May 2012 Financial News

Jamaica chooses austerity to pave way for bond and IMF deal

May 14, 2012

The release on Thursday of Jamaica's estimates of expenditure for the coming fiscal year 2012/2013 reveal that Finance Minister Dr Peter Phillips has taken a decisive step towards a credible fiscal budget for this year. Indeed, he may yet emerge almost Houdini like (after the famous escape artist of the last century) from what had looked to many observers as an almost impossible situation, verging on a fiscal crisis.

This escape from fiscal crisis is not without price. The true level of austerity is shown by a quick look at the recurrent budget. Out of a total budget (including debt repayment) of $612.5 billion, total recurrent spending, meaning programmes, wages and interest, is $375 billion, or a $23 billion (about seven per cent) increase above the final revised estimates for the previous financial year. This increase is misleading however in calculating the tightness of the budget, as just under $16 billion represents an increase in interest costs to $136.5 billion. Of the remaining $7 billion increase in non - interest recurrent spending to $239 billion, just over $2.3 billion reflects an increase in pension costs to just over $24 billion, and just under $4 billion reflects an increase in local government costs to $7.5 billion. The majority of this latter increase reflects a quadrupling of the money spent on fire protection services to just over $3.1 billion.

What all this means is that overall there is a total freeze on expenditure on wages and programmes for every other category of recurrent spending, which with Jamaica's Central Bank Governor Brian Wynter projecting an increase in the rate of inflation of six to eight per cent in this fiscal year, means a severe cut in spending in real terms. Furthermore, a number of key ministries, including health, education, national security and justice appear to have had their funding cut in absolute dollar terms.

The projected increase in capital spending, from $184 billion at the end of the last financial year to just over $237 billion in the budget, is entirely driven by a huge $70 billion increase in debt amortisation (repayment of debt), from $128 billion to $198 billion. This increase in amortisation is primarily driven by a $57.4 billion increase in the repayment of internal debt, from $67.2 billion to $124.6 billion (signalling the end of the benefits to our maturity schedule of the Jamaica Debt Exchange) and a smaller $12.8 billion increase in external debt repayment, from $60.8 billion to $73.6 billion.

Real central government capital expenditure, on projects and capital equipment, has been cut dramatically. If we subtract debt amortisation of $128 billion from last year's final capital budget of $184 billion, we get last year's capital spending figure of $56 billion. If we compare this with the $237 billion of budgeted capital expenditure for 2012/2013, and subtract planned amortisation of $198 billion, the remainder is total real capital expenditure of around $40 billion, meaning that capital expenditure has been cut by $16 billion dollars. It should also be noted that last year's final figure for real capital expenditure of $56 billion was itself a significant reduction from the over $60 billion in the original budget.

This suggests that a very serious, almost herculean effort is being made to satisfy the requirements of the international capital markets and the IMF, involving both a wage freeze and real and nominal cuts in programmes and capital expenditure respectively. This has a number of consequences, both good and bad.

Firstly, this greater than expected fiscal effort should allow Jamaica to borrow abroad next week by issuing a Eurobond at a rate of around nine per cent, or perhaps even a bit less, despite the worsening condition of the global financial markets, thereby demonstrating the government still has international capital market access. The rigour of the budget itself would also mean that the government has gone a long way towards meeting the IMF's likely demands on the expenditure side, particularly the need for a freeze in the public sector wage bill, a key part of the so called bitter medicine. This would suggest that the IMF would be willing to ignore the increase in pension costs this fiscal year, leaving it as a medium term requirement, thereby accepting that one could not do every tough reform in one year, particularly in view of the proposed wage freeze. In addition, the figure for interest costs looks somewhat over stated, or at least assumes a worst case scenario of a substantial return to the local domestic capital market, or a significant rise in interest costs. Whilst both scenarios are possible, they become much less likely with a successful bond deal and IMF agreement, with the more likely outcome being some of the interest "savings" (from interest costs being again below budget) being part of the contingency to meet the almost inevitable need for some level of additional programme spending.

It also reduces the need for an enormous, as opposed to merely large, tax package to meet the IMF's fiscal targets. It appears that the government has in fact fully realised that the serious fragility of the Jamaican economy, added to weakness in the global economy, meant that an overly large tax package could actually be quite counterproductive, with higher rates resulting in reduced tax revenues in some areas. If the remaining fiscal gap to reach a primary surplus target of six per cent and a 4.5 per cent fiscal deficit target is say $18 billion (assuming passive tax revenue growth of about six per cent), as suggested by financial analyst Colin Steele, this is a far cry from a tax package previously expected at up to $30 billion, always depending of course on the level of expenditure restraint assumed. If at least one creative current private sector proposal is adopted, it may be possible to reduce the remaining fiscal gap to around $6 billion, or remarkably close to that of the additional tax revenue requirement originally proposed by the Private Sector Working Group of $7.3 billion. If the society accepts the consequences of such an unexpected, as yet unnamed fiscal cushion, then this would both present an opportunity for further reform in a critical area of the local financial markets, and would allow a real tax reform to occur (another IMF requirement) with a potential virtuous circle emerging from the compliance dividend that would result. Indeed, a minimum initial compliance dividend of about $6 - 8 billion for the first year would be entirely reasonable, with much more over the medium term, including the benefits of faster growth. We shall explore in more detail in subsequent articles what these glimmers of hope of such a "magical" performance from Phillips might look like.

It also reduces the need for an enormous, as opposed to merely large, tax package to meet the IMF's fiscal targets. It appears that the government has in fact fully realised that the serious fragility of the Jamaican economy, added to weakness in the global economy, meant that an overly large tax package could actually be quite counterproductive, with higher rates resulting in reduced tax revenues in some areas. If the remaining fiscal gap to reach a primary surplus target of six per cent and a 4.5 per cent fiscal deficit target is say $18 billion (assuming passive tax revenue growth of about six per cent), as suggested by financial analyst Colin Steele, this is a far cry from a tax package previously expected at up to $30 billion, always depending of course on the level of expenditure restraint assumed. If at least one creative current private sector proposal is adopted, it may be possible to reduce the remaining fiscal gap to around $6 billion, or remarkably close to that of the additional tax revenue requirement originally proposed by the Private Sector Working Group of $7.3 billion. If the society accepts the consequences of such an unexpected, as yet unnamed fiscal cushion, then this would both present an opportunity for further reform in a critical area of the local financial markets, and would allow a real tax reform to occur (another IMF requirement) with a potential virtuous circle emerging from the compliance dividend that would result. Indeed, a minimum initial compliance dividend of about $6 - 8 billion for the first year would be entirely reasonable, with much more over the medium term, including the benefits of faster growth. We shall explore in more detail in subsequent articles what these glimmers of hope of such a "magical" performance from Phillips might look like.


Source:
By Keith Collister
Jamaica Observer
Sunday May 13, 2012

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