GOJ PROPOSES BALANCED BUDGET FOR 2005/06

UNCLAS SECTION 01 OF 03 KINGSTON 001256 SIPDIS STATE FOR WHA/CAR/ (WBENT),WHA/EPSC (JSLATTERY) SANTO DOMINGO FOR FCS AND FAS TREASURY FOR L LAMONICA E.O. 12958: NA TAGS: ECON EFIN JM SUBJECT: GOJ PROPOSES BALANCED BUDGET FOR 2005/06 REF: 04 KINGSTON 895 -------------- SUMMARY -------------- ¶1. (SBU) Finance and Planning Minister Omar Davies proposed Jamaica's 2005/06 fiscal budget on April 14, 2005. The budget, which is formulated within a medium term program aimed at eliminating the fiscal deficit, increasing growth and reducing the debt to GDP ratio, is forecast at USD 5.7 billion. This represents a decline of 5.8 percent over the 2004/05 revised budget. Debt-servicing costs of USD 3.7 billion, will again account for the largest share (more than 65 percent) of the budget. The new tax package is projected to yield about USD 153 million. The budget has drawn mixed reactions, with opposition spokesman on finance Audley Shaw stating that Davies has again concentrated only on revenue earning measures. However, a Jamaica Chamber of Commerce contact told emboffs that while the private sector was not happy with the budget process, he could not overemphasize the importance of eliminating the fiscal deficit. While the new tax measures will be burdensome, the balanced budget objective is expected to reduce the GOJ's appetite for debt, further reduce interest rates and increase investment, growth and employment. End Summary. -------------- MEDIUM-TERM FRAMEWORK FOR 2005 TO 2008 -------------- ¶2. (U) On April 14, Minister of Finance and Planning Omar Davies presented his twelfth budget formulated within a three-year macroeconomic program aimed at eliminating the fiscal deficit and generating moderate fiscal surpluses thereafter. The medium-term program has also targeted an increase in the primary surplus, a gradual reduction in inflation and a rebound in real GDP growth. The reduced borrowing requirements, in light of a balanced budget combined with higher levels of economic growth, are expected to result in a reduction of the debt-to-GDP ratio. 2004/05 2005/06 2006/07 2007/08 Inflation (%) 12.4 9.0 8.0 6.0 Real GDP Growth (%) 1.0 3.6 3.0 3.5 NIR (USD Billion) 1.9 1.9 2.1 2.2 Debt/GDP (%) 136.6 125.7 113.9 103.0 Fiscal Bal/GDP (%) -4.8 0.0 0.5-1 1-2 Primary Bal/GDP (%) 11.8 13.8 14.0 14.0 Source: Ministry of Finance and Planning �00A; -------------- EXPENDITURE BUDGET -------------- ¶3. (U) The expenditure budget for 2005/06 amounts to USD 5.7 billion or 5.8 percent (USD 310 million) more than the revised budget for 2004/05. This level of expenditure also represents a real decline of 6.6 percent, reflecting the GOJ's commitment to a balanced budget. Of the total expenditure budget, USD 3.1 billion, or 54 percent, is set for recurrent or day-to-day spending, while the other 46 percent (USD 2.6 billion) is slated for capital spending. While interest payments of about USD 1.4 billion will again absorb the lion's share of recurrent spending, the allocation represents a real decline of almost 19 percent. The contraction in interest payments is a direct result of consistent reduction in interest rates and has freed up over USD 627 million for social services. Wages and salaries of USD one billion also declined by 15.7 percent in real terms due to the Memorandum of Understanding (MOU) between the GOJ and trade unions (reftel). ¶4. (U) The reduction in interest payments has also freed up extra resources for the physical development of the country following years of neglect. Capital projects will account for USD 284 million, or 11 percent, of the capital budget. This represents a 57 percent jump over the allocation for 2004/05. The remaining USD 2.3 billion of the capital budget will be consumed by principal payments, up 12.1 percent due to the repayment of a USD 250 million Eurobond maturing in June 2005. This allocation to principal payments, combined with the USD 1.4 billion in interest payments, will bring debt servicing costs to USD 3.7 billion or 66.3 percent of the budget. This compares with USD 3.6 billion or 67.3 percent of the revised budget for 2004/05. Of the remaining budget, only USD 2.1 billion, or about 23.7 cents out of every dollar, will remain for non-debt expenditures. In keeping with its commitment to improve education, the GOJ allocated USD 621 million (up 9.6 percent in real terms),or 32.5 percent, of the non-debt budget to the sector. National security and health have been allocated USD 280.3 million and USD 220 million, respectively. -------------- FINANCING THE BUDGET -------------- ¶5. (U) The financing of the 2005/06 expenditure budget took place within the context of a review of the tax system by a committee appointed by the GOJ and headed by businessman Joseph Matalon. The review, which highlights deficiencies in the tax system, suggested a re-engineering from direct to more indirect taxation. Given these recommendations as well as the need to balance the budget, the GOJ proposed borrowing only USD 2.3 billion (equivalent to principal payments),4.7 percent less than in 2004/05. The GOJ also projected a 14 percent increase in revenues and grants to USD 3.2 billion. Higher revenues are predicated on the trend during the last three years when revenues averaged 18.7 percent. The remaining USD 153.3 million is to be covered by a new tax package. In keeping