Wednesday, October 29, 2008

Big problems needs big solution

Published: October 29, 2008

Until early September the international financial crisis had had only limited impact on the emerging debt markets, despite the very sharp falls in the emerging stock markets.
As a consequence, and partly due to good timing, over the past year since the election, Jamaica had been able to borrow money twice from the international capital market, a major achievement considering its low rating.

Since the collapse of Lehman Brothers in mid-September however, the full force of the international financial crisis has begun hitting the Jamaican economy, in common with other hitherto unscathed emerging markets. The international capital market is now essentially closed for virtually all emerging market issuers, even for the better credits.

Last week Thursday US-based Trinidadian broker Mark Scott noted with respect to emerging markets "Panic is in the air. EM Mutual funds and hedge funds are facing massive redemptions, which is forcing selling into a market with no bid. Everything is getting thrown over the side."

The depth of the fall in broader emerging debt prices is best captured by Brazil. As late as the end of last month, President Lula appeared to believe the crisis was a US phenomenon that would not affect Brazil. Commenting specifically on the Brazilian 7.125 per cent coupon bonds due in 2037 bonds last Thursday, Scott noted these benchmark bonds were above 110 (well above their issue price) all year up to September, and were still 103 at the beginning of this month.
Over the last two day, however, (up to last Thursday) they had fallen 17 points to 68, and traded as low as 66 on Thursday morning. He noted that the yield at the time was over 10.5 per cent, for a total price drop this month of 35 points.

Jamaica's internationally traded debt has seen similar falls over the same period. Commenting on the current situation yesterday, Oppenheimer's Greg Fisher notes:

"My gut tells me that we are finally seeing some sort of bottoming process here with respect to the GOJ curve in general." Fisher bases his assessment on the fact that "the shorts have all covered and the curve is now left with local buying with not too much selling abroad".

Fisher believes that the key as to whether this is a price bottom is "How much is actually left out there in non-Jamaican hands?" and guesses that the only Jamaican US dollar Eurobonds not mainly held by the Jamaicans are the 2019s and 2039s.

Despite this externally driven bond market volatility, the Jamaican currency has so far been relatively stable, neither seeing the falls the pound and Euro have seen against the dollar over the past few months, nor having suffered from the major currency/debt crisis driven falls seen in a number of emerging market countries eg Hungary and Pakistan.

There is no room for complacency, however. The huge external economic shock from the massive rise in food and energy prices over the past 12 months since the election has led to a sharp reduction in consumer purchasing power, and an emerging squeeze on the profitability of many businesses.

Over the past six months, this external shock has been compounded by the internal shock of the demise of the Ponzi schemes. The immense financial strain that the business sector is currently under from falling consumer spending has now been compounded by financing stresses from a reduction in working capital eg overseas supplier credit, whilst local banks are also becoming more reluctant to lend as their non performing loans eg credit cards, are rising sharply.

Some importers are already unable to finance the increased working capital now required, and may be forced to liquidate their inventories to meet increased rent, electricity and other costs, destroying their chances of staying in business, and paying taxes. The current high level of duties means that many goods are now beyond the reach of hard-pressed Jamaican consumers, a situation likely to be worsened by any further weakening of the Jamaican dollar.

Reduced consumer purchasing power also means that September will probably mark the end of the out performance of local tax revenues against budget, even without the expiry of the tax amnesty in October. The next six to twelve months will instead be one of the most difficult periods in Jamaica's recent financial history, where businesses will have to choose between paying tax penalties, the light or wage bill, and closing.

In the light of the success of the tax amnesty in bringing in 4,000 new taxpayers, and the extraordinarily difficult economic conditions now emerging, the government may be well advised to extend the period of the amnesty to the next budget.

Jamaica is of course not the only country to have faced tough times. Last week former Trinidad Finance Minister Wendell Mottley, now managing director of investment banking for the region at Credit Suisse, noted that Jamaica has "a big problem so you must have a big solution". Mottley, who was minister of finance in the early 1990's, has just written a very timely book entitled "Trinidad and Tobago Industrial Policy 1959 - 2008". Mottley is widely seen as the minister of finance who put Trinidad on the path to its current economic success through a combination of taking extremely tough and courageous decisions on spending and public sector employment, combined with an innovative and far sighted industrial policy. He also presided over the liberalisation of Trinidad's exchange controls, which occurred a little under two years after Jamaica abolished exchange controls, but unlike Jamaica did not involve any fall in the value of the Trinidad dollar.

In a short interview for the Business Observer after his presentation at NCB's function last week, Mottley noted that he believed "Governments have a critical role far beyond just creating the right macro-environment".

In addition to their responsibility for creating macroeconomic stability, Mottley's own experience suggests governments must focus on promoting foreign investment, including the need for "some kind of picking" of the key areas to push, which in Trinidad's case was clearly energy.

To ensure the success of their investment promotion efforts, the Trinidad Government appointed one man for foreign investors to deal with. This investment "Czar" was "operating in a structured fashion", supported at the Cabinet subcommittee level by an "interlocking directorate" with the ability to straighten out the road blocks faced by foreign investors in areas such as water, electricity, and the ports.

The third critical attribute was a sense of urgency. In the Trinidad of the early 1990s, 80 cents out of every budget dollar was going to pay debt service and public sector wages, leaving very little for everything else. In order to create the fiscal space for needed infrastructure and other investments, Mottley successfully negotiated with the Paris Club to restructure Trinidad's debt. Mottley described Jamaica today as "being in pretty much the same pickle" as Trinidad was at the time. In his view, our Government needs to actively engage in getting things done, focusing on implementation so things actually happen.

Source: Jamaica Observer

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