UNCLAS SECTION 01 OF 02 KINGSTON 002359

SIPDIS

STATE FOR WHA/CAR (WBENT), WHA/EPSC (JSLATTERY),
EB/IFD/OMA (DJUNCKER)

SANTO DOMINGO FOR FCS AND FAS

TREASURY FOR L LAMONICA

E.O. 12958: NA
TAGS: ECON EFIN JM
SUBJECT: GOJ'S FISCAL PROGRAM OFF TRACK


SENSITIVE BUT UNCLASSIFIED


1. (SBU) Summary: Data released by the Ministry of
Finance on September 30 showed that the GOJ's fiscal
deficit of USD 290 million continued to run ahead of the
GOJ'S target of USD 270 million. The deficit overrun was
primarily due to lackluster revenue generation, reflecting
a slump in consumption taxes. To curtail the fiscal
downturn, the GOJ slashed overall expenditures by curbing
spending on capital projects and recurrent programs such
as utilities and social programs. To finance the deficit
and amortize debt, over USD 1 billion was sourced from the
capital markets, pushing the national debt to USD 13
billion. The government, already faced with the Herculean
task of meeting its balanced budget objective, will
encounter even greater challenges given its recent
decision to grant public sector workers a hardship
allowance. The fiscal authorities will therefore have to
find creative ways to increase compliance and broaden the
tax base, as any major deviation from the balanced budget
objective could upset the capital markets. End summary.


2. (SBU) Data released by the Ministry of Finance on
September 30 revealed that GOJ operations generated a
deficit of USD 290 million during the first five months of
this fiscal year (April to August 2005). This represents
an approximately USD 20 million departure from budget
forecasts and marks the continuation of a trend observed
since April. Poor revenue inflow, due largely to a slump
in consumption, was the main reason for the deviation in
the deficit. Revenue collections of USD 1.1 billion were
USD 83 million below the USD 1.2 billion budgeted for
April to August. During the period, General Consumption
Taxes (GCT) amounted to USD 302 million or USD 60 million
less than projected. Keith Collister of the Jamaica
Chamber of Commerce told emboff that the underperformance
of GCT was particularly striking as it occurred within the
context of a 1.5 percentage point increase in the rate to
16.5 percent in April 2005.


3. (SBU) However, Senior Fiscal Economist at the Ministry
of Finance, Courtney Williams, told emboff that he was not

surprised by the underperformance in taxes, as the target
was overly optimistic. Williams said that while data were
not yet available, anecdotal evidence suggests that most
individuals had curtailed spending due to flat wages and
double-digit inflation. He said inflation-based revenues
were not a factor, as inflation was being fuelled by oil,
which has a flat tax rate, and food, which does not
attract taxes. Williams said gas consumption had also
fallen by at least two percent since the start of the
fiscal year. The falloff in revenues was also partly due
to the sluggishness in the Jamaican economy, which is
still recovering from the effects of three hurricanes in
under a year. Despite the downturn in overall revenues,
there was a 26 percent increase in actual profit taxes
over projection, reflecting the significant increase in
the profits of large publicly-listed financial companies
such as the Bank of Nova Scotia.


4. (SBU) The falloff in revenues forced the GOJ to chop
spending by USD 62.6 million to contain the expansion in
the fiscal deficit. Total expenditures for the period
amounted to USD 1.39 billion compared to a budget of USD
1.45 billion. While the contraction in expenditures was
widespread, the fiscal restraint was most evident in
capital spending and programs (utilities, social programs
and day-to-day spending). Capital expenditures of USD 102
million were slashed by 23.3 percent from projections of
USD 125 million, while programs were cut by 9.8 percent to
USD 264 million. The GOJ'S decision to cut the capital
budget following three hurricanes will lead to further
deterioration of the island's physical infrastructure in
general and roads in particular. The reduction in
spending on programs will also lower the benefits to the
most vulnerable groups, already buckling under the high
prices. Collister pointed out that the notable exception
in the expenditure restraint was the spending on domestic
debt payment, which was USD 4.1 million above target. He
said the overshoot could suggest that the interest rate
reduction program was now running behind target,
reflecting inflation that was higher that anticipated.
Collister said the GOJ should therefore consider borrowing
more funds internationally, substituting cheaper external
financing for higher domestic borrowing.


5. To finance the fiscal deficit and to amortize debt,
the GOJ had to source USD 66 million from the capital
markets. This brought the total amount of debt contracted
for the five-month period to USD 1.1 billion and the
national debt to USD 13 billion. While most of the
borrowing came from the domestic market, the GOJ also
issued a ten-year USD 300 million eurobond with a coupon
on nine percent per year. This is the lowest rate Jamaica
has raised funds on the international capital market and
occurred amidst rising US interest rates and at a time
when investors are shunning emerging market debt. This
suggests that external investors continue to have a high
level of confidence in Jamaica's ability to repay debt,
notwithstanding the macroeconomic challenges. The
country's continued generation of high primary surpluses
(revenues minus non-debt spending), a measure of debt
sustainability, would also have buoyed investor's appetite
for Jamaican bonds.

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COMMENT
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6. Fiscal Outlook: The GOJ will be hard pressed to
balance the 2005/06 fiscal budget, particularly given its
recent decision to grant all public sector workers a
hardship allowance - amounting to approximately USD 16
million - to alleviate the pressure being caused by the
wage restraint. This combined with the increasing cost of
providing public goods and services will make further
expenditure restraint difficult in upcoming months.
Domestic interest payments could also continue to outstrip
projections, as the Bank of Jamaica (BOJ) has halted its
interest rate reduction program due to higher than
anticipated inflation. Revenue collections could also
remain moribund for the remainder of the fiscal year due
to the sluggish economic conditions and waning business
and consumer confidence. The fiscal authorities will
therefore have to find creative ways to increase
compliance and broaden the tax base in order to bring
revenue collections in line with projections, as any
deviation from the balanced budget objective will be
viewed with disfavor by an expectant capital market. In
particular, the country would have to pay higher rates of
interest to borrow from both the local and international
capital markets in 2006. End outlook.

TIGHE