Friday, March 23, 2007

What's up with the economy?

From time to time I get the question from people involved in all sectors, “what’s up with the economy?” In summary my view is that the economy is like a bird perched on a tree limb after flying head on into a pane of glass. The bird could recover and fly into the skies or could find that the shock of the collision was too much and fall to the ground. This of course depends on how well positioned the bird is on the branch and also how devastating the impact of the collision was.

This is the current position of our economic affairs. The economy is precariously positioned and any strong wind or deliberately crafted support structure could move it in one direction or another. The major factors of course include (1) how we address the crime situation; (2) how effectively we wipe out any corruption by public officials; (3) our ability to eradicate general lawlessness and indiscipline; (4) creating efficiencies in the public sector and eliminating bureaucracy; (5) a more practical legislative framework, encouraging investments; (6) continued reduction in interest rates and care not to over regulate the economy; (7) continued investments in our physical and social infrastructure; and (8) not put politicking above the economy.

If we can strategically deal with these major issues, to ensure a positive outcome, then we will not have to worry about economic growth, and we will see an upswing in all our critical sectors and capital market.

Fiscal Accounts
One of the dark clouds that has continued to hang over the economy (seems like eternity) has been the state of our fiscal accounts and national debt. The fiscal deficit that was budgeted to be around J$21 billion, or 2.5% of GDP, has once more overshot that target, and with the tabling of the supplementary estimates last week, is certain to be at least J$40 billion and 4% of GDP come March 31, 2007. This has resulted from the increased expenditure estimates, less than projected revenue collection, and a slower than anticipated economic growth.

This of course has come as no surprise to me, as I had stated at the start of the financial year that:

The revenue targets were too optimistic, as a 20% growth in tax revenues was just not on the cards, and this was said against the back ground of (a) the cement crisis; and (b) predictions of a very active hurricane season. We did not have any hurricanes and still, as at the ten months ended January 2007, the revenue was some J$5 Billion behind target. Imagine if we had a hurricane, or even a glancing Ivan-type blow;
I do not think that the economy had the capacity to grow at 3% to 4%. This of course is because of the crime levels, that affect investor and consumer confidence, and the lack of a proper road infrastructure, which if we are relying on agriculture as a main pivot for growth then this is extremely important. Since then we have made some gains in this area; and
Debt was going to end the year close to J$1 trillion. This is no surprise to me, as I did not believe that we would make the revenue targets, and since we were hosting world cup this year, and also going into elections, I thought that we would need more money than projected and would have to go to the capital markets, as the country cannot bear anymore taxes, which would be counter-productive.

Now that we have seen the first supplementary estimates, we know that the expenditure side will come in at J$372 billion, instead of the original J$358 billion. But what of the revenue side. After all if we want to project the deficit then we will need to estimate what the revenue is likely to be. This calls for some financial statement type analysis, and I will try to use my training as an accountant to do some estimates here.

Revenue estimates
We know that at the end of January 2007, the ten months results showed that revenues were some J$5.2 billion behind target. Of this amount tax revenues were J$4.2 billion behind; non-tax revenues were J$1.7 billion ahead; bauxite levy was J$211.5 million above; capital revenues were J$1.3 billion ahead; and grants $1.7 billion ahead. So as I had anticipated, the tax revenue line is where the major problem is, and this is primarily because for some reason we were too optimistic in the budget. And this was after the GCT collections of the Christmas season.

So in the two remaining months (February and March 2007) is it possible for us to catch up with the J$5.2 billion deficit, while at the same time meet the J$26.3 billion tax collection in March, which I think will be the deciding factor as to whether or not we even come close to our revenue targets.

Of the J$26.3 billion tax revenues projected for March 2007, J$8.4 relates to company profits tax (J$6.7 billion collected in March 2006), and J$4.8 billion of PAYE (J$3.4 billion in March 2006).

Table 1 shows the significant revenue line items that will affect the budget out turn for 2007. It clearly shows that in all lines, except tax on interest and GCT on imports, we are behind revenue projections. In the case of tax on interest this is only so because the government practices cash accounting and the tax on interest to pension funds was not being paid back, in a timely manner, in the first half of the fiscal year. The column to the far right shows the likely out turn for company profits taxes, PAYE, and local GCT, which are the more significant items.

Revenue outcomes
With the poor results being shown by publicly listed companies, I do not expect that we will exceed the J$34.6 billion collected last financial year. My reason for saying this is based on a quick analysis of the financial results over the two years. I looked at the 2006 audited reports of 34 companies that pay taxes in Jamaica, or in the case of some companies that are late, at the date of writing, the third quarter reports.

In 2005 they would have made accumulated profit before tax of J$43 billion and J$45.4 billion in 2006, a mere 5.67% increase. The tax charge in 2005 was J$8.9 and J$9.2 billion, an increase of 2.75%. The tax charge in both years were calculated under the same accounting standard dealing with income tax charges, and so there would not be any material difference in the way the computations were done. This means that company taxes can be expected to grow around 3%, as these public companies should be representative of the companies in Jamaica.

Based on this reasoning then we may end up with company profits taxes of around J$17.4 billion, growing from $15 billion in the 2006 fiscal year. This would fall short, of the 2007 projection of J$20.1 billion, by J$2.7 billion, of which it is already J$1.2 billion behind.

