November 28, 2023
The Bahamas’ economy continued to rebound vigorously in 2022. Real GDP growth reached 14.4 percent and unemployment fell to 8.8 percent with a broad-based expansion that was especially strong for tourism. However, labor force participation, particularly among men, remained below pre-pandemic levels. In 2023, international flight and cruise arrivals rose well above their pre-pandemic levels leading to a projected 4.3 percent expansion in the year, bringing the economy back to estimates of potential output.
After peaking at 7.1 percent in July 2022, inflation has fallen steadily to 2.3 percent in July 2023, largely driven by the fall in global energy prices.
Risks to the outlook are skewed to the downside. A fall in tourism demand, due to an economic slowdown in source markets could weigh negatively on the growth outlook. Furthermore, renewed pressures on global food and oil prices could impose a burden on lower income households and put pressure on the balance of payments. Any associated fiscal measures to dampen the pass-through of global prices to the domestic economy would have to be well-targeted to mitigate further strain the fiscal position. . Finally, The Bahamas is highly exposed to risks emanating from climate change and natural disasters. In the event that risks are realized, domestic financing challenges could increase.
Creating A More Efficient and Progressive Fiscal Framework
A strong cyclical recovery in revenues and a wind down of pandemic-related spending have reduced the fiscal deficit to 4.1 percent of GDP in FY2022/23, bringing the central government debt down to 84 percent of GDP at end-June 2023.The authorities intend to reduce the deficit to 0.9 percent of GDP in 2023/24, reaching an overall surplus of 2.1 percent of GDP by FY2026/27. The bulk of this adjustment would come from a 3½ percent of GDP increase in revenue collections, largely from improvements in administration. In addition, ½ percent of GDP in additional capital spending are expected to be funded from lower current spending. This fiscal path is expected by the authorities to bring public debt to 68 percent of GDP by FY2026/27.
While the objectives of the authorities’ medium term fiscal plan are laudable, staff assesses that more policy measures will be needed to achieve this targeted adjustment. In particular, based on current policies, the fiscal deficit is expected to be 2.6 percent of GDP in 2023/24 (considerably larger than that expected in the budget). Over the medium-term, debt would fall to 78 percent of GDP by 2027/28 but gross financing needs would remain high for the next several years (at around 20 percent of GDP). Even though, under this path, debt is judged to be sustainable, a faster reduction in debt would be valuable in lessening the risk of sovereign stress and, in so doing, would be rewarded through a lower interest burden for the public debt.
Beyond reducing the fiscal deficit, a set of comprehensive tax reforms would be valuable in both raising revenues and improving progressivity. In particular, the implementation of the OECD global minimum corporate tax by trading partners provides an opportunity for The Bahamas to introduce a well-designed corporate income tax accompanied by a personal income tax on the highest earners. There is also scope to significantly rationalize existing preferences, loopholes, and exemptions in the tax system.
Efficiency gains in spending programs and improvements in the financial management of state-owned enterprises will be needed to offset some of the budgetary pressures arising from an aging population. To improve longer-run growth and strengthen social inclusion, there will be a need to reorient spending priorities toward education, healthcare, targeted social transfers and infrastructure (particularly those which will increase resilience to the effects of climate change).
Better debt management would help reduce the vulnerabilities created by The Bahamas’ high debt rollover needs. Recent reforms to strengthen the primary and secondary debt markets should help increase the liquidity of government bonds and incentivize an increase in domestic holdings of longer duration securities. In particular, the central bank continues to facilitate the issuance of T-bills by competitive auction and intends to extend this across domestic government security maturities. Further reforms to bolster these efforts can include improving investor relations and increasing the transparency and predictability of sovereign issuance plans.
Additional steps should be taken to place more binding limits on central bank financing of the fiscal deficit. The authorities have made amendments to the Central Bank Act prohibiting financing the government via the primary bond market and have also imposed a lower limit on central bank advances; however, this limit is above that of regional peers with pegged regimes. A reduction in the limit on central bank financing should be accompanied by a well-defined “escape clause” that would be triggered in exceptional circumstances (e.g., in the event of a large scale natural disaster). Repaying central bank advances, already at the ceiling, could also serve to strengthen the credibility of the exchange rate regime.
Recent welcomed amendments to the new Public Finance Management (PFM) and Public Procurement Acts will usefully strengthen the governance framework of SOEs and improve the transparency of public procurement. The publication of beneficial ownership information is now mandatory for public contracts funded by an international funding agency but should be the applicable standard for all providers that obtain public contracts. Similarly, procurement documents and audited financial statements of SOEs should be published on a regular basis. An independent process should be put in place to select members of the fiscal council. Finally, any deviations from the targets mandated in the PFM Act should be time-bound and underpinned by clear guidance on the speed at which the authorities will revert back to their goals.
