By Al Edwards, Financial EditorTHE MINISTER of Finance and Planning, Dr. Omar Davies, returned to Jamaica last week having completed a very successful round of talks with both the International Monetary Fund (IMF) and the World Bank in Washington with a view to obtaining financing from some of the leading multilateral agencies.
The talks came against the background of the country's economy showing nascent signs of a recovery and recording growth, albeit at around two per cent. For the fiscal year 2003/2004, both Services and Goods Producing sectors increased by two per cent. Real Gross Domestic Product (GDP), a measure of national production, grew by an estimated two per cent. Inflation is showing signs of trending down. For the month of April, inflation stood at 0.4 per cent down from 1.6 per cent for April, 2003. Dr. Davies has set a single digit inflation target for this fiscal year and maintains that he will present a balanced budget in 2005/2006.
An IMF team is now in the island ahead of schedule and have had meetings with both the Governor of the Bank of Jamaica (BoJ) and the country's leading traders to ascertain the state of the financial sector.
Speaking to The Gleaner last week the Minister of Finance said: An IMF team is in the island in order to conduct an Article IV Consultation which will be released as a published document. There will be two studies done per year, both of which will assess due economic progress and programmes for growth. We currently have loan agreements with the Inter- American Development Bank (IDB) and grants totalling some 40 million euros from the European Union. The disbursement of these loans is largely dependent on the reports submitted by the IMF.
JAMAICA UPDATE
Dr. Davies gave a presentation on recent and prospective economic developments in Jamaica at the 13th Annual Bear Stearns Global Credit Conference in New York on May 18. The presentation was positive and upbeat, focusing on the attainment of fiscal objectives and the FDI pipeline.
Below is an assessment by Bear Stearns of Jamaica's near term economic prospects:
Jamaica has not been spared from the generalised emerging market sell-off of the past month.
The Jamaica component of our BSCAX (total return) index has fallen by 3.32 per cent in the month of May. However, due to strong outperformance in the January-to-April period, Jamaican bonds have returned 9.4 per cent for the year to date, probably the best performance in the entire emerging market sector.
We have been bullish on the near-term fundamentals in Jamaica since late December 2003.
Although fairly severe medium-term challenges are present and we remain cautious on the credit overall, we are becoming somewhat more optimistic in our medium-term outlook, mainly based on the FDI pipeline.
Jamaica offers less compelling value relative to other single-B credits than it did a few months ago, especially compared with some of the more mainstream credits (Brazil, Turkey) that have sold off more severely than Jamaica.
MACROECONOMIC TARGETS/GUIDELINES
The latest macroeconomic and policy targets of the government are presented in the table.
Let us consider these targets in turn.
REAL GDP GROWTH
The Government is forecasting growth of 2.5 per cent - three per cent in the medium term. Our view is that this is conservative, and that the risk to the forecast is to the upside. Growth in 2003 was 2.2 per cent, driven by recoveries in mining and tourism as well as strong performance by other service sectors such as financial services. Growth in the first quarter of 2004, according to figures just released this week, was 2.4 per cent year over year, which is still below potential but represents a modest acceleration. We believe that the combination of sharply lower interest rates, currency stability, positive dynamics in the tourism and bauxite/alumina industries (a positive global backdrop and a very robust FDI pipeline), and higher domestic business confidence bode well for growth being above three per cent. We are encouraged that the most dynamic sectors tend to be ones that generate foreign exchange. Bauxite and alumina had record years in 2003. Driven by higher prices and investments in capacity expansion, bauxite production reached 13.44 million tons last year, the highest in 29 years. Output of Alumina (a derivative of bauxite that is used to make aluminium) reached 3.84 million tons, the highest ever in Jamaica. Planned expansion in the sector, including a huge $690 million expansion by Alcoa to begin later this year, should ensure higher production levels in the future. In tourism, both stopover and cruise ship passenger arrivals reached record levels in 2003. Approximately 1,000 new rooms are expected to come on stream this year, and about 5,000 over the next five years (for an approximately 25 per cent increase in room stock).
There are several factors detracting from growth that may keep Jamaica from growing at five per cent-plus rates for some time. First, fiscal policy is exceedingly tight, with primary surpluses forecast to average more than 13 per cent of GDP in the coming years. This is a big fiscal drag on the economy. Second, the manufacturing sector in general is weak and has been in decline. As a result, we believe, the proportion of imported goods in the median household's consumption basket is rising. One consequence of this is that remittance inflows (which have been showing strong growth and totalled nearly $1.4 billion in 2003) probably are directed disproportionately toward imports. Third, Jamaica faces all the constraints attributable to a small island economy, such as higher transportation costs, labour force issues, and lack of economies of scale in domestic production. However, at this time, we see these as taking a back seat to the more positive cyclical and structural trends described above.
