USA / THE BAHAMAS – The Bahamas’ tourism-dependent economy was hit hard by the COVID-19 pandemic which came on the heels of the devastation caused by hurricane Dorian. The economy is recovering strongly but the pandemic has exacted a tragic human and social toll and caused a significant weakening in public finances. The policy priorities ahead are to safeguard the recovery, preserve debt sustainability, and promote sustained and inclusive growth. First and foremost, this will require vaccinating the population as swiftly as possible. As the pandemic’s impact recedes, policies should focus on tackling long-standing challenges by improving the structure of revenues and spending, rebuilding fiscal space, and making the economy more resilient to the effects of climate change.
The economy is recovering from an unprecedented downturn. Growth in 2020 was -14½ percent, among the lowest in the region, as tourism receipts fell by more than
75 percent. Starting in the second half of 2021, the tourism sector experienced a significant rebound, with stopover arrivals doubling relative to 2020. Coupled with an uptick in construction activity, output is estimated to have expanded by around 5½ percent last year. Real GDP growth is estimated at around 6 percent this year, although a full recovery to pre-pandemic levels is not expected before end-2023. Inflationary pressures are building in line with global developments and are expected to ease only gradually. Despite this, it will be important to allow higher international food and energy costs to pass through to domestic prices alongside targeted support to protect the poorest members of society. The tourism recovery is projected to narrow external imbalances over the medium term and thereby keep international reserves at adequate levels.
The pandemic has deepened the country’s medium-term growth challenges and public finances have deteriorated. Education gaps have increased given the varied quality and access to remote learning. Private investment and employment will take time to recover. Additionally, the economy will have to contend with lasting effects of the pandemic on travel preferences as well as broader shifts in technology and climate risks. The new administration has pledged relief through tax cuts and increasing investment in resilient infrastructure, health and education. However, fiscal space has been eroded, limiting the room for maneuver to achieve these goals. Public debt is close to 100 percent of GDP, gross financing needs are high, and fiscal financing costs are elevated.
Risks to the outlook are significant. A re-intensification of the pandemic cannot be discarded. With about 40 percent of the population fully vaccinated, the emergence of new COVID-19 variants could prolong the pandemic and induce renewed economic disruptions. Alternatively, rising cases in source countries could dissuade travel and lead to a renewed decline in tourism. Higher food and oil prices, including because of the effects of the war in Ukraine, could erode consumer demand and impose a particularly heavy burden on the vulnerable. In addition, a sharp rise in global risk premia could limit the ability to place new debt and further strain public and private balance sheets. Natural disasters related to climate change are a continuous risk. On the upside, the global recovery could prove stronger than is currently anticipated, which would help support tourism.
Bolstering debt sustainability
The fiscal deficit is expected to narrow this year. The supplementary budget retains some pandemic related spending (mostly on social programs), cuts the VAT rate from 12 to 10 percent, and raises public salaries and non-contributory pensions. To offset the impact of these steps on the deficit, the authorities plan to strengthen tax administration and remove some zero-rated VAT items. Staff estimate that the primary deficit will narrow from about 9 percent of GDP in FY2020/21 to around 3 percent of GDP this fiscal year. The economic recovery accounts for about half of this decline in the primary deficit.
The government’s goal to achieve a 1½ percent of GDP fiscal surplus over the medium term is well-calibrated. The authorities have invested considerable resources in strengthening tax administration with a goal of increasing the revenue-to-GDP ratio to 25 percent. Measures include the re-establishment of the Revenue-Enhancement Unit and an updated property tax roll. The envisaged overall surplus would be consistent with rebuilding fiscal buffers and putting public debt-GDP on a decisive downward path towards the debt target of 50 percent, as laid out in the Fiscal Responsibility Act.
A well-calibrated tax policy reform should go hand-in-hand with ongoing revenue enhancement efforts. Options include gradually bringing VAT rates close to the regional average of 15 percent, further limiting tax concessions, and increasing property tax rates on higher value residences. In addition, consideration could be given to corporate and personal income taxes for large businesses and high earners.
A reprioritization of public spending is also needed to promote better social and economic outcomes. The government plans to reassess the various roles and responsibilities of civil servants to improve efficiency. Measures are also underway to contain rising outlays to state-owned enterprises (monthly performance reports will be published by these enterprises starting in the next fiscal year). Discussions are ongoing on civil service pension reforms. Conducting rigorous cost-benefit analyses would help ensure sound capital projects selection. A more effective allocation of scarce public resources would create room for increased spending on health and education, which is well below regional peers. Improving social assistance will require obtaining better information on potential recipients (including a timely and comprehensive household survey). Fiscal transparency would be further enhanced by the timely publication of audited financial statements for public sector entities (including beneficial ownership information of those receiving COVID-related spending).
