Sunday, January 22, 2012

The IMF and interest rates

TWO issues that will be most critical in the current economic environment are the IMF and what will happen to interest rates. This is against the background of the weakening fiscal and trade situation that Jamaica faces, as well as the weakening global situation, with Europe still in a significant debt crisis, growth in China slowing, and the US economy still uncertain.

In fact there are two international reports that should cause some concern, both reported on Tuesday January 17, 2012.

In the first report, the World Bank lowered its growth forecast for the world economy down from 2.5 to 2.7 per cent, while at the same time warning of a possible shutdown of a major European economy and a situation similar to the Lehman collapse.

Additionally an article on, which states that more investors are going more into cash than stocks and bonds.

What these show is that there is still a lot of uncertainty and perception of risk in the markets. It is when these perceptions lead to negative consumer behaviour that Jamaica will see the effects. That is a slowdown in consumer demand that will have an adverse effect on our foreign exchange earners, and an increased perception of risk means an upward pressure on interest rates.

But even without this slowdown effect, Jamaica still has (and always had) a significant foreign exchange problem. This problem is only exacerbated now because of the lack of a capital market to run to. This means for us that there is no other option for us but to secure a favourable deal with the IMF. In fact it was reported on January 13, 2012 that UBS had warned its investors to stay away from Jamaica's debt until the issue with the IMF is sorted out. The expectation of UBS is that yields would climb, which is consistent with my view from last year that interest rates would trend up. In fact rates have already started to trend up and we have been seeing an increase in activity of government going to the market for financing.

The reason for our current situation stems from the unrealistic targets of the IMF agreement originally which caused us to worsen the fiscal situation through the further contraction of economic activity. This is a lonely position I have always maintained along with Ralston Hyman, while others espoused the need to have the structural adjustments done swiftly. Well, if you take away drugs at one go from an addict, he might go into shock and die.

But here we are with worsening fiscal and balance of payments numbers, and as far as i am concerned they will deteriorate further. So the only practical saving grace, to ensure that inflation, exchange rate and interest rates remain relatively low and stable, will be not only saving the IMF agreement but more importantly getting a more realistic agreement that will ensure sustainable growth. Even with that, there will still be upward pressure on inflation and interest rates. This is why I have always maintained that the government needs an independent team to advise them on solutions. But I am just a minion so I don't expect it will happen.

What is certain is that the challenges we face are significant, as these realities have to be balanced with the expectation from the manifesto declarations, particularly the JEEP programme.

Whatever the promises were, however, it is important to take a realistic approach to the issues. One such is the matter of the rollback of GCT on electricity charges. This, in my view, would only be of short-term (maybe for two months) benefit to consumers. Instead what we need to do is use that fund of around $2 Billion annually to reduce the dependence on electricity by providing a credit to taxcompliant individuals who install renewable energy solutions at home.

An argument was made to me recently that this will not benefit small businesses, which in my view is a very narrow way of thinking about it. If consumers have more disposable income because of lower electricity use, they will have more money to spend with businesses, resulting in greater economic activity and profits for businesses. The only thing that will help industrial use of electricity is cheaper distribution costs in the medium term, and new energy sources in the long term. My choice, of course, has always been coal.

Telecommunications landscape

From as early as April 2011 I wrote that the Digicel-Claro deal was a red herring, and I see that it is still being focused on as LIME's Waterloo. In June 2011, after reviewing LIME's financials, I indicated that although LIME had cash resources for about two years or so, the business model and regulatory environment would eventually lead to their demise. The key regulatory issues being number portability and cross-network charges. What we will be careful of when addressing particularly the latter is that government does not start setting rates and overregulating, as this will surely kill the industry also.

Today it is obvious not only that LIME is close to shutting down, which would be the prudent decision with the current environment and business model, but more importantly that Jamaicans could once again face a monopoly when the telecommunications sector is so important to productivity.

So we are almost a year after my article and nothing has been done to address the regulatory issues, which I think speaks to the uselessness of the OUR, just as they seemed impotent in the JPS situation. I am happy to hear that the Minister is going to take it into his own hands to ensure that the environment is changed to accommodate greater competition. It is important that this be done immediately, as the ones who will really suffer are the consumers.

What is important from the above is that it is critical that we find immediate solutions to (i) the IMF agreement; (ii) the fiscal challenge; and (iii) the cost of energy.

Friday, January 06, 2012

Facing the challenges ahead

One certainty of the upcoming fiscal and calendar year is that it is going to be difficult and will require all hands on deck. This is why it disturbs me that when I look at some of the messages on social media, I see young persons, apparently expressing their disgust that the PNP won the election, saying that they expect that they will fail as a government. This is similar to the sentiments I saw expressed in 2007 by young persons sympathetic to the PNP.

