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.

Wednesday, October 18, 2006

Governance – the real Trafigura lesson

After enduring Trafigura for the past two weeks, the question all Jamaicans must ask is how have we benefited? Have our leaders dealt with the issue in a manner that will significantly reduce the risk of it ever happening again, and more importantly than preserving a political party, will ensure that Jamaica maintains a good image.

The way we have handled the Trafigura issue brings to mind the 90/10 principle, written by well known author Stephen Covey. The 90/10 principle tells us that we cannot control 10% of things that happen to us, but the other 90% we can. The example he gives is as follows:

You are eating breakfast when your daughter knocks over a cup of coffee onto your shirt. You have no control over what just what happened. What happens next will be determined by how you react. You curse. You harshly scold your daughter for knocking the cup over. She breaks down in tears. After scolding her, you turn to your spouse and criticize her for placing the cup too close to the edge of the table. A short verbal battle follows. You storm upstairs and change your shirt. Back downstairs, you find your daughter has been too busy crying to finish breakfast and get ready for school. She misses the bus. Your spouse must leave immediately for work. You rush to the car and drive your daughter to school. Because you are late, you drive 40 miles an hour in a 30 mph speed limit. After a 15-minute delay, and receiving a speeding ticket, you arrive at school. Your daughter runs into the building without saying goodbye. You arrive at the office 20 minutes late and find you forgot your briefcase. Your day has started terribly. As it continues, it seems to get worse and worse. You look forward to coming home, When you arrive home, you find a small wedge in your relationship with your spouse and daughter.

What happened is completely determined by your reaction to the spilling of the coffee. Alternatively you could have said nicely to your daughter not to worry about it, go upstairs and change the shirt and everything would have worked out fine.

Political conduct
Similarly the Trafigura situation occurred. I am among the first to say that the accepting of even a donation from Trafigura is poor governance, and am pleased, though not surprised, by the comments attributed to Dr. Davies that accepting the donation was an error. But what followed the incident further compounds the poor state of governance. The reaction by the government, and the opposition to a lesser extent, showed us how sorry a situation Jamaica is in with respect to leadership.

The fact is that the display by both political parties is in breach of the political code of conduct as on both sides party paraphernalia is clearly hanging out even more than the flags along Mountain View a few weeks ago. This hanging of “party colours” climaxed for me on Tuesday night in Parliament when both garrisons were at each others throat in defense of their object of worship, the party. Clearly both the government and opposition forgot that they were supposed to be sitting in Parliament representing the interest of Jamaicans, as they unashamedly drew the line in the sand, daring each other to cross it while snarling and gnashing their teeth in defense of their colleagues in the pack.

And after over seven hours of debate, and electricity and media costs, can Jamaica truly say that we have got one step further to finding out what went wrong and learning from it so that it will never happen again. And can we say that we have taken appropriate action where it needs to be taken, to ensure that anyone involved in such an unethical breach does not purport to represent Jamaica again.

The opposition brought a motion against the government, but it must have failed, as it is uncertain whether the PNP members are even fully aware of all the circumstances. Still they continue to support the tribe and jeer the opposition, and many could find themselves apologizing as the Attorney General did. But in all fairness one could not have expected them to support the opposition even if their conscience would have moved them in that direction, because they may not even know what happened.

It is ironic though that even without the benefit of full knowledge, on either side, they all carry on like a set of school children, consistently talking when a member was on the floor. The prime minister commented on this, as clearly she was incensed by it, giving some amount of hope of it being arrested.

A different approach
Let us assume a different approach had been taken. The opposition leader came across the information and immediately brought it to the attention of the finance minister and prime minister, and alerted them to the fact that he would be bringing it to the attention of the political ombudsman and police commissioner if necessary. He then gives them two weeks to investigate the matter and make a public statement on it, after which he will be going public.

The prime minister investigates and finds that some members of government are implicated and takes appropriate action, and communicates it to the opposition leader. The opposition leader then goes public with it after agreeing what happened with the prime minister. He still calls for the resignation of the government and puts it to Jamaica that such an arrangement is scandalous. The prime minister makes the findings of the investigation public and the matter is discussed in parliament with all the facts and debated without heckling from both sides, so that Jamaicans are not treated to this sort of display by our leaders in the highest body of the land.

