Friday, June 22, 2007

Can the debt be capped?

Probably the most problematic part of the budget is the amount of money that we have to pay in servicing the debt. In 2007/08 we are projected to pay out 42 percent of revenues in interest payments, down from 59 percent in 2003/04. While this reduction is good, it has not come because we have managed to reduce the absolute amount of interest being paid, but rather because of increased revenues. Since 2003/04 interest payments have risen from $88 billion to the projected $101 billion in 2007/08.

It is good that we have managed to reduce the percentage of revenues paid out in interest costs, but 42 percent is still too high if we are to have any meaningful impact on social programmes. The focus therefore must be on looking at ways that we can reduce the amount of money paid for debt servicing. A big part of the problem of course, is that between 2003/04 and 2006/07, we have borrowed a net of $92 billion more than projected, primarily because we have not been able to meet budgeted revenue targets.

The argument has been forwarded that we must place a constitutional limit on the debt, not necessarily an absolute amount, but a percentage of GDP. But the question must remain, is it possible to actually cap the debt when we seem to depend so much on the borrowing flexibility to meet our budgetary requirements? Debt to GDP has actually been projected to increase this year because of the increased fiscal deficit projected. The size of the fiscal deficit, that is the excess of expenditure over revenues, is what determines how much debt is needed. So unless we can reduce the fiscal deficit then the debt will keep growing. The way we have been reducing the debt to GDP ratio, is not by reducing the debt servicing cost, but by trying to increase GDP value.

Debt to Equity
Despite this inability to properly manage our deficit, however, could we actually cap the debt? If we were to do so then what would be the negative effects on the country? I think that this is really the question that we need to ask. In the case of a company, for example, one of the ratios that you want to manage carefully is the debt to equity. The debt to equity ratio is derived by dividing the total debt by total equity. So if debt equal $200 and equity equal $200, then the debt to equity ratio is equal to 1. This is similar to our debt to GDP ratio, where GDP can be seen to represent the equity of the country. The debt to GDP ratio for Jamaica is 133 percent, or 1.33.

The reason why the debt to equity ratio is important is because it tells you how highly leveraged a company is, and the more highly leveraged a company is then (1) the more of the company has been pledged to creditors, who can move in and call the loan or take the security; and (2) the more expensive is the capital base of the company, which means that it may have lower returns on capital than a similar company with a lower debt to Equity ratio. The reason for (2) is that debt is always more expensive than equity.

This is one of the reasons why Jamaica has a problem with our fiscal accounts. The high level of debt to GDP ratio is playing havoc with our fiscal accounts, and ability to fund social programmes and critical sectors such as education, health, and security. What has happened is that we have managed to borrow so much debt as a percentage of GDP, that whatever we produce (GDP) is mainly being used to pay for the interest cost and principal payments of the debt. This is the same situation that a company faces, when they borrow money and have to pay it back. Say they borrow $100 at an annual interest of $10 per year and annual principal payment (paying back the amount borrowed) of $20. If they make a profit of $20 for the year, before interest, then they have to pay back $10 out of the profit leaving only $10 in profit after interest. If another company had the same profit with no debt (had only equity) then they would still have the entire $20 to put back in the business. From a cash point of view they would have to use $30 of the cash (interest plus principal) to pay back the loan, therefore, having $30 less cash to invest in working capital or research and development, putting them at a disadvantage to a competitor company with no debt.

This is what happens in the case of the country. Because we have this massive debt that we have to service then we have much less of our monies available (58 percent of revenues after interest) to spend on the country. So for each $100 collected, we have to spend $42 paying interest leaving only $58 to spend on running the country, and the poor people that we have made poor by mismanagement, which is a paradox I cannot understand. I mean if we love poor people so much then why have we, on gaining independence, mismanaged their affairs so badly that we have made them poorer so that we can make “saviour type” announcements, like free health and education, coming up to election. Shouldn’t we have managed the country in such a way that we can provide those things as a matter of course like developed countries do?

Proper management options
A proper management option I think is to put a cap on the debt, as responsible management would do in a company. We need to do so to ensure that in 2007 we do not give away anymore of our independence that we earned in 1962. We may have political independence but still have multilateral agencies and creditors dictating what we are to do. They might not do so directly, but when they issue credit ratings on our bonds, and sell off our bonds when they are uncomfortable, then they are indirectly influencing our behaviour. When the IMF issues reports on Jamaica, although we have stopped borrowing from them, it can affect the way our creditors see us, and so we better make sure that we continue to please them with our performance.

The question may be asked then, if we cap our debt then what will happen to the programmes that we usually use the debt to undertake? How are we going to expand the programmes that we use debt for and will this not affect the less fortunate amongst us? Of course this will be much more beneficial for us in the long run, as it will ensure that we do not use more than a certain percentage of revenues to pay back debt. But what of the short term thinking cycle we are always preoccupied with.

The answer to that of course is that many of the projects that we borrow money for is not geared towards national development anyway. If we were forced to use our resources more efficiently then would we be spending $10 billion each year on Air Jamaica, or hundreds of millions on the Sugar Company? Would we be spending $2.5 billion on the most expensive cow pasture in the world, the Trelawny stadium? In the case of Air Jamaica, it seems as if the argument that the benefit to Jamaica is far greater than the direct cost of carrying the tourists to Jamaica is no longer valid, after so many years of losses, as that does not seem to have been a consideration in selling the London route. And since it is a private airline being funded with public money, then we are not entitled to any further clarification on the sale amount and the process behind the sale.

So can we afford to cap the debt? Although it should not be necessary, as what is needed is prudent management of our affairs, then if we have to cap the debt to control the impulses of our politicians then we must do so. In the long run it will be better for us to do so, although we may not be able to afford things such as a national airline and propping up a dying sugar industry, when other countries have taken the decision to leave sugar. But at least the people of Jamaica may be saved from greater impoverishment so that they won’t have to wait until every five years to be considered by our politicians.


Jamaican Girl said...

Excellent site! I was wondering if I was hallucinating when I was thinking about these things myself....They just can't see it!

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