The storm clouds of the global financial crisis may affect Jamaica in 2011

By Keith Collister

Sunday, December 19, 2010    

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On Wednesday, the Irish Parliament approved a joint 85 billion Euro bailout on an 81-75 vote. Opposition leaders complained about the high average interest rate of 5.8 per cent required by their European Union partners, but Prime Minister Brian Cowen argued that Ireland had no choice as bond investors were demanding "far, far higher rates."

The bailout was financed by the IMF (22.5 billion euros or US$30 billion), the European Union (including bilateral loans from the UK, Sweden and Denmark) for a total of 45 billion euros (about US$60 billion), and Ireland's own contributions of 17.5 billion euros.

On Friday, Moody's downgraded Ireland's government bonds by five notches to Baa1 from Aa2 with a negative outlook, meaning it could lower its creditworthiness further, citing losses from Ireland's ailing banking sector, increased uncertainty in the economic outlook and a drop in fiscal strength.

Ironically, the Irish downgrade occurred as Europe's politicians closed a summit intended to prop up confidence in the eurozone. Whilst it can be argued that Moody's (as has been typical of rating agencies during the crisis) are still behind the markets, they have clearly reviewed the IMF staff report accompanying the agreement.


In that report, the IMF reduced its October forecast of Irish growth for 2011 from 2.3per cent to 0.9per cent. The report notes "The economic and financial pressures facing Ireland are intense. At the heart of the problem is Ireland's banking sector, which is over-sized relative to the economy and holds sizeable vulnerable assets despite major support measures taken by the authorities..."

The IMF notes that "Ireland's total external debt is projected at over 1000 per cent of GDP at end-2010... While a substantial portion of gross debt is accounted for by the liabilities of International Financial Sector Center (IFSC) participants, which do not reflect Irish risk, excluding an estimate of the bank component of this IFSC debt would still leave total external debt at almost 800 per cent of GDP, with banks' external liabilities accounting for about half... At end-2010, Ireland's total stock of private short-term external debt is projected at approximately 370 per cent of GDP, of which about a fifth consists of banks' repos with the ECB."

The IMF forecasts that Ireland's ratio of government debt to gross domestic product is expected to reach 99 per cent by the end of 2010, up from 25 per cent in 2007, and to peak at 125 per cent of GDP in 2013.

It is important to understand that this is not a problem unique to Ireland. As I had implied in my article on Europe's sovereign debt crisis at the beginning of December, on Wednesday Moody's (which had lowered Spain's rating from the top Aaa to Aa1 in September) warned it may downgrade Spain's debt because the government may need to recapitalize weak banks (which they state could prove more costly than expected) amidst high government financing needs in 2011.

More importantly than even the ongoing European crisis was a little noticed announcement by Moody's on Monday that it could move a step closer to cutting the US Aaa rating if President Obama's tax and unemployment benefit package becomes law, which it duly did on Friday. The package increasing the likelihood of a negative outlook on the United States rating in the coming two years, which if adopted, would make a rating cut more likely over the following 12-to-18 months. Just over two weeks ago, Moody's estimated that general government debt to GDP in the US will reach just under 90per cent by the end of 2010, rising to 95per cent in 2011. This was before the announcement of the deal.

Carmen Reinhart and Ken Rogoff, in their ironically titled book "This Time is Different" (their subtext is it is never different) note "Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang! - confidence collapses, lenders disappear, and a crisis hits." Clearly, we know this in Jamaica.

In a recent conversation with author John Maudlin, they argue that the US will hit a financing limit, which they argue is a ratio of 90 to 100per cent debt to GDP for developed countries, exactly where the US is now.

The recent rise in US ten year bond yields is instructive. On August 27th Fed Chairman Bernanke announced he was going to start a second round of quantitative easing by buying $600 billion in treasury debt. Over the full period, the stock market has rallied 17per cent (according to the S&P 500), but since the buying actually started on the 3rd of November, ten year treasury rates have climbed to just under 3.5per cent, from 2.64per cent in August. Whilst some believe this reflects upgraded growth prospects for the world economy next year, others believe it reflects growing concerns amongst international investors about the ability of the key developed countries to deal with the ongoing crisis.

All of this makes it imperative that our Prime Minister and his economic team get the best possible economic advice so as to avoid being surprised again by the depth of the economic crisis as occurred in 2008. It also means that Jamaica has lost valuable time, over the past six or so months, in not being able to utilise the breathing space granted by the Jamaica Debt Exchange to forge a true social consensus on how to move forward together on the economy. The key to such a consensus, a social contract if you like, is fairly allocating the tax burden, and identifying those areas for growth that the country should puts its resources behind. Recent tax measures, as in any number of previous budgets, have been imposed with a lack of consultation and public analysis, despite it being obvious (to outside observers at least) that there would be problems of implementation if some level of agreement was not obtained beforehand. The international environment may become much less forgiving, particularly in the second half of 2011, suggesting we would be wise to plan ahead.

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