The Path to Exchange Control Liberalisation:
Completing the Journey in One Piece
Remarks by John A Rolle, Governor
Bahamas Business Outlook 2018
18 January, 2018
Introduction
A special thanks to the Counsellors for inviting me to make this presentation on exchange
control liberalisation. I intend to keep the focus narrowed to issues related to capital and
investment flows, as these are the areas where policies and administrative practices have
the most substantive impact. Rather than argue that The Bahamas should resist
liberalisation, I would instead like to convince you that we should make more credible
preparations to do so-but in a stable fashion. I would also like to convince you that some
of the roadblocks to liberalisation are matters related to our national investment policy
regime, which defines the limits of property rights enforcements for those who might
otherwise, already be able to circumvent the exchange control regulations. Finally, there is
the question of dollarization, and whether this option would allow The Bahamas to speed up
the process of liberalisation.
Purpose and Scope of Exchange Controls
The system of exchange controls, and the monetary policy tools available to the Central
Bank are to ensure that The Bahamas is able to maintain the fixed exchange rate, with
B$1.00 = US1.00. The parity with the US currency provides a necessary convenience for
tourism, which is mostly transacted in US dollars and mostly with US clientele. The fixed
exchange rate has also provided a stable anchor for domestic inflation, which has closely
mirrored the inflation rate in the United States. This is an achievement almost unrivalled in
independent countries in Latin America and the Caribbean, or in most developing countries.
It should also not be so quickly discounted given the importance of stable inflation
expectations in the medium and long-term decision making processes of the private sector--
whether it is about investments, savings or wage negotiations.1
Our exchange controls have been effective, not because they are fool proof, but because
they provide safeguards around very liquid and mobile financial flows, which if shifted
rapidly could destabilise the exchange rate. Given enough time, people do manage to evade
controls but the short-term fallout from such movements is not felt. Meanwhile, the
national investment policy provides a check on restricted categories of inflows, because it
determines the ease of forming legally binding commercial contracts with non-residents.
The downside, however, is that protection can reduce the incentives for expedited
structural reforms that would have longer-term benefits. More liberal capital flows do
expose policies and policy makers to greater market scrutiny and accountability. It is to our
advantage to subject ourselves to such discipline, and to push for reforms that positively
reinforce good policies.
The exchange rate peg has only survived because the Central Bank, with the help of
exchange controls, has consistently been able to assure a supply of foreign currency to the
public at the official rate. The system also allows excess inflows from tourism and other
export activities to accumulate in the external reserves until they are needed.2
In accommodating foreign exchange demand, the system then distinguishes between
international transactions that are current in scope, versus those of a capital or financial in
nature. Current transactions, most commonly cover goods and services (including travel),
interest and profits on investments and remittances such as expatriate workers' income or
transfers. Capital transactions cover both portfolio and direct investment flows, and the
contracted liabilities of individuals, financial institutions and businesses.
The use of foreign exchange is permitted freely to pay for current transactions. In this area,
there has been significant delegation of authority to commercial banks to approve
payments without prior reference to the Central Bank. A forthcoming round of delegation
will provide additional flexibility to banks to approve commercial payments, and particularly
benefit medium and larger businesses. For individuals, small businesses and most medium-
size businesses, there is already virtually no direct contact with exchange controls for these
trade related transactions.
There is, however, a more selective approach in dealing with private financial transactions.
Policies have always embraced private direct investment inflows in the foreign exchange
earning sectors, but paced slower to accommodate outflows by Bahamians. The ability of
Bahamians to make outward direct investments that were not assessed an investment
currency premium, only started to be embraced as a policy in 2006, and is now
accommodated up to a limit of $10 million, per investment, every three years. The approval
process considers whether such investments would produce returns that would be
repatriated to The Bahamas.3 In 2017, access by Bahamians to financing in foreign currency
for domestic ventures was also strategically relaxed,4 with a limit of up to $5 million per
business firm every 5 years.5 This is available for businesses operating in sectors generating
positive net foreign exchange impact or where expressed national development goals have
been articulated.
On portfolio or potentially liquid investments, the approach has been one-sided. Inflows are
still not very much embraced. However, since 2006, Bahamians have been able to invest
abroad without paying the investment currency premium, once they purchased instruments
marketed through local broker dealers and traded on the local stock exchange (BISX). The
collective annual accommodation limit for these vehicles is now $35 million. Other portfolio
transactions still incur an investment currency premium. The premium used to be at 25
percent, but was reduced to 12.5 percent in 2006 and will be reduced further to 5 percent in
2018. That said, the Investment Currency Market exists primarily to limit speculative
pressures that could deplete the supply of foreign exchange and render the exchange rate
unsustainable.
Figure 1: Bahamas Utilisation of Investment Currency and
Stock Exchange (BISX) Linked Facilities
Note: Cumulative capital outflows for selected vehicles area as follows:- ICM: more than $50
million; BISX vehicles: $150 million; NIB: $109 million.
