On June 5, 2009, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with The Bahamas.1
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Background
Since mid-2008, the global downturn has significantly affected economic activity in The Bahamas. Tourism began declining in September and a number of foreign direct investment projects were postponed or cancelled due to the downturn or financing difficulties. As a result, real GDP is estimated to have contracted by 1.7 percent after having grown 2.5 percent per year in 2006–07, and unemployment rose to 12–14.5 percent (preliminary March 2009 estimates) from 7.9 percent at end-2007, with hotel and construction accounting for most of the layoffs. Inflation for the twelve months ending in March stood at 4.9 percent. Private sector credit growth decelerated to 5.1 percent in 2008 from almost 10 percent a year earlier, reflecting weaker demand and tighter lending standards by banks. Direct exposure to the global financial crisis has been limited by exchange controls that cap Bahamian residents’ foreign-currency denominated assets and liabilities.
The external current account balance improved in 2008, mainly reflecting lower construction-related imports and higher retained earnings. Although private sector financing flows dropped substantially, government borrowing in foreign currency to finance capital expenditures helped bolster international reserves, which stood at US$563 million at end-2008, about 87 percent of base money.
The FY 2008/09 overall fiscal deficit is expected to increase to about 5 percent of GDP, reflecting shortfalls in revenues associated with the downturn. The authorities maintained budgeted expenditure levels, while shifting spending to provide transitory means-tested unemployment benefits. The fiscal deficit is being financed by new external and domestic borrowing, increasing central government debt to around 40 percent by the end of FY 2008/09, still low relative to the regional average.
Domestic banks remain well capitalized, despite an increase in non-performing loans as a result of the downturn. Banks have proactively restructured troubled consumer and mortgage loans, and the central bank has enhanced monitoring. Negative spillovers from the offshore financial sector to the domestic financial sector appear limited so far, due to exchange controls and restrictions on net open foreign exchange positions of domestic banks. The linkages to the domestic economy are limited to employment and consumption of services by the sector. A large insurance company, CLICO Bahamas, was placed into liquidation in February 2009 after it became insolvent due to real estate investments in the United States, but its demise has not had systemic implications for the domestic financial system. In May, the authorities tabled amendments to put into effect a law to align insurance supervision with international standards.
Executive Board Assessment
Executive Directors commended the Bahamian authorities’ strong track record of prudent macroeconomic management. They noted that the global economic downturn has put significant stress on the Bahamian economy because of the latter’s strong ties to the U.S. economy, and that downside risks to the outlook remain. However, they considered that the Bahamas’ low debt ratios provide the authorities with room for maneuver to cope with the current difficult economic environment, and noted the authorities’ readiness to adapt their policy agenda as economic conditions warrant.
Directors welcomed the authorities’ efforts to strike a reasonable balance between countercyclical fiscal policy and fiscal adjustment to contain the adverse impact of the shock on medium-term sustainability. They supported the authorities’ plans to maintain priority spending and expand targeted social benefits, despite dwindling fiscal revenues, while streamlining non-essential spending, introducing administrative and legal reforms to enhance revenue collection, and strengthening the public enterprise sector to reduce its burden on the public finances. Directors noted, however, that the attainment of budgetary objectives would depend importantly on privatization proceeds and increased revenue, both of which are uncertain in terms of magnitude and timing. They cautioned that if receipts fell short, additional adjustment measures might be needed.
Directors concurred that the fixed exchange rate regime has served the Bahamas well by contributing to a stable investment climate. They stressed that macroeconomic policies would need to be supportive of the peg under the current difficult environment. They noted the staff analysis indicating that the real exchange rate appears broadly in line with fundamentals and that, despite the recent appreciation, tourism indicators do not suggest a loss of competitiveness.
Directors noted that the direct financial impact of the global downturn and negative spillover from the offshore financial sector appear limited thus far. They observed that, despite increases in non-performing loans, domestic banks remain liquid and well capitalized with healthy margins. Directors welcomed the authorities’ enhanced bank monitoring and plans to strengthen supervision of credit unions and the insurance sector, and encouraged further regional coordination of bank supervision. They highlighted the authorities’ commitment to adhere to international standards for offshore financial regulation, strengthen the framework for Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT), and adopt Organization for Economic Cooperation and Development (OECD) standards on tax information exchange.
Directors welcomed the authorities’ plans to shift from credit controls to more market-based monetary policy instruments, including by introducing an auction mechanism for government securities to allocate credit more efficiently and to provide a vehicle for liquidity management. Directors concurred that gradual relaxation of exchange controls, under a well-sequenced implementation plan, once the global environment becomes more supportive, would help deepen domestic capital markets.
Directors encouraged the authorities to implement structural reforms to promote economic diversification and private-sector-led growth over the medium term. In particular, they stressed the need to diversify tourism exports, and to broaden the domestic tax base in order to help finance priority spending, reduce distortions, and increase the resilience of revenues to shocks. Strengthened administrative capacity could facilitate the eventual introduction of a goods and services tax, which in turn would help achieve the authorities’ objective of reducing the debt to 30–35 percent of GDP over the medium term.
