JAMAICA: ECONOMIC CHALLENGES FACING THE NEW GOVERNMENT OF

UNCLAS SECTION 01 OF 03 KINGSTON 001445

SIPDIS

SIPDIS, SENSITIVE

STATE FOR WHA/CAR (JOE TILGHMAN)

TREASURY FOR INTERNATIONAL AFFAIRS (SARA GRAY)

PASS TO USAID - FOR DIRECTOR HENRIETTA FORE

E.O. 12958: N/A
TAGS: PREL PGOV ECON EFIN ETRD EAID JM XL
SUBJECT: JAMAICA: ECONOMIC CHALLENGES FACING THE NEW GOVERNMENT OF
PRIME MINISTER BRUCE GOLDING

REF: KINGSTON 1419 (172048Z SEP 07)

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Overview
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1.(SBU) This first of several cables outlining challenges facing the
new Government of Prime Minister (PM) Bruce Golding's Jamaica Labour
Party (JLP) focuses on pressing domestic and international economic
problems, including:

-- a reemergence of fiscal difficulties;

-- a debt-to-GDP ratio approaching 140 percent;

-- high unemployment and anemic growth;

-- the global credit squeeze;

-- the slow-down in the U.S. economy;

-- and rising international oil prices.

These difficulties-- recently compounded by nearly USD 300 million
in damages to Jamaica from Hurricane Dean-- would be disconcerting
to any new government-but particularly so to Golding's JLP, which
during the election campaign promised free health care and
education, faster growth, and job creation. End Overview.

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Fiscal Difficulties Resurface
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2.(SBU) The reemergence of fiscal difficulties will be the first
major challenge facing the incoming government. While figures for
the first four months of the fiscal year showed some amount of
consolidation, the Ministry of Finance now has revealed that over
USD 220 million, or almost two percent of GDP, worth of expenditures
are yet to be included in the budget. This is not surprising, as
Senior Director of the Fiscal Policy Management Unit Courtney
Williams had confirmed EmbOff's view that expenditures could spike
after the elections, given the (now well-established) practice of
deferred financing. This revelation also bears out the contention
of then-Opposition finance spokesman (now Finance Minister) Audley
Shaw made during the 2007 budget debate that the Government was
presenting an "election budget," and that additional expenditures
would emerge thereafter. When the cost associated with the JLP's
free tuition promise is added, the fiscal deficit could jump to
almost 7 percent of GDP, up from 4.5 percent. (Comment: Given that
the country has been overshooting its fiscal deficit target in
recent years, and given the emerging international credit crunch, it
thus should come as no surprise if Jamaica's credit rating is
downgraded in the upcoming year. End Comment.)

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Hurricane Dean Blows Targets Off Track
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3.(SBU) The new administration is faced not only with the
unenviable job of reshaping the fiscal budget, but also with
revising the entire macroeconomic program, given the damage meted
out by Hurricane Dean (reftel). Total hurricane damages are
estimated at almost USD 300 million, and will have serious
implications for economic growth and fiscal consolidation. The
economy is projected to slow to only 1.1 percent, down from an
already anemic 2.1 percent; this will have negative consequences for
tax revenues, which recently have been outperforming programmed
levels. Inflation, which recently has slowed to single digits, now
is expected to jump to low double digits given the shock of Dean,
especially to domestic agriculture. Soaring oil prices also should
contribute to a further spike in inflation. (Note: Septel will
provide more details on the impact of Hurricane Dean. End note).

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Credit Crunch To Affect Funding
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4.(SBU) With tax revenues expected to slow, the government will be
forced to look to the domestic and external markets for funding.
But either approach could have consequences for the economy.
Increased domestic borrowing could stymie the central bank's efforts
to further reduce interest rates. Domestic borrowing requirements
could also crowd out the local private sector, which is expected to

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be one of the engines of growth. Sourcing funds on the external
market will be no different, particularly given the country's
worsening fiscal dynamics and the tightening international capital
market, given the credit crunch. But even if funds are available on
the external market it will come at a much higher cost and will
influence local investors to shift from local to foreign denominated
assets. This would place even more pressure on the local currency,
forcing the central bank to use more of its reserves to shore up
supplies. Demand pressures also will emanate from soaring oil
prices now hovering around USD 80 a barrel, well above the USD 71-72
predicated in the economic program. This is sure to put additional
pressure on the current account and by extension the local currency
as more resources will be required to pay the oil bill. On the
supply side, declining tourist arrivals are expected to slow tourism
receipts.

5.(SBU) That said, the greatest threat of any increase in rates
will be to the fiscal dynamics, as any increase in interest cost
will only serve to exacerbate an already tenuous situation. When
this is added to the issues of sluggish revenue growth and the JLP's
promise to cap both the fiscal deficit and the debt, the challenges
facing the new government appear almost insurmountable in the short
term. The fiscal dynamic could also be affected if the JLP acts on
its promise to make the central bank fully independent-and thus not
obliged to make the monetary adjustments necessary to accommodate
fiscal profligacy. But fiscal efficacy aside, an independent
central bank is important from a rules-based approach. And this
policy position should be simple to implement, as the current
governor always has supported greater independence for the bank.


