THE Bahamian dollar is “overvalued between 10-20 per cent”, the IMF has revealed, warning that this is further eroding the economy’s cost competitiveness.
The International Monetary Fund (IMF), in its full report on the Article IV consultation, found that the Bahamas’ currency was “17.6 per cent stronger than the level deemed consistent with fundamentals and desired policies” on a real effective exchange rate (REER) basis.
This strips away the one:one peg with the US dollar, and measures the Bahamian dollar’s value against a basket of other currencies adjusted for inflation, to determine its competitiveness.
The IMF said its analysis, suggesting the Bahamian currency was overvalued, had major implications for the competitiveness of an economy still struggling with structural impediments such as high energy costs/unreliability and bureaucratic bottlenecks facing the private sector in its dealings with government.
While the Bahamas’ reliance on US tourists had helped to mitigate the dollar’s appreciation via the peg, the Fund warned it was exacerbating a situation where real wages are growing faster than productivity.
“The currency appreciated 11.25 per cent in real effective terms on average between 2014 and 2015, reflecting a strengthening of the US dollar and, to a lesser extent, the introduction of the VAT in January 2015,” the IMF report said.
“Since 2015, the real effective exchange rate (REER) has remained virtually flat. In staff’s view, the currency is overvalued between 10 and 20 per cent. The introduction of the VAT in early 2015 was a factor accounting for about two percentage points of the strengthening of the REER”
The Fund said the Bahamian dollar’s attachment to its appreciating US counterpart had implications for efforts to diversify tourism source markets, as this made vacations to this nation relatively more expensive for Canadians, Europeans and others.
“From a cost perspective, the Bahamas is among the most expensive tourism destinations and its share in the ‘exclusive’ Caribbean tourism market has been declining,” the IMF added. “The strength of the currency in real effective terms, and real wages growing faster than productivity, have further eroded competitiveness.
“Overall, staff assess the REER to be overvalued by around 9 to 18 per cent in 2016. The model finds that the REER is 17.6 per cent stronger in 2016 than the level deemed consistent with fundamentals and desired policies..... The current level of the REER is around 11 per cent higher than the long-term average.”
The IMF said the currency overvaluation, and tie to the US dollar, gave the Bahamas less flexibility than Caribbean tourism rivals such as Jamaica and the Dominican Republic, both of which do not have fixed exchange rate regimes.
It added that while the Bahamas’ foreign currency reserves of $904 million at year-end 2016 were below the international benchmark of three months’ worth of imports, standing at 2.4 months’ worth, they were above 100 per cent of the country’s short-term debt.
On a more positive note, the IMF is forecasting that the Bahamas’ ‘negative credit gap’ will gradually be closed as bank lending to the private sector picks up to an annual 2.5-3 per cent growth rate by 2021-2022.
However, it revealed that bank ‘spreads’ - the difference between lending and deposit rates - are currently “much higher” than before the 2007-2009 recession due to a lack of economic growth and difficulties in assessing borrower creditworthiness.
“Banks have maintained a cautious lending attitude, particularly as the lack of a credit bureau and of a well-established book-keeping tradition have made it difficult to assess borrowers’ creditworthiness,” the IMF said.
“These challenges have led banks to increase the risk premium on new lending, bringing intermediation spreads to levels much higher than those seen before the global financial crisis. Consequently, the total stock of credit to the private sector has remained flat, leading to a negative credit gap.” This gap was assessed as equivalent to 2 per cent of GDP (around $200 million) in 2016.
The IMF urged the Bahamas to “reverse the self-reinforcing negative feedback loop” created by the lack of GDP growth, and high levels of loan delinquency, on credit supply. It said the enactment of legislation to create a Credit Bureau is also essential to this effort.
The Article IV report also exposes why the 2008-2009 recession hit the Bahamas, and so many families, especially hard as it revealed the high level of household indebtedness and “explosion” in reckless bank lending prior to the crash.
“Households have not been able to fully repair their balance sheets following the sharp economic contraction during the global financial crisis, which turned many loans non-performing,” the IMF said.
“Bank household debt increased from about 40 per cent of GDP in 2005 to a peak of 62 per cent of GDP in 2011, declining only to 57 per cent of GDP in 2016.”
It continued: “Total credit grew at an average annual rate of 10 per cent over 2002-2008. The expansion was particularly pronounced in household credit, with residential mortgage lending and consumer credit growing at average annual rates of 20 and 9 per cent, respectively.
“Business lending, with only a small fraction going into commercial mortgages, expanded only modestly at average annual rates of 3 per cent, although it temporarily accelerated to slightly above 10 per cent in 2005 and 2006. The rapid acceleration in household credit led to a significant increase in household leverage: household debt (mortgages and consumer loans) increased from 37 per cent of GDP in 2002 to 58 per cent in 2008.”