NASSAU, The Bahamas – A strong rebound. The Bahamian economy has staged a remarkable recovery following hurricane Dorian in 2019 and the Covid-19 pandemic. Activity and employment have recovered to their pre-pandemic levels and inflation has fallen back below pre-pandemic levels. Public finances are improving and borrowing costs have declined. Over the medium-term, growth is expected to slow to its long-run potential (of 1½ percent) as capacity constraints in tourism become more binding. Barring global commodity price shocks, headline inflation is expected to converge to around 2 percent.
Nonetheless, long-standing challenges remain
Income per capita continues to diverge from that in the US At the same time, expensive electricity, a shortage of skilled labor, and obstacles to business formation and expansion continue to weigh on growth. As in many other countries, government debt-GDP jumped during the pandemic and borrowing costs remain uncomfortably high. The archipelago is also highly susceptible to natural disasters and rising sea levels, both of which argue for increased investments in resilience and building fiscal buffers so as to better respond to climate-related shocks.
Risks to the outlook for activity are balanced
Upside risks include the execution of announced infrastructure and hotel construction projects and a higher-than-expected boost from an expansion of short-term rentals. The main downsides stem from large public debt rollover needs and the ever-present risk of natural disasters.
The need to restore fiscal buffers
The fiscal deficit was 1.3 percent of GDP in FY24, around 2½ percentage points of GDP lower than FY23.
The adjustment was driven by both revenue increases (better tax compliance, a cyclical rebound, and policy measures) and expenditure containment (lower transfers to public corporations and some under-execution of capital spending). Central government debt fell to 78.8 percent of GDP in FY24 but there has been an upswing in the reliance on central bank advances (now at 2 percent of GDP). Global factors have pushed down sovereign spreads on foreign currency debt, but domestic financing has increasingly relied on issuance at short maturities, raising the near-term gross financing needs.
The authorities’ debt target of 50 percent of GDP by FY31 provides a useful anchor for policy
The FY25 budget targets an overall fiscal balance of –0.5 percent of GDP and 2.8 percent of GDP in FY26. Improved tax administration and lower interest payments will get the fiscal position part of the way to the government’s targets. However, in the absence of additional policy measures, revenues are likely to underperform and the fiscal balance will be smaller than assumed in the authorities’ forecast (especially in FY26), putting the debt target out of reach for FY31.
The introduction of the 15 percent qualified domestic minimum top-up tax (QDMTT) on large multinational corporations that are resident in The Bahamas is expected to generate 1 percent of GDP in new revenues (which are already incorporated into staff’s baseline).
The bill has been passed by the House of Assembly and the Senate. Additional legislation will be needed to lessen disincentives to invest in tangible depreciable assets through accelerated depreciation or refundable tax credits and to bring offshore indirect transfers of Bahamian property into the tax net.
Further revenue measures are needed to support the targeted fiscal adjustment
The budgeted 3½ percentage points of GDP increase in the primary balance between FY24-FY26 was achieved only once in the 18 years prior to the pandemic (and that was as a result of an increase in the VAT rate and a sharp reduction in expenditure two years after recovery efforts following Hurricane Matthew). However, the adjustment could be spread out over a moderately longer horizon, raising the primary balance to 5½ percent of GDP by FY26 and to 7 percent of GDP by FY29. This would still bring debt to 50 percent of GDP by FY31 and would allow the private sector a longer horizon to adjust to the withdrawal of fiscal resources. Such an adjustment could be achieved through some combination of:
- Replacing the business license fee with a 15 percent profits tax on large domestic firms;
- Introducing a personal income tax for the top earners;
- Eliminating the ceiling on the property tax;
- Reducing tax expenditures;
- Increasing the VAT rate;
- Raising water rates for heavy users;
- Ensuring the collection of patient fees at the Public Hospital Authority.
These measures, along with the supply-side reforms described below, would ensure the debt target is met and help build fiscal credibility while still generating resources to increase investments in education, targeted social transfers, and climate-resilient infrastructure.
Proposed reforms to civil service pensions should be supplemented with more holistic changes to both the civil service and national (NIB) pension systems. The draft proposal introduces a contribution for new hires, increases the mandatory retirement age, and eliminates the possibility of early retirement at age 55. These are constructive changes that will lessen the actuarial imbalance of the civil service pension system. However, additional steps are needed to harmonize the two systems including gradually raising the contribution rate for the NIB, aligning the minimum retirement age between the NIB and the civil service systems, and indexing the retirement age to life expectancy for both systems.
The authorities have taken steps to increase the transparency and effectiveness of domestic debt management operations. This has included instituting competitive auctions for primary issuance and building a cash buffer to accommodate potential shocks. Fully staffing the debt management office, publishing rules for changing the composition of securities issued, and improving the capacity for liability management operations would help to further strengthen debt management.
The reconstitutions of the Fiscal Responsibility Council and the Public Sector Audit Committee are welcome. Members of both committees should be independently selected. To enhance fiscal transparency, beneficial ownership information should be published for all companies that are awarded public contracts. The audited financial statements and procurement information for public corporations should also be published.
Supporting Financial Stability and Inclusion
New liquidity management tools and reductions in central bank advances to the government would decrease systemic liquidity. Improving liquidity forecasting and introducing tools such as interbank repos or 30-day Treasury Bills could better manage systemic liquidity over the long-term. Reducing the statutory limit on central bank advances to the government and repaying the outstanding stock of advances would help absorb liquidity and strengthen the credibility of the fixed exchange rate regime. A well-defined “escape clause” could be introduced to allow a temporary increase in the limit on central bank advances in exceptional, emergency circumstances.
