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Jamaica - down, but not out
Keith Collister
Friday, July 11, 2008
Keith Collister, local economist and financial analyst
The headline is the title of a research piece by Dr Carl Ross, formerly of Bear Stearns and now managing director of investments for Oppenheimer, representing his views on Jamaica after his research trip here last week.
Dr Ross notes "Jamaica is facing the same headwinds as other energy- dependent countries, but I was surprised to see a few glimmers of positive news, such as a high level of net international reserves, decent fiscal results, and strong tourist arrivals. These trends give me some comfort that Jamaica can continue to muddle through, but muddling through is not a sustainable, long-term path."
The research piece, aimed mainly at Oppenheimer's international clients, lists weaknesses in our macroeconomic variables that will be very familiar to Jamaican investors, including our continued "anaemic" growth, 22.5 per cent inflation in the year to May, a "significantly higher" current account deficit than last year, much of which he unsurprisingly attributes "largely to higher oil prices". Dr Ross does not see much reason for bullishness near term, noting that second-quarter business and consumer confidence (as measured by the JCC index) is at a two-year low.
Of interest is his "applause" of the "Golding administration's inclination to supply side economics", which he believes is the proper response (not just for Jamaica) in the face of the current "stagflationary environment". In his view, policymakers must do what it takes to reduce business costs and increase supply.
With respect to tax reform, Ross notes the recent amnesty programme has yielded "better than expected results", which should broaden the tax base going forward and allow tax rates to be cut eventually. He also regards positively the emphasis on marketing-driven investment promotion, and an energy policy based on conservation, renewable energy and offshore drilling.
Concerning privatisation, Ross notes ,"One gets the feeling that in talking to these policymakers that there are few, if any, "sacred cows" and everything is on the table."
On interest rates, Ross questions the efficacy of domestic monetary policy, since the market knows the Bank of Jamaica (BOJ) cannot raise rates indefinitely with our high debt, and argues that our negative real interest rates means that "investors are likely to favour US dollar assets".
Ross sees some positives in Jamaica's situation
Despite our rising current account deficit, he notes our net international reserves are holding up very well, buoyed by a combination of favourable financing terms from Petrocaribe and some cross-border transactions, particularly from Trinidad, a clear reference to the purchase of Lascelles. He notes that our recent US$350 million bond issue met over half our external financing requirements, and the balance of approximately US$250 million may be financed through "multilateral lending institutions in Washington at lower rates".
Ross believes that the Government is placing a large "credibility bet" on its ability to meet its fiscal deficit target of 4.5% GDP this fiscal year, so that "barring a massive shock that is larger than those currently foreseen, the Government will meet its fiscal target for this year". He cites the signing of the new MOU with the unions as evidence that "the fiscal outlook for the next two years looks decent".
Finally, Ross explains that "tourism, the bread and butter of the Jamaican economy, has been strong," with arrivals for January to April up 10 per cent, with tourism officials projecting that 2008 "will see an 8-9 per cent increase in arrivals.", with the caveat that tourism officials are cautious about the next peak season.
Bubbles bursting
One thing that Dr Ross has not mentioned in his otherwise comprehensive analysis is the impact on our economic growth if financial bubbles, both in Jamaica and abroad, continue to burst.
In an article "Pyramids crumbling -- Major financial hurricanes have arrived, both local and foreign" for the Jamaica Observer early this year, I forecast that the "local" financial hurricane" had now arrived "as the players in our own "shadow banking system" appear to be suffering widespread redemptions, forcing many (and perhaps soon all) to cease paying".
Over the past week, the Jamaica Observer has carried a number of stories about one of the major "schemes", which the Financial Services Commission (FSC) now refers to as UFOs, or unregulated financial organisation, a reference that avoids the words alternative and investment.
The "musical chairs" money game appears to be finally at an end, even for what were supposedly "blue chip" schemes. What is remarkable is the extremely small size of the main "foreign exchange trading" broker mentioned in terms of all the key measures of capital, assets under management (far smaller than those of our smallest local securities dealer), and average assets per customer, as well as the totally negligible amount of trading that occurred in relation to the assets moved in and out of the broker by the scheme, which is normally a "red flag" for money laundering.
The bursting of the bubble of double digit monthly interest rates will differ from a typical stock market bubble in that, if no new money was created, those who did not get off the merry-go-round and still hold "assets" in the scheme will see their 'investment" go to zero, whereas even the most vicious stock market collapse would not normally exceed 80 per cent of the investment value. Unfortunately, it will not only be the well-heeled, but widows and orphans that find themselves without any assests, having been carried along by the false promise of easy money.
