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Jamaica's debt threat
A Tale of Two Crises - 2003/4 and 2008/9 - Part I
By KEITH COLLISTER
Friday, October 09, 2009
The University of the West Indies held a very timely economic forum last Wednesday, where they asked me to speak on the issue of Jamaica's debt. The following is a highly edited version of my speech which was entitled - A Tale of Two Crises - 2003/4 and 2008/9, to be published in two parts. The first part, dealing with the period 2003 to 2004, has important lessons for the current crisis.
KEITH COLLISTER
Shortly after the closely contested election of October 2002, Finance Minister Dr. Omar Davies made his famous speech telling his audience of party supporters that he had had to sacrifice the fiscal targets to win the election.
Following the release of Jamaica's supplementary budget estimates in early December, on December 19th, 2002, international rating agency Standard and Poors (S&P) revised the outlook for Jamaica's B+ long-term foreign currency sovereign rating from stable to negative.
In her research note justifying the outlook revision, S&P's then sovereign analyst Jane Eddy had noted "Jamaica's projected budget deficit is about eight per cent of GDP for Fiscal Year 2002, which greatly exceeds the 4.5 per cent budgeted deficit." She argued that "This slippage occurred during a parliamentary election year, when the government eased its traditional tight fiscal control."
Jane Eddy projected that, as a result, the general government's heavy debt burden would climb to an estimated 139 per cent of GDP for Fiscal Year 2002 (it actually reached 150 per cent of GDP), reversing the recent gradual downward trend. She noted that proposed tax measures and expenditure cuts "may prove insufficient to lower the government's significant debt level over the medium term, thus tilting the risks to the rating to the downside."
The same morning, Prudential stockbroker Jason Abrahams, one of the top traders in Jamaican debt internationally and also close to the local market, noted in a client e-mail "the very real risk in a situation like this is a self fulfilling debt spiral. In a relatively highly taxed country (by emerging market standards) where infrastructural deficiencies and crime combine to limit economic growth, the Government has few viable solutions. With debt expected to reach a 140 per cent of GDP this year Jamaica has one of the highest debt to GDP ratio's in the measured universe". He also noted that "the media in Jamaica has recently enjoyed comparing Jamaica to Argentina and I am frequently asked by clients whether or not Jamaica is going to follow Argentina down the slippery slope to default".
Jamaica's problems were not, however, common to the emerging debt market universe as a whole, as JP Morgan's emerging market bond index (EMBI) returned 13 per cent in 2002, outperforming all US bond asset classes that year.
On the first day of the New Year in 2003, a noticeable acceleration in capital flight in Jamaica began. The high net worth domestic clients of a number of leading money market players asked for their money to be moved outside of Jamaica immediately, with no interest in any product with Jamaica sovereign risk.
In early 2003, then Finance Minister Omar Davies made a presentation at the Bear Stearns Central American and Caribbean Credit Conference, the leading investment conference of its kind on the Caribbean at the time, which was open only to select institutional investors. In a research note on the conference, Dr Carl Ross, then chief emerging markets economist for US investment bank Bear Stearns, noted that "last week, the Bank of Jamaica and the Ministry of Finance instituted a special reserve requirement on banks that appears to have been aimed directly at currency speculators betting against the Jamaican dollar". Whilst noting that the dollar rally to $50.50 from $52.05 "feels temporary" and that "this is a very blunt policy instrument", Dr Ross advised that "we do not expect the Jamaican dollar to collapse", no doubt reflecting the views of the policymakers he had recently spoken to.
Around the same time, in the first PSOJ economic policy meeting of 2003, I advised a senior official no longer at the Ministry of Finance of the likelihood that we could face a currency crisis, but the person seemed to believe it would be business as usual.
A few short weeks later, on the 26th of March, the Bank of Jamaica increased interest rates on its 30, 60, 90, 120, 180 and 365 day open market instruments sharply to 15, 15.3, 20, 24, 33.15, 34.5 and 35.95 per cent respectively. Particularly noteworthy was that the key six month treasury bill rate jumped from just over 18.75 per cent to 33.15 per cent, in line with BOJ's new six month policy rate. One of Jamaica's leading economic analysts estimated that the annualised increase in interest costs would be between $30 to $35 billion, based on a rough estimate that a one per cent increase in debt costs raised interest costs by $2.5 billion. At that time, the Bank of Jamaica appeared to believe its traditional high interest rate medicine would still work to protect the dollar.