with the proposal to shift the tax burden from income to consumption, most of the new taxes (USD 153.7 million) will be sourced from changes to the General Consumption Tax (GCT) regime. The income tax threshold will be initially increased by over USD 800 per person and then by USD 400, costing about USD 25 million in revenues. Higher taxes on cigarettes will provide USD 5.2 million. Additional revenues will flow from: a two percentage points increase in the GCT on the tourism sector, which brings it to half the 16.5 percent to be charged on all other goods and services (USD 10 million); a gross profit tax on gaming (USD 5 million); and, a revised property transfer tax on death (USD 5 million). ¶6. (SBU) The GOJ frequently misses its targets, so emboff asked Senior Fiscal Economist at the Ministry of Finance (MOF) Courtney Williams about the robustness of the current estimates. Williams said that, given the data the Ministry is privy to, the estimates are "pretty realistic". Keith Collister of the Jamaica Chamber of Commerce (JCC) in supporting this position said the key factor was that most of the underlying assumptions were credible. He opined that the tax measures might well be understated to provide a cushion in the event of a shock to the economy. These positions are also similar to those espoused by Ralston Hyman of the Sunday Herald, who argues that increased compliance could result in the GOJ collecting more revenues than expected, since the forecast, given recent trends, is conservative. -------------- COMMENTS ON THE BUDGET -------------- ¶7. (SBU) While the 2005/06 budget has been well received by most stakeholders, the private sector has been less than happy with the process. Collister told emboffs that, following the last tax hike, Davies had promised consultations with the JCC, but this did not happen. However, Williams said that consultations are never a good approach. Following the last tax hike, lobbyists convinced Davies to cut the package by up to 50 percent. He said that the Minister's decision to meet with hoteliers peeved with the small increase (two percent) in taxes on the sector was, therefore, out of courtesy. "Given the recommendations in the Matalon Report, hoteliers should have expected, and planned for, an increase", he continued. When asked about the position being taken by hoteliers, Collister said he was not sympathetic to the sector as it was already under-taxed. In his response to the budget in Parliament, Audley Shaw, of the opposition Jamaica Labor Party, stated that Davies has concentrated primarily on the revenue earning measures, while delaying those aimed at easing the income tax. Shaw bashed Davies for increasing the tax burden, since the mandate of the tax reform committee was to simply the tax system without changing the tax intake (tax neutrality). "The taxation strategy cannot be limited to the constant need for financing corruption and waste and the ever widening stock of debt," Shaw concluded. ¶8. (SBU) However, Hyman, who focused more on the balanced budget objective, argues that balancing the budget is not just an accounting exercise, but demonstrates to creditors that the GOJ is serious about reducing borrowing and debt. He said this should further reduce interest charges and free up resources for education and national security. "A balanced budget puts the banking sector in a better position to free up resources to the private sector at lower rates, leading to higher levels of investment, growth and employment," he continued. Hyman also opined that a balanced budget will help to maintain investor confidence in the country at a time when external funds are getting more expensive. Collister shared this view, telling emboff that, while he was not sure if increasing GCT was the right approach, he could not overemphasize the importance of a balanced budget. When asked about the importance of a balanced budget, Williams said the GOJ had little choice, since creditors have been promised this outcome since 2003. He said any other approach would have been catastrophic. -------------- COMMENT -------------- ¶9. (U) Following the decline in investor confidence and the subsequent steep decline in the local currency at the beginning of 2003, Prime Minister Patterson in a bid to stem the hemorrhaging promised investors a balanced budget by 2005/06. The Patterson-led administration has made good on its commitment so far, and a success in tax reform would have many positive impacts on the country. ¶10. (U) The country still faces some pressing issues, chief among them the neglect of essential services (fire departments in particular). While reduction in interest rates has freed up some resources, the debt-to-GDP ratio of 125.7 percent still places Jamaica among the most indebted countries in the world. The MOU with trade unions (reftel), which caps annual wage increases at three percent, will come to an end in March 2006, and workers are expected to agitate for higher wages and salaries to compensate for the period under the MOU. Indeed, Collister told emboff that there has to be some payback at the end of the period, especially given the proximity to the general elections constitutionally due by October 2007. In the final analysis, barring shocks, the GOJ should be able to navigate through the challenges and deliver a balanced budget in March 2006. End Comment. TIGHE