Identifier
Created
Classification
Origin
08KINGSTON1001
2008-11-24 20:01:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Kingston
Cable title:  

FINANCIAL CRISIS ROCKS JAMAICA

Tags:  ECON ENRG EINV ETRD IADB IBRD IMF TRSY JM XL 
pdf how-to read a cable
VZCZCXRO0229
RR RUEHGR
DE RUEHKG #1001/01 3292001
ZNR UUUUU ZZH
R 242001Z NOV 08
FM AMEMBASSY KINGSTON
TO RUEHC/SECSTATE WASHDC 7002
INFO RUCNCOM/EC CARICOM COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHDC
UNCLAS SECTION 01 OF 03 KINGSTON 001001 

SENSITIVE
SIPDIS

STATE FOR WHA/CAR (ACADIEUX) (VDEPIRRO) (WSMITH)
WHA/EPSC (MROONEY)
SANTO DOMINGO FOR FCS AND FAS

E.O. 12958: N/A
TAGS: ECON ENRG EINV ETRD IADB IBRD IMF TRSY JM XL
SUBJECT: FINANCIAL CRISIS ROCKS JAMAICA

REF: A) KINGSTON 936
B) KINGSTON 883
C) KINGSTON 704

KINGSTON 00001001 001.2 OF 003


SUMMARY
-------

UNCLAS SECTION 01 OF 03 KINGSTON 001001

SENSITIVE
SIPDIS

STATE FOR WHA/CAR (ACADIEUX) (VDEPIRRO) (WSMITH)
WHA/EPSC (MROONEY)
SANTO DOMINGO FOR FCS AND FAS

E.O. 12958: N/A
TAGS: ECON ENRG EINV ETRD IADB IBRD IMF TRSY JM XL
SUBJECT: FINANCIAL CRISIS ROCKS JAMAICA

REF: A) KINGSTON 936
B) KINGSTON 883
C) KINGSTON 704

KINGSTON 00001001 001.2 OF 003


SUMMARY
--------------


1. (SBU) Jamaica's fragile economy has begun to feel the effects of
the global financial meltdown, with the contagion effects already
evident in the financial market. The local currency has depreciated
by more than six percent since the beginning of October, due largely
to margin calls from overseas creditors. The increased demand for
hard currency could not have come at a worse time, as the country is
going through its traditional dry season for foreign exchange
earnings. Jamaica has also suffered from downgrades by three major
rating agencies (S&P, Moody's and Fitch). To stem the slide in the
currency, the central bank hiked interest rates and increased the
supply of foreign currency. The Government of Jamaica (GOJ) offered
an attractive US dollar indexed bond to the market. These measures
could have negative implications for fiscal policy as debt costs
increase. Although the pace of depreciation could slow in coming
months, the pass through effect of depreciation could stymie the
anticipated drop in consumer prices. End summary.



Financial Instability Emerges
--------------


2. (SBU) Jamaica has begun to suffer the effects of the global
crisis with the country's currency market in turmoil. The Jamaican
dollar (JMD),which depreciated 1.6 percent for the first nine
months of the year, has slid by over six percent since the beginning
of October, moving from JMD 72 to JMD 77.2 against the US dollar.
The sharp depreciation has been underpinned by a confluence of
demand and supply factors led by increased margin calls from
overseas creditors. With the value of Jamaican global bonds
declining on the back of the financial meltdown, overseas brokers
who had provided margin loans to local firms to buy these

instruments demanded payment of the outstanding amounts to shore up
their liquidity position. Overseas suppliers faced with liquidity
constraints also shut the credit window they traditionally provide
to Jamaican importers, thus, requiring traders to secure foreign
currency upfront in order to make purchases.


3. (SBU) Demand pressures are also being compounded by increasing
JMD liquidity as local financial institutions convert maturing debt
instruments into hard currency. The increased demand for hard
currency could not have come at a worse time as it coincided with
the slow period for inflows and the traditional demand spike for
foreign currency to purchase Christmas supplies. (Note: Tourist
arrivals tend to be slowest during the September quarter, commonly
referred to as the tamarind or dry season. End note.) Revenues from
bauxite companies have also declined on the back of falling aluminum
prices. The large amount of foreign exchange invested (and now
lost) in the infamous collapsed alternative investment schemes
(reftels) have further reduced the supply of available hard
currency.

