Friday, August 07, 2009

What are Jamaica's options?

While the country prepares for the IMF, another blow has been delivered in the form of an Independence Day (birthday) gift. Namely, Standard and Poor's (S&P) has downgraded us to CCC+, which it indicated earlier in the year it would have done if conditions did not improve.

So now that both the IMF and the S&P downgrade are here, what next for the country?

It is quite clear we face severe challenges as a result of the onslaught of the global crisis. These are illustrated in what I consider to be the country's "financial statements", the Balance of Payments (BOP) and the Fiscal Accounts. For anyone who was paying attention to the trend of these accounts it would have been clear that both the IMF and the S&P downgrade were inevitable, as any basic financial analysis would have shown the country trending to this position.

There are three indicators that would have been cause for concern, namely:

1. Since tracking the fiscal accounts the first three to six months of the fiscal year always show positive cash flows over budget;

2. Since the last published BOP numbers, oil prices have moved from just over US$30 per barrel to over US$71 per barrel. The implication of this of course is that our import bill will increase, while at the same time our exports have been declining; and

3. While there is a fall in imports (outside of oil), this is against the background of an economy where 72 per cent of our GDP output is based on imports for local consumption. The inevitable result of that as it shows in the GCT and SCT on imports (from the fiscal accounts) is a contraction in the economy.

So it is obvious that the 2009/2010 fiscal year is going to be a very challenging one, and for more reasons than just the fiscal out-turn. While many continue to espouse the "green shoots" in the global economy, they forget some very important factors as they relate to Jamaica. While I have always believed that the global economy will start to see a bottoming and a slow start to recovery come the last quarter of 2009, the fact is that the Jamaican economy will still continue to feel negative consequences for the following reasons:

. Initially the global recovery will be a jobless recovery. In fact the recent US earnings results and consumer confidence numbers are not as good as expected. Jamaica's main foreign exchange earner depends on jobs in the US and UK mainly. This means that even after recovery starts, alumina/bauxite and remittances in particular, and tourism to some extent, will still see a negative impact;

. Oil continues to be in an uptrend and as the US economy in particular starts to show increased recovery. There will be an increased demand for oil and the US dollar will continue to lose value internationally, sending up the price of oil (based on a cursory look at the charts oil could end up between US$90 and US$100 per barrel by the first quarter of 2010). The implication for Jamaica is increased imports in dollar terms;

. A declining US dollar will be bad for Jamaica, as our main foreign exchange earnings are in US dollars, so prices from places like China, Europe and Canada will increase; and

. The more fundamental factors are crime and bureaucracy. The fact is that the cost of crime and bureaucracy on Jamaican businesses is greater than even the cost of high interest rates and will negatively affect investments in the areas that will lead us out of the slump - agriculture and small businesses. The greatest benefit for future growth comes from solving these factors that are under our own control.

Two main areas of focus

The two main areas that we need to focus on are: (1) the Balance of Payments (BOP); and (2) the fiscal accounts. These require different actions, but if both areas can be brought under control then the fundamental paradigm shift required in the economy can be achieved with the least pain possible. It entails, however, taking the correct policy decisions that will drive the appropriate economic behaviour to favour reductions in both.

One of the calls that many seem to be saying today is "export or die". While that is commendable, it is a longer-term target, as if we wait on exports to pick up to save the economy then we will be in for a long, painful ride, as it takes time for businesses to get up to speed with exports. For example, although we have been seeing growth in the agriculture sector, this will not result in the increase in exports we need in the short term to deal effectively with the BOP challenge.

In order for the economy to realise the paradigm shift needed, it must first contract. The reason for this is because 72 per cent of our GDP output is based on imports for local consumption, while only 28 per cent is based on exports. This means that we need to see around 50 per cent of GDP value change from production for local consumption to exports in order for foreign exchange inflows to equal outflows, given our current level of imports for production. If not managed correctly this can be a very painful exercise.

