## 1. Fiscal Rules Around the World

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### Background and motivation
- Average central government deficit was 3.8 percent of GDP over 2008-2017, compared to 1.1 percent of GDP during 1998-2007.
- Central government debt doubled over the past ten years and grew more rapidly than the average for Caribbean peers.
- Under Moody’s, The Bahamas’ sovereign rating was downgraded from A3 in 2007 to Baa3 in 2016. Under Standard & Poor’s, The Bahamas lost investment grade status in 2016 and received a rating of BB+.
- VAT introduction in 2015 and revenue administration reforms helped boost tax revenues by 4.4 percent of GDP between FY2014 and FY2017. Total revenue increased by 2.6 percent of GDP on average over 2008-2017 relative to 1998-2007.
- Current spending rose more rapidly than revenues, keeping fiscal deficits high.
- Natural disasters and the lack of an effective fiscal framework contributed to unplanned spending and repeated misses of budget deficit targets.
- A rules-based fiscal framework is proposed to increase fiscal discipline, transparency, and accountability.

### Rule design (objectives and instruments)
- Objectives:
  - Prioritize fiscal sustainability and operational feasibility.
  - Allow space for countercyclical policy given exposure to external shocks.
  - Tailor design to existing capacity constraints; structural balance rules are excluded due to data/forecasting requirements.
- Recommended instruments:
  - A headline deficit ceiling (simple to communicate and monitor).
  - A cap on current expenditure growth (to reduce procyclicality during upturns).
  - A pre-defined medium-term debt anchor to guide calibration.
  - Built-in room for countercyclical policies in the calibration of the deficit ceiling.
- Rationale:
  - Combining deficit and spending caps leverages complementarities between debt sustainability, stabilization, operational guidance, and transparency.

### Rule calibration — debt anchor
- Staff estimates favor a central government debt anchor of 50 percent of GDP.
- Three approaches produced debt-anchor estimates ranging from 50 to 71 percent of GDP; staff favors the lower bound (50 percent) because:
  - The median debt ratio among investment grade emerging market economies declines to 42 percent of GDP if floating exchange rate regimes are excluded.
  - Sizable fiscal contingent liabilities from SOE’s debt equal to 14 percent of GDP as of 2017 warrant a prudent anchor for central government debt.
  - A 50 percent anchor implies putting debt on a downward trajectory from the current level of 58 percent of GDP.
- Notes on methodologies:
  - Approach 1: median public debt ratio among emerging markets with investment-grade sovereign rating.
  - Approach 2: DSAs identify a “critical-debt” benchmark of 70 percent of GDP for emerging markets; subtract a safety margin from that benchmark based on stochastic simulations of potential macroeconomic shocks.
  - Approach 3: estimate “critical debt” as the maximum debt ratio credibly sustained in a large prolonged slowdown assuming bounded upward primary balances; subtract a safety margin.
- Additional methodological details:
  - Safety margin calibrated to ensure —with a 95 percent probability— that debt does not cross the critical ceiling in the event of macroeconomic shocks.
  - A large macroeconomic shock is defined as the 75th percentile of the distribution of interest rate-growth differentials in The Bahamas’ history.
  - The maximum primary balance is standardized at 2 percent of GDP for emerging markets based on Escolano and others (2014).
  - For reference, the highest primary balance sustained over a rolling 5-year period in The Bahamas’ history is 0.9 percent of GDP.

### Rule calibration — operational targets (deficit and spending)
- Targeting horizon and transition:
  - Convergence horizon: 10 years including transition period.
  - Transition period: 3 years (consistent with authorities’ announced FY2018-FY2020 timetable).
  - Current level of headline deficit: 5.8 percent of GDP in FY2017.
  - Authorities’ announced path: 1.8 percent of GDP for FY2019, and 0.8 percent of GDP for FY2020.
- Deficit ceiling calibration:
  - Using the debt-anchor and standard debt dynamics, a deficit target of 1 percent of GDP would need to be maintained at the end of the transition period, assuming:
    - Estimated medium-term nominal growth of 3 percent,
    - Medium-term debt anchor of 50 percent of GDP,
    - Convergence horizon of 10 years (including transition).
  - To create space for a savings fund for natural disasters requiring additional savings of 0.5 percent of GDP each year, the recommended headline deficit target is 0.5 percent of GDP (i.e., implied operational ceiling accommodates both sustainability and savings).
- Current spending cap:
  - For a given deficit ceiling (b*), and average tax pressure (r*), the implied expenditure ratio (e*) follows e* = r* − b*.
  - Assuming stable revenue ratio (∆r* = 0) and compliance with the deficit rule, spending should grow at the same speed as nominal GDP growth or remain constant as a share of GDP.
  - Staff recommends calibrating the current spending cap equal to long-term nominal GDP growth, i.e., 3 percent.
- Mathematical relations preserved:
  - b* = [λ/(1+λ)] N−1 [ d0(1+λ)N − d* ]  (Equation (1)), where λ is a function of expected long-run nominal GDP growth (γ), d0 is initial debt stock, and N is convergence horizon.
  - e* = r* − b*  (Equation (2))
  - ∆e* = ∆r* − ∆b*  (Equation (3))

### Allowing space for countercyclical policy
- The proposed framework incorporates some room for countercyclical policy by calibrating the deficit ceiling above the steady-state deficit consistent with the debt anchor.
- Safeguards to avoid misuse of the additional room:
  - Legislative provisions clarifying conditions for use of the additional fiscal space between the deficit target and the deficit ceiling.
  - Alternatively, rely on reputational costs for repetitive unjustified deviations from initial budgets; policymakers would be required ex ante to comply with the 0.5 percent-of-GDP deficit target and use the additional 1 percent-of-GDP ceiling only when necessary.

### Net debt path and projections
- Current central government debt: 58 percent of GDP.
- Proposed medium-term anchor: 50 percent of GDP (implies a downward trajectory over the convergence horizon given the calibrated deficit rule and growth assumptions).
- SOE indebtedness: 14 percent of GDP as of 2017 (noted as a fiscal contingent liability).

### Implementation strategy and institutions
- Transition handling:
  - Embed transitory clauses in legislation specifying a timetable and transition path for the deficit, allowing the spending rule to bind only at the end of the transition period.
- Reporting and transparency:
  - Reporting on compliance with fiscal rules should be mandated in law and occur at ex-ante, in-year, and ex-post stages.
  - Ex-ante reporting: include assessment of compliance and macroeconomic assumptions used (GDP growth, interest rates, revenues).
  - In-year and ex-post reporting: systematically assess compliance and discuss factors explaining observed outcomes.
- Public Financial Management (PFM) requirements:
  - Timely, exhaustive, and accurate fiscal information is critical.
  - Strong expenditure controls and credible budgets are essential to ensure compliance.
  - Technical forecasting capacity must be strengthened to credibly inform policy planning.
- Safeguards and credibility:
  - Clear safeguards or reputational mechanisms are needed to prevent misuse of countercyclical room.
  - Frequent and large ex-post revisions of budget plans could undermine credibility of the fiscal rule framework.

