JAMAICAN ECONOMY STAGNATES AMID SHOCKS, A REVIEW OF THE

UNCLAS SECTION 01 OF 05 KINGSTON 000704

SENSITIVE
SIPDIS

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

E.O. 12958: N/A
TAGS: ENRG EAIR EINV ECON ETRD EIND SENV IADB IBRD IMF
TRSY, XL, JM
SUBJECT: JAMAICAN ECONOMY STAGNATES AMID SHOCKS, A REVIEW OF THE
FIRST HALF OF 2008

REF: A. KINGSTON 648

B. KINGSTON 422

C. KINGSTON 366

D. KINGSTON 111

E. KINGSTON 542

F. KINGSTON 703

G. KINGSTON 651

H. KINGSTON 571

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


1. (SBU) Growth in the Jamaican economy, suffering from a number of
shocks, has slowed to less than one percent during the first half of

2008. The downturn was most evident in the goods producing sectors,
which declined by 3.5 percent. Services grew by a moderate 1.7
percent fueled by robust tourism performance. The sluggish economic
conditions occurred against the background of increasing
macroeconomic instability and in particular price and foreign
exchange market volatility. Inflation of 11.5 percent for the first
half of 2008 already has exceeded the original target for the entire
calendar year. Although the exchange rate has remained relatively
stable, declining less than a one percent, it has been largely due
to increased intervention by the Central Bank to temper demand
pressures. Government of Jamaica (GOJ) operations also are
outperforming targets due to a combination of reduced expenditure
and higher revenue collections. But even this unlikely success
story is tenuous, given the impact rising energy and food prices and
non-performing state assets like Air Jamaica could have on
expenditure. The Jamaican economy is expected to face even more
serious challenges during the next six months, given the expected
slowdown in investment and consumer spending following the meltdown
of a number of alternative investment schemes (reftel A). Add to
this the country's susceptibility to shocks, and the near term
outlook dims. End summary.

Output Stagnates
--------------


2. (SBU) Economic output for the first half of 2008 declined to less
than one percent as a result of a number of shocks. Global
challenges including increasing commodities prices and in particular
crude oil, wheat, rice and fertilizer, as well as unusually heavy
rains in February, provided the underlying impetus for the economic
downturn (reftels C and D). The impact was particularly evident in
the goods producing sectors, which, with the exception of the
construction sector, stagnated. But it was the double digit
downturn in agricultural output which underlined the negative
performance. Agriculture was severely hampered by the residual
effects of Hurricane Dean, which hit the island in August 2007.
This, coupled with the heavy rainfall and fires associated with the
subsequent drought, combined to decimate export crop production.
Mining output also declined due to decreasing bauxite production as
a result of maintenance and equipment problems at a number of
refineries--particularly disconcerting in an environment in which
Jamaica could have capitalized on rising aluminum prices. Despite
the fall in output, Jamaica's gross export earnings from bauxite/
alumina grew by more than 14 percent in 2007 to USD 1.3 billion.
Growth in the sector is expected to be 3 percent in 2008. While the
construction sector improved, the major stimulus was provided by
public sector projects. Increased tourist arrivals continued to
provide the growth impetus in the services sector.


Macroeconomic Instability Emerges
--------------


3. (SBU) Jamaica's vulnerability to external shocks, including
rising international commodities prices, makes it susceptible to
frequent bouts of instability. In fact, current rising external
prices and domestic policy-induced measures have combined to fuel
prices for the first half of 2008. Inflation of 11.5 percent for
the six month period already has exceeded the original target of
nine to ten percent. The movement was also 6.4 percentage points
above the 5.1 percent recorded in the similar period of 2007. Most
of the inflation was registered in urban areas, with soaring prices
in energy (up 34.3 percent) and food (up 34.9 percent). The impact
of rising oil prices was particularly devastating, given that
Jamaica depends on imported crude oil for over 90 percent of its
energy needs. Although the GOJ provided a three month subsidy on
basic food items, the shock to domestic agriculture and the
subsequent hike in domestic prices essentially nullified the
benefits. Further impetus was provided by a number of policy
induced measures including increased tax, transportation, and

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utility rates. The policy decisions were largely responsible for
the near five percent rate of inflation recorded in May and June.


