In a story headline entitled ‘Gloomy Jamaica’ published on the November 14, 2009, the highly respected Economist magazine, read by business and financial leaders worldwide, referred to Jamaica as “unfixable”.

In words that may even reflect some sympathy as to the extreme difficulty of Prime Minster Golding’s job, the Economist noted: “Just over two years ago when Bruce Golding’s Labour Party came to power in Jamaica, ending 18 years in Opposition, there were modest hopes that it might make progress in tackling the island’s endemic problems of economic stagnation and gang violence. Quite how hard that is has become clear in the past fortnight with the departure first of the central bank governor and then the police chief. Mr Golding’s people inherited a huge national debt, much of it borrowed in the markets at interest rates that have sometimes topped 20 per cent. Just servicing this eats up about 60 per cent of government revenues. Then came the world recession, which has hit tourism, bauxite and remittances from Jamaicans abroad, the island’s three big foreign exchange earners. UC Rusal, the country’s biggest bauxite operator, has shut most of its Jamaican mines because of low world prices. With tax revenue down and privatisation plans stalled, the fiscal deficit has soared.”

It is therefore probably not entirely a coincidence that the bad news flow continued with the downgrade to Caa1 by the world’s number two international rating agency on November 18, ostensibly on the possibility of further delays in reaching an IMF agreement.

In evaluating the accuracy of the rather gloomy assessment of these two leading international institutions, it is fortunate that probably the most respected international analyst of Jamaica’s economic situation, Oppenheimer’s Dr Carl Ross, had visited Jamaica last week. Commenting within an hour of the downgrade, Ross noted that:

“Moody’s joins S&P in essentially believing that an involuntary debt restructuring is highly likely within a 12-month horizon, if not imminently.”

Ross noted, however, that “the strong consensus on the ground is that a comprehensive forced restructuring is not going to happen” and that the Government has other “liability management” alternatives.

“For example, much of the local debt is either floating rate (and due to re-price at lower coupons) or is callable at par, which is a theoretical discount to where the local debt is trading, since local rates have been trending lower. On the external side, the average cost of the external debt is due to fall as multilateral funding takes the place of market financing.”

Contrary to the expressed view of Moody’s that “there are signs that an agreement with the IMF may not be within reach yet”, Ross argues that the reason for the delay is that the IMF and the Government are crunching these numbers, assessing any impact these measures would have on the capital of some local financial institutions, and that this is why the IMF deal is taking so long.

Whilst admitting to being unsure as to whether this will be enough to stabilise our debt dynamics, Ross nevertheless believes that if this happens, it could result in a short-term “pop” in Jamaican bond prices.

Ross could have added that one of the indicators of stress in our financial system, Jamaica’s stock market, has been rallying in an almost interrupted fashion since S&P’s downgrade on Monday, November 2. This rally has been dominated by financials, which would hardly be likely if the smart money thought a restructuring of the debt was imminent.

Breakfast Club discussion of Moody’s downgrade

Thursday morning’s Breakfast Club radio programme, involving Jason Abrahams, Charles Ross and Colin Steele, provided a further valuable opportunity to assess the accuracy of the downgrade. Perhaps reflecting the apparent disconnect between local and international views of Jamaica’s situation, Deutsche Bank’s Jason Abrahams’ views appeared to be the most bearish on our situation.

Quite reasonably, Abrahams argued that the Moody’s downgrade was unsurprising, following as it did two successive downgrades by Standard and Poor’s. He noted Moody’s’ view that our options to restore debt sustainability without a debt restructuring were narrowing, and that the external view of Jamaica’s situation continues to deteriorate. As a result, international markets won’t lend money to Jamaica, and combined with our difficult fiscal situation, the calls of the rating agencies have elements of “self-fulfilling prophecies”.

Sterling Asset Management’s Charles Ross took issue with Moody’s’ view that our options were narrowing, arguing that the major problem was the high cost of Jamaica’s domestic debt. He argued that there was still scope for the Bank of Jamaica to lower interest rates dramatically, and asked what else can investors do with their Jamaican dollars.

Abrahams argued that investors had the option of converting their Jamaican dollars, and the risk of holding Jamaican dollars now was very different than when the rate on treasury bills was around 12 per cent in mid-2007. It would therefore not be unreasonable for investors to demand a higher risk premium. As he put it, at this point, return of principal becomes more important than return on principal, and we now have two rating agencies saying default is imminent. Moreover, he did not believe markets behaved altruistically, and thought that it would be difficult for the central bank to reduce interest rates rapidly due to capital flight.

Whilst agreeing it was time for “tough choices”, Ross countered that a much less painful solution than either debt restructuring, or cutting 20,000 people, is lower interest rates.

Respected local financial analyst Colin Steele started by noting that the fundamental problem was that average interest rates had increased sharply over the past two years, and were now just under 20 per cent from around 13 per cent in fiscal year 2007/2008.

In his view, the key mistake was when interest rates were pushed up sharply in response to margin calls in the financial sector in late 2008. Addressing the issue of why we overused the interest rate weapon, Steele noted that some had projected that a 30 to 40 per cent fall off in tourism revenues, when combined with similarly weak remittances, could lead to net international reserves falling as low as US$800 million.

However, instead of this grim scenario, the current account deficit had improved dramatically by over US$1.5 billion in the first seven months of 2009, to an easily financeable US$297 million. This did not just reflect the fall in the price of oil, as over US$100 million a month reflected non-oil imports.

Steele noted that it was the huge rise in the wage bill, and the even bigger rise in interest costs over the past couple of years, that was responsible for this crisis. The question then became whether interest rates can be brought down on a sustained basis. Tax revenue had underperformed mainly because consumption had been squeezed excessively by our overshooting the interest rate target.

The bottom line is that Finance Minister Shaw should be believed when he says that Jamaica is “close” to an IMF agreement, which is likely before the end of the year. Minister Shaw should also be believed when he says that reducing interest rates “is now a fundamental feature of Jamaica’s debt management strategy” and that “the IMF also shares that view”.

It should be noted, however, that it is still correct to say that “The IMF alone is not enough”, as the Observer said in Thursday’s headline, as without Jamaica adopting a strategy of “Export led growth”, as the Jamaica Chamber of Commerce argued in its recent economic seminar, Jamaica’s problems will become “unfixable”.