September 13, 2017
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.
An International Monetary Fund (IMF) team led by Fabian Valencia visited The Bahamas from July 12-25 to conduct discussions for the 2017 Article IV consultation. The team met with Hon. Dr. Hubert Minnis, Prime Minister; Hon. Mr. K. Peter Turnquest, Deputy Prime Minister and Minister of Finance; Mr. John Rolle, Governor of the Central Bank of The Bahamas; and other senior government officials, representatives of the opposition, private sector, and civil society. At the end of the mission, Mr. Valencia issued the following statement:
Macroeconomic Context and Focus of the Consultation
The Bahamas has been struggling with a stagnant economy since 2012. Natural disasters, interruptions in the completion of the mega resort Baha Mar, and eroding competitiveness, have resulted in declining real GDP and income relative to other Caribbean economies. Weak economic activity, compounded with high fiscal deficits, have led to a sharp increase in the public debt burden, and has complicated the resolution of banks' high level of non-performing loans (NPLs). In this context, the 2017 Article IV consultation focused on policies to restore fiscal and external buffers, raise growth, and strengthen financial stability.
Real GDP is estimated to have contracted ¼ percent in 2016. Hurricane Matthew, which hit The Bahamas in October, significantly impacted tourism activity in 2016 and early 2017. Completion of Baha Mar and post-hurricane reconstruction activity provided a boost to job creation with the unemployment rate declining to 11.6 percent in November 2016 (down from 12.7 percent in May 2016).Baha Mar opened in April, 2017 and has created about 2,000 jobs so far.
The fiscal position has deteriorated sharply. The central government fiscal deficit is estimated at 5.7 percent of GDP in FY2017 (ending in June), up from 3.5 percent of GDP in FY2016, due mainly to large increases in the wage bill, post-hurricane cleanup and reconstruction spending, temporary tax reliefs, and disruptions in revenue collection.
Commercial banks remain liquid and well capitalized but reluctant to lend in an environment of low growth. As of March, 2017, the average capital adequacy ratio stood at 27.8 percent, well above the regulatory requirement of 17 percent, and liquid assets represented 25.6 percent of total assets. NPLs declined to 11.1 percent of total private sector loans, down from 14.2 percent in 2015, due mainly to a large disposal of distressed mortgage debt by one institution. However, the Bank of Bahamas, a majority state-owned commercial bank, continued to face losses, triggering a new recapitalization by the government in late 2016. Despite ample capital and liquidity for the sector as a whole,the stock of commercial bank credit to the private sector has remained flat. The loss of correspondent banking relationships (CBR) has not resulted in major disruptions so far.
The external sector position is weaker than suggested by fundamentals and desirable policy settings. The current account deficit is estimated to have reached 12.9 percent of GDP in 2016. However, the deficit is expected to widen to 17.8 percent of GDP this year due to a surge in Baha Mar-related imports of goods and services to complete the resort. Over the medium term, the current account deficit is projected to narrow to 7.1 percent of GDP but would still be above the level consistent with fundamentals and desirable policy settings. The real effective exchange rate has remained flat since 2016 after increasing 11¼ percent on average between 2014 and 2016. At an estimated 2.4 months of next year's imports of goods and services, reserve coverage remains below traditional adequacy benchmarks.
Outlook and Risks
Real GDP growth is projected to pick up to 1¾ percent in 2017 and 2½ percent in 2018 and to stabilize at around 1½ percent over the medium term. The baseline scenario is predicated on an expected acceleration in U.S. growth in 2017, the phased opening of Baha Mar, and related construction activity. Post-hurricane reconstruction and a pickup in FDI-financed private investment should further boost growth and employment with spillovers to private consumption. Improving economic conditions should facilitate a faster reduction in commercial banks' NPLs, freeing up additional balance sheet space to support a pickup in credit demand.
Nonetheless, risks are skewed to the downside. Weaker-than-projected U.S. growth or tourism activity would lead to lower growth. A faster-than-expected pace of interest rate hikes in the United States and a generalized tightening of global rates could lead to lower-than-projected foreign investment inflows. Additional appreciation of the U.S. dollar could further erode competitiveness. Natural disasters, an intensification of pressures on CBR, and the potential emergence of Cuba as a competitor for U.S. tourists are additional near- and medium-term risks. On the domestic side, failure to implement fiscal consolidation could undermine investor confidence and reduce projected foreign investment flows. On the upside, a stronger-than-projected U.S. economy, FDI flows, or boost from Baha Mar would lead to higher growth.
Key Policy Messages
Sharp increases in public debt call for decisive fiscal consolidation efforts to ensure that debt remains sustainable and external buffers are strengthened. The sharp increase in the deficit in FY2017 to 5.7 percent of GDP pushed central government debt to an estimated 73 percent of GDP (up from 45 percent of GDP in FY2011), triggering a review for a new downgrade by a rating agency.
