Economist warns over ‘critical’ reserves levels
Guardian Business Editor
Published: Oct 24, 2013
The Bahamas’ financial capacity to cover its import needs is the lowest in the region – at just seven weeks worth of import cover, or around half of the regional average – and significantly below international “prudential” benchmarks for external reserves, a senior economist has warned.
Marla Dukharan, senior economist with RBC Caribbean, told a crowded gathering of business people yesterday that this is just one of the reasons she views taxation reform for The Bahamas as “quite critical” at this stage in the evolution of the Bahamian economy, suggesting that the alternative could be a “spiraling” debt situation.
If not addressed, debt defaults or restructurings that would have much more “longlasting and painful” consequences for this country than the currently proposed tax reforms might be on the horizon, business people were advised.
Dukharan presented her position at the Bahamas Chamber of Commerce and Employers Confederation (BCCEC) VAT luncheon yesterday at the British Colonial Hilton, arguing that value-added tax is necessary for The Bahamas to turn around its “critically” low level of U.S. dollar reserves and deficit trends which now have the tendency to “spiral” beyond sustainable limits.
Around 150 people attended the packed meeting, which was scheduled from 12:30 p.m. to 2:30 p.m., but continued until 4:30 p.m. as speakers took questions about VAT and its implications.
Linking this nation’s “persistent primary fiscal deficit”, which sees The Bahamas borrowing to cover the cost of interest payments on existing debt, to its “structural current account deficit” – a gap between what we earn in U.S. dollars and what we spend on goods and services – Dukharan said that tax reform and the implementation of VAT is fundamental if this nation is to avoid more painful adjustments down the line.
Dukharan focused on tourism and foreign direct investment and noted that given the high concentration of the Bahamian economy on tourism, which has been weak of late, and on FDI, which declined significantly in 2012, Bahamian fiscal vulnerability has grown.
“You’ve had wide fiscal deficits, weak FDI and tourism activity, and this has thrown the balance of payments into a deficit and has reduced the level of foreign exchange reserves at the Central Bank,” said the economist.
Turning to tourism, Dukharan noted the fact that The Bahamas has the second highest level of dependence on tourism in the region, behind Aruba, signalling that the performance of this sector is critical to maintaining a sustainable fiscal balance.
However, while overall tourism arrivals have been growing, and surpassed pre-crisis levels, there has been “little growth in the high value added air arrivals” component, and The Bahamas has fallen behind the Dominican Republic, Cuba, Jamaica and Barbados in terms of stopover arrivals over the past several years and remained relatively stagnant in terms of growth.
“This has some implications for fiscal performance and external balance as well, that is the level of reserves and the level of U.S. dollars,” noted Dukharan.
With respect to foreign direct investment, Dukharan said The Bahamas has traditionally experienced some of the highest levels of net FDI to GDP.
However, in 2012 net FDI fell by 28 percent, “significantly” impacting external reserves.
These trends come against a background in which The Bahamas has long suffered from a primary fiscal deficit, said Dukharan, who pointed to this as one of the critical problems that VAT implementation and the additional revenue it should generate is fundamental to addressing.
“A primary fiscal deficit means that you are already in deficit before paying the interest on your existing debt, and so you are borrowing to pay interest on existing debt. It’s a sort of spiral situation, and that of course is unsustainable, and it’s not where you need to be.”
“A structural problem is not related to any external catastrophe, so the financial crisis is not the source of this problem. It has to do with structural issues within the economy.”
The longstanding primary fiscal deficit is one of the major drivers of the balance of payments deficit, and has led to “rapidly rising debt, which is approaching non sustainable levels,” according to Dukharan.
Dukharan highlighted how The Bahamas’ primary fiscal deficit has declined from one percent of GDP to closer to four percent of GDP since 2008.
“The overall fiscal deficit has approached six percent. That is a pretty steep deficit, and it means it must be addressed.”
This, she said, has contributed to an overall increase in debt, of around 30 percent in the pre-crisis era, to above 50 percent of GDP in 2012.
With fiscal reform, including VAT, Dukharan suggested that the upward rise of debt could be reversed by around 2018, and remain below the “sustainability threshold” of 60 percent which has been identified as a critical turning point for the region at which additional borrowings beyond this have a shrinking effect on growth.
Drawing attention to The Bahamas, structural deficit on the current account – the fact that the country is “spending more U.S. dollars on goods and services than it is earning on goods and services” – Dukharan said this again amounts to a “structural problem” that relates back to the primary fiscal deficit.
The current level of U.S. dollar reserves in the Central Bank of The Bahamas is equivalent to “roughly seven weeks of import cover”, the lowest in the Caribbean region, explained Dukharan.
“Seven weeks of import cover means that if you were not to earn a single U.S. dollar in this economy, you have seven weeks of money which you can spend on your imports,” he said. “In this region, most countries have somewhere around 15 weeks, 12 weeks; the internationally accepted prudential benchmark is three months of import cover.
“So seven weeks is critical. And part of the solution to that problem is to fix the fiscal deficit.”
“So the fiscal deficit in and of itself is a problem because you are entering this point where you are going to pass that debt sustainability threshold, but you also need to fix that problem to fix this problem (the structural current account deficit).”
Dukharan said that tax reform is “always painful”, but revenue and expenditure measures have to be combined to eliminate the primary fiscal deficit problem The Bahamas has found itself in during recent years.
“If this (primary fiscal deficit) is not eliminated very soon you can see things continue to spiral and as we’ve seen in other countries, this could possibly lead to default or debt restructuring”
“With default and restructuring, the consequences are much more longlasting and painful than the current tax reform proposal.”