Sovereign Analysis /
Bahamas

Bahamas: Budget seeks to avoid debt crisis through revenue-based consolidation

  • The new government presented its FY 22/23 budget last week amid mounting concerns over financial distress

  • Debt and deficits ballooned due to Covid while twin external shocks of war and rates also hit sentiment. Yields at 13%

  • Budget signals attempt at correction, although revenue-based consolidation may be overly optimistic; Assign Buy

Bahamas: Budget seeks to avoid debt crisis through revenue-based consolidation
Stuart Culverhouse
Stuart Culverhouse

Head of Sovereign & Fixed Income Research

Tellimer Research
1 June 2022
Published by

The government of the Bahamas presented its budget for the forthcoming 2022/23 fiscal year last week. It was the first budget under the centre-left PLP government of Prime Minister Philip Davis since it was elected after a landslide victory in the country's snap elections last September – therefore, the event marks a key test of its fiscal credibility and economic competence. The then-opposition PLP took 32 of the 39 parliamentary seats in the election (with the incumbent FNM taking the remaining seven).

The budget comes against a challenging backdrop for the Bahamas amid the twin external shocks of war and rates, and the legacy of the pandemic, and mounting concerns over financial distress. The IMF recently warned about the "perilous state" of the country's public finances. Public debt is 90% of GDP while the budget deficit is 6% of GDP, although both have narrowed from their post-Covid peaks (100% and 14%, respectively), as a revival in tourism – which was decimated by the pandemic – spurs the economic recovery. Yields on the Bahamas' benchmark dollar bond (8.95% 2032) have risen to 13% and the yield curve has inverted.

It is hard to gauge the investor reaction to the budget, given the relatively illiquid nature of the Bahamas' bonds, but the 2.5pts increase on the '32s (from US$75 to US$77.6 ) from Wednesday to Friday suggests the planned fiscal consolidation might have been greeted favourably by bondholders as the government seeks to avert a debt crisis. However, we caution that there is still a long way to go. The mainly revenue-based fiscal consolidation may be overly optimistic and the size of the planned adjustment unrealistic. Meanwhile, financing needs are large, amid limited financing options. That said, the budget is a start and may have bought time.

Still, we think, amid a tourist-led recovery and with the government's budget suggesting that it recognises the fragile fiscal situation (and is trying to do something about it), valuations are attractive. We assign a Buy to the BAHAMA 8.95% 2032 dollar bond, with a yield of 13.2% (price US$77.6) as of cob 27 May on Bloomberg (mid-price basis).

Bahamas US$ bond yields (%)

The budget

The FY 22/23 budget (the year runs from 1 July-30 June), entitled "The way forward", was presented on 25 May. In it, the new government, now eight months in office, sets out its priorities and plans for the coming fiscal year. Key among them is dealing with the cost of living crisis, job creation and security. But the domestic and external economy provides a challenging backdrop and limits its room for manoeuvre.

That said, the planned fiscal consolidation evident in the budget projections suggest that the government at least recognises the situation and is trying to do something about it, for which it can be commended. Whether it is realistic and can be implemented, and the government can stick to it, will be key.

The government targets a further narrowing in the budget deficit from an expected 6% of GDP in FY 21/22 (ending June 2022), down from 13.7% in FY 20/21, to 4.3% in the coming fiscal year, and 0.9% in FY 23/24, and moving into a surplus of 1.9% in FY 24/25. The government is targeting an overall fiscal surplus of 1.5% of GDP by FY 25/26 in its medium-term fiscal plan.

Fiscal balance (% of GDP)

However, the planned fiscal consolidation is largely based on revenue gains, rather than upfront nominal spending cuts, with overall fiscal revenue projected to rise 14% next year, after a 30% increase this year, due to the recovery in GDP. Real GDP growth is projected at 1.9% in the next fiscal year, compared with 23.3% in the current fiscal year, after the deep contraction caused by Covid.

Higher revenue also reflects the government's efforts at domestic revenue mobilisation. This includes revenue-enhancing measures, including property taxes, improved VAT performance (following the government's 2% cut in the VAT rate in January 2022, a key election pledge, but likely against IMF advice) and greater revenue efficiency. VAT collection alone, which accounts for half of all government revenue, is expected to rise by 52% next fiscal year.

Overall, revenue is projected to increase from 19.4% of GDP in the current fiscal year (FY 21/22) to 23.8% in FY 24/25, a bold 4.5ppts increase.

