Public Information Notice No. 01/89

Public Information Notice: IMF Concludes Article IV Consultation with The Bahamas

August 14, 2001

On August 1, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with The Bahamas.¹

Background

After a decade of low economic growth, the Bahamian economy began to experience a sustained recovery in the mid-1990s due to substantial inflows of private investment in tourism, shipping and construction, and a steady expansion of financial services. Real GDP growth picked up from 3-3½ percent a year in 1997-98 to 6 percent in 1999, and remained strong at 5 percent in 2000, as tourist expenditure grew markedly following the expansion and upgrading of the country's hotel infrastructure. Inflation averaged less than 1½ percent a year in 1996-2000, reflecting the peg to the U.S. dollar. The recovery in economic activity was accompanied by a decline in unemployment and an improvement in social indicators, which remain among the most favorable in Latin America and the Caribbean region.

The present administration's policy of gradual fiscal consolidation has been a key factor in the economic recovery. The deficit of the central government narrowed from over 3 percent of GDP in FY 1996/97 (fiscal year begins July 1) to an estimated 0.2 percent of GDP in FY 2000/01, due to an increase in tourism taxes, the elimination of some import duty exemptions, and a reduction in both current and capital outlays. After peaking in 1998 owing to a sharp increase in imports associated with investments in the tourism sector, the external current account deficit declined to about 8½ percent of GDP in 1999-2000 as several investment projects were completed and tourism receipts increased substantially. Credit to the private sector increased strongly during 2000, with banks reducing their excess reserves during the second half of the year to expand their operations. Net international reserves declined by US$60 million to US$343 million by year's end, but recovered to US$365 million (96.5 percent of base money and 1½ months of imports) as of end-June 2001, largely because of seasonal factors.

Following the very strong performance of recent years, real GDP growth is expected to moderate to about 3½ percent in 2001, partly because of the impact on tourism of the slowdown in the United States. In June 2001 parliament approved the budget for FY 2001/02, which envisages the achievement of a balanced position for the central government. The budget incorporates a reduction in the high import duties applied to several items.

Regarding structural issues, the government has taken important steps to address international concerns about the supervision of the offshore financial center, money laundering, and tax practices. To that end, in December 2000 parliament enacted a comprehensive body of legislation, which is being implemented. The authorities also intend to privatize the telephone company (BATELCO) and would begin to open the telecommunications sector to private competition during the second half of 2001; this would be followed by the privatization of the electricity corporation (BEC) in 2002. In addition, in 2000 the government submitted to parliament draft labor legislation that seeks to reduce the workweek from 48 to 40 hours; establishes a minimum wage, as well as health and safety requirements; codifies current practices regarding severance payments and increases maternity benefits; and regulates the settlement of labor disputes.

Executive Board Assessment

Executive Directors commended the authorities for their continued adherence to sound macroeconomic policies, which had contributed to a sustained economic recovery led by substantial inflows of private investment, a decline in unemployment, and an improvement in the country's social indicators. Directors noted that the main challenge for the period ahead was to build on these accomplishments by maintaining a prudent fiscal stance, enhancing competitiveness, and pressing ahead with pending structural reforms.

Directors welcomed the progress made by the authorities in almost eliminating the central government deficit, as well as their commitment to achieve a balanced budget position this fiscal year. They felt, however, that additional efforts were needed to further strengthen central government savings to ensure an adequate level of public investment to sustain growth. In this connection, Directors noted that revenue could be strengthened by reducing tax exemptions and improving property taxation, and that the import tariff system needed to be rationalized by lowering high tariff rates and tariff dispersion. The authorities' decision to conduct a broad review of the tax system with Fund assistance, with a view to evaluating the possibility of introducing a sales or value-added tax, was welcomed. Directors supported the authorities' request for technical assistance in this area.

Directors stressed the need for adherence to a prudent wage policy to maintain fiscal discipline and avoid parallel wage pressures in the private sector that could affect competitiveness. They encouraged the authorities to proceed with current plans to lower government transfers to certain public corporations by reducing their operating costs, and to improve the reporting practices of these corporations. The planned introduction of fiscal guidelines was considered a positive step for preserving fiscal discipline over the medium term.

Directors cautioned the authorities to monitor credit developments closely and tighten the credit stance as necessary to protect the international reserve position. They also encouraged them to work on the development of indirect monetary instruments and to allow interest rates to play a greater role in containing credit growth.

Directors commended the authorities for their major legislative effort made within a short period of time to address international concerns about offshore supervision, money laundering, and tax practices, as well as for the decisive steps taken to implement the new legislation. Looking ahead, they underlined the importance of broadening the scope of on-site inspections of financial institutions and of monitoring closely the quality of the banks' portfolios. The authorities' intention to conduct a Fund-led assessment focusing on the offshore sector following a self-assessment to be completed during the remainder of 2001 was welcomed, as well as their willingness to complement such an exercise with a comprehensive evaluation of the financial system under an FSAP.

Directors were of the view that the long-standing fixed exchange rate regime had served The Bahamas well. They observed that sustaining a strong performance in tourism and other key sectors depended crucially on containing labor costs and raising labor productivity through continued emphasis on education and training. The prompt privatization of the telephone and electricity companies and the opening of the telecommunications sector to competition were considered important to modernize infrastructure and improve the delivery of these services.

Directors emphasized the need to analyze carefully the implications of the draft labor legislation that has been submitted to parliament so as to avoid a significant increase in labor costs that could have an adverse impact on external competitiveness. They highlighted the need to preserve flexibility with regard to part-time and temporary employment, and reduce rigidities in labor arrangements. Directors also welcomed The Bahamas' interest in acceding to the WTO.

Directors encouraged the authorities to address quickly several statistical weaknesses that hamper the assessment of economic developments, including by developing data on private sector debt and the national accounts for the period beyond 1995.