The Negative Ratings Trifecta
--------------


4. (SBU) The single greatest shock to the foreign exchange market
came from the ratings released by Standard and Poor's (S&P) Ratings
Services (reftels). On October 21, 2008, the agency revised its
outlook on Jamaica to "negative" from "stable," although the credit
rating was maintained. S&P is particularly concerned about the
country's weak fiscal position, narrow economic structure and rising
external liquidity risks. The S&P posits that external pressures
could stymie already moribund economic growth, strain government
access to credit, and weaken the country's external liquidity
profile. These factors could further weaken the currency, with
attendant negative implications for fiscal performance and the debt,
given the GOJ's reliance on external borrowing. But worse yet, the
S&P concluded that the negative outlook could lead to a downgrade if
external pressures add to fiscal uncertainty, increase capital
outflows or significantly impair external liquidity.


5. (SBU) Moody's Investors Service also placed Jamaica's ratings on
review for downgrade. The agency stated that despite the GOJ's
adequate policy response and continued strong commitment to
servicing debt, the challenges imposed by the global financial
crisis and economic slowdown are simply too severe for Jamaica to
avoid an increase in credit risk. According to Moody's "the
combination of a fiscal deterioration and lower real GDP growth
would lead to a worsening of Jamaica's debt metrics".


KINGSTON 00001001 002.2 OF 003



6. (SBU) This was closely followed by an even more negative rating
from Fitch, which downgraded Jamaica's actual credit ratings from
'B' to 'B+'. The agency cited shocks from the global financial
turbulence; the expected US recession; deteriorating external
imbalances; and, high public debt as the underlying factors for its
decision. 'The recent depreciation pressures on the Jamaican
dollar, as well as sales of international reserves, signal rising
challenges facing the island due to the worsening international
environment," said Shelley Shetty who met with emboffs during her
recent visit to Kingston.


7. (SBU) These less than flattering ratings compounded an already
tenuous situation, precipitating a further slippage in the JMD as
local investors switched assets from local to foreign currency to
hedge against any fallout from the report. Bank of Jamaica (Central
bank) Governor Derick Latibeaudiere, speaking at his Quarterly
Monetary Policy Review briefing, said that the ratings agencies
analysis was disingenuous. He stated that the ratings were
inconsistent and given the agencies' history of massive errors as
being played out on Wall Street, their analysis if not their
credibility was at best questionable. A realignment of the currency
was anticipated given the 16.8 percent spike in inflation from
January to September which in effect represented an almost 15
percent real appreciation in the currency. High inflation was
rendering near negative returns on local instruments, encouraging
savvy investors to switch to foreign assets to hedge against any
further erosion in real returns. High commodities prices, led by
oil imports, caused a USD 793 million deterioration in the current
account balance to June 2008. As foreign investment inflows dry up
and the credit market are severely tightened there would have been a
shortfall in the supply of foreign inflows required to finance the
current account, forcing the exchange rate to adjust accordingly.

Fiscal and Monetary Authorities Fight Back
--------------


8. (SBU) The increasing instability is not lost on the authorities,
as the BOJ draws from its arsenal of monetary tools to temper the
demand pressures. On October 15 the BOJ introduced a temporary U.S.
dollar loan facility for institutions affected by margin calls. In
essence, the facility allowed securities firms facing the risk of
losing credit facilities in respect of GOJ bonds to have these
credit arrangements transferred to the BOJ along with the collateral
formerly held by overseas creditors. Two days later the bank
complemented this response by hiking interest rates on its open
market instruments by up to 1.2 percent. The bank followed up by
facilitating the flow of credit among financial institutions to
moderate the pressures in the foreign exchange market, while
assisting the continued functioning of the inter-bank credit market.
At the same time, the bank sold over USD 400 million or 20 percent
of its stock of Net International Reserves (NIR) to the currency
market to shore up the supply of US dollars in the market.



