FEW OPTIONS FOR CASH STRAPPED JAMAICA

UNCLAS SECTION 01 OF 03 KINGSTON 000306 SENSITIVE 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: N/A TAGS: ECON TRYS ENRG EFIN EINV ETRD EAIR IADB IBRD IMF KCOR, KIPR, XL, JM SUBJECT: FEW OPTIONS FOR CASH STRAPPED JAMAICA REF: A) KINGSTON 303 B) KINGSTON 269 C) KINGSTON 245 D) KINGSTON 223 ¶1. (SBU) SUMMARY. As the Bruce Golding-led administration reaches the 18 month mark; the Government of Jamaica (GOJ) faces difficult decisions on the eve of its second budget presentation. Still suffering the effects of the global economic meltdown and frozen credit markets, the GOJ has been forced to take a hard look at its practice of generating persistent fiscal deficits and greater debt. The severity of the situation is weighing on Golding, who has signaled that changes are inevitable. Already, he has taken the symbolic step of foregoing a wage increase and taking a 15 percent wage cut and has encouraged his civil service colleagues to follow suit. He has made it clear that public sector workers either have to accept a wage freeze or face up to 22,000 job cuts. Given the current economic malaise, more robust action will be needed, including a possible return to the IMF and perhaps debt restructuring. The GOJ may also be seeking a new central bank governor. Some analysts are concerned that a mooted gas tax could spark unrest and rioting, as occurred in 1997. End Summary. BUDGET HIKE AMIDST ECONOMIC MALAISE -------------- ¶2. (SBU) The GOJ is set to spend USD 6.2 billion (up 8 percent in nominal terms) during the 2009/10 fiscal year of which 56 percent or USD 3.5 billion has been allocated to servicing the country's gargantuan public debt. (Note: The budget has actually shrunk nearly 8 percent in real terms compared to last year). The increased spending is coming amidst a 0.6 percent decline in GDP following growth of 2.7 and 1.4 percent in 2006 and 2007 respectively. Although commodities prices, and by extension inflation, have moderated to some degree, the current account deficit of USD 3.2 billion or 21.9 percent of GDP for 2008 is the largest on record for Jamaica. The deterioration in the current account deficit was influenced by a widening of the trade deficit to USD 5 billion following a USD 1 billion spike in oil imports. At the same time, slowing global growth reduced external demand for Jamaican goods, particularly bauxite and alumina, leading to a far more modest rise in exports at USD 399 million. ¶3. (SBU) The shortfall of payments relative to receipts, coupled with the reduction in access to global credit and financial markets, precipitated a demand supply imbalance, leading to a 23 percent depreciation in the local currency since September 2008 (reftels). To stem the tide the central bank hiked interest rates to 24 percent, while continuing its practice of augmenting supplies using resources from its stock of Net International Reserves (NIR). However, with demand pressures resilient, the stock of NIR has declined to USD 1.6 billion or 12.8 weeks of goods imports. This is just above the international benchmark of three months of goods imports, suggesting that any further depletion could lead to renewed speculation and further instability in the foreign exchange market. REVENUES DIVE -------------- ¶4. (SBU) The proposed budget hike also comes against the background of stagnant revenue growth, a direct result of the economic slowdown. For the first 11 months of the 2008/09 fiscal year the GOJ collected USD 2.7 billion, USD 240 million below projections. As a result, the fiscal deficit for the same period is running at USD 784 million, or USD 10.2 million more than targeted. The revenue shortfall is largely due to the fall off in sales taxes as demand for goods and services by Jamaicans declines. There was also no levy on profits from Bauxite/Alumina companies following the decision by companies to halt production in the face of falling global demand for aluminum (reftels). CAPITAL SPENDING SLASHED TO COMPENSATE -------------- ¶5. (SBU) As revenues fell and wages and interest payments rose, the GOJ was forced to cut capital expenditure by USD 200 million. Although this non-obligatory area of expenditure remains easy prey, it starves the economy of the capital infrastructure required to boost economic activity. A lack of capital spending also reduces jobs in the construction sector for both skilled and unskilled workers, a sector that was already hit by a slowdown as construction KINGSTON 00000306 002 OF 003 of tourist hotels has stalled. To close the financing gap the GOJ also sourced USD 257 million more than planned from the debt market. The higher demand for credit by the GOJ is partially responsible for the continued high domestic interest rates; in addition to increasing debt servicing costs, GOJ credit demand will continue to crowd out private sector investment. WAGE FREEZE OR JOB CUTS? -------------- ¶6. (SBU) While little emphasis is placed on wages and salaries, this area of expenditure is expected to account for 21 percent of the budget this year. This means that 77 cents of every dollar of revenue or new borrowing will be used to finance wages and salaries and debt servicing for next fiscal year. The GOJ's determination to make good on its debt obligations means it will need to focus on ways of reducing its increasingly burdensome public sector wage costs. Already, PM Golding has signaled his intention to arrest the growth in this area by agreeing to forego his own wage increase in addition to giving up 15 percent of his current salary. Golding has encouraged his colleagues on both sides of the political divide to follow suit. ¶7. (SBU) Although his party officials have agreed to the request, members of the opposition party are resisting. In the face of robust trade union opposition, Golding also has announced a wage freeze in the public sector, noting that the only other option would be a cut of up to 22,000 jobs. Even though Golding is taking a tough stance, he faces significant opposition from three of the strongest public sector groups: teachers, nurses, and doctors. Already Labor Minister Pearnel Charles has had to apply for an injunction to stop doctors from staging a work slowdown. GAS TAX COULD FUEL RIOTS -------------- ¶8. (SBU) Golding is opting for a potentially politically volatile route of increasing borrowing and introducing new tax measures to finance the budget. The GOJ will likely introduce a new tax package including a gas tax (Note: in 1997 a similar measure fuelled the only island-wide riot in Jamaica's recent history, reftels. End Note). The "gas riots" lasted for three days, crippling economic activity and hurting tourism, and