The result would be that the public is made aware of the facts, a proper investigation might have been done, the banking act would not have been breached, and the world would not have to sit by and watch the lack of substance of our leadership. The private sector leaders, who have spoken out may not be wondering if they are to consider further investments in Jamaica.

Wouldn’t this have been a better option for Jamaica, and it may not have been necessary for members to stand in Parliament and defend one unethical action by saying that the other side does it also. In all of this did anyone remember that it was more an explanation for Jamaica rather than trying to keep the other party quiet by accusing them of the same thing, or is Parliament a place for political “knights” to jostle. I guess a good defense of a crime is that everyone else does it. I am again heartened by the report that Dr. Davies said he would be fully investigating the income tax leak and taking action. A glimmer of hope.

What Trafigura has shown is not that our politicians are capable of errors. What it has shown is that Jamaica has a weakness in governance. After all is said and done it is the way that we deal with our problems that make us seem like a developed country with proper leadership, not the fact that we have issues.

This is no different from a company that is in crisis. It is the reaction to a crisis that determines if you continuously remain in crisis mode or are able to rise above the tide and swim to shore. That in my view is a mark of good leadership.

Tuesday, October 10, 2006

The Trafigura effect

This year, blessed with a quiet hurricane season, Jamaica has created our own category 10 hurricane, Trafigura. The issue has been the subject of hot debate over the last two weeks, with charges and counter charges being laid. It is of both national and commercial importance, making it very easy to forget the underlying issue for Jamaicans.

When news first broke, it was posited as a reason for the current PNP government to resign en bloc, by the JLP. The PNP denied anything illegal or immoral about it, and at first seemed to deny that the account name, CCOC, had any particular meaning and then back tracked. They then stated that Trafigura made the contribution as a political donation, but then Trafigura described the $31 million as a commercial arrangement with CCOC, no doubt influenced by the investigations against them in Holland.

In all of this I am heartened by the statements from the JCC and PSOJ, as for the first in a very long time the private sector is not only showing a unified voice, but is actually making public comments in the interest of the country. This inspired by a newly elected, and more importantly, younger generation business leader, Mark Myers.

Public trust
This matter led to the resignation of the Information Minister, Colin Campbell, and the JLP is calling for more heads. The way the PNP handles this one can determine their foreseeable political future, and they should ensure that it is dealt with in Jamaica’s interest and not with the party as primary concern. I trust also that both parties will have campaign reform included in their manifestos for early implementation, although neither has shown any real commitment to campaign reform as yet.

Even if there is nothing illegal about the contribution, it is unethical to have accepted it, under the cover of darkness from a company the government has negotiated a commercial arrangement with. What would be government’s position if a government agency accepted a significant Christmas gift from a company it was in a contract negotiation with?

While serving on the board of the Betting, Gaming and Lotteries Commission, one principle the then Chairman insisted on was that no commissioner should accept any gift from a licensee, including lunch. The fact is, even if the donation was legal, on the face of it it appears to be wrong, and the reality of perception is very important for our persons publicly elected or appointed. It is very difficult for (1) Governments to rule without moral authority; and (2) for foreign and local investors to have confidence in an environment where trust is minimal. We are only two familiar with the effect confidence has had on our economy.

The 2006 Global Competitiveness report states that amongst the 1st Pillar needed in a country to provide a foundation for competitiveness and growth are the state of (i) Ethics and corruption [Diversion of public funds and Public trust of Politicians]; (ii) Undue influence [Judicial independence and favouritism in decisions of government officials]; (iii) Government inefficiency [Wastefulness of government spending and Burden of government regulation]; (iv) Corporate ethics [Ethical behaviour of firms]; and (v) Accountability [Efficacy of corporate boards, protection of minority shareholders’ interests and Strength of auditing and accounting standards].

This illustrates a need to maintain transparency, especially if we are serious about attracting foreign investments, which is a deliberate strategy of this administration. This also supports the argument against the breach of customer confidentiality. The banking sector has its foundation in the principle of confidentiality, as do lawyers, doctors and accountants. This alleged action by an FCIB employee, if true, would be a fundamental breach, and the passing of documents even more damning. The bank has realized this and has taken swift action, and must be commended, but must go further to ensure that preventative systems and controls are in place, rather than react, as must be done by all financial institutions.

