JAMAICA: FISCAL CRISIS THREATENS MONETARY STABILITY

UNCLAS KINGSTON 000048 SENSITIVE SIPDIS STATE FOR WHA/CAR (VDEPIRRO) (WSMITH) (JMACK-WILSON) WHA/EPSC (MROONEY) (FCORNEILLE) EEB/IFD/ODF (MSIEMER) EEB/ESC/IEC (GGRIFFIN) EEB/ESC/IEC/EPC (MMCMANUS) EEB/TRA (VLIMAYE-DAVIS) 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 ETRD ENRG EFIN EINV PREL PINR SOCI TRSY OPIC IBRD, IMF, XL, JM SUBJECT: JAMAICA: FISCAL CRISIS THREATENS MONETARY STABILITY REF: KINGSTON 735; KINGSTON 914; KINGSTON 956; KINGSTON 737 Summary and Analysis -------------- ¶1. (SBU) Jamaica's fiscal crisis is beginning to threaten monetary stability, with the Bank of Jamaica (BOJ) (central bank) forced to extend direct credit to the Government of Jamaica (GOJ) as well as purchase debt instruments shunned by the market. The BOJ accommodation has become necessary because of the significant decline in revenues as well as the uncertainty associated with the drawn out International Monetary Fund (IMF) negotiations for a Standby-by Agreement and the likely impact of a liability management program (Reftel A). Declining confidence combined with recent rate cuts also have prompted investors to hold funds at the BOJ on short-term deposits at low rates of interest. But the BOJ action has serious implications for price stability, as it could fuel inflation and inflationary expectations. With investors relatively liquid and losing confidence by the day, there also could be a run on the currency, which has its own monetary implications. Against this background, the urgency of an IMF Stand-by Agreement cannot be overstated. End Summary and Analysis. Fiscal Crisis Deepens - New BOJ Leadership -------------- -------------- ¶2. (SBU) The fiscal crunch facing Jamaica since the closure of the international capital markets continues unabated. The fiscal deficit for the eight month period to November was USD 980 million, USD 167 million more than targeted. At this level, the fiscal deficit was just below the USD 1.1 billion projected for the entire fiscal year and was twice the amount generated during the same period last year. This highlights the worsening fiscal dynamics facing the cash strapped economy, particularly since the beginning of 2009. The stagnation in revenue collections remains the underlying reason for the deterioration in the fiscal position. Revenues and grants were USD 250 million lower than projected, largely because of the falloff in consumption taxes. This underperformance in revenues is not surprising, given the sluggish economic conditions. The almost USD 2 billion in new taxes over the last five years has led to increased tax evasion, thus diminishing expected returns. The falloff in revenues and higher than expected interest costs forced the GOJ to slash programs and capital spending by USD 130 million. These challenges also will test the BOJ's new leadership: Brian Wynter assumed the position of BOJ Governor on December 1, 2009, replacing Derick Latibeaudiere (Reftel B). Investor Confidence Wanes -------------- ¶3. (SBU) As revenues continued to underperform, the GOJ was forced to tap the domestic capital market funds to finance its spending. However, this occurred at the same time the central bank reduced benchmark rates by 200 basis points. The BOJ predicated its decision on: the positive trends in inflation; balance of payments; the exchange rate; and the economic program being negotiated with the IMF. The government has said this program was underpinned by a package of policy measures geared towards fiscal and debt sustainability which is expected to lay the foundation for stability and growth. The rate reduction, combined with the imposition of a USD 250 million tax-package as well as the uncertainty associated with the timing of an IMF Stand-by Agreement contributed to a further decline in confidence; investors shunned two securities on offer from the government. Central Bank Turns on Printing Press -------------- -- ¶4. (SBU) This forced the GOJ to tap the BOJ, which turned on the printing press to satisfy the credit appetite of its largest client. During November, the bank extended credit in the amount of USD 57 Million to the GOJ, of which only USD 28 million was repaid in December. With the GOJ strapped for cash, the remaining USD 29 million had to be converted to securities. But things took a turn for the worse in December; with revenues declining at an increasing rate, the GOJ was forced to seek even more loans from the domestic capital markets. The GOJ offered two instruments amounting to USD 212 million, of which only USD 12 million was taken up by the public. With the market shunning the offers, the bank was forced to prop up the government by purchasing the remaining USD 200 million. ¶5. (SBU) In a bid to stave off criticisms, the BOJ argued that the extension of the credit coincided with a period of heightened uncertainty among investors surrounding the terms of an IMF agreement and the potential impact of the anticipated debt management initiatives. The GOJ also held special meetings with major bankers on January 10 and January 11, seeking a voluntary agreement on lowering interest rates on government paper. Thus far, there is no indication of significant capital flight. In fact, investors have been holding their funds at the BOJ as overnight and short-term deposits, suggesting they were uncomfortable with the prevailing rates of interest on offer, given the increasing levels of risk. The moving target for an IMF agreement is continuing to erode the little confidence remaining in the market. (NOTE: In a televised address on January 13, Prime Minister Bruce Golding presented the GOJ's proposal, negotiated with the IMF, for a debt swap arrangement with domestic creditors. The Bank of Jamaica was expected to explain the program in more detail in a press conference on January 14. End Note). Comment -------------- ¶6. (SBU) The BOJ has been quick to point out that the practice of providing credit to the GOJ is a normal part of its operations. However, this new money, which influences demand, is bound to drive core inflation the longer it remains in circulation. The fact that increasingly skittish investors are holding significant amounts of funds at the BOJ at relatively low rates of interest also risks a run on the currency the longer current conditions prevail. In addition to the inflation risk, a run on the currency would also have serious implications for the government's interest rate reduction policy. But the BOJ action points to the even larger unsustainable fiscal and debt problems which are now threatening monetary stability. As debt and wage related expenditures are mounting, the country is running out of the cash needed to finance its day-to-day operations, thus further highlighting the urgency of an IMF Stand-by Agreement. End Comment. Parnell