The fact is that on an annualised basis Jamaica will lose between US$1.4 billion to US$1.8 billion out of total foreign exchange earnings of approximately US$6.6 billion, a loss of at least 20 per cent. This will no doubt result in a slowdown of economic activity, even with IMF support, which will result in the painful experience of many businesses either significantly reducing profits or making losses. If not managed correctly, one of the painful consequences will be that many businesses will close their doors, leading to negative social and economic consequences. The natural extension of this is less tax revenues for the fiscal accounts, and this in itself will force the reduction in government spending, further contracting the economy.

It is therefore critical that policies are put in place to make this necessary transition as painless as possible, and while a part of that solution must be some borrowing from multi-laterals (after receiving the IMF stamp of approval), it cannot be seen as the panacea. The only real solutions must come from the fiscal policies implemented to deal with first reducing the imports of oil and food, an easier short-term solution than "export or die".

So while we fall at the feet of the IMF, let us remember that it is nothing more than a bank intent on being repaid, and just like a bridging loan for personal use, is no cure for a relative shortage of income. If we do not implement the necessary policies to transition during the period of IMF support we will only end up with more debt and the same problems.

Small business

Apart from the need to implement policies to (i) reduce crime and bureaucracy (the biggest problems we can control directly), (ii) reduce dependence on oil, and (iii) reduce dependence on imported food; the real growth in the economy will come from an increase in small business activity. It is therefore very important that the improvement in the environment to encourage small businesses continues. The main inhibitors to small businesses are crime and bureaucracy.

There is, of course, a need for cheaper financing. Even if present, in a difficult environment to operate the chance of success is reduced. So as I have always said, even if we have cheaper funds available for small businesses, if the small entrepreneur sees business risk from crime and bureaucracy, then why would he borrow? Business is all about risk management and entrepreneurs will always assess the risk in relation to payback on their investment.

It is going to be a difficult adjustment in the economy and will be painful for some businesses. How painful it is going to be will depend significantly on how much we embrace the change and what policies are put in place to make the transition easier, just as the US realised the need for stimulus funds to ease its own economic crunch.

Unlike the US, however, Jamaica does not have the money needed to create a fiscal stimulus programme sufficient to significantly halt the slide in the economy. It is therefore necessary that the limited funds available be used in a targeted manner, not to try to create a surplus of funds to replace the dying economic activity, but rather as a targeted stimulus for new businesses to emerge. My vote therefore has always been, and continues to be, the spending of stimulus primarily to support the emergence of small businesses.

The logic is simply that if funds are limited, then you have to look to spend those limited resources in the area(s) that provide the greatest growth opportunities. In a declining economy, it is going to be very difficult for large businesses to expand and create jobs, so the creation of jobs must come from the emergence of small businesses. In addition, the market economy is always going to be able to grow much quicker than the bureaucracy of government.

So as I wrote in July 2008, 2009 will be the most difficult economic time for independent Jamaica. At the time I wrote it many shrugged off what I was saying as pessimism about the Jamaican economy, but that was what all the numbers were showing. Let me hasten to say that it is strictly as a result of financial analysis, based on my training as an accountant, and not any form of "card" reading, lest I be thought of as some sort of sorcerer and condemned to be burnt at the stake.

The question now therefore is, what do the numbers show about the economy for 2010? While I have an opinion on that, I will continue to reserve it for now, and say that it depends on what policy actions are taken. If we take the appropriate steps now, then 2010 could be a better year, but not without some amount of pain first. If, on the other hand, the wrong steps are taken, 2010 could very well end up being worse than 2009.

Just like when we gained independence in 1962, we are again faced with choices to make about our future. These are not choices to be faced by the government alone. The choices have to be made by all of us about what sort of 2010 and beyond we will face as a country. Which road will we choose?

1 comment:

Anonymous said...

I couldnt agree with the analysis more. I'm not an accountant, just a patriotic Jamaican, and it saddens me that there is no real discussion on the issue (esp. in the long term) only hoping for the best and covering heads in the sand. The numbers dont lie and as you indicated if they are not done properly in 2009, 2010 could be worse. The problem is that we have a fixed time period to do the sums right and there is no collective dicussion on this. I do hope that your words reach the ears that matter and that a constructive and public approach will be forthcoming.