Friday, August 10, 2007

The price of debt

The euphoria surrounding elections has caused many of us to forget the economy that needs to be grown. Last week the JLP stated in its manifesto that it wants to place a constitutional level on debt/GDP of 95% within five years. This means they would have to reduce debt/GDP to 95% or lower by 2012. Many are legitimately asking, within the context of all the accomplishments the JLP wants to make whether this is possible? I would be the first to agree that not all the policies set out in the manifesto are achievable within the five-year period, and some amount of prioritising must be done, as well as reallocation of capital to its most efficient use.

Consideration would also have to be given to social consequences of any action, which is what the present government has had to do. No doubt, however, the debt/GDP ratio is an important factor to manage, as the higher the ratio is then the less monies are available for country spending, and the more debt we will have to borrow in the future to alleviate social hardships. The long-term solution, of course, is to address the social policies of proper education and law and order, as even with the best intentions in the world no Finance Minister will be able to improve the fiscal situation without proper social policies.

Effect of debt
We even see in the great USA where the massive trade deficit, and heavy reliance of the consumer on debt, has placed the economy in a quandary and the likelihood of a recession is increasing. This will of course have devastating effects for Jamaica, as 25 per cent of our exports are sent to North America and 75 per cent of our tourists come from there. We already are seeing lower tourist arrivals this year over last. These are the global issues that we should be discussing on the campaign trail, but then again politicians spin information to people and many of us, including those who should, do not understand these issues, so why bother? My thoughts are that if the Fed does not intervene soon, then the US economy will see greater negative effects.

A look at the June-07 quarter end fiscal accounts does show a promising sign - the lower than projected net borrowings over the period. After considering loan receipts and amortisations we have borrowed J$2.8 billion less than projected. This is a hope of some amount of fiscal prudence, especially when coupled with the fact that expenditures have come in under target while revenues are basically on target. The lack of accrual accounting could, however, reverse the position of the primary surplus and it is still early to comment. More importantly, though, I hope the lower than projected net borrowings will continue to be a hallmark of this year's fiscal accounts, and that no matter who assumes power on August 28th this trend will continue.

The graph shows the relationship between debt and nominal GDP since 1980. It shows that up to around 1997 we were still showing GDP growing at a faster pace than debt, and that this trend started to reverse at around the 1997 mark. Believe it or not though, in my opinion what happened after the 1997 period was more in the interest of the country than the prior period of the 1990s. This may sound silly, but in fact what caused the GDP to grow at a faster pace than the debt was inflation.

In 1991 we had inflation of 80 per cent, 1992 - 40 per cent, 1993 - 30 per cent, 1994 - 27 per cent, 1996 - 16 per cent, and 1997 - nine per cent. It was this inflationary pressure that caused the debt/GDP ratio to look good, but it also caused macroeconomic instability, causing unpredictability in the business environment. Reducing inflation caused the debt/GDP ratio to look bad, but was essential to create macroeconomic stability as a precursor for private-sector growth. The problem though is that the business environment was not conducive for investments and growth, and still is not where it should be.

Social policies
We continue to have high crime levels, a poor justice system, and high levels of bureaucracy that prevent the sort of investment, growth, and development we need. For this reason I continue to say that Jamaica has a social and political problem and not an economic one. And although we always complain about high interest rates, high interest rates are necessary because of these social policies we must fix, otherwise we will continue to live with even higher interest rates. Remember, the price of money is interest, and money goes where it feels safest. So while a stable macro environment is essential, this alone will not help. We need a business-friendly environment and low social and political risk to attract capital at lower relative rates of interest.
So can we achieve debt/GDP of 95 per cent in five years? My answer to that would be, whether the PNP or JLP is in government, it is highly achievable. It is going to depend, however, on the social and political policies we pursue. It is going to depend on how much we transform our environment into being business friendly. It is going to depend on how well we can deal with our education system and get young people in productive training rather than loitering on the roads and selling when they should be in school. It is going to depend on productivity and accountability in the public and private sector.

What the graph clearly shows is that from January 07 we see where the debt has been levelling off. This is a very important trend for us to maintain. Because if we can manage to keep the debt capped at around J$940 billion for five years, then even if we have average inflation of six per cent and growth of 2.5 per cent, over five years, we can achieve debt/GDP of 82% by 2012. And if we grow an average of five per cent over the period, we can see debt/GDP of 72 per cent. This will also set us up for lower relative real interest rates. But I would like to stress again that enlightened social policies will be critical to ensure this.

So it is going to be very important for us to prudently manage the fiscal side to ensure there is no increase in debt levels. One of the greatest threats to our expenditure is the energy bill, and therefore it is critical to do everything to encourage fuel efficiency and discourage fuel inefficiency, such as lower taxes on energy-efficient vehicles, and incentives to energy-efficient buildings. Not power cuts, JPS.

On the growth side we will have to ensure that crime is controlled, an efficient and equitable justice system is quickly put in place, and that quality education standards abound. If we can achieve this, then we will see an improvement on the numerator and denominator of the debt/GDP ratio, and more money available for spending.


Morpheus Rablings said...

Your blog(s) have been a must read for me ... thanks

P.S. I have added your blog to my recently created.

Morpheus Rablings said...

I am not sure when you will get to read this, however, I thought I would send my commiserations at this time.
I wish to provide my congratulations on your impending appointment to the JUTC.

I not only wish you the best, and I know you will do well.

You are not here merely to make a living. You are here in order to enable the world to live more amply, with greater vision, with a finer spirit of hope and achievement. ~ Woodrow Wilson


Anonymous said...

We talk so much about the public debt. Does the govt actually know who are these people who have lend money. When our debt is reaching almost a trillion dollars, and most of it is secured locally, i would love to know who are these people who have financed the govt to this extent. Considering that the economy was in the dumps (it still is), where did these trillion dollars come from. Assuming a population of 2.5 mil. it amounts to 400,000, per individual. Unbelievable
I have a very uncomfortable feeling that all these monies are invested from unaccounted sources of income

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