Directors underscored that the key policy challenge is to ensure sustainable public finances. They encouraged the authorities to strengthen revenue mobilization by improving tax administration and reducing tax expenditures. Directors noted that revenue reforms, such as a broad-based consumption tax, would improve debt dynamics. They also advised the authorities to exercise expenditure restraint, strengthen the financial position of public enterprises, and enhance fiscal transparency.

Directors viewed the authorities’ growth strategy as broadly appropriate. They agreed that measures to enhance the business environment, improve infrastructure, and develop high value-added downstream tourism products are key to achieving higher growth.

Directors agreed that the fixed exchange rate regime serves the country well. They noted the staff’s assessment that the level of the exchange rate remains broadly in line with medium-term fundamentals. Directors called for close monitoring of the current account position. They welcomed the authorities’ commitment to strengthen the country’s external position by continuing to build up foreign exchange reserves.

Directors commended the authorities’ measures to strengthen financial sector supervision, including the adoption of macro-prudential policies and steps to enhance supervision across sectors and at the regional level. They also welcomed the strengthening of the Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) framework. Directors looked forward to timely implementation of plans to establish a credit bureau and bring credit unions under the supervisory oversight of the central bank. Noting the high level of non-performing loans and limited provisioning, Directors called on the authorities to further intensify the monitoring of financial institutions. They supported the authorities’ request for a Financial Sector Assessment Program (FSAP).

Background

The Bahamian economy began a tepid recovery in 2010, following a sharp recession in 2008 and 2009 in the wake of the global financial crisis. Real Gross Domestic Product (GDP) grew by about 1 percent. The rebound was driven by the trade, hospitality, transport, and government services sectors, while the construction and offshore financial services sectors continued to contract. Inflation remained subdued at 1.5 percent, despite higher fuel and transportation prices, reflecting their relatively low share in the Consumer Price Index (CPI) basket. The external current account deficit remained broadly stable at 11.5 percent of GDP. Exports rebounded, and growth of non-oil imports remained subdued in line with economic activity. At the same time, rising foreign direct investment and other private capital inflows boosted international reserves to US$860 million at end-2010 (about 2.5 months of next year’s imports of goods and services).

Staff estimates that the deficit of the central government deteriorated in Fiscal Year 2010/11 (July to June). Total revenues increased, owing to large one-off transactions, but expenditure—especially current spending—increased more than proportionately. As a result, the central government deficit rose to 4.7 percent of GDP (from 4.4 percent in 2010). The sale of 51 percent of the shares of the Bahamas Telecommunications Company (about 2.5 percent of GDP) eased financing pressures. The ratio of government debt to GDP continued rising and exceeded 48 percent of GDP by mid-2011. The bulk of the debt is held domestically by commercial banks, public corporations, and pension funds.

Financial soundness indicators remained strong. Banks have maintained high overall capital-adequacy ratios (well above the minimum requirement) and prudent levels of provisioning. Banks’ loan portfolio, however, continued to show signs of weakness, as the severe economic downturn pushed up the ratio of non-performing loans to total loans above 10 percent.

The outlook is for stronger growth, but weaker fiscal and debt positions. Real GDP growth is expected to hover around 2.5-3 percent per year, but the central government deficit is projected to remain at about 4.5 percent of GDP over the medium term under current policies. Increased economic activity and ongoing improvements to the regulatory and supervisory frameworks are expected to contain financial sector risks. The risks to the outlook, however, are tilted to the downside, given the uncertainties about the pace of the global recovery and world commodity prices.