Meanwhile, spending is expected to rise by 4.8% next fiscal year, in line with nominal GDP, after a 0.9% decline in nominal terms in the current fiscal year (which has resulted in a sharp fall in spending/GDP from 32.9% to 25.3%), before declining by 1.5% in FY 23/24 and 1.9% in FY 24/25. As such, spending remains at c25.4% of GDP in the coming fiscal year, FY 22/23, before declining as a share of GDP over FY 23/24-FY 24/25 by 3.5ppts. That is, after the GDP-led decline in spending/GDP this year, the further spending cuts are essentially back loaded.

Indeed, over the three years from FY 21/22, revenue is expected to increase by 44%, while spending rises by just 1.5%.

In addition, the primary balance is expected to shift from an expected deficit of 1.9% of GDP this year (FY 21/22), after a 9.4% deficit in FY 20/21, to a surplus of 5.1% by FY 24/25 (with the interest burden, c20% of revenue, falling from 4% of GDP to 3.3%). That is a swing of c7ppts over three years. However, this would be somewhat unprecedented in the Bahamas; such a high and sustained primary surplus has not been seen before. The average primary balance in the 20 years prior to Covid was -0.6% of GDP, while previous periods of multi-year primary surpluses (mid-1990s, early 2000s, mid-2000s) generally averaged below 1% of GDP, according to IMF WEO data.

Primary balance (% of GDP)

IMF concerns

The IMF concluded its 2022 Article IV on 4 May, with the board press release and staff report published soon after on 9 May. We don't know the extent to which the FY 22/23 budget incorporated the authorities' discussions with the Fund, but Fund thinking and policy advice would have been known to the authorities as they were preparing the budget.

Crucially, the IMF noted that the Bahamas's "public finances are in a perilous state" and presumably staff would have wanted to see a strong and credible fiscal consolidation path, consistent with restoring debt sustainability.

For its part, the IMF's baseline projected the fiscal deficit to narrow to 6.7% of GDP in the fiscal year just ending compared with the government's 6% projection. But whereas the government projects the deficit to narrow to 4.3% in the coming fiscal year, the IMF is more optimistic, expecting 3%. However, the IMF's 3% deficit forecast for FY 22/23 is largely based on expenditure reduction (-5%) and that doesn't seem to chime with the budget statement.

The IMF is more pessimistic over the medium term. Whereas the government projects the deficit to narrow to 0.9% in FY 23/24, and move to a 1.9% surplus in FY 24/25, the IMF expects the deficit to remain at c3%. That is, the IMF expects no further improvement in the fiscal balance after the large gains next fiscal year, while the government expects a more gradual improvement to continue.

The IMF's baseline envisaged the primary balance shifting from a deficit of 2.7% in FY 21/22 to a surplus of 1.4% in FY 24/25, a consolidation of c4ppts over three years (and less if the starting point is a lower primary deficit). This is more cautious than the 7ppts adjustment envisaged in the government's budget. Thereafter, the IMF sees the primary surplus rising to 1.8% in FY 26/27, a consolidation of c4.5ppts (although just 1.5% on a cyclically adjusted basis). After a sharp fall in the debt/GDP ratio due to the recovery in GDP this year, the IMF's more cautious path is enough to stabilise debt/GDP over the medium term, although a bolder fiscal adjustment would be required to produce a meaningful reduction in the debt/GDP ratio. Indeed, the IMF has previously said that a primary surplus of 4% would be needed to achieve the authorities’ debt target of 50% by 2030/31. Hence, an even higher primary surplus might now be needed given the weaker starting point – something like the 5% primary surplus in the budget, perhaps.

Debt sustainability

The IMF projects public debt (consolidated public sector debt, as per the DSA) to fall from 109.2% of GDP in FY 20/21 to 94.8% in FY 21/22, largely due to the rebound in GDP. The debt/GDP ratio is expected to fall further, to 87.8% in FY 22/23, although it is still projected to remain at c80% in five years' time (ie, by 2027, it will still by c20ppts above pre-pandemic levels).

Meanwhile, central government debt, which is lower and closer to the government's definition, declines from 103.3% in FY 20/21 to 90.6% in FY 21/22 and to 84.2% in FY 22/23. It only falls gradually from there, to 80.4%, by FY 26/27.

Public debt (% of GDP)

The Bahamas' public debt is also high relative to that of some other tourist-dependent nations.

Public debt ratios in selected tourist-dependent economies (% of GDP)

Still, the IMF assesses the Bahamas' public debt to be sustainable, given the declining path, although it is vulnerable to shocks. The slow debt reduction is in part a function of weak debt dynamics, with real interest rates exceeding low real GDP growth (trend growth is just 1.5%); that is, (r-g>0).

