrate commitment to ensuring a transparent and well-regulated industry. The Bahamas is removing preferential tax treatment for non-resident entities by implementing a unified business licensing fee framework. Economic presence requirements for non-resident firms are being strengthened along with entity transparency regarding beneficial ownership. Potential spillovers into the domestic financial system from the unification of banking license regimes require careful monitoring.
Demonstrating effectiveness of the AML/CFT regime will strengthen financial integrity. The Financial Action Task Force (FATF) continues to identify The Bahamas as a country with strategic AML/CFT deficiencies. Progress in further improving technical compliance of the AML/CFT regime, including by revising laws and regulations and strengthening supervisory guidelines and codes of conduct, is welcome. Continuing to move the focus to implementation to demonstrate the effectiveness of the AML/CFT regime, including in line with the FATF Action Plan, is recommended.
Excess liquidity calls for a strengthening of the monetary policy transmission mechanism. The accommodative monetary policy stance is appropriate given the cyclical position of the economy and the negative credit gap. However, a large structural liquidity surplus exists given exchange controls and the absence of a well-developed domestic securities market. Deepening the domestic sovereign debt market through regular auctions is recommended. The Central Bank of The Bahamas (CBOB) should continue to reduce its holdings of government debt and adoption of the amendments to the CBOB law is recommended to strengthen its governance and define limits on government lending.
New financial technologies can advance financial inclusion; nonetheless, risks involving a central bank digital currency need to be well understood. Wider geographic penetration of digital payments can also be achieved by modernizing payment systems and using proven technologies. The CBOB is planning to pilot a digital central bank currency to boost financial inclusion. The team welcomes the CBOB’s emphasis on protecting against risks to financial stability, cybersecurity, and in the AML/CFT sphere, and recommends that relevant safeguards be carefully reflected in the project design.
Strengthening External Accounts and Competitiveness
Strengthening competitiveness and external buffers is recommended to boost external sustainability. The current account deficit increased to 15.9 percent of GDP in 2018, in part reflecting one-off factors related to the completion of Baha Mar and an overvalued real effective exchange rate. Significant—albeit declining—current account deficits are projected to continue, financed mainly by foreign direct investment. In the context of the continued strong commitment to the exchange rate peg, structural reforms to boost competitiveness alongside fiscal consolidation and accumulation of foreign exchange reserves are critical to strengthen external buffers.
Addressing structural impediments and preparing the economy for a further gradual opening is critical. Several steps have been taken to address long-standing structural issues, boost private investment, and lower the cost of doing business. Planned accession to the World Trade Organization (WTO) makes it even more urgent to tackle remaining impediments. Lowering energy costs, improving private sector credit access, and tackling skills mismatches in the labor market are critical priorities.
More investment in statistics is necessary to inform policy making. Recent improvements to data dissemination through the enhanced General Data Dissemination System and increased fiscal data reporting frequency are important steps. Investing further in the production of comprehensive and frequent information regarding national and external accounts, the labor market, and household surveys would enable better informed policy making and timely policy response to new developments.
An IMF team visited Nassau from April 1-12, 2019 to hold discussions for the 2019 Article IV consultation. The team would like to thank the Bahamian authorities, private sector interlocutors, and civil society representatives for the candid and productive discussions.
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