The Big Idea
The Bahamas | Slow rating trajectory
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
The impressive 14% total returns so far this year ranks the Bahamas as one of the top regional emerging markets performers. However, the country’s sovereign debt now likely moves to a slower phase of spread compression with total returns largely reflecting carry as yields normalize below 9%. This sovereign remains an attractive option with relatively low beta and high carry at a mature phase of outperformance among other high yielding alternatives.
S&P just recently confirmed a neutral outlook on the Bahamas ‘B+’ rating. The Bahamas has been stable in the ‘B+’ category since the post-Covid shock in 2021 and 2022. The economic team remains focused on shifting the nominal fiscal deficit to surplus. This is a slow trajectory not only for the gradual approach to fiscal surplus but also the gradual path to reducing the high debt ratios. The fiscal gradualism isn’t ideal and leaves the economy vulnerable to latent external shocks, especially without the anchor of an International Monetary Fund program.
There has been credible policy management. There is more transparency, effective financing and significant fiscal adjustment. The transition from a 3.7%-of-GDP fiscal deficit in FY2022/23 to a deficit of 1.3% of GDP in FY2023/24 shows impressive improvement and the beginning of an important track record towards their target goal. Next is corporate tax reform. That would help the Bahamas get to a fiscal deficit of 0.5% of GDP in FY2024/25. There will have to be more effort to improving tax collection, focused on property taxes and reducing broader VAT evasion. The spending restraint in the fourth quarter of FY2023/24 should also represent permanent as opposed to temporary cutbacks and a stabilizing adjuster for reaching the fiscal target if revenues disappoint.
S&P assumes conservative projections for low trend GDP growth of 1.5% and no further improvement on the fiscal deficit at 1.3% of GDP. The potential for higher ratings depend on “sustained near-balanced financial results and improved economic prospects.” The outlook remains neutral; however, S&P did signal positive rating action specifically referencing “successful implementation of a corporate income tax and carbon credits, combined with improved state-owned enterprise (SOE) finances after effectively executing energy sector reforms.” There is room for optimism, especially on follow-through approval of a corporate income tax before year end. The guidance is for consistent progress on lowering the fiscal deficit, gross financing needs and vulnerability to shocks.
The transition toward ‘BB’ will require a more decisive shift towards the targeted 2%-of-GDP fiscal surplus. There have been various revisions to the target trajectory with the 2%-of-GDP fiscal surplus pushed back to FY2025/26. The progress on higher tax collection and spending restraint validates current sub-9% yields, however, it’s difficult to expect any rating upgrades or ‘BB’ credit convergence until the final phase of fiscal adjustment. This is not a controversial statement with high level officials also confirming much work to do. The approval of the corporate tax reform should further strengthen the track record with further efforts necessary on meeting their goal target.
The Bahamas current sub-9% yields seem appropriate with the current trajectory of fiscal gradualism and a mature phase of credit spread compression heading into next year. This suggests a shift from the 14% EMUSTRUU total returns YTD closer to carry returns into next year. This remains still a favorable alternative for its lower beta, off-index status and wide margin compared to ‘BB’ credits. There are not many other high yielding alternatives in the region, aside from the distressed credits of Argentina and Ecuador.
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