The Tribune

By NEIL HARTNELL

Tribune Business Editor

nhartnell@tribunemedia.net

THE Bahamas has reacted coolly to persistent nudging from the International Monetary Fund (IMF) that it should raise short-term interest rates to narrow the gap with those in the US.

The Fund, unveiling its full Article IV report on The Bahamas late on Friday night, suggested “there is scope to raise interest rates without major harm to credit growth or the economic recovery” in The Bahamas should the foreign currency reserves supporting the one:one peg between the Bahamian and US dollars come under pressure.

The report reaffirms that the IMF has been suggesting that The Bahamas allow domestic interest rates to rise in line with the US Federal Reserve’s monetary tightening to combat inflation, but the Central Bank has maintained its discount rate at 4 percent and given no indication it plans to change its long-standing “accommodative” monetary policy stance any time soon.

“The recovery in tourism, external public sector borrowing and the presence of longstanding capital flow management measures have supported international reserves accumulation, even though domestic short-term interest rates are currently 250 basis points (2.5 percent- age points) below those in the US,” the Washington D.C.-based Fund said in its report.

“However, capital flows remain sensitive to interest rate differentials, especially during uncertain market conditions. Liquidity management operations, and allowing short-term interest rates to rise toward those in the US, would help mitigate these risks, reduce banks’ carrying cost of reserves and narrow the spreads between deposit rates and rates on loans to private borrower.”

But, based on the IMF’s report on the “authorities” response to this, The Bahamas is unlikely to be following its interest rate-related recommendations.

“Regarding the sensitivity of capital flows to interest rate differentials, the authorities believe that the risk of sudden capital flight is insignificant given existing capital flow management measures, and that interest rate differentials could only play a role in exceptional circumstances” the Article IV report said of this nation’s response.

No country agrees with, or adopts, all the IMF’s economic policy recommendations and adjustments, and it appears likely that the IMF based its analysis on open economies where capital flows freely across borders as opposed to a country such as The Bahamas where there are more restrictions in place to protect the fixed exchange rate regime.

John Rolle, the Central Bank’s governor, could not be reached for comment before press time last night, but the regulator is likely to be confident that there are sufficient controls in place to prevent sudden - and significant - capital flight searching for better yields from the higher interest rates that exist elsewhere.

The Central Bank’s discount rate has remained unchanged at 4 percent since 2016, and only been changed three times in the two decades since 2003. Any increase in interest rates, which effectively represent the cost of money or credit, would disadvantage borrowers as it will increase the payments necessary to service their loans but benefit savers as they would see a rise in deposit interest income.

The Central Bank’s own website shows the average interest rate on short-term three month deposits stands at just 0.25 percent, creating a wide and profitable interest spread for commercial banks given that the average lending rate for residential mortgages and consumer loans presently stands at 5.1 percent and 12.86 percent, respectively.

Mr Rolle, as recently as the Central Bank’s quarterly press briefing, said “the Central Bank’s monetary policy stance is to continue to accommodate firmer credit growth” - thus giving no signal that it plans to follow the IMF’s suggestion any time soon.

However, the IMF said its study showed that net foreign currency purchases by the Central Bank “are sensitive to interest rate differentials in specific circumstances. These effects are economically significant during periods of elevated global risk aversion or when the foreign currency sovereign credit rating falls below investment grade”.

The Bahamas’ sovereign credit rating is presently at ‘junk’ status with both Moody’s and Standard & Poor’s (S&P), and the Fund’s study added: “There is scope to raise interest rates without major harm to credit growth or the economic recovery, should global volatility or the negative interest rate differential put pressure on international reserves.

“During periods of elevated global risk aversion or when assessments of sovereign risk are high, interest rate differentials have materially positive effects on the central bank’s net foreign exchange purchases. Local projections suggest that the transmission of changes in the bank rate to domestic interest rates is high but depends on the degree of excess liquidity in the domestic banking system.

“Still, interest rate tightening will likely have little impact on domestic credit, with almost no noticeable effect on economic activity.” High excess liquidity in the commercial banking system, which stood at $2.884bn at year-end 2023, was said to largely limit the knock-in effect of interest rate cuts to residential mortgages.

“When faced with high excess liquidity, banks are prone to reduce deposit rates quicker in response to a cut in the policy rate, possibly to discourage additional deposit accumulation or to reduce the carrying cost of the existing liquidity.

In contrast, banks adjust lending rates less aggressively, pushing banking spreads higher, although not significantly so in the medium-term,” the IMF study added.

“Except for a small impact on residential mortgages, cuts to lending rates do not elicit statistically significant effects on private sector credit. One percentage point cuts to the residential mortgage rate increase the stock of residential mortgages by less than 0.1 percentage point over eight quarters.

“In contrast, consumer credit appears almost immune to cuts to consumer lending rates. Consequently, the effect of cuts to the weighted average lending rate on overall private sector credit, while positive, is marginal and statistically insignificant. In contrast, cuts to the weighted average deposit rate reduce deposits, but the effects are modest at best,” it continued.

“There is limited scope for using interest rate decisions to influence private sector credit, but raising interest rates is equally unlikely to do significant damage to credit growth.”