---

### Credibility of fiscal rules
- Political buy-in and countries’ track records are the best predictors of success in implementing fiscal rules (Kumar et al., 2009, Eyraud et al., 2018b).
- Additional institutional and design features that foster credibility:
  - Presence of independent monitoring institutions (fiscal councils, parliament budgetary committees).
  - Broad institutional and economic coverage to monitor and control a large part of government fiscal activity.
  - Calibration that is in line with sustainability and stabilization objectives.
  - Well-defined escape clauses to deal with tail events (Mbaye and Ture forthcoming, Caselli et al., 2018).

### Exceptional circumstances / escape clauses
- Exceptional circumstances clauses should be well defined to avoid undermining credibility.
- Typical triggering events include natural disasters, states of emergency, and large economic recessions, often with pre-defined intensity thresholds.
- Procedures for triggering could include parliament approval.
- The application period of the escape clause and the path to reinstatement of the rule should be clearly defined ex-ante.

### Recalibration and revisions of fiscal rules
- Procedures for future recalibrations/revisions of the rule could be embedded in law.
- Periodic recalibrations can ensure underlying macroeconomic parameters remain adequate.
- Recalibrations should not be too frequent to avoid undermining credibility — example: Kosovo provides for a revision of its rule framework every 5 years.
- Benefits of revising fiscal rules should be weighed against potential costs, e.g., loss of credibility; legal, borrowing and political costs (Eyraud et al., 2018c).

### Communication and building support
- A well-crafted communication strategy is important to generate support for fiscal rules.
- Best practices include:
  - Simple but clear messages aimed at educating the public about objectives of the fiscal rules.
  - Inclusive consultation with major stakeholders to build buy-in and guarantee institutional entrenchment.
  - Early and wide dissemination through multiple vehicles (speeches, press interviews, conferences) to multiple audiences (politicians, private sector, civil society, investors).

### Conclusions on proposed fiscal framework for The Bahamas
- The proposed rules would fill an important gap in The Bahamas’ policy framework.
  - The lack of an effective fiscal anchor and framework has in part allowed rapid increases in spending and in public debt.
  - The proposed framework, if implemented effectively, should help anchor fiscal policy.
- Political will remains a critical ingredient in ensuring sustainable public finances.
- The proposed calibration would need periodic revision as circumstances change.
  - The framework aims to balance: (i) ensuring fiscal sustainability, (ii) allowing enough flexibility for stabilization over the business cycle, (iii) building buffers to deal with natural disasters, and (iv) adapting to existing (technical) capacity constraints.
  - As the economy experiences permanent changes affecting this balance, a recalibration of the rule would be warranted.

*Prepared by Qiaoe Chen (WHD) and Samba Mbaye (FAD). Sources and figures as presented in the original IMF chapter.*

### AN OVERVIEW OF THE BAHAMIAN LABOR MARKET

### Key summary and policy direction
- The Bahamas has experienced persistently high unemployment rates, averaging over 10 percent, in the past 2 decades.
- Youth unemployment remains stubbornly high, falling only to 22 percent in November 2017.
- Main barriers to employment identified:
  - Narrow economic base.
  - Insufficient skill sets among the young.
  - Inefficient job placement services.
- Policy implications and recommendations:
  - Expand vocational and apprenticeship programs to help reduce youth unemployment.
  - Improve skill databases and job placement services to improve matching between employers and job seekers.
  - Enhance the quality of general education to sustain employment in the long term.

### A. Snapshot of the Bahamian labor market — Demographics
- Median age (2010 census): 29.4 years.
- Old age dependency ratio: 9.2.
- Working age population (age 15-64): 66.8 percent of total population.
- Young (age 15-24): about 25 percent of the working age population.
- Labor force participation in 2017: 81 percent.
- Educational attainment of labor force in 2017:
  - 59 percent completed secondary education.
  - 29 percent completed tertiary education.
- Notes on education and emigration:
  - More than 70 percent of Bahamians with tertiary education emigrated to OECD countries in 2010.
  - Education from primary to secondary school (age 5 to 16) is compulsory and free in public schools.

### Employment and wages
- Most employed work in the services sector.
- Tourism-related industries and financial services are the two major private-sector labor absorbers.
- Hotel and restaurant industry accounts for 19 percent of total employment.
- Community, social and personal services industry absorbs 36 percent of employment; most jobs in this category are public sector, accounting for 21 percent of total employed.
- Nominal wages in the hotel and restaurant industry: The Bahamas’ wage is higher than ECCU countries except St. Kitts and Nevis (figure-based comparison).
- Wage range in the accommodation and hotel industry (2009 survey): $191 per week for a waiter or bartender to $1912 per week for a managing director.

### Labor market regulation
- The Employment Act is the main law governing the labor market.
  - Allows part-time employment; does not require a minimum number of working hours per week.
  - Severance payment: 2 weeks of basic pay per year for employees working for a year or more, with a maximum payment of 24 weeks.
  - Employment Amendment Act of 2017: allows hospitality (seasonal) industry to lay off employees during off-peak season without paying severance pay (as designated by the Minister of Labor).
- Disputes over dismissals resolved by the Industrial Tribunal; the law does not stipulate time limits for the process.
- Other labor laws: Health and Safety Work Act, Industrial Relation Act, The Trade Union and Labor Relation Act, The Immigration Act.
- Minimum wage:
  - Introduced in 2002 at $4.00 per hour; raised to $5.25 in August 2015.
  - Minimum wage and the ratio of PPP-adjusted minimum wage to GDP per capita do not stand out as outliers in the Caribbean region.
- Social security:
  - Governed by the National Insurance Act.
  - Social benefits contributions: employees 3.9 percent and employers 5.9 percent of insurable earnings.
  - Unemployment benefits: 50 percent of the unemployed’s average weekly insurable income for a maximum period of 13 weeks within a 52-week period.

### B. Recent developments in the labor market
- Population and participation trends:
  - Total population about 351 thousand (latest census).
  - Share of working age population: 66.8 percent, up from 57 percent in 1980.
  - Share of young (age 15-24): 22.4 percent, down 6 percent since 2005.
  - Labor force participation: trend increase since 1980; temporary dip around the global financial crisis to 72 percent; reached 81 percent in November 2017.
- Unemployment:
  - Unemployment rate averaged 11.3 percent since 1991, peaking at 16 percent in 2011.
  - Youth unemployment hovered around 20 percent from 2005 to 2017.
  - As of November 2017: youth unemployment rate 22 percent; unemployment rate for rest of population 8 percent.
- Education quality and outcomes:
  - Share of low-skilled labor declined from 11.6 percent in 2006 to 4.3 percent in 2017.
  - Share with tertiary education increased from 25.1 percent to 28.6 percent.
  - Secondary completion rose from 53.8 percent in 2006 to 59 percent in 2017.
  - BGCSE performance:
    - 2006: 18 percent of public high school students passed math exam; 45 percent passed English.
    - 2016: 5.7 percent of high-school students scored a “C” or above in math, English, and a science subject under BGCSE; average score for math “E” and English “D+”.
  - BTVI (The Bahamas Technology and Vocation Institute):
    - November 2015: out of 1798 enrolled students, only 253 graduated in school year 2014-15 (IDB).
    - 2016-2017 school year: 187 students graduated from BTVI; one third in office administration; 12 or 6 percent earned degrees in information technology.

