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New Finance Paradigm: National Consensus Required on Debt
J'ca should refinance, not restructure its debt
By Keith Collister
Wednesday, October 28, 2009
Just under two weeks ago on Friday, the Observer's Caribbean Business Report led with the headline "Restructure Jamaica's debt". The CBR quoted former Russian finance minister Alexander Livshits as stating that he believed the Jamaican Government needed to restructure its debt in order to bring it under control.
The article quoted from Livshits written speaking notes, from which he had presented at the Jamaica Chamber of Commerce's (JCC's) very successful two day economic forum that began on Tuesday October 13.
However, the full quote of what Livshits actually said, with the aid of his translator, is that if the debt "cannot be refinanced, it should be restructured."
This is perfectly consistent with the key argument in his written notes that "new borrowing should be capped and anyway should be limited to the refinancing of existing debt on more favourable terms."
Livshits correctly argued that Jamaica's debt problem is a long term problem, and that "the solution to the problem cannot be solved on a partisan basis". Instead, it "needs national consensus, as it is a national task that needs a national solution." He added "if you unite, you will succeed".
In the preamble to his talk, Livshits had made a point of emphasising, in a very humble manner, that he was not trying to reproduce the Russian experience here, nor lecture Jamaica on what it should do, as he was not an expert on Jamaica's economy, which was in any case very different from that of Russia's. As he put it drily for emphasis "Russia was too cold, Jamaica too hot".
Livshits admitted that, while in his opinion Russia's domestic debt default was inevitable "we never defaulted on our foreign debt".
In 1998, like Jamaica, Russia had only recently started issuing Eurobonds on the international capital market. It was not the recently issued fixed rate Eurobond's that were Russia's problem, but the rising cost of Russia's very short term domestic debt. The domestic interest rate on Russia's debt first doubled in the months preceding May 18, 1998, reaching 47 per cent when inflation was only 10 per cent, before rising even more sharply to reach an annual yield of over 200 per cent when Russia defaulted less than three months later on August 13.
Like Russia in 1998, Jamaica's problem is not primarily the cost of our foreign debt, although substantially lower rates on any new foreign borrowing would certainly help. The main problem is the increase in overall interest costs for the current fiscal year reported in the supplementary budget, from J$159 billion to J$175 billion. This is entirely due to a J$15.7 billion rise in the interest cost of the internal debt, from $112.5 billion to $128.2 billion, the latter figure exceeding the entire level of interest costs (both domestic and foreign) for the 2008/2009 fiscal year of $125.3 billion. If we use the March 2009 figure for domestic debt of just under $652 billion (out of a total debt of $1.2 trillion), the average interest rate on the domestic debt would have increased from just over 17 per cent at the time of the budget to just under 20 per cent currently.
In analysing potential solutions to our debt crisis, we should first note that about 60 per cent of the domestic debt, or about $400 billion of the domestic debt, is variable rate meaning that it is (mostly) priced off the six month treasury bill. Over the course of a full year, a one per cent increase in treasury bill rates would therefore increase interest costs by approximately $4 billion. The six month treasury bill rate peaked at 24.45 per cent in December 2008, compared with an average yield of just over 14 per cent at the end of fiscal year 2007/8. The starting point of a solution for Jamaica's debt problem is therefore much lower domestic interest rates on a sustained basis, with the first order of business being to completely reverse the $50 billion rise in overall interest costs experienced this fiscal year. As the debt is likely to increase by at least $100 billion from the impact of this year's fiscal deficit alone, this will require even lower interest rates than those experienced in the 2007/2008 fiscal year.
However, our goal cannot be to merely return to our former path of simply muddling through. In the first place, this option may no longer even be possible, as tax revenues for the first five months to August of $100.3 billion are only $2.8 billion above the comparable five months in 2008. Without the imposition of a sizeable tax package in April, particularly the tax on gas, actual tax revenues would have been negative for the year to date compared with a similar period last year. This should be no surprise when the Jamaican economy is expected to decline by at least 4 per cent in real terms this year. Moreover, tax revenues are falling in nearly every country across the world, automatically leading to wider fiscal deficits.
