Jamaica debt sustainable under IMF programme

Jamaica debt sustainable under IMF programme


Wednesday, March 06, 2013

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THERE is a clear logic to the IMF deal that has so far escaped most observers. While we are not yet privy to the full analysis that would be part of a published IMF letter of intent, it is possible to estimate approximately where we are with the numbers we currently have. The proposed IMF programme has a very clear emphasis on "making the numbers", in that, as much as possible of the adjustment has been front-loaded into its first year.

If we start with interest costs as a percentage of GDP, the projection in the Government's fiscal policy paper for 2012/2013 was about 9.8 per cent of GDP, although interest costs have actually been running at about five per cent less than this for the first nine months of the year, or approximately in line with the historical number for 2011/2012 of 9.3 per cent, and the forecast for future interest costs in 2013/2014 of 9.2 per cent. The National Debt Exchange is supposed to save about $17 billion or 1.25 per cent of GDP, so that, all things being equal, interest costs would fall to about eight per cent of GDP in next year's budget, the lowest in many years.

The primary surplus is projected to rise to 7.5 per cent as a result of the IMF agreement, driven mainly by a tax package of just under $16 billion, or just under the savings in interest costs, and $11 billion a year from the National Housing Trust (NHT), for a combined roughly two per cent of GDP.

The primary surplus is government revenue minus expenditure, excluding interest costs. If these numbers are correct, this means that the IMF has demanded that the Government goes cold turkey, and essentially stop borrowing any money for most of the next three years. If these numbers hold, the difference between the primary surplus and interest costs, the fiscal deficit, would only be half a per cent of GDP, and the impact of this would be massively compounded by the rescheduling of the local debt, reducing the repayment of local debt to near zero for the next two years. This impact is compounded by the absence of any major US dollar Eurobond repayments before the middle of 2015. In 2014, there is only a Euro currency Eurobond maturing in October, and a small domestic US dollar bond, both of which should be easily manageable.

In this scenario, the Government not only no longer needs to borrow any money, but it might even repay some locally issued debt on a net basis depending on the level of external financing it receives from the multilateral lenders, putting downward pressure on interest rates. It therefore becomes clear why Bank of Jamaica Governor Brian Wynter felt able to cut his policy interest rate by half a point to 5.75 per cent despite the continuing decline in the dollar, and we should expect further cuts, perhaps to as low as four per cent once we have an IMF deal. Indeed, the market may already be forecasting further cuts, as at the latest Treasury bill auction, the average yield for 30-day bills was 5.25 (a full half point below the new comparable 30-day Bank of Jamaica policy rate), while 90 and 180 day rates were 5.5 per cent and 5.75 per cent, respectively. Indeed, if the Governor was able to cut interest rates to near the four per cent level, the reduction in interest costs on the variable rate paper (linked to T-bills) would reduce overall interest costs enough to wipe out the small anticipated deficit.

In this scenario, the main risks to debt sustainability are the underperformance of taxes and the ever-rising wage bill. Most analysts will be surprised if the government collects much more than 80 per cent of the new tax package of $16 billion. Unsurprisingly, the previous mammoth tax package of May last year is underperforming, due to our weak economy, by just under one per cent of GDP so far. Taking the whole additional $27 billion, or two per cent of GDP, required to meet the IMF's 7.5 per cent primary surplus target, in new taxes would have imposed unacceptable damage to the economy. This makes the $11 billion per year contribution from the NHT the best of a number of bad options. The only question is whether it would have been better to have done this through an employer contribution holiday for the NHT, and raising the employer portion of education tax commensurately, thereby avoiding entirely the legal issues involved in the Trust. This has been previously suggested by, amongst others, local financial analyst Colin Steele, and endorsed by the PSOJ-led Private Sector Working Group as a potential option in such a severe fiscal crisis. From the perspective of the employer, their NHT contribution is already effectively a tax, as the company is not entitled to any benefit, and therefore moving it to the consolidated fund will not further damage the economy in the way a new tax undoubtedly would. Moreover, if the NHT contribution allows sustainably lower interest rates it would have a much more powerful impact on homeownership than even the best-intentioned social subsidy.

What we should now be focussing on, instead of the NHT, is the size of the public sector wage bill, nearing $150 billion, whose continued growth now makes it the principal threat to debt sustainability, dethroning the position once held by interest costs. The wage bill is still projected to rise by over $10 billion in 2013/2014 according to the Government's fiscal policy paper (a figure apparently reconfirmed at a recent Parliamentary hearing), and this does not include pension costs, savings from whose reform does not appear to be part of either the IMF pre-conditions the 2013/2104 fiscal programme.

To get an IMF deal, and unlock vital balance of payments financing, we still need union agreement to a wage freeze. To keep an IMF deal, we desperately need to avoid the large increase in the wage bill that derailed our last IMF agreement.

In this regard, we anticipate good news today.

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