Tweet
Default or devalue - Jamaica's choice
Published: Friday | September 28, 2012 0 Comments
Aubyn Hill, Financial Gleaner Columnist
Aubyn Hill, Financial Gleaner Columnist
Finance Minister Peter Phillips faces the most awful ]economic and political dilemma. He is the minister whose job it is to make a choice, a recommendation to Cabinet, on whether the Jamaican government will default on Government of Jamaica (GOJ) bonds, or whether the GOJ will allow, or have no choice but to allow, the Jamaican dollar to devalue against the USD and other major currencies.
The dragging, incomplete arrangement with the IMF and the August 8, 2012 announcement of a major bond restructuring plan (default) by the Government of Belize (GOB) have added a rather sharp edge and urgency to the decision.
The move by the GOB on its 8.50 per cent 2029 bonds puts it in the pariah category with a country such as Ecuador or maybe Ivory Coast.
The three options offered bondholders by the GOB are unattractive in the extreme. Bondholders can opt for a 'no haircut' deal but would have to accept a slash of the coupon rate from 8.5 per cent to two per cent — a drop of 76.27 per cent — and a brutal maturity extension to 2062; or a 45 per cent principal haircut, a 13-year maturity extension and a massive cut in the coupon rate with step-ups from one per cent to four per cent over the new tenor; or a 45 per cent haircut in principal with payments structured like those of a mortgage with principal and interest levelled, and a 58.82 per cent cut in the coupon rate to 3.5 per cent per annum.
BONDHOLDERS JITTERY
Bondholders in Jamaica are jittery and scared. If we look at the published data of three of Jamaica's large financial institutions, the source of the anxiety is easy to identify and just as easily understood.
On September 30, 2011, NCB listed J$204.75 billion as "investment securities" and now has J$187 billion invested in GOJ paper. Sagicor's December 31, 2011 "financial investments" totalled J$114.76 billion, while Scotiabank's current exposure to the GOJ is J$140.64 billion (not counting another $40 plus billion to the Bank of Jamaica).
If we take 90 per cent of Sagicor's exposure and add Scotiabank's J$141 billion and NCB's J$187 billion we get the whopping figure of J$431 billion as the exposure of just these three major financial firms to GOJ securities.
If the minister of finance were to recommend a 15 per cent haircut, that would wipe out J$65 billion of wealth from these three institutions. A 25 per cent default would erode J$108 billion.
After the loss and pain which holders of GOJ securities have had to bear under the Bruce Golding administration's JDX scheme, it will be a very, very brave finance minister, backed by a fearless and confident prime minister that will put this policy decision to the country.
One can just presume that the finance minister has been getting very forceful pushback at any sign of such a default, or strong pre-emptive discouragement from executives at these firms.
All this pushback is not without a significant measure of irony. Through the 1990s and up to 2011 some of these financial institutions were major debt facilitators who were consistently influential in loading the GOJ - and, by extension, Jamaican taxpayers - with unsustainable debt. One major luminary in the financial publicly labelled Jamaica a 'failed state', and still the institution he led, and others like his, kept piling debt on the backs of taxpayers.
THE DEVALUATION OPTION
With Jamaica's debt to GDP running at about 140 per cent — the total debt is about J$1.7 trillion — our productivity below par, our economic growth rate near negative and our exports negligible at best, many objective observers believe the Jamaican currency is overvalued.
Many believe that Minister Phillips should have allowed the currency to adopt a more significant slide as soon as he took office in January.
The BOJ would have cautioned him against letting the Jamaican dollar slip too fast, but very weak demand and high unemployment reduced the risk of a serious spike in inflation.
Instead, we have been using our scarce NIR funds at the BOJ to defend an unsustainable JMD exchange rate.
Demand for the US and Canadian dollar by local businesses and individuals is strong.
The NIR could continue to shrink. It's already down to US$1.428 billion at the end of August from US$2.126 billion at August 2011, and from US$1.967 billion at the end of December 2011 when Portia Simpson Miller and her party were voted into power.
AWFUL CHOICES FOR MOF, PM
If the GOJ goes for a default on the bond, or whatever name they choose to call it, we can rule Jamaica out of the credit markets for years.
Lenders in the current recession and sovereigns-at-risk climate will be unforgiving. The haircut will hurt tens of thousands of local shareholders and pensioners, the latter through their pension funds which hold GOJ securities and shares in companies like Sagicor, Scotiabank, NCB and JMMB.
If the currency is allowed to slide more speedily instead of the bond haircut, there is the risk that it might overshoot the 'target level' and the BOJ will be unable to halt the slide. The USD-denominated debt will be more costly.
On the other hand, the GOJ will be able to repay its JMD-denominated debt in devalued Jamaican dollars.
The GOJ still has to address the long overdue structural changes if any of the two options (or, really worst case, both) is to bear any economic fruit.
Tax reform, which is taking too long; pension reform; the reform of our educational system; and the cutting of red tape have to be tackled to make our IMF proposal credible.
Jamaicans are in for a harder time than most expect and the Government would be wise to turn the options discussion into a broad public debate.
Dr Phillips and the prime minister need to open up and lead the discussion.