### C. Empirical assessment of labor market flexibility
- Method:
  - Okun’s coefficient estimated from equation: U_t − U_t* = β (Y_t − Y_t*) + ε, where U is unemployment rate, Y is natural logarithm of real GDP, β is Okun’s coefficient, * indicates long-run level approximated by Hodrick-Prescott filter. Data from IMF World Economic Outlook.
- Results and interpretation:
  - Estimated Okun’s coefficient for The Bahamas: -0.26.
  - Global mean Okun’s coefficient: -0.26.
  - The Bahamas’ coefficient is higher than the regional and small state average, suggesting unemployment fluctuations track output evolution relatively more closely than in those groups.
  - Context: relatively high average unemployment around 11 percent, above total sample average of 8.5 percent, close to averages of small states (10.9 percent) and Caribbean countries (11.7 percent).
- Conclusion on regulation and unemployment:
  - Labor market regulation does not appear to be the major culprit behind high structural unemployment.
  - 2018 World Bank Doing Business indicators: firing costs in The Bahamas, in terms of severance payments, are between those for advanced and emerging economies.
  - 2010 World Bank enterprise survey: private sector in The Bahamas does not view labor market regulation as a major obstacle to business.
  - Findings are broadly consistent with Okun’s coefficient results: The Bahamas does not stand out as an outlier.

---

### Skills gaps and employer complaints

### Evidence on skills gaps and employer complaints
- PSAR (2013): “Bahamian enterprises agree that their major problem is an inadequately educated workforce” and “the workforce shows deficiencies of required skills”.
- IDB report (2012): firms most frequently cited difficulties in hiring related to specific skills or “underqualified applicants”, followed by applicants’ lack of experience and applicants’ lack of soft skills.
- IDB: main reason for dismissals is the lack of soft skills; certain industries cited lack of soft skills as the sole reason for dismissals.
- Soft skills defined as personality traits (responsibility and commitment, common sense and integrity) and practiced abilities (communication, team work, leadership, good manners and sociability).

### Labor market outcomes: wages, productivity, and unemployment
- Real wages grew faster than labor productivity before 2007, but deviations were short lived.
- Global financial crisis caused real wages to fall initially and then remain broadly stagnant over 2008-2014, while productivity recovered temporarily over 2009-2012.
- Productivity’s temporary recovery reversed from 2013 on, with real wages picking up and in recent years diverging from productivity growth estimates.
- Change in labor productivity over 2000 to 2016 was driven mainly by real GDP growth, suggesting employers adjusted labor costs mainly by reducing the number of employees rather than by controlling nominal wage increases.

### Role of collective bargaining and labor institutions
- The Bahamian Constitution grants labor unions the right to free assembly and association; rights exercised extensively, particularly in state-owned industries and in the hotel industry (where 80 percent of the employees are unionized).
- Trade unions negotiate collective agreements and conduct collective bargaining on wage increases every three to five years; wage increases can be spread over this period or increased by one-time lump-sum payments.
- Unions have at times accepted wage freezes in response to unfavorable economic times (e.g., real wages remained flat between 2008 and 2014).

### Structural features and matching frictions
- Strong dependence on tourism makes The Bahamas vulnerable to external shocks (including natural disasters), with limited room in other sectors to absorb slack when tourism weakens.
- IDB data: the public employment system run by the Department of Labor captures only 12 percent of listed businesses’ vacancies, while only 2 percent of registered job-seekers found jobs through this system.

### Ongoing efforts to reduce skill gaps and improve matching
- National Training Agency (NTA) created in 2013 to provide vocational and soft skill training:
  - NTA has trained 4,500 participants, and more than half have been able to find their first jobs.
  - NTA complements BTVI (since 1980).
  - Public high school curriculum revised to better meet private sector skill demand.
- Department of Labor (since July 1, 2017) revamped the Employment Exchange (online) and launched job fairs:
  - “Labor on the Blocks” job fairs attracted 4,000 participants, mostly unemployed young people, 900 of whom were hired.

### Apprenticeship initiative and vocational expansion
- National Apprenticeship Program (NAP), funded and designed by the IDB:
  - Targets young workers with a one-year on-the-job and off-the-job training in internet technology, marine, and medical services.
  - Will bring NTA, Chamber of Commerce, BTVI together to design program, supply mentors, and establish an apprenticeship skill council.
  - NTA will focus on the 4-month pre-apprenticeship training to select qualified candidates.
  - Under the NAP program, 1,350 trainees will benefit if they complete the training.
- Box 1 literature review: vocational and apprenticeship training can smooth school-to-work transition but cannot substitute for strong quality in general education; cited evidence includes Hanushek, Schwerdt, Woessmann, and Zhang (2017) finding individuals with general education were initially 6.9 percent less likely to be employed than those with vocational education, but the advantage of vocational education diminishes with age.

### Policy conclusions and recommendations
- Main drivers of high structural unemployment:
  - Insufficient and low-quality skillsets of the young.
  - Difficulties in the matching process between employers and job seekers (poor skill match and limited labor market information).
- Labor market regulations do not appear to be a major determinant of high unemployment, though improvements could help.
- Recommended policy actions:
  - Expand vocational and apprenticeship programs to reduce skill mismatches and youth unemployment.
  - Boost quality of high school education, including math and English.
  - Use information technology to mitigate teacher shortages in remote islands and improve teaching quality.
  - Consider conditional cash transfer programs to incentivize school attendance and reduce drop-outs.
  - Expand public awareness of the online skill database and encourage employer and job seeker usage.
  - Facilitate firm pre-screening and other placement services to improve matching.
  - Department of Statistics (DOS) should increase the frequency of labor force surveys and ensure adequate staffing and resources to improve data availability and quality.
  - Improved data should better inform collective wage bargaining and the planned national productivity council to help align real wage growth with productivity gains.
  - Advance structural reforms to improve competitiveness and reduce structural bottlenecks to spur investment and job creation, recognizing tourism will likely remain a major economic sector.

---

### Natural disaster (ND) vulnerability and financing for small states

### Vulnerability of small states
- The average damages for small states is nearly 13 percent of GDP, compared to less than 1 percent of GDP for larger states.
- A greater part of the population in small states are also affected compared to larger states, 10 percent versus 1 percent respectively (IMF, Small States Resilience Paper, 2016).
- Conclusion: governments of small island states must strengthen resilience and ensure adequate buffers to smooth the impact of NDs.