PAYE should follow the trend for the performance to date, and should come in at around J$41 billion, some J$2.4 billion less than projections. This is affected by the fact that the MOU2 restricted the increases to public sector workers, and private companies, based on their results, have not given any significant salary increases, or bonuses, in the financial year. A 25% increase on this line was never in the cards.

Local GCT has of course not met projections because the economy has not grown at the 3% to 4% projected, and instead has come out at less than 3%. The shortfall here will be about J$2.9 billion. GCT from the activity generated from world cup will not get in government coffers until April to May 2007, as there is a one month delay in filing GCT returns.

Revenues then will come in at about J$8.1 billion below budget, unless outstanding taxes, or some other unexpected revenue in take is forthcoming. This means that the fiscal deficit will come in at the projected J$21 billion plus the supplementary estimates of $14 billion plus the revenue shortfall of J$8 billion, for a total of around J$43 billion. It could always be a little better or worse.

Equity Market
Another concern people have is what will happen on the equity market. Last year the equity market started its recovery, after going through a major downturn for the two years prior. So obviously investors are concerned about what will happen going forward.

The bottom line is that stock prices move, over the medium to long term, based on fundamentals of the company, which is affected by the economy. The economy also affects investor confidence levels and can affect stock prices. Last year we saw where consumer and investor confidence rose from the lows of the prior year, and similarly we saw where the equity market made a comeback. I believe there is a direct correlation between these, and so the way that the economy is handled is very important in determining what happens in the equity markets.

I expect, however, that certain stocks on the equity market will continue to do well. My view is that most will not perform as in the past, and there are certain stocks that one can zero in on. Some that performed well in the past will not perform well in the future, as we have seen a change in the paradigm, as interest rates have been coming down and some amount of realignment is taking place. Those capable of competing effectively with, and distributing, internationally produced products will fare better.

One reason for not expecting much from most stocks this year is that Jamaica’s economy is now around 70% service and 30% goods producing. If you look at the public companies, the main service sector are the financial companies, and with the reversal of interest rates many will under perform last year, as the results have been showing. There are some financial companies that will do well, however, and these have adjusted well to the changing market conditions already, with more adjustments to come. The main growth areas of agriculture, tourism, and construction are not well represented on the equity market. The financial companies that benefit from these growth areas will be the ones that realign their loan portfolios to accommodate these sectors. One can get an indication of these by looking at the balance sheet.

Alternative investments
One certainly could not comment on the market without looking at alternative investments. This has been the buzz for the past few months. Even TVJ’s news asked the public if they would invest in unregulated investment clubs, and over 50% of respondents said yes. Whether we want to accept these or not the fact is that the investing public is willing to take risks. We must educate and regulate.

The fact also is that the investment products provided in the Jamaican market have been far less than innovative, and has not kept pace with international markets. When we look at the development of capital markets in the United States, we can certainly appreciate how far behind we are. With the ease of access to these markets what it means is that if we over regulate, and seek to keep alternative investments out of Jamaica, then we will find that capital will leave Jamaica for investments in other countries. We are in a global market and we can either adapt or suffer the consequences.

It is important, however, that the regulators continue to have oversight over what products are offered in the market. And we see that even the US has tried to control private activity by banning internet gaming, which is a private transaction between the player and the service provider over the internet. This is the challenge that regulators face.

Today’s alternative investments, however, become the staple investment products of tomorrow. It is this creativity that drives capital markets. Even in the US they are trying to grapple with how to deal with hedge funds, and the general consensus is that although they provide a big risk, the best way to deal with them is to have some oversight but not outlaw them. Whether we like it or not, these alternative investments are here to stay, and just as in the US hedge funds have grown to be significant players, so too will alternative investments continue to grow in Jamaica, and whichever financial institution refuses to get into the market will find that they will lose market share.

Legislative framework
I would like to make a comment on the importance of the legislative framework in encouraging investment. This of course is very important, as if we are unable to put the proper legislative support in place, then businesses will not feel comfortable investing in Jamaica, not to mention the fact that every day Jamaicans will not be able to be productive in an environment where their rights are not protected.

I give one example, as relates to the labour laws. I know hat labour laws are important to protect the rights of workers but sometimes I think we go too far. I am involved in an organization that employed a watchman. He was working with the organization for a few years and had been warned on many occasions about not smoking ganja, as well as sleeping on the job. Finally he was fired and paid a total of four weeks notice and all other outstanding amounts.

He went to the Ministry of Labour, and complained that he got less than was due to him, in that he should have gotten more notice pay, which under the law is true. But after being dismissed for smoking and sleeping on the job, the organization is now being asked to pay more money, when he was not living up to his side of the contract, and what’s more is that this was told to the Ministry but they were not concerned with this. Now how do we intend to encourage local or international investors with this sort of archaic legislation? In other words productivity is the servant of legislation.

It’s leadership
So what happens to us going forward? It is clear that we will not meet the projected growth and fiscal targets and our debt will get close to the J$1 trillion dollar mark, a milestone we should certainly not be proud of. What is not clear is how the politicians will approach the economy going forward into the election, and this is the wild card that we have to deal with. I think that the next few months is going to show what our leaders are made of, and who puts Jamaica and Jamaicans first, and Jamaicans should be aware of the politicking leading up to the election, as this will let us know who is pro-Jamaica, and who is pro-party.

The main problem that we have as a country is one of leadership, not crime, education or the economy. These are mere symptoms of our leadership. So the gauge for me is what the leadership does, as this ultimately affects the confidence levels and the economy.

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