At Fidelity Bank’s recent Cayman Economic Outlook conference in February, economist Tyler Cowen outlined a sobering view of the new global economic reality in a speech titled ‘The new normal: Lower living standards and their impact.’
A professor of Economics at George Mason University and author of the book “Average is over,” Tyler Cowen described the widespread global economic uncertainty in terms that have become all too familiar: unbalanced or anemic growth, burgeoning debt levels, a thinning middle class, increasing income inequality, unemployment. No country has gone unaffected by this “new normal” since the global financial meltdown in 2008, and the consequences – especially for developed western societies – are serious.
“People, cities, countries, and sectors will either do very well (in handling the new economic reality) or will not do so well at all. ‘Average is over’ is the new normal. If you’re simply a worker with not a lot of skills, the new normal will be that the mere fact you were born into a wealthy country will not guarantee you the kind of bright future that it might have in 1995.”
The Bahamas has really been grappling with its own version of new normal – at least in terms of its offshore financial sector, its number two industry – since 2000, when the jurisdiction felt the sting of supra-national pressure in the form of the Financial Action Task Force Blacklist of Non-cooperative Countries. In what could be described as a legislative convulsion designed to placate the international powers, the Bahamas accommodated the FATF (and the OECD by extension) by enacting nine new financial sector laws to tighten the overall regulatory regime. The new laws prompted the closure of IBCs and “brass plate banks,” increased the oversight and operating costs of financial service providers, and irretrievably altered the regulatory landscape of the sector in the Bahamas.
While some applauded this action as long overdue and in line with international best practices, others viewed it as a hypocritical forced sacrifice of sovereignty under the guise of combating international money laundering and tax evasion. Nevertheless, the Bahamas was removed from the FATF Blacklist in 2001.
International challenges and innovation
The Bahamas financial services sector survived the initial FATF onslaught, but the effect of the new local legislation, the global financial crisis and the increased suspicion of offshore financial centers following the terrorist attacks in New York took its toll. According to the Central Bank of the Bahamas, 200 banks and trust companies in the Bahamas had their licenses revoked since the passage of the new legislation.
As the sector contracted, the need to innovate and add true value irrespective of tax issues became apparent. Other offshore financial centers in the region – such as Cayman and Bermuda – also felt the pressure of increased international scrutiny, and competition between the jurisdictions for a dwindling slice of the international financial pie increased.
The Bahamas’ traditional expertise in international private wealth management was bolstered by the introduction of new fund legislation in 2003, known as Specific Mandate Alternative Regulatory Test Funds, or SMART Funds. Designed to meet the needs of professional investors and family offices, SMART Funds quickly became the structure of choice for private wealth management professionals due to their simplicity, ease of set up and less onerous registration requirements than other investment structures.
SMART funds provided the sector with a new competitive arrow to go into its financial services quiver, and, by the end of 2012, 326 SMART fund structures had been established in the Bahamas.
The no-beneficiary, no-shareholder Bahamas Executive Entity (BEE) structure, introduced in 2012, was another such development, designed to address complex governance issues within fiduciary and wealth management structures. In addition, there has been renewed interest in re-establishing the Bahamas as a major participant in offshore captive insurance, an industry the country dominated until 1973 when the Bahamas lost the business to more accommodating jurisdictions.
The country will certainly continue to face international tax-reporting pressures, as U.S. initiatives such as FATCA (which the Cato Institute’s Dan Mitchell calls “financial imperialism”) and multiple bilateral tax exchange information agreements are signed and put into place. But the sector remains fully cognizant of the ever-changing global financial services landscape, and has continued to try to broaden its international appeal with various legislative initiatives in the areas of investment management, insurance, and asset protection.
However, balancing the promotion of a country’s international financial services sector – which often means an influx of highly-paid foreign bankers that can exacerbate domestic income inequality issues –and being seen to be tough on local problems like illegal immigration, can be a political high-wire act, which the current government of the Bahamas recently realized.
In early January of this year, Bahamian immigration officers detained the executive director of UBS Bank, Emmanuel Fiaux, at the Carmichael Road Detention Centre, for not being able to produce proof of legal residency after being stopped at a road block. The effort was intended to combat a growing illegal immigrant problem in the country (mostly Haitians and Jamaicans), and Fiaux simply got caught up in the dragnet.
However, news of Fiaux’s brief detention quickly became a public relations nightmare, and caused many within and outside the country to question how committed the current government really is to supporting the offshore financial sector in the country. To be fair, it’s doubtful that the incident had any direct bearing on UBS’s recent decision to wind down its banking operations in the Bahamas by the end of 2014. But it certainly didn’t make it any easier to attract new foreign financial institutions to the country.
Immigration issues such as frustratingly long delays in work permit approvals and renewals have sometimes been a challenge for the financial services sector in the country, and could act as a tipping point for companies trying to determine whether it’s worthwhile to establish a business presence (or remain) in the jurisdiction. (Especially considering that a regional competitor like Cayman has established a Special Economic Zone to lure qualified businesses with the promise of five-year work/residency visas within five working days.)
The unrelenting tax assault by Uncle Sam and Europe on Swiss banks and secrecy has certainly forced Swiss financial institutions to re-evaluate all their global operations, not just in the Bahamas. But Bank Paribas (2010) and HSBC (2013) have already made their decisions to exit the country, while Credit Suisse (Bahamas) recently consolidated some of its operations there. Whether other foreign financial institutions will follow in these footsteps remains to be seen.
Tourism still number one
The mainstay of the Bahamian economy, tourism, improved markedly with the purchase and development of Sol Kerzner’s Atlantis resort on Paradise Island in 1994. Subsequent employment, construction, and knock-on investment by other foreign hotel and resort operators such as Sandals and Breezes soon followed.