### Economic consequences of natural disasters (NDs)
- Impacts include emergency cash handouts; reconstruction of uninsured or underinsured infrastructure, including critical infrastructure such as roads, bridges or ports; and foregone fiscal revenue due to temporary tax relief measures.
- Pressures on spending from overnight destruction of infrastructure can result in higher borrowing costs, lower credit ratings, reduced investment, and lower productivity and output.

### The Bahamas — historical response and exposure
- The Bahamas has traditionally absorbed ND shocks through re-prioritization of public spending and borrowing (budget reallocations or debt issuance).
- Economic impacts are seen through worsening current account, declines in foreign reserves and widening fiscal deficits.
- Public assets remain uninsured.
- Example: In 2004, The Bahamas was hit by Hurricane Frances and recorded public and private sector losses of almost 20 percent of GDP. Foreign insurance payments amounted to 3.5 percent of GDP at the time.
- Insurance coverage in the hotel industry has been extended to include wind and flood damages since 2004.
- Local insurance companies report widespread underinsurance among households; homeowners’ insurance prevalent only when there is a mortgage or among wealthy individuals.

### Regional risk-transfer tools — CCRIF
- The Caribbean Catastrophe Risk Insurance Facility (CCRIF) created in 2007 pools risks and provides parametric insurance.
- According to CCRIF, insurance costs are less than half of what individual countries would pay if buying the same coverage or by accessing international markets.
- Governments can buy coverage of maximum USD100 million per disaster and year.
- Between June 2007 and October 2017, the CCRIF disbursed a total of US130.5 million to affected countries.
- The Bahamas received a CCRIF payment of USD397 598 following cyclone Irma in 2017, covering only a small part of the estimated total damages, at USD135 million.

### Managing disaster risk — A layering approach
- Fund policy on small states’ resilience: ex-ante risk reduction should be the priority to reduce financing uncertainty and ex-post damages (IMF, 2016).
- Financing layers:
  - Low-impact, high-frequency disasters: funded by budget reallocations or savings (pre-financed reserve fund), complemented by contingent credit lines or post-disaster credit when appropriate.
  - Severe disasters: require ex-ante mitigation and greater penetration of private and public insurance; market insurance and re-insurance for private and public-sector assets; catastrophe (CAT) bonds for transferring extreme-event risk.
- Practical considerations:
  - A government could allocate fiscal savings to debt reduction and borrow when hit by a ND, but it can take up to nine months to access resources.
  - Disaster borrowing may affect marginal interest rates in a small economy; The Bahamas’ high-income status prevents access to concessional financing terms.
- Financing developments:
  - In March 2018, The Bahamas requested a 5-year USD100 million contingent credit line to the Inter-American Development Bank (IDB). This facility does not require any initial payment, but can be drawn upon under specific parameters following ND.

### Methodology to determine the size of a savings fund
- Step 1: Estimate a VAR model for The Bahamian economy using historical data for 1985-2016.
  - Endogenous variables: cyclical components of GDP; government revenues (tax and non-tax); current primary expenditures; capital expenditures.
  - Control variables: US real effective exchange rate; U.S. real GDP growth; oil prices; dummies for September 2001 shock, bankruptcy of Baha Mar in 2015, introduction of VAT in 2015, and election years.
  - Cyclical components calculated as the ratio of the variable to its estimated trend (trend approximated by the Hodrick-Prescott filter on 1985-2016 annual data). All variables transformed into real terms using the GDP deflator and expressed in natural logarithms. Identification of shocks via Choleski decomposition according to the presented ordering.
- Step 2: Run a Monte Carlo experiment using the distribution of residuals from the VAR.
  - One thousand simulations, each corresponding to 15-year periods, generating plausible paths for cyclical components.
  - Focus on events with a probability of occurrence of 15 percent or less.
  - To account for re-prioritization of spending, disasters of this magnitude induce a re-allocation of spending for 0.5 percent of GDP, on average (implemented by adding 0.5 percent of GDP to simulated cyclical primary expenditure paths).
- Fund inflows required to stabilize the fund balance are equal to the average fiscal impact in any given year of a disaster of the chosen probability.
- World Bank data: NDs with damages of at least 5 percent of GDP occur on average every seven years in The Bahamas, implying a probability of 15 percent in any given year. On average 150 out of the 1000 simulations in each year would be identified as a ND.

### Results
- A savings fund of 2-4 percent of GDP and annual savings of ½ percent of GDP would achieve sustainability with a low probability of depletion.
- A fund between 2-4 percent of GDP is needed to obtain a probability of depletion within the subsequent ten years of 11 percent or less, after reaching the target size.
- To stabilize the fund at the target size, under the historical probability distribution of natural disasters, the fund requires inflows for ½ percent of GDP during non-disaster years.
- With the probability set to 0.15, annual savings of 0.5 percent of GDP are needed to achieve financial sustainability of the fund over time.
- Sensitivity:
  - In the 2 percent of GDP scenario, there is a 11 percent risk of depleting the fund over the ten-year period after reaching the target size.
  - In the 4-percent scenario, the probability falls significantly to 2 percent.
- As the frequency of disasters increases, higher inflows are required to stabilize the fund at the target size.

### Conclusions and policy recommendations
- A comprehensive disaster risk management strategy, including adequate financial protection, is critical to confront the consequences of natural disasters.
- Recommended multilayer disaster risk-financing strategy:
  - Establish a savings fund of 2-4 percent of GDP, with annual inflows of ½ percent of GDP during non-disaster years, to enhance fiscal and macroeconomic resilience.
  - Insure public sector assets and encourage broader use of insurance among households to provide additional layers of protection.
- Governance and transparency for the savings fund:
  - The fund should be governed by clear rules on inflows and outflows as well as transparency requirements.
  - Clear objectives and disbursement rules and triggers based on verifiable criteria are critical.
  - The fund should have prudent and transparent investment policies and be consolidated with budgetary information to allow assessment of the overall fiscal situation.
  - At a minimum, the fund balance should appear in financial statements, and drawdowns should appear in budget execution reports.

*Source: IMF staff chapter text provided in content unit cr18119.*

### 1. Fiscal Rules Around the World ______________________________________________________ 5

### 1. Fiscal Rules Around the World

### Background and motivation
- Average central government deficit was 3.8 percent of GDP over 2008-2017, compared to 1.1 percent of GDP during 1998-2007.
- Central government debt doubled over the past ten years and grew more rapidly than the average for Caribbean peers.
- Under Moody’s, The Bahamas’ sovereign rating was downgraded from A3 in 2007 to Baa3 in 2016. Under Standard & Poor’s, The Bahamas lost investment grade status in 2016 and received a rating of BB+.
- VAT introduction in 2015 and revenue administration reforms helped boost tax revenues by 4.4 percent of GDP between FY2014 and FY2017. Total revenue increased by 2.6 percent of GDP on average over 2008-2017 relative to 1998-2007.
- Current spending rose more rapidly than revenues, keeping fiscal deficits high.
- Natural disasters and the lack of an effective fiscal framework contributed to unplanned spending and repeated misses of budget deficit targets.
- A rules-based fiscal framework is proposed to increase fiscal discipline, transparency, and accountability.