The new administration has pledged a strong commitment to restore fiscal sustainability. Its first budget envisages a reduction in the deficit to 3.5 percent of GDP in FY2018 and sets deficit targets of 2.3 percent and 1.1 percent of GDP for the two subsequent fiscal years. However, detailed policy measures to meet these targets still need to be developed. In order to identify measures, the new administration plans to conduct an in-depth expenditure review. In addition, the administration plans to draft new legislation to improve governance and procurement rules, and fiscal discipline. If properly designed and implemented, these initiatives should support fiscal consolidation and strengthen fiscal discipline, accountability, and transparency over the medium term.
Fiscal consolidation should have a strong focus on reducing current expenditure. Delivering on the announced fiscal targets would ensure a firmly downward trajectory for public debt. These targets can be achieved by i) reversing the sharp increases in the wage bill observed over the past year; ii) restructuring state-owned enterprises (SOE) and other public entities to improve their efficiency while ensuring that SOE services are priced at cost recovery levels; and iii) turning the public pension system into a contributory scheme, with contributions commensurate with benefits.
Efforts to strengthen revenues should continue. Revenue administration reforms are commendable and should support fiscal consolidation. Over the medium term, introducing a low-rate income tax as import duties are further reduced should make the tax system more progressive and help protect infrastructure and social spending. Introducing exemptions from VAT should be avoided. Instead, the intended expenditure review should help create space for better-targeted tools to protect vulnerable households. Expanding coverage under the National Health Insurance (NHI) program is not affordable without new revenues to fund it.
The intention to introduce fiscal responsibility legislation is welcome. This legislation should include as key elements: i) a simple fiscal rule with a permanent ceiling on the deficit and a cap on current expenditure growth, consistent with a downward trajectory for the public debt-to-GDP ratio; ii) the requirement to incorporate into the budget process medium-term fiscal projections with their underlying assumptions; iii) an assessment of relevant fiscal risks, particularly those associated with natural disasters, and mitigating policies; and iv) exceptional circumstances clauses, triggered only after significant negative shocks, to avoid procyclicality. Completing on-going reforms to modernize the public financial management system and an adequate financial oversight of public enterprises are critical for an effective medium-term fiscal framework.
Increasing reliance on ex ante insurance and mitigation policies against the risk of natural disasters should strengthen fiscal and economic resilience. The fiscal framework should include awell-designed savings arrangement, as an additional buffer against the fall-out from natural disasters. Incentivizing the use of private natural disaster insurance, including through targeted subsidies to improve affordability for low-income households; and making sure that building regulation, land use, and zoning guidelines are adequate and are reviewed and updated frequently, would enhance economic resilience and reduce fiscal contingent liabilities.
Large pension liabilities call for reforms of the pension system with a view to move toward a defined contribution regime over the medium term . In addition to transforming the public pension system into a contributory regime, the National Insurance Board (NIB) should adopt the recommendations included in the last actuarial report. NIB should also consider raising the pension contribution ceiling to increase progressivity in the system and help safeguard pension reserves.
Significant structural impediments call for urgent action to improve competitiveness to lift medium-term growth. Reform priorities include:
Moving forward with introducing a credit bureau to address information asymmetries, improve the pricing of risk, and expand access to credit;
Upgrading infrastructure in electricity generation and distribution, incentivizing energy efficiency among businesses and the population, and exploiting the potential for cleaner energy sources, including wind and solar power, should improve the reliability of electricity networks and reduce costs. Moving ahead with the planned issuance of the rate-reduction bond by the electricity company is a critical step in this direction. Public-private partnerships, if done effectively, could help fund additional infrastructure in the energy sector and other areas more generally, particularly as SOE reforms move ahead.
Improving the business environment by simplifying administrative processes would reduce the cost 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.
Establishing skills-matching databases; creating a streamlined arbitration process for labor disputes; and expanding vocational and apprenticeship programs would increase labor markets efficiency.
Monetary and Financial Sector Policies
Reducing central bank holdings of government bonds should strengthen the credibility of the peg. Increases in these holdings since late last year should be reversed to ensure compliance with statutory limits.
Encouraging banks to step up loan restructuring efforts should strengthen financial stability and support the economic recovery. An intensification of the restructuring of distressed mortgage debt, including through increased enrollment in the government's Mortgage Relief Program, should free up additional balance sheet space to support the economic recovery. Restructuring the Bank of Bahamas is necessary to strengthen its profitability, enhance financial stability, and reduce fiscal contingencies.
Strong compliance with AML/CFT and tax transparency standards should help stem the withdrawal of CBR. It is criticalto work closely with the CFATF and the FATF to swiftly address the deficiencies in the AML/CFT regime identified in the recent Mutual Evaluation Report (MER). Heightened global focus on tax transparency also calls for efforts to promptly comply with international standards (such as the OECD's Common Reporting Standard).
Improving the quality and timely dissemination of data should help enhance monitoring and transparency. Efforts should include improving the quality and frequency of real sector statistics, such as producing quarterly GDP and labor market data; improving external sector statistics, by including an estimate of the International Investment Position; and moving forward with accrual fiscal accounting and producing general government fiscal accounts.
The IMF team would like to thank the authorities and other interlocutors for their gracious hospitality and frank and open discussions.
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