Systemic financial stability risks are moderate
The credit gap remains negative after several years of credit contraction and household and corporate leverage are both at modest levels. Banks are well capitalized and hold a fifth of their domestic assets in cash or reserves. However, banks’ high exposure to public sector debt represents an important vulnerability.
Progress has been made on implementing the 2019 FSAP recommendations. Plans to establish the Bahamas Financial Stability Council, which are expected to be finalized by end-2024, should help provide a more coordinated approach to macroprudential policy. Deposit insurance premia have been increased and the bank resolution framework has been improved. The creation of a real estate price index is also advancing. Supervisory oversight would be further aided by the collection of loan-level data from bank and nonbank lenders.
The central bank is seeking to improve access to financial services. The expansion of digital banking and the introduction of the moveable collateral register could help with the cost of, and access to, credit. Encouraging new financial technologies may require improvements in data availability, expanding geographic internet connectivity, investing in financial literacy, and potentially establishing regulatory sandboxes and/or innovation hubs.
The 2024 DARE Act has improved the regulatory framework for digital assets.The new act widens the coverage of oversight and strengthens anti-money laundering and combatting the financing of terrorism (AML/CFT) requirements. The priorities are now to ensure sufficient resources for effective oversight, increase onsite inspections, and address data gaps. Additional steps could include introducing a requirement to collect, hold, and share originator and beneficiary information and ensuring that registrable activities do not include anonymity-enhancing services such as mixers, tumblers, and other high-anonymity technologies. The scope of the act could be expanded to include other decentralized finance products and services.
Risk-based AML/CFT supervision of financial institutions and the enforcement of criminal penalties for such activities continue to move forward. The authorities are finalizing a national risk assessment (NRA) for money laundering and will then turn to completing the NRA for terrorism financing. The findings of these risk assessments should then feed into the update of the national AML/CFT strategy. Efforts to align the beneficial ownership regime with evolving international standards should continue (e.g., ensuring that registered agents are collecting and updating adequate information on their customers; requiring domestic companies to retain beneficial ownership information of their own shareholders).
Higher and more resilient growth
Long-term growth needs to be lifted by investing in human capital, closing digitalization gaps, relieving capacity constraints in tourism, reducing labor market informality, and fighting crime. Incentivizing private sector investments in hotel capacity, particularly outside of New Providence, would expand potential growth in the tourism sector. Expanding vocational and apprenticeship programs, improving skill databases and job placement services would build skills, support job matching, and reduce youth unemployment. Reducing crime will require investments in crime mitigation strategies, a larger police force, better leveraging data analytics to target intervention and continuing recent efforts to enhance the effectiveness of the criminal justice system.
Investing in climate-resilient infrastructure will substantially decrease output losses from slow-moving aspects of climate change (e.g., sea level rises) and natural disasters. Public investments in adaptation and the preservation of natural capital could increase real GDP by up to 9 percent over the long-term. Adaptation investment needs in The Bahamas are substantial and are likely to be larger than the estimates in the Nationally Determined Contribution. To align with the authorities’ medium-term fiscal plans, greater revenue mobilization is needed to fund such adaptation investments. In addition, international and private sector support (particularly in the form of grants) will be important. Beyond the resources needed for such investments, it is likely that even further fiscal adjustment will be needed over the medium-term to build up a contingency fund for future natural disasters while adhering to the 50 percent debt target in FY31.
Efforts to enhance disaster insurance coverage for vulnerable populations are a positive step but should be complemented with measures to mitigate moral hazard. The government and the private sector are designing a partially subsidized, natural disaster micro-insurance product for the most vulnerable. To avoid leakage and minimize fiscal costs, effective targeting of this insurance subsidy will be essential. Potential moral hazard (i.e. encouraging excess risk taking with respect to climate-related risks due to underpriced insurance) should be curtailed through integrating disaster risk management considerations into zoning regulations, strengthening the enforcement of robust building codes, and improving access to information on climate risks.
The institutional framework needs to incorporate better coordination and accountability on climate objectives. The government is incorporating climate change considerations into planning, supported by development partners, including through expected updating of the 2005 National Policy for the Adaptation to Climate Change and developing a detailed national adaptation plan. Similar to the 2022 Disaster Risk Management Act, this could include a comprehensive legislation on adaptation to climate change which identifies responsibilities of line ministries and sets up mechanism for accountability, through an inter-ministerial commission that reports to the Parliament.
Further recourse to climate financing would reduce borrowing costs. The authorities have increased access to climate resources through policy-based guarantees from the IDB and plans to join the Development Bank of Latin America and the Caribbean (CAF). Undertaking debt-for-nature swaps that have a third-party guarantor—as contemplated in the 2023/24 budget and initiated in November – could provide resources for specific investments in preservation of natural habitats.
The planned electricity sector reforms seek to modernize transmission and distribution channels and increase the use of renewables. Such a shift in the energy matrix would, over the medium term, help narrow the current account deficit, reduce vulnerability to commodity price shocks, and boost growth. In implementing the government’s plan, strengthening of the institutional framework for public-private partnerships (PPPs) will be an important precondition and, more broadly, there should be a clear definition of risk sharing between private and public sectors. Improving the operations, lowering costs, and optimizing the capital structure of the Bahamas Power and Light Corporation would help support these reform efforts.