From Trafigura’s point of view they are already mired in controversy. Formed in 1993, they are commodity traders and charges have been made of linkages to Marc Rich. Trafigura’s group equity stands at US$600 million (J$39.7 billion), and has 35 offices in 36 countries. The group manages its commercial activities through Trafigura Beheer BV (Parent company in Holland); Trafigura AG; Trafigura Pte Ltd (runs group petroleum trading in the Far East); Puma Group (operate group’s world-wide oil storage and distribution assets and investments); and Galena Asset Management (based in London and FSA registered. This is the subsidiary through which Trafigura established and operates fund management).

In May 2006, the US Department of Justice released a statement that Trafigura AG was convicted of falsely representing that more than 500,000 barrels of Iraqi oil was obtained in compliance with the Oil-For-Food Programme. The company, which Trafigura bought the oil from, Ibex, charged that the scheme “had been cooked up by Trafigura”. Trafigura was ordered by the United States to immediately pay a fine of US$8 million, and forfeit US$9.9 million, representing proceeds of the two implicated oil shipments.

In September 2006, Trafigura was accused of dumping toxic chemicals in Abidjan, Ivory Coast, that caused the death of seven persons and 40,000 to be treated in hospital for nausea, breathing problems and nosebleeds. Ten persons, including two French Trafigura executives, Claude Dauphin and Jean-Pierre Valentini, were charged in connection with this. It also led to the dissolution of the Ivory Coast government “to ensure that those who have a hand in what happened…take full responsibility and are removed…”

Interestingly, the BBC reported that Trafigura tried to dispose of the waste twice before Abidjan. First attempting to discharge the waste in the Dutch port of Amsterdam, but the company that was to do the disposal suddenly increased its charges by 40 times. Trafigura then tried to offload the waste in Nigeria, but failed to reach an agreement with two local firms. The question is, what did those companies become aware of?

Although charges of the second incident would have arisen after them meeting Colin Campbell in August 2006, surely any slight attempt at due diligence would have shown the conviction in May 2006. The responsibility of government must be to ensure that in all their dealings they are very transparent and careful to ensure that it stands up to public scrutiny and maintain public trust.

It is regretful, and distasteful, that certain government representatives have personally attacked the JCC president. This is not what I expect from the new politics brought by Patterson and promised to be continued by the current Prime Minister. Come on let’s all start thinking about Jamaica’s interest as it is only through unity that we can move forward.

At the heart of all of this are the possible effects on the moral credibility of our leaders and the business and economic climate. It is therefore of utmost importance that as a country we are seen to deal with this problem effectively, so that we send the right message to the international community. I am confident that the Prime Minister’s nature will result in the matter being addressed in Jamaica’s interest. The unity of criticism from the private sector, social groups and media underscores its importance.

Tuesday, October 03, 2006

Preparing the foundation for growth

The government recently released the August 2006 fiscal numbers, which show that while we are ahead of budget, for the overall fiscal balance, this seems to have been at the expense of infrastructure and productivity. The fact is that the $5.8 billion amount, which the fiscal balance is better than budget, was at the cost of spending $4.5 billion, $1.1 billion, and $900 million less on capital programmes, social programmes and wages respectively.

One may say that it is prudent to keep spending in line with revenues, and this is correct, but the fact is that we had projected to have a higher deficit to make these expenditures so why are we not carrying out this much needed expenditure. If we could have done without this expenditure then why budget for it in the first place?

I say this because expenditure on capital projects especially are very important in contributing to future development, as if we do not replace our asset base then we will end up with less efficient earning assets in the future. Also, why do we need to announce a $635 million crash programme when we are already under spending on programmes by $900 million? Isn’t this contradictory? Why do we waste productive hours in industrial disputes when we are already under budget with wages and salaries by $1.1 billion? Is it that we do not intend to spend this money or are we uncertain of future revenue flows to support the expenditures, and so we are holding back?

