JAMAICA: CAUGHT IN A DEBT TRAP-- CENTRAL BANK GOVERNOR

UNCLAS KINGSTON 000914

SENSITIVE
SIPDIS
STATE FOR WHA/CAR (VDEPIRRO) (WSMITH) (JMACK-WILSON)
WHA/EPSC (MROONEY) (FCORNEILLE)
EEB/ESC/IEC (GGRIFFIN)
EEB/ESC/IEC/EPC (MMCMANUS)
INR/RES (RWARNER)
INR/I (SMCCORMICK)
SANTO DOMINGO FOR FCS AND FAS
TREASURY FOR ERIN NEPHEW
EXPORT IMPORT BANK FOR ANNETTE MARESH
USTDA FOR NATHAN YOUNG AND PATRICIA ARRIAGADA
OPIC FOR ALISON GERMAK

E.O. 12958: N/A
TAGS: ECON EFIN EINV PINR IADB IBRD IMF TRSY XL JM
SUBJECT: JAMAICA: CAUGHT IN A DEBT TRAP-- CENTRAL BANK GOVERNOR
RESIGNS; IMF SOLUTION?

REF: KINGSTON 614; KINGSTON 800; KINGSTON 422; KINGSTON 517
KINGSTON 551

Summary

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1. (SBU) The resignation of the Governor of the Central Bank,
Derick Latibeaudiere, during the middle of an International
Monetary Fund (IMF) negotiations may be a sign that the time has
come for the Government of Jamaica (GOJ) to face the severity of
the situation and negotiate a solution with private holders of
Jamaican debt, a resolution referred to as a "debt operation" by
the IMF. On November 2 the Standard and Poor's rating agency
downgraded Jamaica to CCC from CCC plus in response to
Latibeaudiere's departure fearing the likelihood of selective
default. Jamaica holds the unenviable record of being among the
most indebted countries in the world, with a debt-to-GDP ratio of
108 percent. At the end of July 2009, the country's stock of
public debt stood at USD 14.2 billion, which means that each
Jamaican's share of debt is about USD 5,260, in a country with a
per capita income of less than USD 4,500. Most of the debt load
arose over a seven year period due to persistent fiscal deficits as
well as the take-over of government guaranteed debt. Over the same
period, there was a marked shift in borrowing from multilaterals to
private creditors, with a majority of the country's debt now owed
to Jamaican residents. This, combined with Jamaica's proud record
of never defaulting on debt, makes any prospect of an involuntary
debt solution daunting. However, the worsening fiscal dynamics
combined with the continued contraction in GDP will make any
further jump in the stock of debt increasingly unsustainable.
Jamaica might therefore be forced to finally swallow its pride and
embark on the politically and financially difficult path of debt
restructuring. End summary.



The Raw Numbers

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2. (SBU) Jamaica holds the unenviable record of being the fourth
most indebted country in the world behind Zimbabwe, Japan, and
Lebanon. At the end of July 2009, Jamaica's stock of public debt
stood at USD 14.2 billion or 108 percent of GDP. Domestic debt
accounts for USD 8 billion of the total debt, while external debt
accounts for the remaining USD 6.2 billion. At this level, each
Jamaican's share of the national debt amounts to USD 5,260, above
the per capita income level of less than USD 4,500. The gargantuan
debt places a huge burden on the country's limited resources, with
almost 52 cents of every dollar of revenue collected by the
Government of Jamaica (GOJ) being used to pay interest. Interest
and principal payments together (total debt servicing) account for
over 100 percent of revenues, forcing the GOJ to borrow to service
debt; a clear warning sign of the chronic fiscal and debt
challenges facing the country.



History of Debt

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3. (SBU) Jamaica's insatiable appetite for debt had its genesis in
the lost decade of the 1970s, when a combination of external and





domestic policy-induced shocks set the stage for borrowing.
Ironically, the 1970s oil crisis not only increased Jamaica's
demand for funds to pay for the commodity, but also provided a
willing cadre of lenders awash with oil revenues. Even worse, the
country's foray into socialism and by extension distributive
policies, led to persistent fiscal deficits and an erosion in
output. By the end of the decade, the left-leaning Michael
Manley-led government was forced to tap multilateral and bilateral
lending agencies for loans in order to fill the gap in the
country's finances.



Forming An Addiction

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4. (SBU) The rising debt load accelerated in the 1980s, when the
center-right Edward Seaga led-administration capitalized on the
availability of highly concessionary loan facilities. This policy
led to a doubling of the debt load to 212.4 percent of GDP by 1984.
Of this amount, external debt accounted for 152.9 percent, up from
63 percent in 1980. However, unlike the previous period when
output was declining, the latter part of the 1980s was
characterized by robust economic growth and fiscal surpluses. The
Peoples National Party (PNP)-led administration that followed from
1989 to 2007 also had a significant appetite for borrowing, but
unlike the earlier decades when debt was sourced from the external
market, this period saw a rapid acceleration of financial
liberalization and the development of the domestic capital market.