Strengthening the Financial System
Protection of the exchange rate peg requires sustained preservation of international reserves. The recovery in tourism, external public sector borrowing, and the presence of long-standing capital flow management measures have supported international reserve accumulation even as domestic short-term interest rates remain well below those in the United States. However, capital flows can be sensitive to interest rate differentials, especially during periods of uncertainty or volatility. Liquidity management operations, as well as allowing interest rates to rise as needed by market conditions could be useful for mitigating these risks, reduce banks’ carrying cost of reserves and, in turn, narrow the spreads between deposit rates and rates on loans to private borrowers.
Usage of the Sand Dollar, the central bank’s digital currency, remains limited. Despite the large diffusion of electronic wallets, the Sand Dollar still represents a small, albeit growing, percentage of money in circulation. The central bank is continuing its outreach efforts to the public and has formalized the governance framework surrounding the Sand Dollar. The Bank multipronged approach to increasing Sand Dollar adoption has the potential to increase financial inclusion and increase the resilience of the payment system. Continued efforts to identify and manage cybersecurity risks and improve the security infrastructure will also bolster confidence in the Sand Dollar, and strengthen prospects for a larger circulation.
Deeper efforts are recommended to analyze, monitor, and mitigate financial stability risks stemming from crypto assets. The regulatory framework for crypto assets has been updated and the authorities have legislated an amendment to the Digital Assets and Registered Exchanges (DARE) Act to strengthen the regulation and supervision of crypto assets. Critically, this should be accompanied by the provision of more resources for onsite inspections to help identify and rectify operational deficiencies and reduce reputational risks. Further amendments to the legislation to fully align The Bahamas’ framework for crypto assets with global standards like the Financial Stability Board’s high-level recommendations on crypto assets and the Basel Committee standards on the prudential treatment of crypto exposures are advised. Vigilance in this nascent but rapidly-evolving area of regulatory oversight will be of the essence.
The progress made by the authorities in implementing the 2019 FSAP recommendations are welcome, but some areas remain to be addressed. A separate Resolution Unit within the central bank has been established but will require adequate staffing to become fully operational. Plans are underway to establish The Bahamas Financial Stability Council (BFSC) to improve interagency coordination and information exchange among financial stability regulators. Efforts should be furthered to increase the coverage of deposit insurance for domestic banks by increasing premiums levied on banks for all deposit liabilities, while improving the Deposit Insurance Corporation’s governance and operational structure. The collection of loan-level data by supervisors would assist in identifying systemic risks and, if needed, in designing macroprudential policies.
Boosting Resilience and Growth
New avenues for climate finance have the potential to bolster fiscal and environmental sustainability. Building credible measurement, reporting and verification frameworks for climate-related projects, developing projects that have co-benefits across other Sustainable Development Goals, and partnering with established institutions in climate finance will help set high standards in assessing projects through an environmental lens. Creating a credible domestic framework for climate-related investments can help catalyze investor interest in green and blue debt instruments as well as the sale of carbon credits. Similarly, developing a domestic framework for Environmental, Social and Corporate Governance bonds (including introducing reporting standards for sustainability disclosures by companies) would help support new avenues for climate financing to Bahamian public and private sector entities.
Accelerating the transition to renewable energy will help boost private sector growth and reduce the country’s exposure to global swings in commodity prices. High and volatile energy prices and supply reliability issues are a disincentive to private investment. Accelerating solar projects and improving the national electricity company’s governance structure could help lower costs, increase the continuity of energy supply, and raise the share of renewables toward the authorities’ goal of 30 percent by 2030. Other investments in renewables—particularly roof-top solar—should be incentivized through either subsidies or tax preferences and private-public partnerships should be encouraged, especially on remote islands.
Property insurance premiums have been steadily increasing due to the high costs of reinsurance. This is leading to decreased insurance coverage which, in the event of an extreme weather event, can potentially lead to significant losses for the population and, ultimately, create large fiscal needs. Partial public funding of micro-insurance products could be expanded in combination with a public mandate to carry a minimum level of property insurance. Increased fiscal buffers will be needed to provide some relief to those that may be affected in a future disaster. Finally, the authorities could consider designing financial instruments that incentivize private self-insurance.
The government has made significant progress in the digitalization of public services and data gathering. Addressing the remaining gaps has the potential to help reduce frictions that dis-incentivize private investment as well as improve the targeting of social assistance programs.