Was Standard and Poor's downgrade justifiable?

Saturday, November 21, 2009 2:49 AM

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By Keith Collister

Wednesday, November 04, 2009

The decision by Standard & Poor's (S&P) to downgrade Jamaica's long-term foreign and domestic currency ratings from CCC+ to CCC, apparently on news of the dismissal of Bank of Jamaica Governor Derick Latibeaudiere, prompted the Government to dismiss the rating agency's reaction as premature at best.

But Oppenheimer's Dr Carl Ross believes the administration did not go far enough in assuring that it would improve its ability to service its debt in the near term, or perhaps more importantly, unequivocally rule out some variance of a debt restructuring factoring in an International Monetary Fund (IMF) agreement.

Latibeaudiere. hawkish, nationalistic, proud Jamaican policymaker

"As a result, we are seeing pressure on Jamaican bonds this morning, since the market's perception of the probability of default has increased significantly," said Ross.

Ross stated that he believes "the IMF talks are proceeding and that an agreement will be signed in December or January that does not include a debt restructuring. It is more likely to include a promise by the Jamaican Government to engineer a significant reform of the public finances (tax reform, public sector administrative reform, reform of tax concessions, etc). Embedded in that programme will be a fiscal deficit path. Due to the weak economy and based on past experience, I think there is a high likelihood that Jamaica misses its quantitative and qualitative targets relatively early in the programme. If this were to happen, I believe the likelihood of the IMF requiring a debt restructuring as a condition of re-working the programme would rise significantly."

He added: "In any case, the range of scenarios for Jamaica is getting narrower, and the policy options fewer."

Last Friday, the finance ministry announced that Latibeaudiere had "demitted" office by mutual agreement with the finance minister.

Ross believes that "S&P reacted by downgrading Jamaica a further notch to CCC. The reason the market is so sensitive to Latibeaudiere's departure is that he is a hawkish, nationalistic, proud Jamaican policymaker who, on multiple recent occasions, has said that as long as he was BOJ governor, Jamaica would never restructure its obligations.

Therefore, his sudden departure, even as the IMF team is in Kingston trying to finalise a deal, can only mean one of three things: a) Latibeaudiere was so hawkish and stand-offish that his presence was hampering the IMF talks; b) a debt restructuring might have been emerging as part of the IMF deal; or c) some other reason, such as corruption or mismanagement. I think it is the former (a)."

Yesterday afternoon, Prime Minister Bruce Golding told Parliament that Latibeaudiere's contract was terminated "as a matter of principle" and that the Government could not continue an arrangement, which included a compensation package for the governor amounting to $38,363,360 and other benefits, such as a fully maintained car.

Golding also highlighted $55.44 million in loans to the former governor which the PM described as having "several troubling issues surrounding (them)".

Ross added that the authorities clearly had a succession plan, with a new governor, Brian Wynter, already appointed. In his view, "the IMF talks should not miss a beat. as the rest of the Jamaican policy team that was liaising with the IMF is still in place".

In a statement entitled "S&P downgrade unjustified; IMF says talks progressing" Stocks and Securities Limited appeared to agree with Ross's first point, stating that their sources tell them that "the transition of leadership at the Bank of Jamaica will be a positive to the timely completion of an IMF agreement".

Pan Caribbean Financial Services (PCFS) also sees the IMF talks as proceeding as planned, referring to the IMF's subsequent statement after the downgrade, reassuring investors that it continues to make progress in its negotiations with the Jamaican authorities.

"The IMF mission currently in Jamaica is working closely with the authorities toward developing a strategy to address current economic challenges and define policies that could be supported under an IMF stand-by arrangement. These discussions cover both the current and next fiscal years and the medium term, and we are examining a range of policy options. We are continuing to make progress. The Fund mission will provide an update on the discussions by the end of this week.

"It is generally agreed that the change in BOJ leadership will not alter the core policy initiatives being negotiated. Therefore, market players are more focused on the timing and terms of the pending IMF agreement. As such, market response to the S&P downgrade has been muted."

PCFS believes that an IMF facility will boost confidence in BOJ's ability to maintain foreign exchange stability and facilitate Government's access to loan flows from the IDB, World Bank, etc, resulting in reduced borrowing in the local market. They argue that along with the moderation in inflation (7.2 per cent year-over-year), this should support further reduction in interest rates.

In a brief comment to the Business Observer, former minister without portfolio in the finance ministry, Don Wehby, now back at GraceKennedy, stated that he agrees with Minister Shaw's statement that the "downgrade was premature and had occurred without sufficient dialogue with the Government".

"In any event," Wehby argued, "the international capital market is still closed." He correctly points out that the government has no plans to borrow from the market, with its financing plans for the coming year based on borrowing from the major multilaterals.

"The majority of our bonds are held by Jamaicans, and they have already priced in our financial position."

Wehby also argues that "governments cannot create policy around rating agencies".

He believes however, that Jamaica's Government "must now focus on getting an IMF agreement in place and producing a credible medium-term plan."

S&P had previously downgraded Jamaica on August 5, 2009 to 'CCC+' with a negative outlook. In justifying the downgrade at that time, they had stated "that Jamaica's severe fiscal situation as well as the vulnerabilities in the Government's debt profile may give it incentives to renegotiate with its creditors, particularly its resident creditors that hold the larger bulk of Jamaican debt".

In their most recent research note, released on Monday, Standard & Poor's credit analyst Roberto Sifon Arevalo argues: "Since then, the government's room to manoeuvre continues to narrow as it becomes increasingly difficult to further cut public expenditures - as reflected, in part, in the recently amended budget - in order to sustain an interest burden of about 60 per cent of general government revenue."

Implicit in S&P's statement is the view that the Governor's departure could disrupt the country's negotiations with the IMF for a US$1.2-billion stand-by facility.

According to S&P, "While the Government's engagement with the IMF is a positive effort to address the long-standing structural issues in Jamaica, recent events highlight the complexity of the negotiation process and create more uncertainty about the timeframe for reaching an agreement with the Fund."

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