Source: Central Bank of the Bahamas
Another reform that has already been foreshadowed is that greater access is being opened
up for residents and businesses to maintain foreign deposits accounts, but with built in
protections for the exchange rate regime. In particular, business will be able to retain a
portion of their foreign currency revenues to meet ongoing trade payments. Also,
Bahamians who have accumulated foreign currency assets abroad will be permitted to
repatriate these and, if they desire, maintain the deposits in foreign currency. The holders
of these facilities will not be able to fund them with foreign exchange that is purchased on
the local market. This ensures that inflows of foreign exchange remain for the most part
available for the private sector's current account needs.
A Stable, Sustainable Path to Further Liberalisation
It is the continued liberalisation of the capital account to which we should aspire in The
Bahamas, to the extent that it is able to stimulate higher rates of national savings and
investment and provide more diversification opportunities for local investors. The proviso is
that the flows, whether inward or outward, ought to be sustainable. We ought also to be
able to maintain relative exchange rate and financial stability. The Bahamas must be
prepared to move in this direction only as fast as we are able to erect the appropriate
safeguards around highly liquid capital flows. At the same time, we should strive to put
such frameworks in place.
Compared to the present environment, the outcome for liberalisation could include the
following:

The ability of Bahamians to invest outside The Bahamas in foreign currency, absent
the investment currency market premium; and the ability of non-residents to invest
more freely inside The Bahamas in both long-term and short-term capital.
 The ability of residents to hold foreign currency deposits in local banks and for non-
residents to maintain deposits in local currency.

The ability for residents to borrow in foreign currency and for non-residents to
borrow in local currency, irrespective of source.
These would, of course imply, no restrictions on converting into and out of Bahamian
dollars.
To be sustainable, net capital inflows must be able to pay for themselves. That is, their
deployment should generate enough foreign currency returns to repay both the initial
inflows and the required returns on those flows. Otherwise, they could become a net drain
or burden on a country's stock of foreign reserves. Now, when the decision is left to banks,
there should be less of a concern about whether financing of a particular currency
denomination should be given to a firm, because from a best practices or regulatory point of
view, banks would be required to match their lending to the currency in which the revenues
of the business are denominated.
Outside of banks and similarly regulated entities, policy makers would have to orchestrate
this sustainable outcome at a national level through direct incentives or disincentives to the
sectors of strategic concern. If the government lacked tools such as tax policy to influence
financing behaviour, it would continue to have to rely on direct, though less efficient
intervention to influence external financing patterns. This is the positon in which The
Bahamas still finds itself, and will likely have to focus if we are to further optimise external
financing inflows to locally owned businesses over the medium-term.
As to stability, The Bahamas must still be able to accommodate the volume and speed of
capital flows, without losing control of the exchange rate or the solvency of financial
institutions. Funds that move through capital markets or sit in liquid bank deposits are
examples of flows that can relocate swiftly. Again, from a regulatory point of view, the risk
of bank insolvencies can be suppressed, by requiring that banks do not rely on short-term
foreign currency deposits inflows to finance long-term lending. Reserve requirements can
also be placed on banks to reduce such tendencies and to provide some insurance against
sudden outflows. That said, there could also be vulnerability to sudden outflows if, en
masse, residents are allowed to shift out very liquid funds they hold in local currency. Faced
with such developments, the exchange rate could be allowed to depreciate-that is, the
price of foreign exchange could be allowed to increase. Such an outcome would not be
desirable for The Bahamas.6
Therefore, we should be striving for an outcome, where other than for diversification
residents are indifferent between holding deposits in local or foreign currency. This would
be an outcome where portfolio decisions are not materially driven by speculative
movements to outrace expected depreciations in the exchange rate. Among other factors,
speculations about whether the currency would maintain its value would depend on
whether it is believed that the government was doing a credible enough job of keeping its
finances in order; whether it is believed that public sector debt dynamics would be kept
within a comfortable zone, or whether misaligned finances were viewed as having a credible
chance of being remedied.
The monetary authority is also part of the fiscal picture. Failed public finance dynamics can
show up in unchecked borrowing from the central bank and in growing gaps between local
currency liabilities of the monetary authority and foreign reserves, which are held to
support the currency. Central bank lending to the government can also be a source of
accumulated bank liquidity, of the sort that might seek to flee the jurisdiction, if they are
allowed to become mobile.
The confidence boost that a financial system would need, before opening itself unchecked
to short-term financial flows would be, in a case where deficits and debts are a concern, to
quiet such concerns. Deficits or debt burden need not disappear at the outset, but there
has to be an anchored belief that such reduction would occur within a comfortable time
frame.
At the Central Bank, we are focused on gradually reducing the amount of outstanding credit
provided to the government. It will also achieve, as a side benefit, some important
reduction in surplus liquidity within the banking system. Over the medium-term it is also
expected that a new Central Bank Act would put stronger governance arrangements in place
to continue to reduce lending to government. At the same time the public finances will
have to support some of the liquidity reduction in the medium-term through direct
slowdown and eventual reduction in the debt burden.7
Aside from exchange control, liberalisation also has to be considered in the context of the
national investment policy. If certain sectors are constrained from foreign participation,
then Bahamians operating in those sectors would also be constrained in how they
collateralise access to foreign currency financing. If majority ownership in a venture must
be Bahamian, then the majority financing source, unless it is domestic would not be
permissible in foreign currency.8 Also, to the extent that restrictions apply to how non-
residents acquire real estate in The Bahamas, use of such assets as security for mortgages
would be subject to a layer of processing and approval that is independent of any EC rules.