Macroeconomic stability
Whatever the answer is, it is clear that we are not (and have not been) managing our budget for growth. Year after year we focus on expenditure cuts as a way to meet our targets. Any company, or country, that focuses on expenditure cuts over an extended period of time to manage profits will find that it reduces its market share, revenues and profitability over time. This is especially true the greater the competitive environment. Instead the focus must be on improving revenues, as this is the only way to truly experience growth.

Jamaica can say that for a wile we have had macroeconomic stability, which is very important, and kudos to the Finance Minister and the BOJ for maintaining this. Macroeconomic stability is essential for economies to grow but we fail to understand that by itself it is not sufficient. It is like laying the foundation for the building of a house, but in order to produce a house you need steel and concrete to erect the walls.

2006 Global Competitiveness report
The 2006 Global Competitiveness Report, presented at the World Economic Forum, ranks 125 countries on a Global Competitiveness Index. The index seeks to measure national competitiveness, as it is believed that competitiveness drives productivity and ultimately growth. Jamaica is ranked 60th, and was 63rd in the previous ranking. Barbados is at 31st, while Trinidad is at 67th.

The report states that the empirical evidence shows that macroeconomic stability is essential for sustained growth to take place. It, however, further states that “there is increasing recognition that a solid foundation of macroeconomic stability alone is not sufficient to ensure rapid economic growth”. The report lists six pillars that are important for economic growth. These are:

1st Pillar: Institutions (Public and Private) –property rights, reduction in government inefficiency, judicial independence, security, corporate ethics and accountability;
2nd Pillar: Infrastructure – overall infrastructure quality, port infrastructure, railroad infrastructure development, air transport, electricity and telephone supply;
3rd Pillar: Macroeconomy – government surplus, national savings rate, inflation, interest rate spread, government debt, real effective exchange rate;
4th Pillar: Health and primary education – medium term impact of HIV/AIDS, life expectancy, primary enrolment;
5th Pillar: Higher education and training – secondary and tertiary enrolment ratio, quality of math and science education, availability of specialized research and training services; and
6th Pillar: Market efficiency – agricultural policy costs, efficiency of legal framework, extent and effect of taxation, number of procedures to start a business, intensity of local competition, imports and exports, prevalence of trade barriers, GDP.

This strengthens the argument that Jamaica simply lacks the capacity to grow above 3% on a sustained basis. The only way for us to sustain such a growth rate is to focus on building these pillars. We can say that we have some amount of macroeconomic stability but even this is not as strong as it should be, as it is propped up by government debt rather than a surplus in our earnings. We can also say that we have some amount of market efficiency but this is affected by a slow legal system, inefficient tax system, and government bureaucracy.

Our education system, which needs to be a main pillar of growth given our low literacy level, is and has been achieving a failing grade. Even after the fanfare around GSAT and the upgrading of non-traditional high schools we still see that at the CXC level our students are still performing poorly in Math and English. We are also, by cutting away at expenditure, reducing the investment in our infrastructure, which will affect our future capacity to grow. If we expect agriculture and tourism to be our main earnings shouldn’t we be investing in the infrastructural support? Instead we see reports that Jamaica’s infrastructure cannot properly support the expected tourism growth and we have farming communities demonstrating for better roads. If we do not address these infrastructural problems then our future competitiveness will be eroded as the cost of delivery will increase.

The report also states “…countries which have invested heavily in creating a well-developed infrastructure for tertiary education have reaped enormous benefits in terms of growth. Education has been a particularly important driver in the development of the capacity for technological innovation…”

Michael Porter, Harvard Business School, in commenting on the report states “The world economy is not a zero-sum game. Many nations can improve their prosperity if they can improve productivity. The central challenge in economic development, then, is how to create the conditions for rapid and sustained productivity growth.”

If Jamaica is truly serious about growth then we cannot just achieve macroeconomic stability and expect growth. We have had macroeconomic stability for a while but we are lacking in the other pillars that are necessary for sustained growth. This is why it is very important to ensure that each dollar spent, especially debt, is targeted for areas that will provide future returns in excess of the cost.

If it were up to me I would identify the pillars that will provide the greatest growth opportunities and derive a strategic plan around developing those given the limited resources we command.