Moreover, the IMF Article IV notes that the authorities' medium-term overall fiscal surplus target of 1.5% of GDP is consistent with debt sustainability, defined as achieving the debt target of 50% of GDP in the Fiscal Responsibility Act. And, given interest of c3-3.5% of GDP, this implies something like a 5% primary surplus – ie perhaps a tacit endorsement of the government's budget target (despite what would seem to be its historical rarity in the Bahamas and in the context of cross-country comparisons of the size of fiscal adjustments).

But the IMF does note that, while the 50% debt target is appropriate, the authorities might need more time to get there, given the impact of Covid and higher debt levels. The Fiscal Responsibility Act targets CG debt/GDP of 50% by FY 30/31. The IMF says that reducing debt/GDP to 50% by 2032/33, two years later, would be appropriate.

However, the Fund adds that fiscal plans "need to be backed by concrete, feasible, and growth-friendly spending and revenue measures". Much of this, it says, could come from an increase in the revenue/GDP ratio by 5ppts, through a meaningful tax reform, and permanent cuts to unproductive spending (of 1.5% of GDP). The IMF's baseline sees revenue/GDP static at c20% of GDP over the medium term.

As such, the 4.5ppts increase in revenue/GDP seen in the government's budget seems to exceed the IMF's baseline projection and could go a long way towards what the IMF would like to see. The IMF may welcome the intention in the budget, if not the composition.

Key, however, will be implementation and whether the government's assumptions on revenue yields are realistic or optimistic. Many countries have struggled with domestic revenue mobilisation and resorting to over-optimistic revenue assumptions as a way of avoiding difficult spending decisions is not unusual either (eg just look at Ghana's 2022 Budget).

Financing challenges

Meanwhile, gross public sector financing needs (GFN) are high. These are estimated by the IMF at 25% of GDP in FY 21/22 and falling to 19% by 2026/27, remaining well above the Fund's 15% threshold. High financing needs poses another vulnerability, leaving the Bahamas exposed to swings in market sentiment and to sudden stops in capital flows.

In particular, the FY 22/23 budget itself will involve financing the deficit of US$564mn (4.3% of GDP), and that is before refinancing amortisation (external and domestic).

However, financing options are limited. The Bahamas could find meeting its large financing needs a challenge as double-digit yields signal loss of market access and its high income status (per capita income is cUS$28,000) restricts lending appetite from IFIs and donors. As such, the Bahamas will be forced to rely on domestic financing (the IMF says domestic banks are expected to roll over maturing debt, at c8% of GDP). Creative use of external sources may (have to) fill the remainder.

The government entered a cUS$200mn two-year repurchase agreement with Goldman Sachs in February (using its holdings of USTs, held in escrow to repay maturing eurobonds, as collateral). The transaction was designed to cover general budget expenses for the remainder of the current fiscal year.

Meanwhile, the Inter-American Development Bank (IADB) approved a US$200mn policy-based guarantee (PBG) in February that could be used to provide a partial guarantee for a eurobond issue. The PBG is designed to support the blue economy. However, given market conditions, timing of any bond issue is uncertain.

Crucially, the Bahamas faces a US$300mn bond maturity in 18-months' time (the maturing 5.75% January 2024 eurobond). The bond is indicated at cUS$87 (mid) on Bloomberg. While there is still some time to design a refinancing plan, and for external conditions to turn more favourable, this may weigh on investor sentiment. After this, there is a bit of space until the next maturity – in 2028 – although, for now, annual interest is still US$177mn a year (the Bahamas has six eurobonds with a total outstanding of US$2.5bn).

Of course, the Bahamas (Ba3/B+/-) last came to the market in October 2020, with the US$600mn 2032s, subsequently tapped by another US$225mn in December of that year, but it was expensive for the issuer. It was priced to yield 9.25% – much like a frontier market. Proceeds were used to refinance a US$248mn Bridge Facility. More creative, expensive and short-term funding operations could be an early warning sign of deeper distress.

On a positive note, the Bahamas has a reasonable liquidity buffer. The IMF observed that international reserves are at historically high levels, helped by the SDR allocation, with gross reserves standing at c5 months of imports at end-2021.

Tourism-led recovery

It hasn't, however, been all bad news. Tourism began to recover last year, with stopover visitors doubling in 2021 to 893,000 compared with 2020 according to the Ministry of Tourism (and 85% of visitors in 2020 came in Q1). However, this is still only half the amount seen in 2019 (although that year was exceptionally strong) and 60% of the average over 2013-2018. The glass half full argument is that there is still plenty of scope for tourism numbers to increase further; costs, transport, capacity, spending power and habits permitting.

