Saturday, June 12, 2010

Analysing the economy's prospects

Ever since the lower interest rates (through the JDX) and the revaluation of the Jamaican dollar, many have been hailing these signs as a recovering economy. It always amazes me that people always seem to arrive at conclusions prematurely without doing any real analysis of the facts, and this leads to incorrect decisions regarding the future of the country and within companies.

No doubt the lower interest rates and a revalued dollar are positives for the economic framework but by themselves are not sufficient for economic recovery. In fact interest rates and the exchange rate are merely symptoms of an underlying factor, and if we are truly to understand the prospects for the economy then we must carefully analyse the underlying factors and not draw conclusions based on the symptoms.

Carl Ross correctly stated that despite the positive indicators, significant risk still remains in the Jamaican economy, and we are not out of the woods. I had also indicated in my book that in order for the economy to move forward we would first have to go through a period of economic decline for structural adjustments to take place. This is because the problem with the Jamaican economy cannot be solved by merely tinkering with the macroeconomic indicators but needs major surgery because of the flawed social and economic foundation upon which it rests.

Effect of social instability
We have all seen the consequences social instability has on the economy, evidenced by the unrest a couple of weeks ago, and on the economic side growth has always had a deleterious effect on the long-term prospects of the economy. I say that because such a significant part of our production is based on imports that when we increase production we are also increasing our appetite for imports and foreign exchange.

This leads me to the recent revaluation of the Jamaican dollar. While this has been a positive so far for the economy (as it helps to stabilise inflation) the fact is that the revaluation has not resulted from any increase in exports but rather by a decrease in imports as a result of shrinkage in the economy (in fact because of the close relationship between imports and exports, the decline in exports also contributed to the decline in imports). At best what this allows is a temporary reprieve where we can make the necessary adjustments in the economy to ensure this trend continues.

This is reflected in the Balance of Payments (BOP) for the calendar year 2009 when compared to 2008. It shows that although the current account balance improved from a deficit of US$2.8 to US$0.9 billion this resulted primarily because of a significant decline in imports (40%), as a result of the reduction in the price of oil. At the same time exports declined by 49%, and there was also a decline in remittances of 7%.

This decline in remittances stems no doubt from the continuing effects of the global crisis on income levels in the US and UK, as a result of unemployment and decline in real incomes. I expect that the global recovery is going to be a long process and the effects on disposable incomes will linger.

What the BOP shows is that Jamaica still remains at the mercy of oil prices, and this is why I have been saying that the greatest economic challenge to business and Jamaica's economy remains the high energy costs. This is even more so than interest rates, which is really just a symptom of the seriously fractured political, social, and economic infrastructure.

JPS rate hike
The recent furore over the proposed rate hike by the JPS is evidence of the high cost energy has on businesses and the disposable income levels of consumers. The approach we take to arresting costs, however, is not to allow the markets to work but to seek to apply strong-arm tactics and regulatory control. The best way to deal with high mobile phone and electricity charges is simple - implement portability for telephone numbers and net metering for the energy sector. If these simple steps are taken I guarantee that the market will ensure that prices decrease.

Since I put solar panels in place at home I have seen my electricity bill decline from $14,000 to $4,000 per month. This is even before any GCT is applied (which I don't pay because I do not use over 200 KWH) and I am oblivious now to the arguments about rate increases or GCT being applied. This ability is available to all taxpayers as they can get the money for a solar system to borrow from NHT and I guarantee that if implemented properly, the loan repayment will be less than the monthly JPS bill. I also expect that oil prices will go up as soon as Europe sorts out their mess, so rates will inevitably go up in the future.

It is important for us to take advantage of these positive signs in the economy though, as the reduced interest and exchange rates are not sustainable if the correct adjustments are not done to the structure of the economy and social conditions. The decline in these two indicators has more to do with a reduction in demand (and disposable income) than with any economic recovery. In fact the recent numbers show that for the first quarter, while the overall economy declined by only 0.6%, the goods-producing sector declined by approximately 6%, and we need to remember that the services sector always lags behind the goods-producing sector, as without real production taking place the services sector cannot survive without new capital being introduced through loans or new investments. It will be difficult to get new investments unless we deal with our social conditions, the cost of energy, and other factors such as bureaucracy.

Recently some of our listed companies have also shown a decline in profitability, which has resulted primarily from a decline in real income, as they have done a good job of controlling costs, which in plain language means they have reduced real incomes by either reducing staff or reducing operating expenditure. This of course translates to lower disposable incomes and leads to a vicious cycle. A deeper analysis of these company results show that even with the declining incomes they have been faced with inflationary pressures that they cannot pass on.

Over the past two years I have called for a few things to happen if we are to get on the path to recovery - (1) restructure the debt (2) deal with the social conditions as a priority (3) borrow more and invest in addressing the underlying challenges to the economy. As I always maintain, there is nothing wrong with debt as long as the marginal revenue is greater than the marginal cost. I see now that the government is seeking to secure some US$1 billion to address the social and crime conditions, and I for one applaud that effort, wishing that it had come sooner.

For example, at one company we took a strategic decision to finance our operations (and negative current ratio at the time) by financing the operations from payables. So instead of paying in 30 days we would pay in 60 to 90 days while building profitability in the company. It paid off because we were able to carefully identify the market opportunities and chart a plan as to how we would get to profitability. This is the sort of careful planning we need to use when borrowing money.

So the economy is at a crossroads right now. It was necessary for the economy to be given an anaesthetic so that the necessary surgery could be performed but it would be wrong to assume that the stable signs indicate that the patient has recovered. It simply means that the patient is sleeping. In order for full recovery to take place, the surgery must be skillfully done so that on awakening we will have growth that adds to development. It is going to be a long process (as was pointed out by Ross) but if we take the necessary steps to make the economic and social structural shifts then the economy will finally emerge on a path of real development. And there are some simple steps that can be taken to put us on that path.