In a study of what it called informal investment schemes (IIS), the Caribbean Policy Research Institute (CAPRI) estimated that investors in IIS numbered at least 14,000, and more likely tens of thousands. The economic effect of this collapse is already being felt in the second quarter of this year, and that impact will unfortunately accelerate in the second half of the year in the form of a large negative wealth effect.
Those who thought themselves wealthy will find their supposed savings no longer exist. As a consequence, the price of real estate, cars and certain other large consumer durables is likely to fall over the next six to nine months, at least in real dollars after inflation.
The deadly cocktail of stagflation
More important than the impact of the failure of the schemes however, is the negative effect of rising energy and food prices on the world economy. Two hurricanes are simultaneously buffeting the world economy: an inflationary commodity price storm and a deflationary financial one.
This deadly cocktail of "stagflation"- induced commodity shocks is similar to both the recessions of 1974-75 and 1980-82 and the asset/credit booms and busts of 1990-91 and 2001, with the likely result being an ugly US recession and sharp global slowdown.
Rising mortgage defaults and bank write-downs and the end of temporary relief on tax rebates leave markets vulnerable to another bout of credit crisis panic. The possibility of an ugly US recession is sharply increased by Israel-Iran tensions that may worsen inflation through its impact on the price of oil. Even without geopolitical concerns, the world is running into limits on resources, at least in the short term. Since the end of 2001, the real price of oil has risen some sixfold, whilst global oil supply stagnated in 2007.
Moreover, recent financial market developments, such as this week's plunge in the price of the shares of major mortgage players Fannie Mae and Freddie Mac on the back of a Lehman report suggesting they needed to raise another US$75 billion in capital, strongly suggests that Wall Street's hope that the worst was behind it in terms of the financial crisis is unwarranted.
We still need to wait to see the impact of a slowing US and global economy on all credit, not just housing. Credit and credit derivative spreads are deteriorating again, and both the main US and UK main stock indexes have reached official bear market territory, down 20 per cent from their highs. Moreover, with the announced extension of the investment bank lending facility of the U.S.'s Central Bank, into late next year, the Federal Reserve appears to be trying to ward off another failure of a systemically important broker dealer, or put simply, another Bear Stearns.
Keith Collister
Friday, July 11, 2008
Keith Collister, local economist and financial analystThe headline is the title of a research piece by Dr Carl Ross, formerly of Bear Stearns and now managing director of investments for Oppenheimer, representing his views on Jamaica after his research trip here last week.
Dr Ross notes "Jamaica is facing the same headwinds as other energy- dependent countries, but I was surprised to see a few glimmers of positive news, such as a high level of net international reserves, decent fiscal results, and strong tourist arrivals. These trends give me some comfort that Jamaica can continue to muddle through, but muddling through is not a sustainable, long-term path."
The research piece, aimed mainly at Oppenheimer's international clients, lists weaknesses in our macroeconomic variables that will be very familiar to Jamaican investors, including our continued "anaemic" growth, 22.5 per cent inflation in the year to May, a "significantly higher" current account deficit than last year, much of which he unsurprisingly attributes "largely to higher oil prices". Dr Ross does not see much reason for bullishness near term, noting that second-quarter business and consumer confidence (as measured by the JCC index) is at a two-year low.
Of interest is his "applause" of the "Golding administration's inclination to supply side economics", which he believes is the proper response (not just for Jamaica) in the face of the current "stagflationary environment". In his view, policymakers must do what it takes to reduce business costs and increase supply.
With respect to tax reform, Ross notes the recent amnesty programme has yielded "better than expected results", which should broaden the tax base going forward and allow tax rates to be cut eventually. He also regards positively the emphasis on marketing-driven investment promotion, and an energy policy based on conservation, renewable energy and offshore drilling.
Concerning privatisation, Ross notes ,"One gets the feeling that in talking to these policymakers that there are few, if any, "sacred cows" and everything is on the table."
On interest rates, Ross questions the efficacy of domestic monetary policy, since the market knows the Bank of Jamaica (BOJ) cannot raise rates indefinitely with our high debt, and argues that our negative real interest rates means that "investors are likely to favour US dollar assets".
Ross sees some positives in Jamaica's situation
Despite our rising current account deficit, he notes our net international reserves are holding up very well, buoyed by a combination of favourable financing terms from Petrocaribe and some cross-border transactions, particularly from Trinidad, a clear reference to the purchase of Lascelles. He notes that our recent US$350 million bond issue met over half our external financing requirements, and the balance of approximately US$250 million may be financed through "multilateral lending institutions in Washington at lower rates".
