New Confidential Economic Bulletin

Monthly Analysis of the Jamaican Economy
Volume 6, No.09, September 2000

Overview
The major item of note in the last month has been the BOJ's decision to raise interest rates on its 9 and 12 month repos by about 4%. This action took many persons by surprise as it came after a slippage of about 5% in the Jamaican dollar, which took place between June and September. It was also taken at a time when the NIR are at an all-time high of over US$900m. The BOJ's action is difficult to understand when it is put in the context of the economic programme, which the government set out in July, in its memorandum to the IMF. The memorandum accompanied the letter of intent from the government requesting the establishment of the Staff Monitored Programme (SMP) and outlined a set of economic policies, which were aimed at rekindling economic growth by reducing interest rates and moving the fiscal accounts from a deficit to a small surplus. The reduction in interest rates is a vital component of the programme because lower rates will lead to an increase in private domestic investment, an important component of growth, and lower rates will lessen the huge burden that domestic debt service places on the fiscal budget. For every 1% fall in domestic interest rates, debt servicing costs fall by just under J$3bn, and of course for every 1% rise, the converse is also true.

The impact of this increase in interest rates on the fiscal deficit will be all the greater next year as the FINSAC debt is due to come onto the budget as of 1st April 2001. The increased debt servicing costs will almost certainly push the fiscal deficit considerably above the targets contained in the SMP and presented to parliament by the minister of finance at his last budget speech in April this year. They will also probably prevent the return to economic growth, which was anticipated to follow the improvements in the fiscal position and the lowering of interest rates. The Minister of Finance has also stated on a number of occasions that the weak fiscal position has been of considerable concern to the rating agencies and the international capital market. Reducing the fiscal deficit is therefore an important objective for the government, as failure to do so will make it more difficult to issue bonds in the international capital market.

While the BOJ has said that their action is a "temporary" one, it does raise fundamental questions about feasibility of the policies presented to parliament in April and to the IMF in July. These questions are all the more pressing because we have been this way a number of times before, that is, interest rates have been lowered somewhat only to be raised again once the exchange rate comes under pressure. For a while it seemed that things would be different this time around, but recent events have shaken any confidence that was being developed in this regard. That it should happen with the NIR at its current level and in the context of the SMP is all the more puzzling and we can only hope that the Minister of Finance will soon make a statement explaining this new direction in government policy. It will also be useful to find out the implications of the BOJ's move for the disbursement of loans by the IDB and the World Bank. Will the SMP need to be renegotiated so early in the game? Will new targets need to be set and how will they differ from the current ones? How long is "temporary" and what do we expect to happen when rates are reduced again, to their previous levels and below?

These questions and many more will need to be answered over the coming days and weeks. The BOJ's action is not likely to have a positive impact on the upward trajectory of the national debt, which at 162% of GDP in March 2000, is already very high. Increases in the domestic debt have been the major driver behind the recent growth in the national debt and unless our adverse debt dynamics are changed, we could again enter a period of much higher inflation and all round economic instability.

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