Thursday, November 30, 2006

Market versus state growth

We can always tell when the silly season of election approaches. At this time the politicians are like men trying to court a woman. Some do so by telling the lady the truth about what their intentions are, but for the most part they will tell the lady what they think she wants to hear to make themselves look good. So if the lady is impressed by fast cars and glitter then they will try their best to acquire a loan to buy the car, or borrow it, and make all the promises about where they will take the lady. The whole plan, of course depends on the vulnerability of the lady and how gullible she is.

In this case, the lady of course represents Jamaica and the fast car and glitter the promises that the politicians will shower on her in order to secure the prized possession, state power. It matters not that after gaining his ultimate goal that the lady is left in emotional shambles and may even consider suicide or develop a cynicism towards all men after that. The satisfaction of the hour, or minute, is similar to a child receiving a lollipop not being concerned of the cavities that may follow.

Opposition announcements
This came to mind in two recent announcements by members of the opposition party. The first is the announcement by the leader of the opposition that he would remove education tax and HEART, if elected to power, and replace these recurring revenue items with low interest loans. Naturally meaning also that we would have annual recurring low interest loans of at least J$20 billion, adding to our mountain of debt. Now doesn’t this seem contradictory to the need to reduce our debt, and is this the way to solve the need to relieve the high burden of taxation on the Jamaican people. I am the first to admit that our tax landscape needs significant reform, in order to ensure the best use of our tax dollar, but if your legs have been torn apart by shrapnel, why amputate the hand.

The second suggestion, with which I take greater issue, is in contradiction to the suggestion of low interest loans each year to replace the taxes mentioned. The statement by the Minister of Finance in waiting, Audley Shaw, that he would use moral suasion with the private sector to reduce interest rates is simply a backward step. If Mr. Shaw has the power to use moral suasion to reduce interest rates then he is an extremely valuable person to the Jamaican people. Why stop at interest rates? That moral suasion should be used to reduce prices on the things that really affect the Jamaican consumer; electricity and telephone bills, and oil prices. This, however, is not known as economics but rather hypnosis and so it seems as if our politicians, having failed to find an economic solution to Jamaica’s challenges, will now be engrossed in the power of the mind.

At the moment the economy is showing signs of being on the mend and poised for greater growth. This is evident in the areas I think, and have always been saying, will drive growth for this country, agriculture and tourism. These two sectors have been the stars performers in the growth numbers over the last one to two years. The fact is that Jamaica’s natural competitive advantage is in our unique flavours (produce) and our natural beauty. In addition to that we also have a relatively high level of unskilled workers. The agriculture and tourism sectors are best suited to absorb the unskilled labour force. So in the adversity of an unskilled labour force we are blessed with the competitive advantage of agriculture and tourism, which can easily take advantage of our disadvantage.

But, just as leading up to the last election, when the economic prospects appeared good we were hit with the “run with it” speech, so once again we look to be gearing up for political promises that could again negatively affect business confidence and push the economy back into the black hole that we only seem capable of peeping out from. Statements from politicians about their intentions in running the country do have an effect on confidence, which is a very important ingredient of what economic viability is made of.

The remark that moral suasion will be used to influence prices (because interest rates is the price of money) can be interpreted to mean state intervention in the running of the economy, as when the Prime Minister or Minister of Finance suggests to the financial sector where rates should be it can be construed as a very strong request given our constitutional arrangements. When Bernanke (not Bush) feels that the US economy is weak he will decrease benchmark rates and see how the market reacts, not go to the market and persuade them to reduce rates.

Interest rate determinants
The level of interest rates is a function of market conditions. So although the government has been marginally reducing interest rates, there are other factors that affect rates, and these primarily have to do with risk. Two such risks include the political and economic risk. So when the market hears intentions of using moral suasion, rather than monetary or fiscal means, to reduce rates, it increases both the political and economic risk of an investment and therefore helps to keep interest rates higher.

One other significant risk has to do with the market that the funds are lent into. Over the last one to two years the commercial banks have recognized the need to shift to consumer type loans, as a result of the falling margins on securities dealing business, which will not get any better soon. They have, therefore, been making the switch to consumer type loans, hence the barrage of advertisements and shows selling car and furniture loans. These are much riskier types of loans and so carry a higher interest rate. This has helped to keep rates high in recent times.

This market will soon stagnate, however, as more and more consumer needs are satisfied and more importantly as many consumers realize that they are unable to repay the payroll advances or car loans they had taken out. So naturally persons will start defaulting, and the banks may end up having more cars than Mack D’s. This will force the banks to get into the corporate finance / business type loans, but not before they have topped out the consumer loans market and have secured the next one year’s payroll of the poor man who bought the fast car to impress the lady.

Eventually interest rates will decrease as more business loans are granted, which carry a lower risk and will not be taken up at the current high rates being offered to consumers. The key to this of course is that the BOJ continues to marginally reduce benchmark rates.

Banks will also have to start lending money, using ideas as capital, as the growth areas will come from small businesses with little or no collateral. My opinion has always been that a sound idea is worth far more than a piece of land or a car, but banks in Jamaica have never had to take on any real risk as their coffers have always been secure by the high yielding government paper and consumer loans. Assuming that the politicians stay out of determining prices in the economy, however, and leave it to the market then the banks will be forced to take more risk if they want to survive. If I were influencing a bank’s policy I would certainly be assembling a team that could assess credit risk based on a business plan, and the principals involved, in preparation for the future.

As history has shown us, the greatest threat to our economic future has not been hurricanes but rather the misguided policies of our politicians.

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