### Rule design (objectives and instruments)
- Objectives:
  - Prioritize fiscal sustainability and operational feasibility.
  - Allow space for countercyclical policy given exposure to external shocks.
  - Tailor design to existing capacity constraints; structural balance rules are excluded due to data/forecasting requirements.
- Recommended instruments:
  - A headline deficit ceiling (simple to communicate and monitor).
  - A cap on current expenditure growth (to reduce procyclicality during upturns).
  - A pre-defined medium-term debt anchor to guide calibration.
  - Built-in room for countercyclical policies in the calibration of the deficit ceiling.
- Rationale:
  - Combining deficit and spending caps leverages complementarities between debt sustainability, stabilization, operational guidance, and transparency.

### Rule calibration — debt anchor
- Staff estimates favor a central government debt anchor of 50 percent of GDP.
- Three approaches produced debt-anchor estimates ranging from 50 to 71 percent of GDP; staff favors the lower bound (50 percent) because:
  - The median debt ratio among investment grade emerging market economies declines to 42 percent of GDP if floating exchange rate regimes are excluded.
  - Sizable fiscal contingent liabilities from SOE’s debt equal to 14 percent of GDP as of 2017 warrant a prudent anchor for central government debt.
  - A 50 percent anchor implies putting debt on a downward trajectory from the current level of 58 percent of GDP.

Notes on methodologies referenced:
- Approach 1: median public debt ratio among emerging markets with investment-grade sovereign rating.
- Approach 2: DSAs identify a “critical-debt” benchmark of 70 percent of GDP for emerging markets; subtract a safety margin from that benchmark based on stochastic simulations of potential macroeconomic shocks.
- Approach 3: estimate “critical debt” as the maximum debt ratio credibly sustained in a large prolonged slowdown assuming bounded upward primary balances; subtract a safety margin.

Additional methodological details preserved:
- Safety margin calibrated to ensure —with a 95 percent probability— that debt does not cross the critical ceiling in the event of macroeconomic shocks.
- A large macroeconomic shock is defined as the 75th percentile of the distribution of interest rate-growth differentials in The Bahamas’ history.
- The maximum primary balance is standardized at 2 percent of GDP for emerging markets based on Escolano and others (2014).
- For reference, the highest primary balance sustained over a rolling 5-year period in The Bahamas’ history is 0.9 percent of GDP.

### Rule calibration — operational targets (deficit and spending)
- Targeting horizon and transition:
  - Convergence horizon: 10 years including transition period.
  - Transition period: 3 years (consistent with authorities’ announced FY2018-FY2020 timetable).
  - Current level of headline deficit: 5.8 percent of GDP in FY2017.
  - Authorities’ announced path: 1.8 percent of GDP for FY2019, and 0.8 percent of GDP for FY2020.
- Deficit ceiling calibration:
  - Using the debt-anchor and standard debt dynamics, a deficit target of 1 percent of GDP would need to be maintained at the end of the transition period, assuming:
    - Estimated medium-term nominal growth of 3 percent,
    - Medium-term debt anchor of 50 percent of GDP,
    - Convergence horizon of 10 years (including transition).
  - To create space for a savings fund for natural disasters requiring additional savings of 0.5 percent of GDP each year, the recommended headline deficit target is 0.5 percent of GDP (i.e., implied operational ceiling accommodates both sustainability and savings).
- Current spending cap:
  - For a given deficit ceiling (b*), and average tax pressure (r*), the implied expenditure ratio (e*) follows e* = r* − b*.
  - Assuming stable revenue ratio (∆r* = 0) and compliance with the deficit rule, spending should grow at the same speed as nominal GDP growth or remain constant as a share of GDP.
  - Staff recommends calibrating the current spending cap equal to long-term nominal GDP growth, i.e., 3 percent.

Mathematical relations preserved from the source:
- b* = [λ/(1+λ)] N−1 [ d0(1+λ)N − d* ]  (Equation (1) in source), where λ is a function of expected long-run nominal GDP growth (γ), d0 is initial debt stock, and N is convergence horizon.
- e* = r* − b*  (Equation (2))
- ∆e* = ∆r* − ∆b*  (Equation (3))

### Allowing space for countercyclical policy
- The proposed framework incorporates some room for countercyclical policy by calibrating the deficit ceiling above the steady-state deficit consistent with the debt anchor.
- Safeguards to avoid misuse of the additional room:
  - Legislative provisions clarifying conditions for use of the additional fiscal space between the deficit target and the deficit ceiling.
  - Alternatively, rely on reputational costs for repetitive unjustified deviations from initial budgets; policymakers would be required ex ante to comply with the 0.5 percent-of-GDP deficit target and use the additional 1 percent-of-GDP ceiling only when necessary.

### Net debt path and projections
- Current central government debt: 58 percent of GDP (as stated).
- Proposed medium-term anchor: 50 percent of GDP (implies a downward trajectory over the convergence horizon given the calibrated deficit rule and growth assumptions).
- SOE indebtedness: 14 percent of GDP as of 2017 (noted as a fiscal contingent liability).

### Implementation strategy and institutions
- Transition handling:
  - Embed transitory clauses in legislation specifying a timetable and transition path for the deficit, allowing the spending rule to bind only at the end of the transition period.
- Reporting and transparency:
  - Reporting on compliance with fiscal rules should be mandated in law and occur at ex-ante, in-year, and ex-post stages.
  - Ex-ante reporting: include assessment of compliance and macroeconomic assumptions used (GDP growth, interest rates, revenues).
  - In-year and ex-post reporting: systematically assess compliance and discuss factors explaining observed outcomes.
- Public Financial Management (PFM) requirements:
  - Timely, exhaustive, and accurate fiscal information is critical.
  - Strong expenditure controls and credible budgets are essential to ensure compliance.
  - Technical forecasting capacity must be strengthened to credibly inform policy planning.
- Safeguards and credibility:
  - Clear safeguards or reputational mechanisms are needed to prevent misuse of countercyclical room.
  - Frequent and large ex-post revisions of budget plans could undermine credibility of the fiscal rule framework.

*Prepared by Qiaoe Chen (WHD) and Samba Mbaye (FAD). Sources and figures as presented in the original IMF chapter.*

### 20. Experience has shown that political buy-in and a good track-record are the most

### 20. Experience has shown that political buy-in and a good track-record are the most

### Credibility of fiscal rules
- Political buy-in and countries’ track records are the best predictors of success in implementing fiscal rules (Kumar et al., 2009, Eyraud et al., 2018b).
- Additional institutional and design features that foster credibility:
  - Presence of independent monitoring institutions (fiscal councils, parliament budgetary committees).
  - Broad institutional and economic coverage to monitor and control a large part of government fiscal activity.
  - Calibration that is in line with sustainability and stabilization objectives.
  - Well-defined escape clauses to deal with tail events (Mbaye and Ture forthcoming, Caselli et al., 2018).