It is interesting to note that these statements are not coming from the politicians who lost but from young persons who are supposed to be tomorrow's leaders. If this is the situation, then what hope do we have for tomorrow? Don't we have the sense to realise that if the PNP fails, no part of Jamaica will be spared? It is not that one area will do badly and the other will do well, based on the occupation by party supporters.

My message to these persons is that they should do everything in their power to make sure that the government of the day succeeds because 2012 is going to be a difficult year, and any wrong move could affect us for a very long time to come. Unless, of course, they have dual citizenship and don't plan to live here.

With that said, I want to look at some of the challenges we face as a country. Let me first say that while I believe that there will be significant challenges ahead I do not believe that they are insurmountable, and further I do not believe that there has to be a heavy dose of bitter medicine to resolve the challenges. It depends on how the situation is handled.

What is certain is that if the wrong moves are made then any slippage is going to have a significant negative effect on the country. One may say the following:

o But there is macroeconomic stability and this means that things are improving and we are on a path to growth; or

o But we have been here before, for example the financial crisis of the mid-1990s, and we managed to bring the economy back to small but consistent growth prior to the recession.

The difference this time is that we are working from a weakened position.

While I agree that there is macroeconomic stability, as I have always said, the best way to achieve stability in a patient is to kill the patient. So the reason why all our macro targets look good is because of the lack of economic activity. So everything seems stable. In fact when economies grow significantly, and start to overheat, the macro variables are never stable without monetary and fiscal policy intervention. If left unchecked, inflation and exchange rates will increase based on demand from growth.

What we have failed to remember is that the primary role of governance and economic policy is for the improvement of the standard of living of the people in the country. So managing to improve macroeconomic numbers, while the majority of the people get poorer, is bad policy. This is why I have always held the view that a Keynesian approach in a recessionary environment is not only necessary but is a responsibility of governance. We are now seeing the effects of the pro-cyclical and fiscal-oriented approach, as is being shown in the fiscal revenue targets.

This brings me to the other point, where one might say that we have been here before. Sure we have seen significant inflation and exchange rate movement in the early 1990s, and to some extent the early 1980s. We also had a significant recession in the early 1980s. We also saw many business failures in the mid-1990s. The difference is that in the 1990s and 1980s we had a very big advantage that we do not have today and that caused us to be able to find a way out of that crisis. We had access to debt through the capital markets.

There is a significant difference between today, the 1990s, and the 1980s. Without the ability to borrow money, or receive grants during those two periods, we would have seen a significant economic problem. The problem Jamaica has always faced is one of not being able to afford what we want to consume, whether it is on the government accounts or balance of payments (BOP) side.

Today what has happened is:

o We have a worsening BOP, with the first seven months of 2011 showing deterioration in the balance of payments by over US$600 million, and a current account deficit of over US$900 million. This was caused primarily by an increase in oil imports of over US$550 million and in addition associated freight costs. It is for this reason that I have always emphasised each time the need to deal with our energy situation as a priority. I am supportive of Paulwell's approach and hope that we can achieve this soon.

o Our fiscal revenues are some J$8.5 billion behind target, wile our expenditures are only J$3 billion behind target. This means that our fiscal deficit is J$5.5 billion worse than projected. I expect that given the low demand environment this situation will worsen.

But alas, there is no capital market to run to and get money unless we are willing to offer higher interest rates, and even so persons will be a lot more wary and unable (because of their own circumstances) to take up GOJ debt. What is certain is that there cannot be a JDX2 unless we want to see a serious problem in the economy. Also the FDI flows that helped us in the 1990s to 2000s are no longer there. In fact it seems more profits are being sent abroad than those coming in.

The government is also faced with the challenge of having to provide jobs, and I think has made the right decision that it is not practical to lay off public sector workers. This is something I have been saying for a while, as the redundancy cost and the negative effect on a stagnant economy would be impractical. Additionally I also agree that pension reform is not something that can materialise in the short term. I think, however, that we can start the process of tax reform in short order. We don't have to implement everything at once, but certainly it is important to pick the low-hanging fruits as soon as possible. How do you in the short term just change an embedded compensation package? Apart from equity issues it is just not an easy task.

So then what do we do? We have a worsening BOP and fiscal deficit and little ability to manoeuvre. It seems obvious to me and comes right back to the argument I have been pushing for the last few years. The only real hope is to grow our value-added debt, as was done in the mid-1980s, and ensure that what we use it for is greater than the cost. I don't know anyone with monthly income and debt payment of $50 and $100 respectively, who can reduce their debt by cutting back on expenditure.

Our only viable option right now is to get an extended fund facility with the IMF, as this is not only the avenue to IMF funds but also other multilateral funding. This means that we must save the IMF agreement, as without the IMF there is little else that can be done. And as I have always said, the targets we were pursuing were doing nothing more than contracting the economy while we were running out of options.

There are some policy moves that can be taken to make things easier ,and I am hopeful that this will be pursued by the government.

At the individual level, this is the time to get out of unproductive debt and consolidate your own expenditures.