Moreover, there has been a strong start to this year, too. Cumulative stopover visitors for Q1 were 241,000, an increase of 126% on the same period last year (but still 36% down on the first quarter of 2020).

This is good news for the Bahamas, one of the world's most tourist-dependent economies (fifth, actually, on certain metrics, behind Aruba, British Virgin Islands, the Maldives and the Seychelles, according to a recent survey by Bounce, a travel company).

Bahamas stopover visitors

But if things weren't already challenging enough, just as the tourist-dependent economy tries to recover from the pandemic, the US CDC raised its Covid risk assessment for Bahamas to Level 3 (High) on 23 May (but then, so are most countries on Level 3). This could dent the tourism recovery currently underway. Most of its tourists come from the US.

Investment implications

The Bahamas' bonds have fallen sharply this year, with yields on the 8.95% 2032 dollar bond rising c300bps to 13.2% (price down 15pts to US$77.6) as of cob 27 May on Bloomberg (mid-price basis), notwithstanding a recent recovery from their year-low, thereby pushing the Bahamas into our 10%-ers list (indeed, the '32s would have entered the list in mid-December, just after our previous update, and well before the twin shocks this year on war and rates). Moreover, the Bahamas curve inverted in recent weeks, with the yield on the '24s rising to 15.2% (mid-price basis), signalling market concerns over financial distress.

That said, its performance has generally been in line with the index. The total return has been -12.6% YTD versus -13.0% for the Bloomberg EM Aggregate Index. Over a longer span, however, the poor performance of the Bahamas bonds is starker. This year's decline continues a downward trend that actually began a year ago (after the bond reached a post-issue high of US$114.5). That marks a 37pts decline. As a result, the total return has been -25.6% over the last year versus -13.3% for the Bloomberg EM Aggregate Index.

The bond's weakness this year accelerated in March after Russia's invasion of Ukraine, and more recently after concerns over the global rate outlook, with the Bahamas exposed to the global economy through its tourism dependence and dependence on food and energy imports. The IMF expect Bahamas inflation to pick up to 6.7% this year (average), compared with its 2% historical average.

And the twin external shocks come as the nation is trying to recover from the pandemic, which saw real GDP decline by 24%, in large part due to the collapse in tourism, while the fiscal deficit rose to 13.7% of GDP and public debt jumped nearly 40ppts (from 60% of GDP pre-pandemic to over 100%).

However, the budget has been an opportunity for the (not so) new government to assert itself and seek to implement a fiscal correction, while the cyclical recovery supports a decline the debt/GDP ratio from its recent peak.

The fiscal effort, a tourism recovery and low cash price for the '32s – that may not be too out of line with reasonable assumptions on recovery – should provide a floor to prices. The '32s are only 6pts above defaulted Suriname '26s (although recovery prospects there may be supported by oil) and 7pts above defaulted Zambia '27s.

That said, Ghana offers a cursory reminder of possible downside, and the cost of a weak commitment to fiscal consolidation, with the 8.125% 2032s now indicated at a post-issue low of US$53 (mid-price basis). Like the Bahamas, Ghana is facing acute fiscal challenges, with a high debt burden, concerns over debt sustainability and large financing needs. However Ghana’s problems have been building for some time and the government’s refusal, or unwillingness, to act more quickly and more strongly has damaged its policy credibility (see here).

High public debt, large financing needs and limited financing options, with loss of market access, are echoes of the Maldives, similarly tourist-dependent, although the Bahamas' public debt (c90%) is lower than that of the Maldives (c130%) and the Bahamas is at least attempting a fiscal consolidation. The Maldives may, however, benefit from bilateral financing and a friendly regional investor base. Both, however, trade at a similar yield. The yield on the MVMOFB 9.875% 2026 is 13.4% (price US$89.5) as of cob 27 May on Bloomberg (mid-price basis). We prefer the Bahamas.

Another obvious comp is Barbados, which has a higher debt burden, although it has benefitted from a debt restructuring, strong policies and good performance under its IMF programme. The IMF reached staff-level agreement on the seventh review of its extended fund facility on 13 May. Hence, the 7.4% yield on BARDAB 6.5% 2029 may be unobtainable for the Bahamas for now.

We assign a Buy to the Bahamas 8.95% 2032 dollar bond.

BAHAMA 8.95% 2032 price (US$)