JAMAICA: TWIN DEFICITS AND A USD 1 BILLION

C O N F I D E N T I A L KINGSTON 000245 SIPDIS STATE FOR WHA/CAR (ACADIEUX)(VDEPIRRO)(WSMITH) WHA/EPSC (MROONEY) (FCORNEILLE) EEB/ESC/IFD/EPC (MCMANUS) SANTO DOMINGO FOR FCS AND FAS TREASURY FOR ERIN NEPHEW E.O. 12958: DECL: 03/28/2024 TAGS: ECON ENRG SOCI EFIN EINV ETRD IADB IBRD TRYS IMF, XL, JM SUBJECT: JAMAICA: TWIN DEFICITS AND A USD 1 BILLION SHORTFALL REF: A. KINGSTON 223 ¶B. KINGSTON 91 ¶C. KINGSTON 45 Classified By: CDA James T.Heg for reasons 1.4 (b) and (d) SUMMARY -------------- ¶1. (C) Jamaica is facing a classic twin deficit problem, with both fiscal and balance of payments deficits rising quickly. The 2008-09 National budget will face a deficit of six percent of GDP, according to Finance Minister Audley Shaw. World Bank Country Representative Badrul Haque estimates that this deficit could rise to over 12 percent of GDP by next year unless serious mitigation measures are implemented. The question remains as to whether the Government of Jamaica (GOJ) has the political will to follow through on aggressive reforms. The World Bank estimates that the GOJ will require nearly USD 1 billion to fill the financing gap. About one-third of these funds already have been secured from multilaterals; the balance may need to come from the IMF. Jamaica has faced significant financial challenges before, but never in such an adverse global climate. END SUMMARY. Usual "Muddle Through" Approach Could Be Disastrous -------------- -------------- ¶2. (C) It is uncertain if the Jamaica Labour Party (JLP)-led government is willing to make a range of difficult and politically explosive choices including raising taxes, cutting public spending and reducing social services. Some measures being considered are a new gasoline tax. The last time this was proposed in April, 1999, there were island-wide riots over three-days, which affected commerce in general and tourism specifically as visitors were stranded in their hotels or at airports. The ensuing riots forced the government to rescind the proposed gas tax). Successive administrations of the GOJ have believed they can always &muddle through8 economic problems no matter how severe. However, this time around that approach could end in disaster. Other Measures On The Table -------------- ¶3. (C) Another option being considered is to freeze and/or cut public sector wages. Dwight Nelson, Minister without Portfolio in the Ministry of Finance and Public Service, told Emboffs on March 19 that a wage freeze was all but secured. Public sector wages and salaries account for the second largest part of GOJ expenditures, second only to service on the public debt. Currently, public debt-to-GDP stands at 114 percent, one of the highest in the world. Public sector workers have been allotted a seven percent salary increase for the upcoming fiscal year. ¶4. (C) Another option being considered is to apply the 16.5 percent General Consumption Tax (value added tax) to items that are currently zero rated. Other &sin8 taxes such as alcohol and cigarettes are likely to rise as well. Property taxes and various user fees may also increase. This new package of taxes will fuel further policy induced inflation, affecting price increases across the island. Twin Deficits and Re-Visit to IMF? -------------- ¶5. (C) Given the rising trade deficit and by extension balance of payment deficit (the second of the twin deficits) there has been significant instability in the foreign exchange market (reftels). The currency has depreciated by more than 10 percent since January 1. With this in mind, Bank of Jamaica (Central Bank) Governor Derrick Latibeaudiere may anticipate further foreign exchange market instability and by extension an attack on his highly guarded Net International Reserves (NIR). ¶6. (C) The NIR currently stand at USD 1.6 billion, down from a high of USD 2.25 billion last year. According to Courtney Williams, Acting Deputy Financial Secretary in the Ministry of Finance and Public Service, Latibeaudiere,s fear has led him to encourage Shaw to approach the IMF to seek balance of payment support. It is worth noting that there are personal tensions between Latibeaudiere--who acts as if he is independent of his boss Shaw--and the technocrats at the Ministry of Finance. (NOTE: Viralee Latibeaudiere, the Commissioner Designate of Taxation, indicated to Emboffs on March 25 that the GOJ is five or six percent away from hitting its tax revenue collection targets for the year. END NOTE). Multilateral Solutions? -------------- ¶7. (C) With the capital markets frozen because of the global financial crisis, Jamaica has little chance of accessing these and will be forced instead to rely on multilaterals. Even if credit conditions were normal, the recent downgrade of Jamaica,s credit rating by Moody,s and Standard and Poor,s (reftels) would have diminished the GOJ,s ability to tap credit. For the upcoming fiscal year, Jamaica has been able to secure USD 170 million from the IDB in policy-based loans, another 100 million in concessionary loans from the World Bank, and USD 33 million from the Caribbean Development Bank (CDB). However, it is estimated that most of these loans will not become available until well into the fiscal year. On March 23, Emboffs met with local representatives of the Embassy of Japan on March 23 who said they are considering a concessionary loan for project financing of nearly USD 55 million. The Japanese Embassy also is concerned about the GOJ,s ability to weather the current crisis. All Three Pillars of Economy Are Threatened -------------- ¶8. (C) Remittances, Bauxite, and Tourism account for just under half of GDP, and together form the three pillars of the local economy. Jamaica,s USD 2 billion in remittances have until recently been a model of resilience. (NOTE: Even after the 9-11 attacks and the ensuing economic downturn in the US economy, remittances continued to grow in Jamaica. END NOTE). Over the past six months, remittances have been declining, but the pace has increased in 2009. Remittances are down an average of 12 percent per month, and slumped to an 18 percent decline in February 2009. ¶9. (C) The temporary closure (possibly permanent) of two Russian-owned bauxite facilities (reftels) will result in a loss of USD 100 million in tax revenue (bauxite levy),as well as income tax from lost jobs. Althougt tourism arrivals have risen slightly over last year -- there were 464,589 visitors from December 15 to March 14 this year, up from 453,000 for the same period last year-- deep discounts by hotels are reducing profit margins. Sandals, a major resort chain, is advertising &once in a lifetime 55 percent off offers8 in the U.S. market. If the GOJ begins reducing public expenditures for police and security, the move could lead to a further rise in crime. Any high-profile incidents of crime against tourists could seriously depress the sector. COMMENT -------------- ¶10. (C) The GOJ held a Cabinet meeting on March 26 to discuss the budget and the fiscal challenges. The Ministry of Finance and Public Service is collecting a range of data that should give the GOJ a better understanding of the current economic situation by next week. There will likely be negative political fallout if the JLP-led government returns to the IMF for assistance, but no other options can be seen on the horizon. With a slim 32 to 28 majority in Parliament the opposition People's National Party (PNP) will likely try to take advantage of the situation. The biggest risk is that the GOJ is slow to act, thinking a "muddle through" approach can succeed one more time. END COMMENT HEG