Jamaica's problem is that our fundamentally weak economy, combined with what is likely to be a very sub par recovery for our main markets, most importantly the US, means that we cannot assume a significant rise in tax revenues next fiscal year even with fundamental tax reform (much less without it).
Furthermore, it is likely that any debt restructuring that endangers the financial system would either condemn Jamaica to many more years of stagnation (the social consequences of which cannot be underestimated), or would create such a serious shock to the economy that we would, like Argentina, take many years to reach our previous level of output.
A better solution is refinancing. The present engagement with the IMF, in the context of the international financial crisis, presents a once in a lifetime opportunity to allow Jamaica to break out of the extremely vicious debt treadmill that we have been on for well over two decades. The goal should be to almost halve interest costs from their current level, to no more than an annual $100 billion at the end of a three year period, with an IMF programme that locks in a sustainably lower domestic interest rate for the life of the programme, say 10 per cent on the domestic side, and at least halve the cost of any new foreign debt issued to below five per cent. It should be noted that as at March 2009, international bond debt represented 62 per cent of the just under US$6.2 billion in foreign debt, with an average interest rate of 9.83 per cent compared with the 3.8 per cent for bilateral and multilateral loans.
Such a fall in rates is only be possible with an extended period of very substantial support from the major multilaterals, namely the IMF, the IDB and the World Bank, who would need to be prepared to lend Jamaica enough money to allow the collapse of domestic interest rates to a level sufficient to make our debt sustainable.
Jamaica's extremely weak economy means that such a fall in rates would be unlikely to start a consumption boom, and the multilaterals would effectively be transferring the impact of the US Federal Reserve's zero interest rate policy, plus their loan spread, to the Jamaican government. Ideally, the template for the loans would be similar to the 1.3 per cent World Bank loan (London interbank offer rate plus a spread) that Jamaica received earlier this year, but that institution alone would need to be lending Jamaica US$1 billion, rather than the US$100 million actually approved.
The IMF should also need to be willing to change its policy from one of only lending for balance of payments support, to one of allowing lending for budget support, as has recently occurred in the case of Ukraine.
Some of the interest cost savings should be used to allow a real tax reform, that, amongst other things, creates the incentive necessary to spark real export led growth in the long neglected area of manufacturing and internationally trades services, particularly those that we don't yet have. The IMF should support this as this would allow Jamaica to generate the export earnings to actually pay it back.
The more mathematically astute will quickly realise that the savings from just lowering interest rates will not be enough to achieve debt sustainability with our extremely high fiscal deficit.
The government should therefore consider using the sixty day clause in domestic debt instruments to legally redeem some of the higher cost, fixed rate instruments, to be replaced as convenient with lower cost debt, taking appropriate account of any balance sheet effects on the financial system.
Such a refinancing is an infinitely preferable option to a higher withholding tax on interest (which all other things being equal would simply raise rather than lower the interest rate demanded by the market), or a super tax on banks (it was an unenviable piece of bad timing that this was last imposed in 1996 just as the financial crisis was starting).
Such a deal would also be preferable to a liability management programme (which it in some ways resembles) that only gave one lower interest rates at the front end, offset by higher rates at the back end. This is essentially what the requirement that the swap be net present value neutral to avoid a default actually means.
Unlike the recently cancelled liability management programme, such a refinancing would not have to be voluntary, and would certainly be opportunistic in terms of lowering interest rates. It would thereby avoid a key problem with the planned liability management programme, namely that Jamaica's downgrade to B- meant that S&P would deem any swap as neither voluntary nor opportunistic.
To agree the refinancing deal proposed, the IMF will at minimum require that Jamaica prepare a transparent set of books, eliminating all the creative accounting that has contributed to a growth in debt that has far exceeded our central government deficit over the past several decades.
The Government should also be ready to further strengthen the core economic team, ensuring that everyone understands that what the Prime Minister has termed "debt sustained" growth, or muddling through, is no longer acceptable.
