The Tribune

By NEIL HARTNELL

Tribune Business Editor

nhartnell@tribunemedia.net

The Central Bank of the Bahamas asked the Government to undertake $400 million worth of foreign currency borrowing this fiscal year to alleviate concerns over a “steady decline” in external reserves.

The International Monetary Fund’s (IMF) full Article IV report on the Bahamas, released on Friday, discloses that the Central Bank asked the Government to “shift the bulk” of its 2013-2014 fiscal year deficit financing to foreign currency to “bolster reserves”.

The Fund’s report shows that by end-October 2013, the Bahamas’ foreign currency reserves had dropped to $685 million - a level that, while able to finance the purchase of 1.6 months’ worth of imports, was well below the recommended three months’ coverage.

The IMF said the decline was driven by a combination of reduced tourism earnings, the absence of previous one-off foreign currency inflows (the BTC privatisation) and increased profit remittances by Bahamas-based banks to their foreign head offices.

“This has led the Government, at Central Bank’s request, to shift the bulk of its budget deficit financing to external loans, the proceeds of which (totalling $400 million for fiscal year 2013-2014) have helped to bolster reserves,” the IMF revealed.

“The authorities recognised that the higher foreign debt increases the economy’s vulnerability to external shocks, but saw the undertaking as temporary - pending materialisation of anticipated improvements in the external position in the medium term.”

The IMF report gives no sense of panic over the external reserves situation, but the fact the Central Bank had to make the request of government shows there is at least a temporary ‘cash flow’ issue when it comes to foreign currency coming into the Bahamas.

The Bahamas’ two main foreign currency income sources are tourism and foreign direct investment (FDI), and the performance of both has been lacklustre in recent months, despite cause for optimism that both will pick up imminently.

The move also sheds new light on the Government’s recent $300 million foreign currency sovereign bond issue, which will provide 75 per cent of the $400 million. The proceeds from this bolstered external reserves to $912.1 million at end-January 2014, achieving the Central Bank’s requirements.

Standard & Poor’s (S&P) was among those who queried the Government’s decision to go to the international capital markets for deficit financing when ample banking system liquidity (over $1 billion) meant there were likely plenty of investors at home.

The IMF report now makes abundantly clear why. Maintaining a healthy level of foreign currency reserves is vital to the Bahamian economy, and is the Central Bank’s key monetary policy objective (together with the exchange rate peg), as it ensures this nation can import all its requirements. This, and the 1:1 fixed exchange rate, could be undermined by sustained deterioration.

“Strong policy efforts are needed to stem a recent deterioration of the external position and replenish reserves,” the IMF urged.

“A larger reserve cushion would help mitigate the impact of negative shocks, provide more room for needed counter-cyclical policy responses, and enhance the credibility of the [currency] peg.”

In a debt sustainability analysis attached to the Article IV report, the IMF said the foreign currency borrowing “warrants greater scrutiny”.

“To bolster foreign reserves, the GFovernment contracted a US$180 million external loan in fiscal year 2012-2013,” the Fund added. “The authorities also shifted the bulk of their deficit financing in fiscal year 2013-2014 to external borrowings (contracting a US$100 million foreign loan in October 2013, and contemplating an additional US$300 million for the remainder of fiscal year 2013-2014).

“The authorities concur that external borrowing to accumulate foreign reserves should be used only as a temporary measure, as the policy increases the country’s external debt service burden and makes the Government’s balance sheet more vulnerable to external shocks. They are committed to ensuring that such borrowing is rigorously contained.”

The Fund reiterated the risks contained in the Bahamas’ over-dependence on the US for more than 80 per cent of its annual stopover visitors.

“The authorities [Bahamian government] saw the recent and anticipated expansion of the tourism base as key to reducing their country’s traditional reliance on North American stopover tourists,” the IMF’s Article IV report added.

“They emphasised that progress on that front, together with improvements in non-price competitiveness through removal of structural impediments to growth, would strengthen the external position and enhance external sustainability going forward.”

The IMF report noted that the Bahamas’ foreign currency reserves fell by $75 million to $810 million in 2012.

“With external current account imbalances persisting in the first half of 2013, and higher foreign-owned banks’ profit remittances, reserves fell further to $685 million (1.6 months of imports or 2.8 months of non-FDI imports) at end-October 2013, despite a foreign loan ($100 million) contracted by the Government, which added 0.4 months of non-FDI import cover,” the IMF said.

The Canadian-owned commercial banks, the Fund added, were enjoying “extremely comfortable capital positions” and a collective loan portfolio that declined by about $105 million between January-October 2013.

The IMF described the Bahamas’ foreign currency reserves adequacy as “mixed” pre-$300 million sovereign bond issue. While they would cover all external debt payments in the medium term, the reserves “continuously fall short” against broad money and total import benchmarks.

But, with 75-80 per cent of capital goods imports financed by FDI inflows, the IMF said stripping these out would leave the Bahamas’ reserves at an adequate level during the 2002-2018 period that was studied.

“The country’s reserve holdings are projected to remain substantially below the broad money norm of 20 per cent, but related risks would be relatively limited given the Central Bank’s strong restrictions on capital flows - all outward capital transfers require exchange control approval, and outflows of resident-owned capital are restricted,” the IMF said.

“Finally, while reserves are expected to undershoot the broad money standard, they would be more than adequate to cover the Central Bank’s demand liabilities (base money plus government deposits), which the authorities use as an additional benchmark.”

Still, it added that reserves are “much below desirable levels” when benchmarked against other small island developing states (SIDS), as these “place more weight on exports and short-term debt, and better reflect the high vulnerability of small islands”.