### Exceptional circumstances / escape clauses
- Exceptional circumstances clauses should be well defined to avoid undermining credibility.
- Typical triggering events include natural disasters, states of emergency, and large economic recessions, often with pre-defined intensity thresholds.
- Procedures for triggering could include parliament approval.
- The application period of the escape clause and the path to reinstatement of the rule should be clearly defined ex-ante.

### Recalibration and revisions of fiscal rules
- Procedures for future recalibrations/revisions of the rule could be embedded in law.
- Periodic recalibrations can ensure underlying macroeconomic parameters remain adequate.
- Recalibrations should not be too frequent to avoid undermining credibility — example: Kosovo provides for a revision of its rule framework every 5 years.
- Benefits of revising fiscal rules should be weighed against potential costs, e.g., loss of credibility; legal, borrowing and political costs (Eyraud et al., 2018c).

### Communication and building support
- A well-crafted communication strategy is important to generate support for fiscal rules.
- Best practices include:
  - Simple but clear messages aimed at educating the public about objectives of the fiscal rules.
  - Inclusive consultation with major stakeholders to build buy-in and guarantee institutional entrenchment.
  - Early and wide dissemination through multiple vehicles (speeches, press interviews, conferences) to multiple audiences (politicians, private sector, civil society, investors).

### Conclusions on proposed fiscal framework for The Bahamas
- The proposed rules would fill an important gap in The Bahamas’ policy framework.
  - The lack of an effective fiscal anchor and framework has in part allowed rapid increases in spending and in public debt.
  - The proposed framework, if implemented effectively, should help anchor fiscal policy.
- Political will remains a critical ingredient in ensuring sustainable public finances.
- The proposed calibration would need periodic revision as circumstances change.
  - The framework aims to balance: (i) ensuring fiscal sustainability, (ii) allowing enough flexibility for stabilization over the business cycle, (iii) building buffers to deal with natural disasters, and (iv) adapting to existing (technical) capacity constraints.
  - As the economy experiences permanent changes affecting this balance, a recalibration of the rule would be warranted.

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### AN OVERVIEW OF THE BAHAMIAN LABOR MARKET

### Key summary and policy direction
- The Bahamas has experienced persistently high unemployment rates, averaging over 10 percent, in the past 2 decades.
- Youth unemployment remains stubbornly high, falling only to 22 percent in November 2017.
- Main barriers to employment identified:
  - Narrow economic base.
  - Insufficient skill sets among the young.
  - Inefficient job placement services.
- Policy implications and recommendations:
  - Expand vocational and apprenticeship programs to help reduce youth unemployment.
  - Improve skill databases and job placement services to improve matching between employers and job seekers.
  - Enhance the quality of general education to sustain employment in the long term.

### A. Snapshot of the Bahamian labor market — Demographics
- Median age (2010 census): 29.4 years.
- Old age dependency ratio: 9.2.
- Working age population (age 15-64): 66.8 percent of total population.
- Young (age 15-24): about 25 percent of the working age population.
- Labor force participation in 2017: 81 percent.
- Educational attainment of labor force in 2017:
  - 59 percent completed secondary education.
  - 29 percent completed tertiary education.
- Notes on education and emigration:
  - More than 70 percent of Bahamians with tertiary education emigrated to OECD countries in 2010.
  - Education from primary to secondary school (age 5 to 16) is compulsory and free in public schools.

### Employment and wages
- Most employed work in the services sector.
- Tourism-related industries and financial services are the two major private-sector labor absorbers.
- Hotel and restaurant industry accounts for 19 percent of total employment.
- Community, social and personal services industry absorbs 36 percent of employment; most jobs in this category are public sector, accounting for 21 percent of total employed.
- Nominal wages in the hotel and restaurant industry: The Bahamas’ wage is higher than ECCU countries except St. Kitts and Nevis (figure-based comparison).

### Labor market regulation
- The Employment Act is the main law governing the labor market.
  - Allows part-time employment; does not require a minimum number of working hours per week.
  - Severance payment: 2 weeks of basic pay per year for employees working for a year or more, with a maximum payment of 24 weeks.
  - Employment Amendment Act of 2017: allows hospitality (seasonal) industry to lay off employees during off-peak season without paying severance pay (as designated by the Minister of Labor).
- Disputes over dismissals resolved by the Industrial Tribunal; the law does not stipulate time limits for the process.
- Other labor laws: Health and Safety Work Act, Industrial Relation Act, The Trade Union and Labor Relation Act, The Immigration Act.
- Comparative severance and notice findings (figure-based):
  - The Bahamas has shorter period of notice but higher average severance payment compared with peers.
- Minimum wage:
  - Introduced in 2002 at $4.00 per hour; raised to $5.25 in August 2015.
  - Minimum wage and the ratio of PPP-adjusted minimum wage to GDP per capita do not stand out as outliers in the Caribbean region.
- Social security:
  - Governed by the National Insurance Act.
  - Social benefits contributions: employees 3.9 percent and employers 5.9 percent of insurable earnings.
  - Unemployment benefits: 50 percent of the unemployed’s average weekly insurable income for a maximum period of 13 weeks within a 52-week period.

### B. Recent developments in the labor market
- Population and participation trends:
  - Total population about 351 thousand (latest census).
  - Share of working age population: 66.8 percent, up from 57 percent in 1980.
  - Share of young (age 15-24): 22.4 percent, down 6 percent since 2005.
  - Labor force participation: trend increase since 1980; temporary dip around the global financial crisis to 72 percent; reached 81 percent in November 2017.
- Unemployment:
  - Unemployment rate averaged 11.3 percent since 1991, peaking at 16 percent in 2011.
  - Youth unemployment hovered around 20 percent from 2005 to 2017.
  - As of November 2017: youth unemployment rate 22 percent; unemployment rate for rest of population 8 percent.
- Education quality and outcomes:
  - Share of low-skilled labor declined from 11.6 percent in 2006 to 4.3 percent in 2017.
  - Share with tertiary education increased from 25.1 percent to 28.6 percent.
  - Secondary completion rose from 53.8 percent in 2006 to 59 percent in 2017.
  - BGCSE performance: average grade moved from “D-” in 2006 to “D” in 2016.
    - 2006: 18 percent of public high school students passed math exam; 45 percent passed English.
    - 2016: 5.7 percent of high-school students scored a “C” or above in math, English, and a science subject under BGCSE; average score for math “E” and English “D+”.
  - BTVI (The Bahamas Technology and Vocation Institute):
    - November 2015: out of 1798 enrolled students, only 253 graduated in school year 2014-15 (IDB).
    - 2016-2017 school year: 187 students graduated from BTVI; one third in office administration; 12 or 6 percent earned degrees in information technology.