9. (SBU) However, these policy responses were not sufficient to
alleviate the demand pressures in the currency market. In fact,
since the beginning of November, the rate of depreciation has
accelerated due largely to a build up in Jamaica dollar liquidity
stemming from maturing debt instruments. To remove this excess
liquidity, the bank embarked on an even more aggressive monetary
program, offering an attractive short-term instrument with interest
payable at 20.5 percent (per annum rate). The BOJ also gave notice
that when the new instrument matures on December 3, 2008, the cash
reserve requirement would be increased by two percentage points to
11 percent. These monetary policies were accompanied by an 18-month
GOJ USD indexed bond with a coupon of 11.5 percent. In addition to
moral suasion, Minister of Finance and the Public Service Audley
Shaw has also been calming fears in the market by announcing a
pending agreement for the IDB to provide liquidity support to
commercial banks. He also disclosed that the World Bank, the IDB
and the Caribbean Development Bank have committed to providing the
additional USD 250 million required to pay down a maturing Eurobond.
In addition, the Managing Director of the International Monetary
Fund (IMF) Dominique Strauss-Khann is to visit Jamaica in early
December.

But At What Cost
--------------


10. (SBU) Although these measures should bring improvements in the
short term situation, they could have serious consequences for both
monetary and fiscal policy. While the latest monetary actions could
halt the slide of the currency, it has eroded a significant portion
of the BOJ's stock of NIR, reducing it to just over USD 1.7 billion
from a peak of USD 2.5 billion in June. Effectively this steep
decline has reduced the country's import cover to about 11 weeks or
returning to levels last seen in 2003. The increased indicative

KINGSTON 00001001 003.2 OF 003


interest rates combined with declining liquidity have already
induced a response from financial institutions, which have adjusted
rates by up to three percentage points. This is bound to crowd out
private credit and investment and by extension growth as investors
find it more attractive to hold cash in relatively low risk
government paper. Worse yet, the GOJ which is already reeling under
high debt costs, could see its fiscal indicators deteriorate on the
back of rising domestic interest rates. Even though the GOJ has met
its fiscal targets for the first half of the year, rising debt cost
will make it difficult for the GOJ to continue on a positive fiscal
trajectory.

Measures Appearing to Work
--------------


11. (SBU) All is not lost as the strict monetary policies appear to
be working, with over half of the liquidity from maturing
instruments already mopped up. In addition, only USD 170 million of
the USD 300 million has been accessed by financial institutions,
suggesting that signs of confidence are emerging. The temporary
window has also had the effect of tempering the price movement of
GOJ bonds while at the same time easing the demand for foreign
exchange by the institutions affected. Even though the NIR has
fallen to just above USD 1.7 billion it is still above December 2007
levels. Most importantly, there is no apparent systemic risk to the
financial sector, with most of Jamaica's prudential indicators still
above international standards. The capital adequacy ratio is
currently at 16 percent, well above local and international
benchmarks of 10 percent and 8 percent, respectively.

Comment
--------------


12. (SBU) While the monetary actions implemented by the BOJ appear
to be working, it should still be noted that Jamaica is one of the
few countries to have introduced such measures in response to the
meltdown (other countries have opted for stimulus packages). The
fear of high interest rates and slow economic growth could explain
why the confidence required to stabilize the local system remains
elusive. But waning confidence and uncertainty are not new to the
Jamaican economy, as in 2003 a similar sequence of events unfolded,
suggesting the country is locked in a vicious cycle of instability.
Therefore, unless deliberate attempts are made to address the
structural problems facing the economy, and in particular the twin
deficits (fiscal and current account),it is almost safe to assume
bouts of instability will reoccur. Prime Minister Bruce Golding and
his Jamaica Labour Party (JLP))-led government are facing increasing
pressure from a populace that question Golding's leadership.
Golding has not been able to secure major victories on his campaign
promises and appears reluctant to have a frank discussion with the
public on the serious economic challenges facing the country.


13. (SBU) That said, some positives are emerging: even though the
pass through effect of depreciation will feed inflation, the recent
moderation in commodities prices in general and oil prices in
particular, will more than offset this increase. Declining
commodities prices combined with the depreciation should also
correct the current account imbalance, even if remittances and
tourism receipts wane. Tourism will likely benefit from the currency
correction, as American visitors find Jamaica a more cost
competitive destination. Add to this the fact that the GOJ's
external debt servicing cost will moderate next year, and the
outlook brightens slightly.
HEG