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.


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