Aubyn Hill is the CEO of Corporate Strategies Limited and was an international banker for more than 25 years. writerhill@gmail.com
Published: Friday | September 28, 2012 0 Comments
Aubyn Hill, Financial Gleaner Columnist
Aubyn Hill, Financial Gleaner Columnist
Finance Minister Peter Phillips faces the most awful ]economic and political dilemma. He is the minister whose job it is to make a choice, a recommendation to Cabinet, on whether the Jamaican government will default on Government of Jamaica (GOJ) bonds, or whether the GOJ will allow, or have no choice but to allow, the Jamaican dollar to devalue against the USD and other major currencies.
The dragging, incomplete arrangement with the IMF and the August 8, 2012 announcement of a major bond restructuring plan (default) by the Government of Belize (GOB) have added a rather sharp edge and urgency to the decision.
The move by the GOB on its 8.50 per cent 2029 bonds puts it in the pariah category with a country such as Ecuador or maybe Ivory Coast.
The three options offered bondholders by the GOB are unattractive in the extreme. Bondholders can opt for a 'no haircut' deal but would have to accept a slash of the coupon rate from 8.5 per cent to two per cent — a drop of 76.27 per cent — and a brutal maturity extension to 2062; or a 45 per cent principal haircut, a 13-year maturity extension and a massive cut in the coupon rate with step-ups from one per cent to four per cent over the new tenor; or a 45 per cent haircut in principal with payments structured like those of a mortgage with principal and interest levelled, and a 58.82 per cent cut in the coupon rate to 3.5 per cent per annum.
BONDHOLDERS JITTERY
Bondholders in Jamaica are jittery and scared. If we look at the published data of three of Jamaica's large financial institutions, the source of the anxiety is easy to identify and just as easily understood.
On September 30, 2011, NCB listed J$204.75 billion as "investment securities" and now has J$187 billion invested in GOJ paper. Sagicor's December 31, 2011 "financial investments" totalled J$114.76 billion, while Scotiabank's current exposure to the GOJ is J$140.64 billion (not counting another $40 plus billion to the Bank of Jamaica).
If we take 90 per cent of Sagicor's exposure and add Scotiabank's J$141 billion and NCB's J$187 billion we get the whopping figure of J$431 billion as the exposure of just these three major financial firms to GOJ securities.
If the minister of finance were to recommend a 15 per cent haircut, that would wipe out J$65 billion of wealth from these three institutions. A 25 per cent default would erode J$108 billion.
After the loss and pain which holders of GOJ securities have had to bear under the Bruce Golding administration's JDX scheme, it will be a very, very brave finance minister, backed by a fearless and confident prime minister that will put this policy decision to the country.
One can just presume that the finance minister has been getting very forceful pushback at any sign of such a default, or strong pre-emptive discouragement from executives at these firms.
All this pushback is not without a significant measure of irony. Through the 1990s and up to 2011 some of these financial institutions were major debt facilitators who were consistently influential in loading the GOJ - and, by extension, Jamaican taxpayers - with unsustainable debt. One major luminary in the financial publicly labelled Jamaica a 'failed state', and still the institution he led, and others like his, kept piling debt on the backs of taxpayers.
THE DEVALUATION OPTION
With Jamaica's debt to GDP running at about 140 per cent — the total debt is about J$1.7 trillion — our productivity below par, our economic growth rate near negative and our exports negligible at best, many objective observers believe the Jamaican currency is overvalued.
Many believe that Minister Phillips should have allowed the currency to adopt a more significant slide as soon as he took office in January.
The BOJ would have cautioned him against letting the Jamaican dollar slip too fast, but very weak demand and high unemployment reduced the risk of a serious spike in inflation.
Instead, we have been using our scarce NIR funds at the BOJ to defend an unsustainable JMD exchange rate.
Demand for the US and Canadian dollar by local businesses and individuals is strong.
The NIR could continue to shrink. It's already down to US$1.428 billion at the end of August from US$2.126 billion at August 2011, and from US$1.967 billion at the end of December 2011 when Portia Simpson Miller and her party were voted into power.
AWFUL CHOICES FOR MOF, PM
If the GOJ goes for a default on the bond, or whatever name they choose to call it, we can rule Jamaica out of the credit markets for years.
Lenders in the current recession and sovereigns-at-risk climate will be unforgiving. The haircut will hurt tens of thousands of local shareholders and pensioners, the latter through their pension funds which hold GOJ securities and shares in companies like Sagicor, Scotiabank, NCB and JMMB.
If the currency is allowed to slide more speedily instead of the bond haircut, there is the risk that it might overshoot the 'target level' and the BOJ will be unable to halt the slide. The USD-denominated debt will be more costly.
On the other hand, the GOJ will be able to repay its JMD-denominated debt in devalued Jamaican dollars.
The GOJ still has to address the long overdue structural changes if any of the two options (or, really worst case, both) is to bear any economic fruit.
Tax reform, which is taking too long; pension reform; the reform of our educational system; and the cutting of red tape have to be tackled to make our IMF proposal credible.
Jamaicans are in for a harder time than most expect and the Government would be wise to turn the options discussion into a broad public debate.
Dr Phillips and the prime minister need to open up and lead the discussion.
Aubyn Hill is the CEO of Corporate Strategies Limited and was an international banker for more than 25 years. writerhill@gmail.com
Comment