only abated after the GOJ rescinded the decision. Jamaica Observer Columnist and Financial Analyst Keith Collister told emboffs that the GOJ was debating a JMD 9-10 flat tax (about USD ll cents) on a liter of gas, which now sells for as high as JMD 65 (USD 74 cents). Collister, a government sympathizer, also alluded to a possible consumption tax on electricity, and told emboffs that he had advised the GOJ to implement the gas tax in smaller tranches over the year. He said if both measures are implemented concurrently, there is likely to be rioting of the proportions seen in 1997. ¶9. (SBU) Collister's advice appears to be finding support, as senior technocrat at the Ministry of Finance and the Public Service Courtney Williams told emboffs that the proposed fuel tax was negotiated down to JMD 7.50 (USD 8.5 cents) per liter, and his preferred position remained JMD 5.00 (USD 5.6 cents). He said the electricity tax was still under consideration but, was even more troublesome, given that a tax could lead to increased theft especially among larger consumers of electricity. ((Note: Non technical loss of electricity-theft-at the Jamaican Public Service Company (JPSC),the monopoly power provider, already stands at 13.2 percent of total output)). Williams said with the JPSC already due for a rate increase, a consumption tax would be a double whammy. He also said that the gas tax, which is being sold as a revenue source to be placed in a dedicated fund for infrastructure, was proposed for implementation in 2008 when fuel prices were falling, but this was rejected by the political directorate. In confirming this position, Collister said that the proposal was actually accepted by Minister Without Portfolio in the Finance Ministry, Don Webhy, but apparently rejected by Audley Shaw, Minister of Finance and Public Service. ¶10. (SBU) Williams, who also confirmed an increase in the income tax threshold to reduce the burden on the formal economy, appears to be less concerned about possible rioting. His view is grounded in the fact that tax payers already are expecting the tax. (Note the idea of a potential new gas tax has appeared in newspapers and on the radio for several weeks). He said the probability of rioting will be largely based on the size of the tax. He appeared even more concerned about the policy-induced inflationary effects of the tax KINGSTON 00000306 003 OF 003 measures and the resulting rising prices that would have a more significant affect on poorer Jamaicans. IMF PROGRAM IMMINENT -------------- ¶11. (SBU) Even if the GOJ is able to add a new tax package and implement expenditure reductions, the country still faces significant economic malaise. Remittances, the country's largest and most resilient foreign exchange flow, have been declining by double digits since the beginning of 2009 (reftels). Coupled with the expected collapse in bauxite/alumina and scrap metals earnings, as well as flat tourism receipts, the overall prospects look bleak. Given this scenario, there is rising indication that the GOJ will have to seek an arrangement with the IMF (reftels). Even PM Golding has backed off his previous position of ruling out a return, by announcing that a team will be undertaking exploratory talks with the IMF. Although necessary, this is not an easy step for Golding given the huge political cost associated with a return to the IMF (Note: Jamaicans blame the IMF for some of the ills facing the country because of the austerity measures previously associated with its lending arrangements. End Note). ¶12. (SBU) Shaw's former personal assistant, Sidjae Robinson, told emboffs that Jamaica already was in discussions with the Fund and an early arrangement could well be a reality. She said the process should be aided by the fact that Shaw and current IMF Head, Dominique Strauss Kahn, have developed a good working relationship -- Strauss Kahn visited Jamaica at the end of 2008. Courtney Williams also told emboff that internal discussions were ongoing for a possible return to the IMF, but the move was facing resistance from central bank governor Derrick Lattibeaudiere, who ironically stands to benefit (the move would help foreign exchange, interest rate and inflation problems). (Note: Although the central bank falls under the authority of Audley Shaw, Minister of Finance and Public Service, the governor has traditionally operated autonomously. However, this may change if Lattibeaudiere remains at odds with Shaw on key issues like the IMF. Lattibeaudiere caused outrage among the business community earlier in the year when he took measures to raise interest rates. Robinson asked Emboffs for resumes of possible candidates with central banking experience, indicating Shaw may be looking to replace central bank governor. End Note). DEBT RESTRUCTURING DEBATE -------------- ¶13. (SBU) Talk about a possible restructuring of the domestic debt has also emerged in the last two weeks. The issue was raised during questioning on the proposed budget at the Standing Finance Committee of Parliament. PM Golding, cognizant of the damage any official talk of debt restructuring could have on the credit market, was at pains to point out that the GOJ was committed to continue making good on its debt obligations. He did disclose, though, that discussions were taking place among a group of creditors, and he would be willing to listen to any proposal they might present. In a thinly veiled warning to creditors, he went on to suggest that it was in everyone's interest to understand the current problems facing the country and do what was in the best interest of everyone. Trade unions also have been arguing that labor should not continue to bear the brunt of the adjustments (wage freeze) and it was about time capital (creditors),the major beneficiary of the high interest rate policy, face some of the pain. COMMENT -------------- ¶14. (SBU) The GOJ faces continued hurdles in the face of the global economic crisis, frozen credit markets, and falling revenue from its three key sectors: tourism, bauxite and remittances. If the proposed tax package does lead to public disturbances or riots, it could further hurt the tourism sector. The sector is still fearful that the recent attempted hijacking incident of Canadian passengers aboard a CanJet in Montego Bay could deal a blow to the sector and hurt future earnings (reftel). Although well handled by Jamaican security forces and the GOJ's tourism public relations team, it is too early to tell what impact that event may have on tourist arrivals. Emboffs are attending the budget debate in Parliament on April 23, and will report suptel on specifics of the tax package and expenditures. End Comment. HEG