### C. Empirical assessment of labor market flexibility
- Method:
  - Okun’s coefficient estimated from equation: U_t − U_t* = β (Y_t − Y_t*) + ε, where U is unemployment rate, Y is natural logarithm of real GDP, β is Okun’s coefficient, * indicates long-run level approximated by Hodrick-Prescott filter. Data from IMF World Economic Outlook.
- Results and interpretation:
  - Estimated Okun’s coefficient for The Bahamas: -0.26.
  - Global mean Okun’s coefficient: -0.26.
  - The Bahamas’ coefficient is higher than the regional and small state average, suggesting unemployment fluctuations track output evolution relatively more closely than in those groups.
  - Context: relatively high average unemployment around 11 percent, above total sample average of 8.5 percent, close to averages of small states (10.9 percent) and Caribbean countries (11.7 percent).
- Conclusion on regulation and unemployment:
  - Labor market regulation does not appear to be the major culprit behind high structural unemployment.
  - 2018 World Bank Doing Business indicators: firing costs in The Bahamas, in terms of severance payments, are between those for advanced and emerging economies.
  - 2010 World Bank enterprise survey: private sector in The Bahamas does not view labor market regulation as a major obstacle to business.
  - Findings are broadly consistent with Okun’s coefficient results: The Bahamas does not stand out as an outlier.

*Source: IMF staff chapter text provided in content unit cr18119.*

### 14. Skills gaps are regarded as an important barrier for businesses expansion. The Private

### 14. Skills gaps are regarded as an important barrier for businesses expansion.

### Evidence on skills gaps and employer complaints
- The Private Sector Assessment Report (PSAR) (2013) concluded that “Bahamian enterprises agree that their major problem is an inadequately educated workforce” and “the workforce shows deficiencies of required skills”.
- The IDB report (2012) showed firms most frequently cited difficulties in hiring new staff related to specific skills or “underqualified applicants”, followed by applicants’ lack of experience and applicants’ lack of soft skills.
- The IDB report noted that the main reason for dismissals is the lack of soft skills. For example, electricity, gas, AC and water, wholesale and retail trade and accommodations and food service industries employed the greatest percentage of young employees, and they cited that the lack of soft skills are the sole reason for dismissals.
- Soft skills are defined as personality traits such as responsibility and commitment, common sense and integrity, and abilities that can be practiced, such as communication, team work, leadership, good manners and sociability.

### Labor market outcomes: wages, productivity, and unemployment
- Real wages grew faster than labor productivity before 2007, but deviations were short lived.
- The global financial crisis caused real wages to fall initially and then remain broadly stagnant over 2008-2014, while productivity recovered temporarily over 2009-2012.
- Productivity’s temporary recovery reversed from 2013 on, with real wages picking up and in recent years diverging from productivity growth estimates.
- The change in labor productivity over 2000 to 2016 was driven mainly by real GDP growth, suggesting employers adjusted labor costs mainly by reducing the number of employees rather than by controlling nominal wage increases.
- Wages only represent the average in accommodation and hotel industry; the wage range in the accommodation and hotel industry is from $191 per week for a waiter or bartender to $1912 per week for a managing director according to a survey conducted by the Department of Statistics in 2009.

### Role of collective bargaining and labor institutions
- The Bahamian Constitution grants labor unions the right to free assembly and association; these rights are exercised extensively, particularly in state-owned industries and in the hotel industry (where 80 percent of the employees are unionized).
- Trade unions negotiate collective agreements and conduct collective bargaining on wage increases every three to five years; wage increases can be spread over this period or increased by one-time lump-sum payments.
- Unions have at times accepted wage freezes in response to unfavorable economic times (for example, real wages remained flat between 2008 and 2014).

### Structural features and matching frictions
- The Bahamas’ strong dependence on tourism makes it vulnerable to external shocks (including natural disasters), with limited room in other sectors to absorb slack when tourism weakens.
- The IDB data show the public employment system run by the Department of Labor captures only 12 percent of listed businesses’ vacancies, while only 2 percent of registered job-seekers found jobs through this system.

### Ongoing efforts to reduce skill gaps and improve matching
- The National Training Agency (NTA) was created in 2013 to provide high-school graduates or drop-out students with vocational and soft skill training.
  - Up to now, the NTA has trained 4,500 participants, and more than half have been able to find their first jobs.
  - The NTA complements The Bahamas Technical and Vocational Institute (BTVI), in place since 1980.
  - The curriculum for public high schools has been revised to better meet private sector skill demand.
- Since July 1, 2017, the Department of Labor revamped the Employment Exchange (an online platform) to collect information on both vacancies and job-seekers, and launched job fairs in targeted areas.
  - Recent “Labor on the Blocks” job fairs attracted 4,000 participants, mostly unemployed young people, 900 of whom were hired.

### Apprenticeship initiative and vocational expansion
- The National Apprenticeship Program (NAP), funded and designed by the IDB:
  - Targets young workers with a one-year on-the-job and off-the-job training in three identified key areas: internet technology, marine, and medical services.
  - Will bring the NTA, Chamber of Commerce, BTVI together to design the program, supply mentors from industrial experts for trainees, and establish an apprenticeship skill council to guarantee quality.
  - The NTA will focus on the 4-month pre-apprenticeship training to select qualified candidates for the following apprenticeship training.
  - Under the NAP program, 1,350 trainees will benefit from it if they could complete the training.
- Box 1 literature review: vocational and apprenticeship training can smooth school-to-work transition, but cannot substitute for strong quality in general education; evidence cited includes Hanushek, Schwerdt, Woessmann, and Zhang (2017) finding individuals with general education were initially 6.9 percent less likely to be employed than those with vocational education, but the advantage of vocational education diminishes with age.

### Policy conclusions and recommendations
- Main drivers of high structural unemployment:
  - Insufficient and low-quality skillsets of the young.
  - Difficulties in the matching process between employers and job seekers (poor skill match and limited labor market information).
- Labor market regulations do not appear to be a major determinant of high unemployment, though continued improvement and modernization could improve efficiency and flexibility.
- Recommended policy actions:
  - Expand vocational and apprenticeship programs to reduce skill mismatches and youth unemployment.
  - Boost quality of high school education, including math and English, to sustain long-term employment.
  - Use information technology to mitigate teacher shortages in remote islands and improve teaching quality.
  - Consider conditional cash transfer programs to incentivize school attendance and reduce drop-outs.
  - Expand public awareness of the online skill database and encourage employer and job seeker usage.
  - Facilitate firm pre-screening and other placement services to improve matching.
  - The Department of Statistics (DOS) should increase the frequency of labor force surveys and ensure adequate staffing and resources to improve data availability and quality.
  - Improved data should better inform collective wage bargaining, including work of the planned national productivity council, to help align real wage growth with productivity gains.
  - Advance structural reforms to improve competitiveness and reduce structural bottlenecks to spur investment and job creation, recognizing tourism will likely remain a major economic sector.

*Source: IMF staff assessment as presented in the cited chapter.*

### 4.      Small states are more vulnerable to NDs than larger countries. The average damages for

### 4.      Small states are more vulnerable to NDs than larger countries. The average damages for

### Vulnerability of small states
- The average damages for small states is nearly 13 percent of GDP, compared to less than 1 percent of GDP for larger states.
- A greater part of the population in small states are also affected compared to larger states, 10 percent versus 1 percent respectively (IMF, Small States Resilience Paper, 2016).
- Conclusion: It is critical that the governments of small island states take steps to strengthen resilience and ensure adequate buffers to smooth the impact of NDs.