The 2003 budget imposed substantial new tax measures, which were opposed by the private sector. In the 10 days after a frosty post budget open meeting between the Jamaica Chamber of Commerce and the Minister of Finance (who left with his key technocrats to Washington immediately after the JCC meeting), the Jamaican dollar experienced one of the world's fastest currency collapses, moving from $50 to over $70 Jamaican dollars to one US dollar.
The real reason for the currency collapse, of course, was not the imposition of new tax measures (although that may have been the tipping point in terms of its impact on private sector confidence) but the severe stress the high interest rates had already placed on the domestic financial sector. The prices of the Eurobond's owned by local financial players had fallen sharply as major international investment banks published research questioning the sustainability of Jamaica's very high debt, then estimated at roughly $600 billion Jamaican dollars or about 150 per cent of GDP, and our sharply rising interest costs. At the time, one major international securities dealer estimated that there was approximately US$250 million in margin lending (loans against Jamaican Eurobonds) to Jamaican security dealers, and perhaps another US$200 to 300 million in additional margin being utilised to buy other instruments eg Fannie Mae/Freddie Mac instruments, on leverage. A key element of the currency collapse was the margin calls caused by the big international brokers reducing their loans to the Jamaican financial sector (this should sound familiar), forcing them to buy US dollars locally. In addition, the local money market players were suffering very negative cash flow on their recently purchased domestic bond portfolio's, which now had to be financed by giving investors much higher domestic interest rates.
In a paper dated April 10th, 2003, entitled "The Jamaican Money Market - A Capital Structure Trap", I argued that "the real reason we have managed to avoid a Government debt crisis to date (although that may be about to change), particularly an exchange rate crisis during the Finsac period, was that investor confidence was maintained by generating an attractive perceived risk/reward ratio through our "over developed" money market. The degree to which policymakers lack understanding of their good fortune over the period, and the potential for overconfidence in their crisis management skills as a result, will in my opinion determine whether we sink into a debt/exchange crisis over the course of the coming fiscal year.
There is a critical macroeconomic reason why the situation in the last quarter of 2008 seems eerily familiar, which we will explore in a subsequent article on Sunday.
http://www.jamaicaobserver.com/magaz...EBT_THREAT.asp
A Tale of Two Crises - 2003/4 and 2008/9 - Part I
By KEITH COLLISTER
Friday, October 09, 2009
The University of the West Indies held a very timely economic forum last Wednesday, where they asked me to speak on the issue of Jamaica's debt. The following is a highly edited version of my speech which was entitled - A Tale of Two Crises - 2003/4 and 2008/9, to be published in two parts. The first part, dealing with the period 2003 to 2004, has important lessons for the current crisis.
KEITH COLLISTER
Shortly after the closely contested election of October 2002, Finance Minister Dr. Omar Davies made his famous speech telling his audience of party supporters that he had had to sacrifice the fiscal targets to win the election.
Following the release of Jamaica's supplementary budget estimates in early December, on December 19th, 2002, international rating agency Standard and Poors (S&P) revised the outlook for Jamaica's B+ long-term foreign currency sovereign rating from stable to negative.
In her research note justifying the outlook revision, S&P's then sovereign analyst Jane Eddy had noted "Jamaica's projected budget deficit is about eight per cent of GDP for Fiscal Year 2002, which greatly exceeds the 4.5 per cent budgeted deficit." She argued that "This slippage occurred during a parliamentary election year, when the government eased its traditional tight fiscal control."
Jane Eddy projected that, as a result, the general government's heavy debt burden would climb to an estimated 139 per cent of GDP for Fiscal Year 2002 (it actually reached 150 per cent of GDP), reversing the recent gradual downward trend. She noted that proposed tax measures and expenditure cuts "may prove insufficient to lower the government's significant debt level over the medium term, thus tilting the risks to the rating to the downside."
The same morning, Prudential stockbroker Jason Abrahams, one of the top traders in Jamaican debt internationally and also close to the local market, noted in a client e-mail "the very real risk in a situation like this is a self fulfilling debt spiral. In a relatively highly taxed country (by emerging market standards) where infrastructural deficiencies and crime combine to limit economic growth, the Government has few viable solutions. With debt expected to reach a 140 per cent of GDP this year Jamaica has one of the highest debt to GDP ratio's in the measured universe". He also noted that "the media in Jamaica has recently enjoyed comparing Jamaica to Argentina and I am frequently asked by clients whether or not Jamaica is going to follow Argentina down the slippery slope to default".