INFLATION
Inflation surged into double digits last year for the first time in eight years. Most of the inflation was due to currency weakness and new tax measures dating back to the first half of 2003. We expect inflation to moderate this year on the back of currency stability, no new tax measures, and well-behaved monetary indicators. Risks to the inflation target would come from unanticipated currency weakness or sharply higher oil prices. The Government estimates that every $1 increase in the price of oil sustained for a year adds 0.1 per cent to the annual inflation rate. The sustainability of the wage agreement with the public sector unions, which is key to the fiscal targets, depends on the authorities delivering inflation below 10 per cent, so this is an important indicator to watch. Cumulative inflation in the first quarter was 1.9 per cent, and the Bank of Jamaica expects the second quarter to record 2.6 per cent, for a total of 4.5 per cent for the first half, so there is not a lot of room for error here.
FISCAL BALANCE
AND PRIMARY SURPLUS
The Government has been unwavering about its stated goal of achieving a balanced budget by FY2005-06. It is only through the combination of balanced budgets and economic growth that the debt/GDP ratio can fall and creditworthiness rise, which is a goal of the authorities. We believe that the targeted fiscal deficit of three per cent - three per cent of GDP for FY2004-05 is achievable if conditions remain largely unchanged. That is, if the public sector wage agreement holds (it will for this
fiscal year, for sure) and interest rates remain at or below their current levels (this is more uncertain), the Government should be able to knock two per cent of GDP from the deficit of FY2003-04. We estimated that the wage agreement itself will contribute one per cent of GDP and lower interest rates should be worth at least one per cent of GDP and perhaps more. The task facing the government during the budget season in early 2005 -how to reduce the deficit by a further three per cent - four per cent of GDP to achieve a balanced budget by March 2006 - will be considerably more challenging, in our view. New taxes and higher tax rates are neither politically feasible nor economically advisable (in fact, lower rates would be desirable). Therefore, we expect to see the Government spending a good deal of time this year trying to figure out ways to reduce tax evasion (considerable progress has already been made, but the view is that evasion is still high) and reduce unnecessary government spending and waste. The difficulty of this task makes us believe that the next budget season (March - April of 2005) may be a period of vulnerability and volatility for Jamaica, but we see little in the way of serious 'crunch points' until then.
Foreign reserves The government's target of $1.29 billion by the end of the fiscal year (March 31,
2005) seems very conservative at this point. Reserves currently stand at about $1.74 billion. Foreign exchange earning sectors are strong, remittances and FDI inflows are rising, there is no evidence of capital flight, and Jamaica appears to have market access. The Government has demonstrated its willingness to use reserves directly to honour external debt maturities if the need arises, and the current stock is ample to cover the approximately $350 million in maturities remaining in the fiscal year. The current account deficit is large, and oil prices will put further pressure on the balance of payments. We believe that this is manageable in the current environment, but worth monitoring. Given the debt structure, the Government cannot afford excessive volatility in the currency or in interest rates. The fact that foreign reserves are high gives us some comfort that the exchange rate and interest rates can be held reasonably stable. Unlike the case of the Dominican Republic, for example, the Bank of Jamaica has ammunition in its policy arsenal.
Debt/GDP ratio
If the Government maintains its double-digit primary surpluses, which will require huge and ongoing fiscal effort, the debt/GDP ratio will decline and this may lead to rating upgrades. Note, however, that the debt/GDP ratio remains above 100 per cent in the Government's projections until well after 2007. This is well within 'single-B' territory and not really close to 'double-B' levels. For this reason, we believe that rating agencies will be slow to upgrade. Having said this, given the current story, we believe that S&P may have sufficient justification to remove its negative outlook in the coming months.
The outlook for Jamaica at this time is not negative. Its ability to honour its external debt, in our view, is significantly higher than it was last year, and willingness to pay is not an issue.
Relative Value
At the time of our last sovereign update on Jamaica (March 1, 2004), the country's bonds were trading wide to all other single-B sovereigns, and we felt the relative value was highly compelling in Jamaica's favour. Since then, there has been a major sell-off in emerging debt that has led to some interesting phenomena. On the short end of the curve ('05 and '07 maturities), Jamaica is still trading significantly wide to exotic single-B credits like Indonesia, Pakistan, Ukraine and Lebanon. However, at the seven-year maturity, Jamaica has tightened dramatically, and is now trading through some of the mainstream sovereigns such Brazil, Turkey and Uruguay. We are not sure that this makes sense from a fundamentals perspective, but it is consistent with the fact that Jamaican bonds enjoy strong local sponsorship, demonstrate lower volatility than mainstream credits as a result, and are benefiting from some positive news. In the context of the current market, we are comfortable continuing to recommend Jamaican bonds, especially at the shorter end of the curve.
