An International Monetary Fund (IMF) team led by Jarkko Turunen visited The Bahamas from March 10-23 to conduct discussions for the 2016 Article IV consultation. Turunen issued the following statement:

Recent developments and outlook
Economic growth is estimated to have slowed down in 2015, as continued growth in air travel arrivals was offset by weaker domestic demand, owing in part to uncertainty over the opening of the Baha Mar resort. Credit to the private sector continues to be restrained by the elevated share of non-performing loans (at 14.2 percent of total in December 2015). Inflation remains modest, at 1.6 percent in October, despite a temporary increase owing to VAT introduction in January 2015. Unemployment, after a brief dip earlier in the year, rose to 14.8 percent in November. Lower oil prices and the winding down of Baha Mar’s construction have helped narrow the still sizeable current account deficit. International reserves stood at $841 million in January 2016, equivalent to about 2.5 months of next years’ projected imports of goods and services. Looking forward, real GDP growth is projected to increase to about 1.5 percent in 2016, supported by the continued rise in tourism arrivals, and to receive an additional boost when Baha Mar opens.

Staff commend the authorities for the successful VAT introduction, which has made an important contribution to maintaining macroeconomic stability and strengthening policy credibility. A simple and effective tax policy framework, strong project management and a robust electronic system for registration, filing and payment created the right conditions for a smooth VAT launch.

As part of the reform, the authorities eliminated the hotel room tax, reduced import tariffs and adjusted other domestic tax rates. VAT revenue over the first 12 months (at $536 million, or about 6 percent of GDP) has exceeded expectations, contributing to a decline in the FY2014/15 central government deficit to 4.4 percent of GDP (from 5.7 percent in FY2013/14). The central government debt nevertheless reached close to 68 percent of GDP in December 2015. Looking forward, strong VAT revenue is expected to support further fiscal consolidation and, when combined with efforts to constrain spending, to help stabilize central government debt.

Policy priorities
Continued fiscal consolidation is critical for rebuilding fiscal and external policy buffers and boosting investor confidence. Policy priorities include:

• Resolute implementation of the current VAT regime with few exemptions. The authorities should resist pressures to weaken the VAT regime’s efficiency through the introduction of exemptions.

• Further efforts to strengthen revenues. Staff welcomes recent progress in improving revenue administration. Further steps to ensure continued success in VAT implementation include strengthening administration and establishing a compliance audit program. Efforts should focus on moving further towards a fully-fledged central revenue agency, with a well-defined institutional and organizational structure, and continued modernization of customs and property tax administration. The authorities should also review the efficiency of tax exemptions and concessions, including to the tourism sector, and consider simplifying domestic taxes that are not business-friendly.

• Spending rationalization in the context of a medium-term budget framework. More emphasis on expenditure restraint would help preserve the hard-won benefits of the VAT. The authorities should contain increases in public wages and employment, especially in view of weak labor productivity growth. Efforts to streamline expenditures would also benefit from advancing on-going reforms to modernize the public financial management system, including strengthening internal controls, procurement practices, and budget preparation and execution. A shift in composition towards growth-enhancing infrastructure spending and further intermediate steps towards a medium-term budget framework would allow fiscal policy to better balance the need for continued consolidation and support for the recovery. Discussion over the introduction of National Health Insurance, still at an early stage, should fully integrate funding considerations to ensure sustainability. Finally, the authorities should begin to address medium-term risks to the sustainability of the pension system stemming from population ageing.

• Far reaching state-owned enterprise reforms. Staff welcome recent steps towards energy sector reform, which is expected to improve reliability and efficiency, and reduce costs. State-owned enterprises, including Bahamasair and the Water and Sewerage Corporation, continue to be a significant drag on government finances, with budget transfers amounting to about 1.4 percent of GDP in FY2014/15. Reforms should aim at reducing their operational inefficiencies, fostering an enabling regulatory environment, and aligning tariffs with costs of service delivery.

A decisive shift in structural policies is needed to raise potential growth, estimated at only 1.5 percent over the medium term, to improve competitiveness and reduce high structural and youth unemployment. Staff welcome the authorities’ efforts towards completing a comprehensive National Development Plan. The authorities should finalize the plan and, acknowledging that it takes time for structural reforms to bear fruit, promptly move towards implementation. Focus should be on a comprehensive strategy aimed at diversifying the economy and lifting barriers to growth by:

• Raising human capital and reducing skill mismatches. Policies should aim at improving productivity through better educational outcomes, further strengthening existing apprenticeship and vocational training programs, easing restrictions on labor mobility and seeking to reverse the “brain drain” of skilled Bahamians;
• Strengthening the business environment and reducing costs. Policies should aim at strengthening competitiveness by reducing energy and other utility costs and better aligning wages with productivity. Reforms to improve the ease of doing business should focus on alleviating the administrative burden and time necessary to start a business, strengthening contract enforcement and frameworks for resolving insolvencies and registering property, and improving access to credit (including through prompt establishment of a credit bureau).
• Investing in growth-enhancing infrastructure. Priorities include investment in information and communication technology, transportation, public utilities, as well as projects that support economic diversification and enhance resilience to natural disasters. Using responsible public-private partnerships where relevant can help reduce the burden of higher investment on government finances.

Despite the prolonged low growth environment, available prudential indicators suggest that the domestic banking system as a whole is well capitalized, liquid and profitable. Building on recent progress, including implementation of the Basel II/III regime, which is welcome, the authorities should continue enhancing risk-based supervision and their framework for crisis management. The authorities should also step up efforts to facilitate the cleaning up of bank balance sheets to spur credit growth. The global trend towards reduction in financial services by international banks, commonly referred to as “de-risking”, has resulted in additional scrutiny of domestic institutions, but has not led to significant disruptions. The authorities recently underwent an assessment of their AML/CFT preparedness and have taken steps to close remaining regulatory gaps, thus further strengthening their regulatory and institutional framework.