Growth in Domestic Debt, Emergence of a Financial Crisis

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5. (SBU) The evolution of the domestic capital market was to open
up a new borrowing option for a government now hooked on debt, due
to the re-emergence of persistent fiscal deficits. Between 1996
and 2003, the national debt increased by 71 percentage points, with
the largest annual increase of 22 percentage points occurring in

2001. Several factors led to the growth of the debt during this
period. Most importantly was the rapid development of the
financial market, spurred on by liberalization in the sector. This
led to an eventual collapse of the financial sector in the latter
half of the 1990s. The GOJ opted to rescue failed financial
entities including several key banks, insurance companies, and
pension funds. The subsequent resolution of the financial crisis,
commonly referred to as the Financial Sector Adjustment Company
(FINSAC),resulted in the GOJ absorbing USD 3.1 billion in debt
(41.2 percent of GDP),probably the most expensive resolution to a
financial crisis worldwide in terms of cost to GDP.



Borrowing From Peter to Pay Paul

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6. (SBU) Jamaica's burgeoning debt stock can also be attributed to
the absorption of public sector liabilities, commonly referred to
as contingent liabilities. Between 1996 and 2003 the GOJ absorbed
USD 124.3 million (4.9 percent of GDP) in government guaranteed
debt from public enterprises. Losses from the Bank of Jamaica
(Central Bank) accounted for a further USD 187 million (8.7 percent
of GDP) over the period. For the GOJ the single greatest





contributor to the build-up in debt has been the practice of
borrowing to service debt, due to persistent fiscal deficits over
the years. These fiscal deficits, which are largely the result of
the GOJ's failure to collect sufficient tax revenues to cover
expenditures, have forced the government into the position of
either rolling over debt when it comes due or borrowing from one
set of creditors to pay another.



Who Holds The Debt?

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7. (SBU) Since 1999 there has been a marked shift in borrowing from
multilateral and bilateral lenders to domestic creditors. At the
beginning of the 1990s over 75 percent of the total debt stock was
owed to external lending agencies. However, by the end of the
decade there was a dramatic reversal, with 60 percent of the debt
stock owed to locals. There was also a shift within the external
debt portfolio from official to private creditors. Even though
these loans were sourced at much higher rates of interest, it was
more attractive to the Patterson-led administration, which was bent
on avoiding the scrutiny of the multilaterals. Patterson, a strong
proponent of the Non-Aligned Movement, was also keen to pursue
domestic policies and escape what he considered the "dictates of
outsiders". The policy started with the much heralded ending of
borrowing relations with the International Monetary Fund (IMF) in

1996. By the end of 2004 the GOJ had repaid its outstanding debt
to the IMF. Bilateral debt also declined from USD 1.7 billion in
1996 to USD 0.6 billion at the end of 2008.



A Return to the Multilaterals

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8. (SBU) The most dramatic shift in terms of the nature of the debt
was the USD 3.8 billion movement in debt sourced from external
private creditors in just over a decade. Although these bonds were
sold in the external capital market, they were immediately bought
by Jamaicans on the secondary market. When the PNP's 18 year rule
came to an end in August 2007, the new Jamaica Labour Party-led
government opted for a major policy shift and returned to the
multilaterals. Since 2007, the GOJ has secured cheaper loans from
the multilateral lending agencies led by the Inter American
Development Bank (IADB) and the World Bank (WB). The GOJ's timing
was remarkably advantageous as it occurred just months before the
worst global economic recession in decades and the tightening of
credit worldwide. As the external capital market closed to Jamaica,
the GOJ was able to source almost USD 1 billion from these
institutions at concessionary rates of interest.



Possible Liability Management Program?

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9. (SBU) The worsening fiscal dynamics led by declining revenues,
has forced the GOJ to increase its appetite for domestic private
debt. This pushed interest rates as high as 24 percent, thus
further stifling access by private creditors at a time when credit
is crucial to kick-start the moribund economy. The meteoric rise
in domestic debt combined with the local ownership of external
private debt also makes any prospect of a liability management
program (a managed or technical default on debt) explosive within





Jamaica. Add to this the country's proud and enviable record of
never defaulting on debt, and the possibility of a radical solution
appears less likely.