Ross believes that the Government is placing a large "credibility bet" on its ability to meet its fiscal deficit target of 4.5% GDP this fiscal year, so that "barring a massive shock that is larger than those currently foreseen, the Government will meet its fiscal target for this year". He cites the signing of the new MOU with the unions as evidence that "the fiscal outlook for the next two years looks decent".
Finally, Ross explains that "tourism, the bread and butter of the Jamaican economy, has been strong," with arrivals for January to April up 10 per cent, with tourism officials projecting that 2008 "will see an 8-9 per cent increase in arrivals.", with the caveat that tourism officials are cautious about the next peak season.
Bubbles bursting
One thing that Dr Ross has not mentioned in his otherwise comprehensive analysis is the impact on our economic growth if financial bubbles, both in Jamaica and abroad, continue to burst.
In an article "Pyramids crumbling -- Major financial hurricanes have arrived, both local and foreign" for the Jamaica Observer early this year, I forecast that the "local" financial hurricane" had now arrived "as the players in our own "shadow banking system" appear to be suffering widespread redemptions, forcing many (and perhaps soon all) to cease paying".
Over the past week, the Jamaica Observer has carried a number of stories about one of the major "schemes", which the Financial Services Commission (FSC) now refers to as UFOs, or unregulated financial organisation, a reference that avoids the words alternative and investment.
The "musical chairs" money game appears to be finally at an end, even for what were supposedly "blue chip" schemes. What is remarkable is the extremely small size of the main "foreign exchange trading" broker mentioned in terms of all the key measures of capital, assets under management (far smaller than those of our smallest local securities dealer), and average assets per customer, as well as the totally negligible amount of trading that occurred in relation to the assets moved in and out of the broker by the scheme, which is normally a "red flag" for money laundering.
The bursting of the bubble of double digit monthly interest rates will differ from a typical stock market bubble in that, if no new money was created, those who did not get off the merry-go-round and still hold "assets" in the scheme will see their 'investment" go to zero, whereas even the most vicious stock market collapse would not normally exceed 80 per cent of the investment value. Unfortunately, it will not only be the well-heeled, but widows and orphans that find themselves without any assests, having been carried along by the false promise of easy money.
In a study of what it called informal investment schemes (IIS), the Caribbean Policy Research Institute (CAPRI) estimated that investors in IIS numbered at least 14,000, and more likely tens of thousands. The economic effect of this collapse is already being felt in the second quarter of this year, and that impact will unfortunately accelerate in the second half of the year in the form of a large negative wealth effect.
Those who thought themselves wealthy will find their supposed savings no longer exist. As a consequence, the price of real estate, cars and certain other large consumer durables is likely to fall over the next six to nine months, at least in real dollars after inflation.
The deadly cocktail of stagflation
More important than the impact of the failure of the schemes however, is the negative effect of rising energy and food prices on the world economy. Two hurricanes are simultaneously buffeting the world economy: an inflationary commodity price storm and a deflationary financial one.
This deadly cocktail of "stagflation"- induced commodity shocks is similar to both the recessions of 1974-75 and 1980-82 and the asset/credit booms and busts of 1990-91 and 2001, with the likely result being an ugly US recession and sharp global slowdown.
Rising mortgage defaults and bank write-downs and the end of temporary relief on tax rebates leave markets vulnerable to another bout of credit crisis panic. The possibility of an ugly US recession is sharply increased by Israel-Iran tensions that may worsen inflation through its impact on the price of oil. Even without geopolitical concerns, the world is running into limits on resources, at least in the short term. Since the end of 2001, the real price of oil has risen some sixfold, whilst global oil supply stagnated in 2007.
Moreover, recent financial market developments, such as this week's plunge in the price of the shares of major mortgage players Fannie Mae and Freddie Mac on the back of a Lehman report suggesting they needed to raise another US$75 billion in capital, strongly suggests that Wall Street's hope that the worst was behind it in terms of the financial crisis is unwarranted.
We still need to wait to see the impact of a slowing US and global economy on all credit, not just housing. Credit and credit derivative spreads are deteriorating again, and both the main US and UK main stock indexes have reached official bear market territory, down 20 per cent from their highs. Moreover, with the announced extension of the investment bank lending facility of the U.S.'s Central Bank, into late next year, the Federal Reserve appears to be trying to ward off another failure of a systemically important broker dealer, or put simply, another Bear Stearns.
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