Bahamas: Downgrade of medium- to long-term political risk classification from 3/7 to 4/7
Monster hurricane Dorian leaves its traces on the economy
In early September, monster hurricane Dorian struck parts of the island archipelago with winds of about 300 km/h. The hurricane was one of the fiercest ever recorded in the Atlantic Ocean to make landfall and the severest hurricane in the history of the Bahamas. Moreover, the hurricane crept at a very slow rate over the Abaco Islands and Grand Bahama, intensifying the damage it caused on these islands. Even though the island archipelago is generally more resilient to hurricanes than small islands, the fierceness of this hurricane is expected to have seriously damaged the tourist and other infrastructure on both islands.
Tourism is a growth engine in the Bahamas. As hurricane Dorian struck just before the holiday season, it is likely that the country’s economic growth will suffer both this year and the next before recovering. Before the passage of the hurricane, the Bahamas was expected to see real GDP growth of 1.8% in 2019, a low rate by international standards but not for the Bahamas. However, a mild recession is more likely this year and possibly next year as well. Rebuilding activity should produce a recovery after that. That being said, economic growth in the USA will be crucial as about 80% of tourists come from the USA.
Baha Mar expected to be a game changer for the current account balance
The Bahamas has run large current account deficits averaging around 12% of GDP in the past decade. On the import side, oil and food imports amount to about 30% of goods import expenditure. More importantly, machinery and equipment and manufactured goods imports – mainly inputs to investment and infrastructure projects – comprise more than half of import expenditure. More specifically, the construction of the mega resort Baha Mar on the island of New Providence (only mildly affected by the hurricane) has weighed on the current account balance in recent years. The construction of the mega resort has been long in the making. In 2010, an agreement on the development of the Baha Mar resort was announced as a joint venture with the Chinese Ex-Im bank. Completion dates were frequently missed and in 2015 the project was even put in receivership. In 2016, the resort was sold to a Hong Kong company and a phased opening started in 2017. In 2018, the construction of Baha Mar was completed and the resort was fully opened. On the export side, tourism revenues are the main source of revenue (accounting for roughly 70% of the current account revenue). The full opening of the mega resort is expected to boost tourist revenue and, as such, improve the current account balance in the long term. However, reconstruction works in the aftermath of hurricane Dorian are likely to weigh on the current account balance in the coming years. Hence, a wide current account deficit of around 10% of GDP is expected in the coming years. The main downside risks for the current account balance are a slowdown in the USA, higher oil prices, a decrease in financing by investors and another large hurricane hit.
Deterioration of public finances
In the past decade, public finances have deteriorated significantly. Public debt almost tripled to a historic high and elevated level of 63.3% of GDP in the fiscal year July 2017/June 2018 compared with 25.3% of GDP in 2007/2008. Wide fiscal deficits followed the financial crisis while expenditure increased before the 2012 election. The deficit improved in 2015/2016, following the introduction of VAT, but quickly widened again after the passage of hurricane Matthew at the end of September 2016. Since 2017/2018, fiscal consolidation has been enacted to tackle the elevated public debt. However, in the aftermath of hurricane Dorian, a widening of the fiscal deficit to -6% of GDP is on the cards, which in turn will lead to an increase in public debt. The risk of deterioration of the elevated public debt is somewhat mitigated. The main mitigating factor is the peg with the USD. It reduces the exchange rate risk of the third of public debt which is denominated in foreign currency, as long as the peg is sustainable. On the downside, reform fatigue could set in as unemployment remains high and the cost of fiscal measures is being felt, especially in the aftermath of hurricane Dorian. Furthermore, the elections in 2022 could increase public expenditure. Lastly, the large transfers to state-owned enterprises are an important risk as some enterprises are facing financial distress in response to weak management, subsidised prices and the high costs of imported goods for their operations.
Large offshore financial centre
The Bahamas is the fourth largest offshore financial centre in the world. Its international financial sector amounted to about 21 times nominal GDP in 2018. Offshore banking is separated from the domestic financial system. Although recent changes will allow financial institutions to offer services to both domestic and international clients, transactions will remain subject to strict exchange controls. In the last two decades, the Bahamas has lost market share due to the perception of being an extensive money laundering country, the global financial crisis and the competition from newer financial centres (e.g. the British Virgin Islands).
Low level of foreign exchange reserves for a country with a fixed exchange rate
Foreign exchange reserves have been hovering at around 2 months of import cover, a rather low level for a country with a peg. Foreign exchange reserves increased to 3.1 months of import cover in 2017 but declined in December 2018 to 2.4 months of import cover. The higher oil import bill and the refinancing by a public-sector entity of foreign currency with local currency debt explain the decline. The overvalued exchange rate is also putting pressure on foreign exchange reserves.
External debt build-up
The current account deficit of recent years has been mainly financed by debt-creating means and to a lesser extent by FDI. External debt stands at a relatively low level vis-a-vis GDP (around 25% of GDP at the end of 2018). External debt has doubled in the past decade – in line with the increase in public debt over the same period. On the one hand, a third of external debt is short-term debt, making the country vulnerable to a sudden change of investor appetite. On the other hand, external debt service has been fairly low, although, since 2017, it has peaked due to high official amortisation.
Downgrade of the medium- to long-term political risk classification from 3/7 to 4/7
Large current account deficits, a public debt build-up and a gradual increase in external debt have eroded the economic fundamentals of the Bahamas. Hurricane Dorian is likely to lead to wide current account and fiscal deficits in the coming years while a low level of foreign exchange reserves is likely to persist despite the positive prospects related to the mega resort Baha Mar. Hence, Credendo has decided to downgrade the medium- to long-term political risk classification to 4/7.
Analyst: Jolyn Debuysscher – firstname.lastname@example.org