GOJ Gets Cold Feet, Shelves Debt Relief Plan

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10. (SBU) During August of 2009, on the back of a downgrade from
ratings agency Standard and Poor's (S and P),the GOJ retreated
from a voluntary liability management program offered by local
financial institutions (REFTEL A). In its analysis the S and P
stated that the offer had the smell of a default, which set off
concerns within the GOJ. The initiative was aimed at relieving the
GOJ's short-term debt service costs by exchanging high-cost debt on
a voluntary basis for debt with lower rates of interest. Minister
of Finance and the Public Service Audley Shaw in a press release
stated that Cabinet had taken a decision not to pursue this option,
stating, "Cabinet, after careful consideration of the proposal and
mindful of the uncertainty in the market, has decided that the
Government will not be pursuing this proposal." The move would
have provided the GOJ with some financial breathing room in the
near term, since the GOJ did not pursue the option it was forced to
increase its allocation to interest payments by USD 182 million, in
the recently tabled Supplementary Estimates (REFTEL B). This
brought the overall allocation of interest payments for fiscal year
2009/10 to USD 2 billion or almost half of the entire recurrent
budget. It also represents a 30 percent increase on the amount
allocated last year, further highlighting the debt conundrum facing
Jamaica.



Point Of No Return

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11. (SBU) The general consensus appears to be that the time has
come for the GOJ to face the severity of the situation and
negotiate a solution with private holders of Jamaican debt, a
resolution referred to as a "debt operation" by the IMF (REFTELS C,
D, E). So firm is the IMF in its conviction, that Director of
Fiscal Policy at the Ministry of Finance, Courtney Williams
confirmed to Emboffs that this issue is a potential deal breaker in
the country's current negotiation for a USD 1.2 billion Stand-By
Agreement. Williams said that although the IMF is pleased with all
the other concessions made by the GOJ, they are still awaiting a
replacement for the failed liability management program, as a
viable solution needs to be found to the debt predicament.
Barclay's Capital, a New York-based division of Barclays Bank, has
also weighed in on the country's debt plight, suggesting that
Jamaica is approaching the "point of no return" and that it will
take more than fiscal adjustments to regain long-term
sustainability. The investment bank is proposing that the GOJ
should seek the help of the IMF to restructure its debt instead of
seeking another loan to merely postpone the country's agony.



Head of Central Bank Steps Down

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12. (SBU) Derick Latibeaudiere, the Governor of the Bank of
Jamaica, who has been staunchly opposed to any form of debt
restructuring, resigned (possibly was forced out) on October 30 in





the middle of a visit by representatives from the IMF. His
departure could open the door to a possible debt operation with the
IMF. On November 2, the S and P downgraded Jamaica to CCC from CCC
plus in response to Latibeaudiere's departure fearing the
likelihood of selective default.





Former Russian Official Weighs In

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13. (SBU) The most radical suggestion to date has come from the
former Russian Finance Minister, Alexander Livshits. Speaking to a
group of Jamaican businessmen in Kingston, the former Minister
argued that the time had come for the GOJ to commence negotiations
with the London Club of creditors to bring its debt under control.
Livshits, who oversaw a similar arrangement while he was Minister,
stated that Jamaica already is experienced in dealing with the
Paris Club having negotiated similar agreements in the past. He
suggested that after the restructuring process, the debt should be
capped and new borrowing limited to cheaper funds. "There should
be a special Government decision or, better, a law establishing a
long-term framework for new borrowing", he continued. He opined
that ultimately Jamaica will only rid itself of a heavy debt burden
in the medium-term if it generates economic growth by investing in
projects such as those leading to cheaper energy. (NOTE: Livshits
currently represents UC Rusal, whose bauxite operations in Jamaica
have ceased operations due to high domestic energy cost. END NOTE)




Comment

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14. (SBU) After years of mortgaging the country's future to satisfy
its insatiable appetite for debt, even the GOJ now appears to be
coming to the realization that the current debt dynamics are
unsustainable. Ever mindful of guarding its reputation of never
defaulting on debt, the GOJ has been slow to take the necessary
measures to address its unsustainable debt problems. This was most
evident when the GOJ shunned the opportunity to gain some relief
under a debt liability management program. The JLP-led government
knows a debt restructuring move will be both politically and
financially explosive because a large portion of the external
private debt is held by Jamaican creditors. Apart from hurting
domestic creditors and possibly financial sector stability, any
attempt to address debt could also drive savvy investors to switch
to foreign assets, creating the unwelcome problem of foreign
exchange market instability. However, despite the possible
short-term ramifications, it would appear that radical surgery in
the form of a debt operation will be required to address the debt
problem and to provide the economy with a fighting chance for
recovery and growth. The GOJ cannot afford to attempt to muddle
through - otherwise, it might well lead to strangulation by debt.
End Comment.
Parnell