World Bank figures show that Foreign Direct Investment (FDI) in the Bahamas went from $102 million in 2001 to its highest level ever at $871 million in 2010. Some may argue that the link between FDI and actual benefit to a host country is tenuous, but the net result of these inflows for the Bahamas was the very real creation of jobs. In 2003, two years after the terrorist attack on the World Trade Center, the unemployment rate in the Bahamas stood at 10.8 percent. By 2006, it had dropped to 7.6 percent.
The Bahamas attracted 1.5 million stop-over visitors in 2005 and 3.3 million cruise ship guests. Although the stop-over numbers declined somewhat by 2013 to 1.3 million, cruise ship visitors surged to 4.7 million, the highest in the Caribbean. A completely renovated international airport and the refurbishment of the road system in Nassau, the capital, have been two substantial infrastructure reforms undertaken over the past seven years that should support new tourism initiatives in the future.
But the country’s tourism industry is not without its own set of ‘new normal’ concerns. On the one hand, the Bahamas has managed to attract arguably the largest single resort construction project in the Caribbean in “Baha Mar Casino & Hotel: The New Riviera.” Funded by the Chinese Export Import Bank (with all the usual strings attached, such as Chinese labor), the $2.6 billion project has become the great hope of employment and a return to widespread Atlantis-era prosperity.
The new 5,000-room resort, due to open in December 2014, has already transformed Nassau’s Cable Beach area, and promises to generate 4,000 new jobs in the country. Even if the number of new jobs created is half the expected amount, it will still be a welcome relief for a country with a 16 percent unemployment rate.
On the other hand, the ever-increasing high cost of essential services, such as electricity (nearly 40 cents per kilowatt hour, one of the highest rates in the Caribbean) and air transport to get to the country (taxes alone can make up as much as 40 percent of air ticket prices, according to former Bahamas Minister of Tourism and Secretary General of the Caribbean Tourism Association Vincent Vanderpool-Wallace), places the jurisdiction at a competitive disadvantage.
A flight from Miami to Nassau – a distance of only about 150 miles – for example, can cost upwards of $460 today. As a matter of comparison, it costs just about the same for a ticket from Miami to Las Vegas, nearly 15 times the distance. Embedded fees such as departure tax and facility charges make a huge difference. And, as Vanderpool-Wallace (who was also a speaker at the Fidelity’s Cayman Economic Outlook) has pointed out, modern travelers have more information than ever before about potential vacation spots, and cost matters. They will vote with their feet.
The Bahamas tourism sector has enjoyed tremendous growth over the past three decades. But like the financial services sector, the country places future prosperity (and jobs) at risk when it ignores the very clear signs of ‘new normal’ in the global tourism industry and the need to adjust accordingly.
The debt story
Related to the high cost of essential services in the Bahamas is the country’s deteriorating debt situation. In September 2012, the IMF indicated that the Bahamas debt-to-GDP ratio stood at 54 percent, up from less than 40 percent prior to the 2008 financial crisis.
In December of the same year, ongoing fiscal issues prompted Moody’s to downgrade the Bahamas to Baa1, citing downside risks in tourism, offshore financial services and construction caused by an uncertain of recovery in the U.S., the Bahamas’ main market for tourism. While a 54 percent debt-to-GDP ratio is not necessarily cause to panic (Barbados, for example, measured a 94 percent ratio in 2013, and the U.S. ratio was about 101 percent), the rating agency was not convinced the country could simply grow its way to more sustainable levels.
The Moody’s report highlighted some of the main contributors to the recurring debt situation: subsidized, state-owned corporations such as Bahamas Electricity Corporation, Bahamas Water and Sewerage Corporation, and Bahamasair, the national airline.
The country’s rising debt levels have also prompted international calls for the collection of additional tax revenues, specifically a Value Added Tax (VAT), to try to bring the deficit under control. However, the proposal has met with substantial local opposition from many sectors, in part because already-high consumer prices will be pushed even higher, and in part because the government planned to actually implement this brand new domestic tax system some 14 months after announcing it to the public.
Opponents have also suggested that it would be better to tighten up the existing system of import duties and property tax collection rather than to introduce a new tax regime with a questionable chance for success in a country like the Bahamas, which has no similar existing domestic tax system in place and no local culture or tradition of regular tax reporting.
In addition, these opponents have pointed out that a key component to the untenable debt levels in the country is bloated government expenditure and waste, as cited in the Moody’s report. This, they have said, should be the first area to address before anything else. (As of the date of this report, the proposed July 1 deadline for the implementation of VAT has been extended.)
The Bahamas has always enjoyed one enviable advantage among tourist destinations in the Caribbean: location. Nassau lies within a two hour flight of the major metropolitan areas along the entire eastern seaboard of the U.S. The country boasts 700 islands and cays, of which about 30 are inhabited and relatively easily accessible. Even though the country struggles with high cost issues on several fronts, simple location will likely assure it will remain one of the main tourist destinations in the region for some time to come, especially once Baha Mar begins operations.
And the country’s long history of political stability, legislative innovation, and strong institutions bodes well for perhaps a smaller, but more focused financial services sector. Government and industry practitioners, however, will need to continue to work closely together to innovate, expand jurisdictional strengths, and effectively manage the coordinated tax initiatives thrust upon the world by the U.S. and Europe. The sector has managed to adjust to external pressures in the past, and there is no reason to believe it cannot successfully continue to do so.
However, if Tyler Cowen’s version of new normal is indeed correct, the Bahamas will have to first accept the notion that the golden opportunities being created within the global tourism and financial services industries will require more than just lip service. Indeed, average is no longer good enough.