By Keith Collister
Wednesday, October 28, 2009
Just under two weeks ago on Friday, the Observer's Caribbean Business Report led with the headline "Restructure Jamaica's debt". The CBR quoted former Russian finance minister Alexander Livshits as stating that he believed the Jamaican Government needed to restructure its debt in order to bring it under control.
The article quoted from Livshits written speaking notes, from which he had presented at the Jamaica Chamber of Commerce's (JCC's) very successful two day economic forum that began on Tuesday October 13.
However, the full quote of what Livshits actually said, with the aid of his translator, is that if the debt "cannot be refinanced, it should be restructured."
This is perfectly consistent with the key argument in his written notes that "new borrowing should be capped and anyway should be limited to the refinancing of existing debt on more favourable terms."
Livshits correctly argued that Jamaica's debt problem is a long term problem, and that "the solution to the problem cannot be solved on a partisan basis". Instead, it "needs national consensus, as it is a national task that needs a national solution." He added "if you unite, you will succeed".
In the preamble to his talk, Livshits had made a point of emphasising, in a very humble manner, that he was not trying to reproduce the Russian experience here, nor lecture Jamaica on what it should do, as he was not an expert on Jamaica's economy, which was in any case very different from that of Russia's. As he put it drily for emphasis "Russia was too cold, Jamaica too hot".
Livshits admitted that, while in his opinion Russia's domestic debt default was inevitable "we never defaulted on our foreign debt".
In 1998, like Jamaica, Russia had only recently started issuing Eurobonds on the international capital market. It was not the recently issued fixed rate Eurobond's that were Russia's problem, but the rising cost of Russia's very short term domestic debt. The domestic interest rate on Russia's debt first doubled in the months preceding May 18, 1998, reaching 47 per cent when inflation was only 10 per cent, before rising even more sharply to reach an annual yield of over 200 per cent when Russia defaulted less than three months later on August 13.
Like Russia in 1998, Jamaica's problem is not primarily the cost of our foreign debt, although substantially lower rates on any new foreign borrowing would certainly help. The main problem is the increase in overall interest costs for the current fiscal year reported in the supplementary budget, from J$159 billion to J$175 billion. This is entirely due to a J$15.7 billion rise in the interest cost of the internal debt, from $112.5 billion to $128.2 billion, the latter figure exceeding the entire level of interest costs (both domestic and foreign) for the 2008/2009 fiscal year of $125.3 billion. If we use the March 2009 figure for domestic debt of just under $652 billion (out of a total debt of $1.2 trillion), the average interest rate on the domestic debt would have increased from just over 17 per cent at the time of the budget to just under 20 per cent currently.
In analysing potential solutions to our debt crisis, we should first note that about 60 per cent of the domestic debt, or about $400 billion of the domestic debt, is variable rate meaning that it is (mostly) priced off the six month treasury bill. Over the course of a full year, a one per cent increase in treasury bill rates would therefore increase interest costs by approximately $4 billion. The six month treasury bill rate peaked at 24.45 per cent in December 2008, compared with an average yield of just over 14 per cent at the end of fiscal year 2007/8. The starting point of a solution for Jamaica's debt problem is therefore much lower domestic interest rates on a sustained basis, with the first order of business being to completely reverse the $50 billion rise in overall interest costs experienced this fiscal year. As the debt is likely to increase by at least $100 billion from the impact of this year's fiscal deficit alone, this will require even lower interest rates than those experienced in the 2007/2008 fiscal year.
However, our goal cannot be to merely return to our former path of simply muddling through. In the first place, this option may no longer even be possible, as tax revenues for the first five months to August of $100.3 billion are only $2.8 billion above the comparable five months in 2008. Without the imposition of a sizeable tax package in April, particularly the tax on gas, actual tax revenues would have been negative for the year to date compared with a similar period last year. This should be no surprise when the Jamaican economy is expected to decline by at least 4 per cent in real terms this year. Moreover, tax revenues are falling in nearly every country across the world, automatically leading to wider fiscal deficits.
