Wednesday, October 25, 2006

Adapting to a changing economic climate

The way with which Trafigura has monopolized the press and commentary was predictable because of the enormity of the scandal in many ways. In fact it certainly would have competed with the soaps on television, as it had all the intrigue of a made for television story. The commentary must continue as it is important that there is a full investigation and revelation of what happened so that we can have the purging necessary to move forward.

One of the inadequacies it has shown up is the inability of some persons to focus on more than one issue at a time, as it seems that some commentators cannot understand why we should also address the confidentiality issue, while at the same time addressing the more important issue of the acceptance of the gift by the government.

The incident has also derailed our continuing discussions on the economy, and the fiscal accounts. The Finance Minister recently held a press conference where he fielded questions on the economy and seemed pretty up beat about the prospects as relates to the fiscal targets being met. He stressed that the “inflation scourge” was being brought under control, as the twelve month point to point as at September 2006, showed an annualized inflation of 6.5%. Recently the confidence numbers also showed an upswing in business confidence. There has definitely been a less tense criminal atmosphere year over year. Other indicators show interest rates being reduced marginally, the exchange rate being pretty stable over the so-called “tamarind” season, a rebound in agriculture, and the industrial climate settling down.

On the negative side, the greater than projected increase in the debt of J$26 billion is of concern. This is especially so as we continue to boast of record NIR levels, which in my opinion is not necessary to be so high. If we maintained an NIR of US$1.5 billion, then this would allow for us to retire J$55 billion worth of debt. The lower than targeted capital expenditure is also a concern, as this is what has resulted in a lower than projected fiscal deficit and this type of spend is necessary for future development.

Changing economic environment
What is evident though is that there is a change taking place in the economic environment for the better. Growth is no longer being driven by the financial and retail sectors, but rather by agriculture and tourism, and this is reflected in our improved current account position year over year. The problem with the trade balance remains that even when we increase exports, we are so import dependent, even in our production that imports naturally increase also. In my opinion, this changing economic climate has resulted primarily as a result of the focus on making cheaper funds available to the market and reducing crime through intelligence gathering rather than brute force.

What this has done, however, is caused firms to strive to become more efficient in order to survive. The truth is that even though we have liberalized our economy (certainly foreign exchange flows) since the 1990s, we had not really removed the protection for companies from the globalization effects. This may not seem like a logical argument, but my reason for saying this is that even though there was a significant amount of liberalization in the economy, local firms have had the false protection of high interest rates. In other words there are many companies, not just financial institutions, which did not have to produce real goods and services to increase profitability year over year. All they would do is invest their cash resources in high yielding government paper to make money. Thus what the government did was to liberalize the foreign exchange movements, and removed some protection for the manufacturing industry in particular, but the protection was afforded to companies with cash resources as they could earn almost risk-free income by investing in government paper, thereby protecting them from the competition in the operational business.

With the fiscal situation improving, interest rates trending down, and greater competition coming to the market it has resulted in corporate earnings slowing down generally. Companies must now change their business models in order to continue to grow, as it now calls for efficient organizations.

Consequently, we have been seeing moves by companies to deal with the changing environment. BNS has made an offer to acquire DBG, Grace Kennedy has announced major restructuring in their operations as they seek to become a world-class organization by 2025, Issa transport has announced that they will be merging eight companies into three, Capital Solutions is offering equipment, and Mainland will be importing 200,000 tonnes of cement annually. All of this is happening no doubt because companies realize the changes that are taking place in the economy, and returns from paper instruments are decreasing.

Preparing for the change
It is a good thing that this change is taking place, as it is impossible for us to continue sustaining an economy without growth in the goods producing sector and economic activity in general. It is the lack of growth in these areas that is at the heart of our increasing debt levels, as the economy was being financed by debt. What is going to be important, however, is how as a country we prepare for the changes that are taking place. For example, we have to ensure that we create a much more productive and efficient public sector. Over the past two weeks I have been making every attempt to pay property tax on behalf of a strata, only to be told that they will not accept the “much needed” tax payment because the strata does not have a TRN number. The solution therefore is not to collect the tax rather than assist to get a TRN number for the strata and collect the taxes.

What this implies is that many persons may be unprepared to face the changes that are coming. It is going to be very important that we have a productive and educated workforce if we are to meet the challenges ahead of us. This is what many commentators have been speaking about for a while. As usual, however, we wait until the changes have occurred and then we try to prepare for them.

As normally happens when economies go through a fundamental shift in the way business is done and profits are made, there will be some fall out. We saw that this was coming with the fall off in the stock market and so it should come as no surprise. This sort of shift happens regularly in developed markets, where based on trends and internal reasons, the company finds that its sales and profits are down and have to restructure the organization to adapt. Because in those countries they normally have many new companies being formed the job fallout is usually replaced by the new jobs.

Based on the shift that is happening in the economy, I do expect that there will be more restructuring in many companies. In fact many companies may be going through the restructuring exercise but without any publicity.

The government has an integral role in ensuring that this needed shift in the economy, from earning profits based on paper to real goods and services, is successful. Primary among these responsibilities are (1) to avoid affairs such as Trafigura to ensure that confidence is maintained; (2) continue the intelligence based approach to fighting crime; (3) improve the access to and quality of education; and (4) develop an efficient public sector. If these are not done then we can easily reverse the benefits that we have started to see, and I pray that the election will not cause irrationality to set in. As I have always said, the government must provide the right environment to allow the private sector to be the main engine of growth.

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