Figure 2: Central Bank Financing to Government
As the government debt burden increased, reliance on central bank financing, especially over the last decade, has also
increased....
The balance sheet impact for the Central Bank has been that the coverage provided by external reserves for B$ currency
liabilities has declined.
Note: The Reserves to demand liabilities coverage spiked in 2009 because of the Bahamas' share of the Special Drawing
Rights allocation that the IMF provided to its membership during global financial crisis.
Source: Central Bank of the Bahamas
8
The Central Bank had to take this into account in how the 2017 liberalisation measures were framed.
The question will still come up as to how far The Bahamas should go with liberalisation, both
for direct investments and portfolio transactions. The extensive work that the IMF has done
has been to advise that countries should sequence liberalisation at least one step after the
upgrade to institutional and policy arrangements has been made, which allow the country
to optimally manage the transformed environment.9 At the extreme, the IMF's view is that
a flexible exchange rate would be ideal to allow a country to absorb the effects of large
movements in short-term capital. This assumes that a country has well developed and
functioning financial markets, and that the regulatory frameworks exist to ensure that
financial institutions operate in a sound fashion. Adequate fiscal policy tools should also
exist to incentivise the right course for the private sector. This would also mean less
reliance on administrative measures, in favour of tools that affect a wider cross-section of
the markets directly.10 Being able to pre-empt adverse outcomes, which is critical, also
means that sufficient capacity must exist to collect timely data to monitor private sector
activities.
The Central Bank and policies affecting the banking sector are a subset of the elements in
this required stronger framework. Indeed there is already progress in on the banking side.
Our local banking system is sound, with the required regulatory framework, and high
frequency reporting requirements to ensure safety and soundness, even if the composition
of balance sheet flows were to change or become more fluid. Moreover, the Central Bank is
developing expanded frameworks to monitor economy-wide indicators of financial
soundness. With modernisation of the government securities market, the Bank will also
have a more flexible set of tools to manage financial sector liquidity. That's said, we have to
continue to improve data quality and coverage for activities outside of the banking sector.11
Consideration also has to be given to harmonised policies that influence other parts of the
financial sector. This means progressing to a legal framework for financial stability that
draws in all of the other financial sector regulators, so that prudential measures, when
required, have a uniform impact. Alternatively, The Bahamas needs to move to consolidate
the supervision of the financial sector, at a minimum, along prudential lines.
The operating frameworks in the government sector also need more evolution, to be able to
intervene in capital flows in a non-administrative fashion. As it stands, the system is still
skewed towards consumption taxes. Moreover, for well into the medium-term the
government's flexibility will be constrained by the necessary emphasis on fiscal
consolidation.
Is Dollarisation an Option?
The working assumption is still that The Bahamas would want to avoid the nuisance of
exchange rate flexibility. Reliance on other fiscal and monetary policy tools therefore
becomes more important. Many have suggested that dollarisation would be an option.
Giving up the B$ entirely and adopting the US currency by default would eliminate the
exchange rate concern.12 It is true that the government would no longer be able to borrow
from the central bank, but it would not alter much else of what would be required in
policies and frameworks to ensure stable and sustainable capital flow trends. It would not,
for example, make a financial stability framework less relevant or relieve the government of
the need when necessary to use fiscal policies to maintain macro-economic stability. Indeed,
this outcome, if we aspire to such, would increase the imperative for good and sound fiscal
frameworks.
Going the route of dollarisation also does not shorten the time required to get to a more
liberalised state. The B$ currency liabilities of the central bank would still have to be
extinguished at the promised rate of one-to-one. The process of deficit reduction and debt
reduction therefore has to run its course. The outstanding balance of central bank lending
to government would still need to be eliminated and the government entirely reliant on the
market and on market pricing to finance its shortfall. In fact, the government has to go
much further than just eliminating its debt to the central bank. Much of the attractiveness
to the private sector of holding government debt rest on the ease at which it can be sold to
the Central Bank. Reliance on the central bank as the "buyer of last resort" for government
debt will also have to diminish, maintaining the overall focus therefore on comprehensive
debt reduction. Even a persistent balance budget rule would not outweigh expenditure
prudence and efficiency. Uncompetitive high rates of taxes as a percentage of GDP would
still be a recipe for capital flight.
Conclusion
To conclude, there are justifiable economic reasons to push for increased capital account
liberalisation for The Bahamas. Where this process could end is much further than where
the economy sits at present. However, there is no shortcut to the pre-requisite reforms to
develop stronger institutions and policy frameworks, and healthier economic fundamentals.
Added to how the central banking framework is strengthened, a more consolidated view of
the financial sector regulations would support this outcome. Improved public finances and
stronger fiscal management systems underscore the central role that the government must
also play in any transformation. Finally, the speed at which we are able to reform will
determine the stable and sustainable pace at which we tackle our capital controls.