Jamaica's problem is that our fundamentally weak economy, combined with what is likely to be a very sub par recovery for our main markets, most importantly the US, means that we cannot assume a significant rise in tax revenues next fiscal year even with fundamental tax reform (much less without it).
Furthermore, it is likely that any debt restructuring that endangers the financial system would either condemn Jamaica to many more years of stagnation (the social consequences of which cannot be underestimated), or would create such a serious shock to the economy that we would, like Argentina, take many years to reach our previous level of output.
A better solution is refinancing. The present engagement with the IMF, in the context of the international financial crisis, presents a once in a lifetime opportunity to allow Jamaica to break out of the extremely vicious debt treadmill that we have been on for well over two decades. The goal should be to almost halve interest costs from their current level, to no more than an annual $100 billion at the end of a three year period, with an IMF programme that locks in a sustainably lower domestic interest rate for the life of the programme, say 10 per cent on the domestic side, and at least halve the cost of any new foreign debt issued to below five per cent. It should be noted that as at March 2009, international bond debt represented 62 per cent of the just under US$6.2 billion in foreign debt, with an average interest rate of 9.83 per cent compared with the 3.8 per cent for bilateral and multilateral loans.
Such a fall in rates is only be possible with an extended period of very substantial support from the major multilaterals, namely the IMF, the IDB and the World Bank, who would need to be prepared to lend Jamaica enough money to allow the collapse of domestic interest rates to a level sufficient to make our debt sustainable.
Jamaica's extremely weak economy means that such a fall in rates would be unlikely to start a consumption boom, and the multilaterals would effectively be transferring the impact of the US Federal Reserve's zero interest rate policy, plus their loan spread, to the Jamaican government. Ideally, the template for the loans would be similar to the 1.3 per cent World Bank loan (London interbank offer rate plus a spread) that Jamaica received earlier this year, but that institution alone would need to be lending Jamaica US$1 billion, rather than the US$100 million actually approved.
The IMF should also need to be willing to change its policy from one of only lending for balance of payments support, to one of allowing lending for budget support, as has recently occurred in the case of Ukraine.
Some of the interest cost savings should be used to allow a real tax reform, that, amongst other things, creates the incentive necessary to spark real export led growth in the long neglected area of manufacturing and internationally trades services, particularly those that we don't yet have. The IMF should support this as this would allow Jamaica to generate the export earnings to actually pay it back.
The more mathematically astute will quickly realise that the savings from just lowering interest rates will not be enough to achieve debt sustainability with our extremely high fiscal deficit.
The government should therefore consider using the sixty day clause in domestic debt instruments to legally redeem some of the higher cost, fixed rate instruments, to be replaced as convenient with lower cost debt, taking appropriate account of any balance sheet effects on the financial system.
Such a refinancing is an infinitely preferable option to a higher withholding tax on interest (which all other things being equal would simply raise rather than lower the interest rate demanded by the market), or a super tax on banks (it was an unenviable piece of bad timing that this was last imposed in 1996 just as the financial crisis was starting).
Such a deal would also be preferable to a liability management programme (which it in some ways resembles) that only gave one lower interest rates at the front end, offset by higher rates at the back end. This is essentially what the requirement that the swap be net present value neutral to avoid a default actually means.
Unlike the recently cancelled liability management programme, such a refinancing would not have to be voluntary, and would certainly be opportunistic in terms of lowering interest rates. It would thereby avoid a key problem with the planned liability management programme, namely that Jamaica's downgrade to B- meant that S&P would deem any swap as neither voluntary nor opportunistic.
To agree the refinancing deal proposed, the IMF will at minimum require that Jamaica prepare a transparent set of books, eliminating all the creative accounting that has contributed to a growth in debt that has far exceeded our central government deficit over the past several decades.
The Government should also be ready to further strengthen the core economic team, ensuring that everyone understands that what the Prime Minister has termed "debt sustained" growth, or muddling through, is no longer acceptable.
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