The Bahamas would benefit from a more robust multi-year debt management strategy. Even with significant fiscal consolidation, financing needs will decline only gradually over the medium-term. This creates elevated risks of the country finding itself in debt distress. Mitigating these risks will require careful planning. The new debt management committee should systematically track performance of the recently published multi-year government financing strategy and undertake contingency planning to ensure the strategy is robust in a less favorable market environment. The government should avoid undertaking strategies that may appear to reduce costs in the short-term but potentially exacerbate debt distress in certain circumstances.
Bolstering external and financial stability
The exchange rate peg to the US dollar has served as an anchor of macroeconomic stability. It is recommended that the central bank allows interest rates to rise, as needed by market conditions, to support the currency peg without having to resort to a drawdown of international reserves. If the market environment were to deteriorate markedly, consideration may need to be given to a temporary tightening of capital flow management measures. Further amendments to the 2020 Central Bank Act—including lowering the ceiling on credit to the government and restricting central bank purchases of securities issued by public corporations—would help safeguard the central bank’s institutional and financial autonomy and bolster confidence.
The Sand Dollar digital currency (CBDC) has the potential to help foster financial inclusion and payment system resilience in the event of a natural disaster. The CBDC currently makes up less than 0.1 percent of currency in circulation and there are limited avenues to use the Sand Dollar. The pandemic slowed education campaigns to inform the general public and businesses about the benefits of the CBDC as well as the completion of technical work in integrating the CBDC with the banking system. However the bank has plans to accelerate these efforts now that the pandemic has subsided. It is recommended for the central bank to continue strengthening internal capacity – including on cybersecurity and the resilience of systems associated with the Sand Dollar – and to maintain careful oversight of the CBDC project, including to safeguard financial integrity.
The financial system is well-capitalized and liquid. Capital ratios are well above regulatory requirements and system-wide liquidity has increased. The pandemic-related loan moratoria have expired leading to a small increase in non-performing loans. Lending conditions for corporations and households remain tight. The operationalization of the recently established credit bureau should improve financial inclusion and reduce the cost of borrowing.
The central bank made good progress in setting up a bank recovery and resolution regime, but there is scope for further enhancements. Interagency coordination on systemic matters could be enhanced, and a new inter-agency coordination body, such as a Financial Stability Council, could facilitate regular information exchange and cooperation on financial stability and crisis management issues. The central bank is encouraged to update its supervisory framework for bank intervention to ensure that early warning indicators are used more effectively. Further enhancements to the Deposit Insurance Corporation are warranted, including strengthening its governance, organizational structure and funding arrangements.
Effective implementation of the strengthened anti-money laundering/combating the financing of terrorism (AML/CFT) framework will be key. The Bahamas has exited the “grey list” of the Financial Action Task Force (FATF). In line with an action plan agreed with the FATF, the authorities set up a register of beneficial ownership, introduced an automated system to collect suspicious transaction reports, and have applied fines for non-compliance. The authorities now need to ensure effective implementation of risk-based AML/CFT regulation and supervision, including for transactions related to the Sand dollar and the country’s expanding crypto trading industry. The 2020 Bahamas’ Digital Assets and Registered Exchanges Bill (DARE) provides a legal framework for the digital asset space.
Addressing longstanding productivity challenges and increasing resilience
While tourism will remain systemically important, the authorities have long recognized the need to diversify toward a more knowledge-based economy. A greater emphasis on energy reforms and educational programs to improve the inclusion of young workers and the underemployed will raise growth potential. The authorities are working with the ILO and employers to implement a national apprenticeship program to address skills gaps. Encouraging digitalization, streamlining administrative processes, closing data gaps, and publishing statistics in line with international standards will all improve the business climate.
The authorities have strengthened their commitment to climate change policies. The country aims to achieve a minimum of 30 percent renewables in the energy matrix by 2030. The Bahamas also introduced measures to protect its marine environment, enhance food security, and improve water conservation. The authorities are in the process of upgrading the country’s building code and zoning rules. The Bahamas would benefit from a comprehensive disaster resilience strategy. There is scope to access a growing stream of international financing for climate change-related projects. In addition, The Bahamas could benefit from including natural disaster clauses in the country’s debt contracts.