### Economic consequences of natural disasters (NDs)
- Impacts include emergency cash handouts; reconstruction of uninsured or underinsured infrastructure, including critical infrastructure such as roads, bridges or ports; and foregone fiscal revenue due to temporary tax relief measures.
- Pressures on spending from overnight destruction of a country’s infrastructure can result in higher borrowing costs, lower credit ratings, reduced investment, and lower productivity and output.

### The Bahamas — historical response and exposure
- The Bahamas has traditionally absorbed ND shocks through the re-priotization of public spending and borrowing (budget reallocations or debt issuance).
- Economic impacts are seen through worsening current account, declines in foreign reserves and widening fiscal deficits.
- Public assets remain uninsured.
- Example: In 2004, The Bahamas was hit by Hurricane Frances and recorded public and private sector losses of almost 20 percent of GDP. Foreign insurance payments amounted to 3.5 percent of GDP at the time.
- Insurance coverage in the hotel industry has been extended to include wind and flood damages since 2004.
- Local insurance companies report widespread underinsurance among households; homeowners’ insurance prevalent only when there is a mortgage or among wealthy individuals.

### Regional risk-transfer tools — CCRIF
- The Caribbean Catastrophe Risk Insurance Facility (CCRIF) created in 2007 by 16 Caribbean countries pools risks into a single diversified portfolio and provides parametric insurance.
- According to CCRIF, insurance costs are less than half of what individual countries would pay if buying the same coverage or by accessing international markets.
- Governments can buy coverage of maximum USD100 million per disaster and year.
- Between June 2007 and October 2017, the CCRIF disbursed a total of US130.5 million to affected countries.
- Payments are determined by the coverage a government buys and the deductible selected; damages are estimated through an index using hazard levels as a proxy for losses.
- The Bahamas received a CCRIF payment of USD397 598 following cyclone Irma in 2017, covering only a small part of the estimated total damages, at USD135 million.

### Managing disaster risk — A layering approach
- Fund policy on small states’ resilience dictates that ex-ante risk reduction should be the priority to reduce financing uncertainty and ex-post damages (IMF, 2016).
- Policies include risk identification; strengthening engineering and building standards; appropriate legislation; zoning laws to prevent building in flood plains; supportive business environment; and ensuring adequate safety nets to protect the most vulnerable.
- Clark and others (2016) model a cost-efficient disaster financing strategy: ex-ante measures and extended insurance coverage are critical.
- Financing layers:
  - Low-impact, high-frequency disasters: funded by budget reallocations or savings (pre-financed reserve fund), complemented by contingent credit lines or post-disaster credit when appropriate.
  - Severe disasters: require ex-ante mitigation and greater penetration of private and public insurance; market insurance and re-insurance for private and public-sector assets; catastrophe (CAT) bonds for transferring extreme-event risk to international investors via an SPV that signs a reinsurance contract.
- Practical considerations:
  - A government could allocate fiscal savings to debt reduction and borrow when hit by a ND, but it can take up to nine months to access resources.
  - Disaster borrowing may affect marginal interest rates in a small economy; The Bahamas’ high-income status prevents access to concessional financing terms.

### Financing developments and contingent credit
- In March 2018, The Bahamas requested a 5-year USD100 million contingent credit line to the Inter-American Development Bank (IDB). This facility does not require any initial payment, but can be drawn upon under specific parameters following ND.

### Methodology to determine the size of a savings fund
- Step 1: Estimate a model for The Bahamian economy using a vector auto-regression (VAR) with historical data for 1985-2016.
  - Endogenous variables: cyclical components of GDP; government revenues (tax and non-tax); current primary expenditures; capital expenditures.
  - Control variables: US real effective exchange rate; U.S. real GDP growth; oil prices; dummies for September 2001 shock, bankruptcy of Baha Mar in 2015, introduction of VAT in 2015, and election years.
  - Cyclical components calculated as the ratio of the variable to its estimated trend (trend approximated by the Hodrick-Prescott filter on 1985-2016 annual data). All variables transformed into real terms using the GDP deflator and expressed in natural logarithms. Identification of shocks via Choleski decomposition according to the presented ordering.
- Step 2: Run a Monte Carlo experiment using the distribution of residuals from the VAR.
  - One thousand simulations, each corresponding to 15-year periods, generating plausible paths for cyclical components.
  - Focus on events with a probability of occurrence of 15 percent or less.
  - To account for re-prioritization of spending, disasters of this magnitude induce a re-allocation of spending for 0.5 percent of GDP, on average (implemented by adding 0.5 percent of GDP to simulated cyclical primary expenditure paths).
- Fund inflows required to stabilize the fund balance are equal to the average fiscal impact in any given year of a disaster of the chosen probability.
- World Bank data: NDs with damages of at least 5 percent of GDP occur on average every seven years in The Bahamas, implying a probability of 15 percent in any given year. On average 150 out of the 1000 simulations in each year would be identified as a ND.

### Results
- A savings fund of 2-4 percent of GDP and annual savings of ½ percent of GDP would achieve sustainability with a low probability of depletion.
- A fund between 2-4 percent of GDP is needed to obtain a probability of depletion within the subsequent ten years of 11 percent or less, after reaching the target size.
- To stabilize the fund at the target size, under the historical probability distribution of natural disasters, the fund requires inflows for ½ percent of GDP during non-disaster years.
- With the probability set to 0.15, annual savings of 0.5 percent of GDP are needed to achieve financial sustainability of the fund over time.
- Sensitivity:
  - In the 2 percent of GDP scenario, there is a 11 percent risk of depleting the fund over the ten-year period after reaching the target size.
  - In the 4-percent scenario, the probability falls significantly to 2 percent.
- As the frequency of disasters increases, higher inflows are required to stabilize the fund at the target size.

### Conclusions and policy recommendations
- A comprehensive disaster risk management strategy, including adequate financial protection, is critical to confront the consequences of natural disasters.
- Recommendation (multilayer disaster risk-financing strategy):
  - Establish a savings fund of 2-4 percent of GDP, with annual inflows of ½ percent of GDP during non-disaster years, to enhance fiscal and macroeconomic resilience.
  - Insure public sector assets and encourage broader use of insurance among households to provide additional layers of protection.
- Governance and transparency for the savings fund:
  - The fund should be governed by clear rules on inflows and outflows as well as transparency requirements.
  - Clear objectives and disbursement rules and triggers based on verifiable criteria are critical.
  - The fund should have prudent and transparent investment policies and be consolidated with budgetary information to allow assessment of the overall fiscal situation.
  - At a minimum, the fund balance should appear in financial statements, and drawdowns should appear in budget execution reports.

*International Monetary Fund — THE BAHAMAS (excerpts from the supplied content)*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18119.pdf_