6.(SBU) The JLP also has identified funding from multilaterals as a
substitute for high cost debt. But while funding from this source
has its advantages, it cannot be used for recurrent spending; it
also takes time to negotiate and is therefore not a short term
solution. Similarly, resources could be garnered by selling state
assets but time will also be required to identify the assets to be
sold, making this at best a medium term solution. And while
loss-making assets like Air Jamaica and the Sugar Company of Jamaica
may merit consideration for sale, any decision actually to do so
could turn out to be political dynamite.

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Debt to Remain a Drag
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7.(SBU) At the end of July 2007, the total stock of debt amounted
to USD 14.1 billion or almost 140 percent of GDP, thus maintaining
Jamaica's unenviable record as one of the most indebted countries in
the world. And this does not even include the stock of publicly
guaranteed debt, considered a contingent liability to government,
which could push the debt up by another four percent of GDP. Given
that debt has the first call on the budget, after the Governor
General's remuneration, the cost of financing this gargantuan debt
and its attendant effect on the rest of the economy must rank as one
of the major challenges facing the new administration. This could
explain why the JLP has wooed Grace Kennedy Executive Don Webhy to
support Finance Minister Audley Shaw. (Webhy will serve as Minister
without Portfolio, but has been explicitly attached to the Finance
Ministry.) With debt servicing cost accounting for almost sixty
percent of the budget and climbing, the JLP's social spending
promises will be challenged. While Shaw had enumerated a number of
strategies to address the debt overhang while in opposition, and
while the JLP has outlined an ambitious plan to bring down the debt
to 100 percent of GDP in its Manifesto, it will realize that the
emerging international credit dynamic could make some proposals
moot. That said, if the administration is able to make good on its
promise to grow the economy and create new jobs, then it could begin
to generate the revenues required to pay down the debt. In fact,
aside from debt forgiveness (which is unlikely),the only credible
way to reduce the debt burden is to grow out of it. As such, Shaw's
proposal to use the savings from the PETROCARIBE Agreement, while
plausible, can only serve to complement the solution of increased
economic growth and by extension revenue growth.

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Investment and Growth
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8.(SBU) Investment and growth are key planks of the JLP's
manifesto. The administration has decided to concentrate on
job-creating "greenfield" investment as well as the creation of an
offshore financial sector. To enable the rapid private sector

KINGSTON 00001445 003 OF 003


growth needed to create jobs and reduce the fiscal imbalance, the
new government is planning to reduce the bureaucracy and corruption
that have been Jamaica's major bugbears. But while there is little
doubt that growth is manifestly required, the new administration
will discover that it will first have to overcome a number of
structural bottlenecks that currently limit competitiveness of the
Jamaican private sector. Jamaica may lack the capacity to grow by
the 5-6 percent enunciated by the JLP due to its chronic shortage of
skilled labor. Crime, which is considered the number one problem
facing Jamaicans (to be the subject of septel),also magnifies the
cost of doing business and will figure prominently in the minds of
prospective investors. A 2005 World Bank report, drawing on a
survey of 159 firms operating in the region, argued that to improve
the investment climate, Caribbean countries must improve their
infrastructure (including information and communication technology),
policy and legal environment, and taxation and customs; these
factors continue to limit investment in Jamaica today. Regarding
the offshore financial sector, while Jamaica has natural advantages
and a relatively sound regulatory framework, it will have to compete
with both existing and emerging players. And while cutting
bureaucracy does not require much financial outlay, it might still
be difficult to achieve given that bureaucracy benefits stakeholders
who will resist losing the associated economic rent. The damage
caused by Hurricane Dean, the slow down in global growth, and the
prospect of a possible recession in the U.S. also could militate
against the growth and investment platform.

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Comment
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9.(SBU) Given the reemergence of fiscal indiscipline, the new
administration might be advised to use the remainder of the fiscal
year (which ends March 31, 2008) to concentrate on the
implementation of those manifesto items that do not require funding.
In this regard, it is expected that the new government will spend
the time addressing the legislative framework necessary to improve
governance, which has been in need of redress and is actually a
prerequisite for some of the investment and growth policies outlined
in the manifesto. This may be one reason that the widely respected
former opposition spokesman on justice, Delroy Chuck, who has a
legal background, now has been named Speaker of the House. But the
administration nevertheless will face a number of challenges going
forward. Chief among these are the rehabilitation efforts following
Hurricane Dean and the attendant effect on the fiscal accounts. The
revelation of fiscal indiscipline at the Ministry of Finance can
only serve to erode the consolidation which had characterized the
last seven months. The new administration's desire to grow the
economy by between six and seven percent also will be stymied by the
slow-down in global economic activity and in the U.S. economy in
particular. This is particularly disconcerting because of the
Jamaican economy's heavy dependence on the U.S. economy,
particularly in the areas of bauxite, remittances, and tourism.
While remittances have proven a most resilient flow of income,
during a possible recession tourists tend to stay at home and demand
for commodities declines. Jamaica already has seen a fall off in
tourist arrivals and an attendant decline in tourism receipts. End
comment.

JOHNSON