Monetary Policy Challenged
--------------


4. (SBU) The increased prices have provided their own set of
challenges to the Central Bank. Although the local currency has
remained relatively stable, with the exchange rate depreciating by
just over one percent for the first half of the year, the foreign
exchange market has been relatively volatile. Attendant efforts to
maintain exchange rate stability have come at a significant cost to
fiscal and monetary policy. The Central Bank therefore has had to
utilize all the instruments at its disposal to defend the currency.
In particular, the bank has been forced to engage in open market
operations (OMO),increasing interest rates by three percentage
points (to 15 percent) for the first half of the year. In addition
to crowding out private investment, the increased rates eventually
will impact fiscal policy, as the higher cost of money will only
magnify the debt burden. The bank also has had to frequently
intervene in the market by selling foreign currency from its stock
of net international reserves (NIR) to temper rising demand
pressures. Despite the pressure on its foreign currency reserves,
the NIR was supplemented with USD 250 million raised through the
sale of government bonds on the capital markets and loans from
multilateral lenders. In total the stock of NIR jumped by USD 350
million to USD 2.3 billion. But again, this and the OMO have not
come without cost, as at the end of June the Central Bank recorded a
loss of USD 26 million to implement its monetary policy.


5. (SBU) Soaring commodities prices also have fuelled a
deterioration in the current account position, with the deficit
climbing by USD 340 million to USD 538.6 million for the first three
months of the year. A deterioration in the merchandise (goods)
trade deficit was the main source of the widening, stemming from
significant increases of USD 237.4 million (58.3 percent) and USD
38.9 million (22.6 percent) in the values of mineral fuels (crude
oil and refined products) and manufactured goods imports,
respectively. The impact of soaring mineral fuels has been softened
by increased earnings from alumina and non-traditional exports. But
even as other areas of the current account continue to decline,
remittances from Jamaicans living abroad remained resilient.
Central Bank economist Chandar Henry told emboff that remittances
for the first half of the year jumped an impressive 11.5 percent.
These figures are not surprising to Noel Greenland of Western Union,
the country's largest remittance company. Greenland told emboffs
that in addition to the obligatory nature of the remittance flows,
most overseas Jamaicans are employed in areas that have been
relatively unscathed by the economic downturn in North America.
Tourist arrivals also have remained buoyant as European and Canadian
tourists are finding Jamaica a bargain. Arrivals from the U.S.
climbed 7.7 percent due to the diversion of visitors from more
expensive destinations in Europe. Stop over visitor arrivals
climbed by 9.9 percent for the first five months of 2008.
Antoinette Lyn, a statistician at the Jamaica Tourist Board, told
emboff that barring any unforeseen challenges she expects both
earnings and arrivals to continue on an upward trajectory.


Reforms Help Government Accounts
--------------


6. (SBU) Even though the monetary side struggled, fiscal policy
continued to outperform expectations, with government operations
generating a deficit of USD 126 million for the first two months of
the fiscal year; four percent better than projected. A combination
of moderate spending and, more importantly, increased revenue
collections were responsible for the improvement. The higher tax
collection is attributable to Minister of Finance and the Public
Service Audley Shaw's ambitious reform agenda. Shaw claims there
has been a 37 percent increase in taxes collected in June 2008 from
the same month last year. Ministry of Finance officials told Emboff
that about USD 30 million of the USD 170 million in tax revenue
collected is due to the tax amnesty.

But Debt Overhang Persists
--------------


7. (SBU) Despite efforts to reduce the country's gargantuan debt
stock, Jamaica continues to be the fourth most indebted country in
the world, with a debt to GDP ratio of close to 130 percent (USD 14
billion) at the end of May. The problem is that the associated
interest payments can run up to fifty cents out of every dollar of

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revenue, leaving government to borrow to finance principal payments
and to a lesser extent some of its house keeping spending. Although
Jamaica has a long history of debt, most of the load was accumulated
between 1996 and 2003, when the debt to GDP ratio jumped by over 70
percentage points. The doubling is largely attributable to
recurrent fiscal deficits and the absorption of liabilities from
loss making public sector entities like Air Jamaica (reftel E).
(Note: The airline has lost USD 85 million for the first five months
of the year, building on a loss of USD 171 million for 2007. The
GOJ hopes to privatize the airline by March 2009, End Note). The
GOJ's medium-term goal is to balance the budget by fiscal year
2010/11 and bring the level of debt down to below 100 percent of
GDP. While the government has garnered low cost loans from
multilaterals, there continues to be an up tick in the stock of
debt, with almost USD 50 million added during the first four months
of 2008. And with GDP stagnating, the ratio could move in the wrong
direction, eroding the medium-term goal.