Jamaica's problems were not, however, common to the emerging debt market universe as a whole, as JP Morgan's emerging market bond index (EMBI) returned 13 per cent in 2002, outperforming all US bond asset classes that year.
On the first day of the New Year in 2003, a noticeable acceleration in capital flight in Jamaica began. The high net worth domestic clients of a number of leading money market players asked for their money to be moved outside of Jamaica immediately, with no interest in any product with Jamaica sovereign risk.
In early 2003, then Finance Minister Omar Davies made a presentation at the Bear Stearns Central American and Caribbean Credit Conference, the leading investment conference of its kind on the Caribbean at the time, which was open only to select institutional investors. In a research note on the conference, Dr Carl Ross, then chief emerging markets economist for US investment bank Bear Stearns, noted that "last week, the Bank of Jamaica and the Ministry of Finance instituted a special reserve requirement on banks that appears to have been aimed directly at currency speculators betting against the Jamaican dollar". Whilst noting that the dollar rally to $50.50 from $52.05 "feels temporary" and that "this is a very blunt policy instrument", Dr Ross advised that "we do not expect the Jamaican dollar to collapse", no doubt reflecting the views of the policymakers he had recently spoken to.
Around the same time, in the first PSOJ economic policy meeting of 2003, I advised a senior official no longer at the Ministry of Finance of the likelihood that we could face a currency crisis, but the person seemed to believe it would be business as usual.
A few short weeks later, on the 26th of March, the Bank of Jamaica increased interest rates on its 30, 60, 90, 120, 180 and 365 day open market instruments sharply to 15, 15.3, 20, 24, 33.15, 34.5 and 35.95 per cent respectively. Particularly noteworthy was that the key six month treasury bill rate jumped from just over 18.75 per cent to 33.15 per cent, in line with BOJ's new six month policy rate. One of Jamaica's leading economic analysts estimated that the annualised increase in interest costs would be between $30 to $35 billion, based on a rough estimate that a one per cent increase in debt costs raised interest costs by $2.5 billion. At that time, the Bank of Jamaica appeared to believe its traditional high interest rate medicine would still work to protect the dollar.
The 2003 budget imposed substantial new tax measures, which were opposed by the private sector. In the 10 days after a frosty post budget open meeting between the Jamaica Chamber of Commerce and the Minister of Finance (who left with his key technocrats to Washington immediately after the JCC meeting), the Jamaican dollar experienced one of the world's fastest currency collapses, moving from $50 to over $70 Jamaican dollars to one US dollar.
The real reason for the currency collapse, of course, was not the imposition of new tax measures (although that may have been the tipping point in terms of its impact on private sector confidence) but the severe stress the high interest rates had already placed on the domestic financial sector. The prices of the Eurobond's owned by local financial players had fallen sharply as major international investment banks published research questioning the sustainability of Jamaica's very high debt, then estimated at roughly $600 billion Jamaican dollars or about 150 per cent of GDP, and our sharply rising interest costs. At the time, one major international securities dealer estimated that there was approximately US$250 million in margin lending (loans against Jamaican Eurobonds) to Jamaican security dealers, and perhaps another US$200 to 300 million in additional margin being utilised to buy other instruments eg Fannie Mae/Freddie Mac instruments, on leverage. A key element of the currency collapse was the margin calls caused by the big international brokers reducing their loans to the Jamaican financial sector (this should sound familiar), forcing them to buy US dollars locally. In addition, the local money market players were suffering very negative cash flow on their recently purchased domestic bond portfolio's, which now had to be financed by giving investors much higher domestic interest rates.
In a paper dated April 10th, 2003, entitled "The Jamaican Money Market - A Capital Structure Trap", I argued that "the real reason we have managed to avoid a Government debt crisis to date (although that may be about to change), particularly an exchange rate crisis during the Finsac period, was that investor confidence was maintained by generating an attractive perceived risk/reward ratio through our "over developed" money market. The degree to which policymakers lack understanding of their good fortune over the period, and the potential for overconfidence in their crisis management skills as a result, will in my opinion determine whether we sink into a debt/exchange crisis over the course of the coming fiscal year.
There is a critical macroeconomic reason why the situation in the last quarter of 2008 seems eerily familiar, which we will explore in a subsequent article on Sunday.
http://www.jamaicaobserver.com/magaz...EBT_THREAT.asp
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