And Other Vulnerabilities Remain
--------------


8. (SBU) Several major alternative investment schemes including Cash
Plus, CAREIF have collapsed since April. One of the largest, Olint,
collapsed in July. It is not certain how much money was invested in
the various schemes, but some major investors were affected by
Olint; the impact of the collapse is expected to deal a serious blow
to the economy in general and the real estate market in particular
(reftel A). There also could be a downturn in domestic investment
as affected investors recover from the fallout. The stalling of
some investment projects also could result in the addition of a
number of Jamaicans to the ranks of the unemployed, putting a dent
in the consumer spending and consumption tax revenue needed to keep
the economy afloat. But the worst impact yet could be felt in the
real estate market, which was partially driven up by a false sense
of new wealth by those involved in the schemes. Add to this the
over USD 200 million in debt accumulated by loss making entities
like Air Jamaica, the National Road Operating and Construction
Company, and the Jamaica Urban Transport Company (JUTC),and the
burden on fiscal policy increases. And while the privatization of
the Sugar Company of Jamaica was completed in recent days, the GOJ
will have to absorb the USD 40 million redundancy costs.


Government's Reform Agenda
--------------


9. (SBU) The GOJ's nine month economic performance has been largely
set by Shaw's ambitious reform agenda, which includes: (1) fiscal
discipline; (2) reduced bureaucracy; (3) investment promotion; (4)
tax reform; (5) engagement of multilaterals; and (6) energy
diversification. Shaw has been particularly passionate about tax
reform and in particular an assault on corruption. As a precursor
to the reform process, Shaw pledged to provide transparent
governance so taxpayers receive value for their taxes. However, he
has pointed out that almost USD 1 billion in tax arrears remains
outstanding, of which over USD 600 million is owed by the private
sector. To address the issue Shaw introduced a graduated tax
amnesty program expected to end in October (reftel F). Shaw also
has started reducing transfer taxes and stamp duties and is pledging
to bring corporate taxes in line with personal income tax (25
percent) before further reducing both to 15 percent. Plans are on
track to consolidate statutory deductions by the end of 2008, and
legislation is being drafted for tax agencies to share information
under a Tax Collection Act. Customs, which Shaw says is a hotbed
for corruption, is under increased scrutiny, with the no-nonsense
former Director of Elections Danville Walker recruited to overhaul
operations. A number of top level tax officials suspected of either
corruption or incompetence already have been suspended, transferred,
or retired. There also has been a significant increase in the value
of goods declared.

Reforms Yielding Positive Results
--------------


10. (SBU) On May 19, 2008, Standard & Poor's Ratings Services
affirmed its 'B' long-term and short-term sovereign credit ratings
on Jamaica, while maintaining its stable outlook. According to S&P,
the ratings were supported by the GOJ's commitment to fiscal
discipline, debt reduction, and economic reinvigoration. The rating
was also premised on continued political stability and capital
market development. The IMF, in its 2008 Article IV Consultation,
also considered the broad nature of Jamaica's structural agenda as
appropriate, and even encouraged an expeditious implementation of
reforms. IMF officials also welcomed the GOJ's pursuit of fiscal

KINGSTON 00000704 004 OF 005


adjustment aimed at balancing the budget by 2011 and at establishing
a virtuous cycle of lower debt and higher growth. However, they
noted the adjustment effort must be underpinned by broad-ranging
reforms of the tax system and the public service.


11. (SBU) The GOJ also has made good on its plan to engage
multilaterals and has received commitments for over USD 130 million
for fiscal year 2008/09, including USD 30 million for the tax reform
initiative. The GOJ's reform agenda also has allowed it to benefit
significantly from technical expertise, with the IMF providing a
team of consultants to review the tax incentive system. In addition
to a USD 1.6 million grant to focus on enhancing the accountability
framework, the IDB also has provided consultants to work on the tax
system, while the World Bank has been providing ongoing technical
assistance. Positive results also have taken place on the
divestment front, with the USTDA providing USD 820,000 in grant
funds to assist in the privatization of Air Jamaica. The GOJ also
has entered into an agreement with Brazilian company Infinity
Bio-energy to take over the assets of the Sugar Company of Jamaica
(SCJ). The government also has taken the decision to discontinue
offering guarantees to public sector entities raising private
financing, a practice which has contributed significantly to amount
of the debt accrued.

Energy a Binding Constraint, Jobs Elusive
--------------


12. (SBU) Rising energy costs continue to reduce Jamaica's
attractiveness to investors, especially in energy intensive sectors.
Jamaicans now pay about USD 0.31 per kilowatt hour for electricity
compared to USD 0.13 for other Caribbean countries. This is largely
due to the fact that the country relies on imported oil for more
than 90 percent (29 million barrels of crude) of its energy needs.
In 2007 the country spent USD 2.2 billion (almost 25 percent of GDP)
on oil imports, and this figure could climb to almost USD 3 billion
or 30 percent of GDP by the end of 2008. Recognizing the magnitude
of the problem, the GOJ has made a commitment to have 15 percent of
its energy needs come from renewable sources by 2015. Minister of
Energy Clive Mullings also outlined a number of energy conservation
measures during his budget debate in July 2008. He also proposed
the creation of legislation to allow for net metering. And while
Don Gittens of Jamaica's Trade and Invest told emboff that the new
government has been able to attract a number of tourism, information
technology, and mining projects, to date it has fallen short on its
promise of massive job creation. On the contrary, the GOJ has been
forced to lay off almost 1,000 workers from some public sector
entities, which were heavily overstaffed. Add to this the almost
2,000 expected to join the ranks of the unemployed due to the sale
of the SCJ. The U.S. garment manufacturer Jockey will close its
last plant in Jamaica by December ending 575 jobs. Jockey also
closed a 600 worker plant in Clarendon Jamaica in 2007.

Outlook for Next Six Months
--------------


13. (SBU) Rising prices remain one of the biggest threats to the
Jamaican economy over the next six months particularly in the
context of the meltdown in alternative investment schemes. The
expected reduction in effective demand amidst rising prices could
slow government and consumer spending as well as investment, which
in turn will keep economic growth moribund. The spike in the cost
of imported commodities will also feed expectations for higher wages
as well as a demand for increased returns on investments. If these
expectations are satisfied it could lead to further adjustments in
domestic goods and services prices even when international prices
recede. Higher international commodities prices combined with the
erosion of traditional trade preferences could lead to a widening of
the country's current account to over 15 percent of GDP. Respected
financial analyst Keith Collister has told emboffs that this figure
could escalate as high as 20 percent by the end of 2008. The
Balance of Payments (BOP) situation would have been worse, if it
were not for the concessionary terms offered under the Petrocaribe
Agreement. The fact that Petrocaribe benefits have helped Jamaica
avert economic disaster has not been lost on Prime Minister Bruce
Golding. In recent months he has been warming up to Cuba and
Venezuela in contrast to his pre-election stance (reftel G).

And Political Imperatives Emerge
--------------


14. (SBU) Record prices and the current crime wave making life
difficult for average Jamaicans and are likely to thwart the Jamaica
Labor Party's (JLP) reform agenda (reftel H). Polls also show that
Golding's favorability ratings have stagnated. Although Opposition

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Leader Portia Simpson-Miller is facing her own set of challenges,
her ratings have rebounded. With these issues in mind, the GOJ
could well stall or backtrack on its reform agenda to win back
support, a concern expressed by Acting Deputy Financial Secretary at
the Ministry of Finance and the Public Service, Courtney Williams.


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


15. (SBU) The Jamaican economy is expected to face serious
challenges during the next six months, particularly given the
expected slowdown in investment and consumer spending following the
meltdown of alternative investment schemes. Add to this the
country's susceptibility to natural disasters such as hurricanes,
and the near-term outlook dims. Even in the face of these
challenges, the GOJ is better served if it continues to embark on
the reforms required to spur growth and development. Minister Shaw
appears determined to remain on track for tax reform and bolstering
anticorruption efforts regardless of the political costs. His
efforts already are paying significant dividends, especially in tax
collections. Shaw also has defied local critics and the opposition
Finance Minster Omar Davies by garnering substantive loans and
technical expertise from multilaterals. But, Shaw could find the
next couple months to be particularly challenging as the slowing
world economy takes a further toll on Jamaica. The single biggest
threat to reform will come from emerging political dynamics with
talks of a new election remaining topical. If this materializes, it
could thwart, if not reverse, some of the reforms, as the government
tries to regain popularity among a disenchanted electorate. End
comment.
JOHNSON