How will Jamaica emerge from its debt problem?
published: Friday | November 28, 2003
By Dr. Carl Ross, Senior Managing Director,
Bear Sterns
TO ANSWER this question, we start from the premise that Jamaica's debt levels are completely unsustainable. There are two general ways in which to reduce the debt burden.
The orthodox way is for the government to generate fiscal surpluses and foster conditions for economic growth, thereby lowering the debt-to-GDP ratio over time. This is the current strategy of the Jamaican government, as it was for Argentina in 2001. The unorthodox way to reduce the debt burden is to do a debt restructuring, which would lower the debt burden very quickly.
In either case the costs are massive, and it is unclear which is the lower cost alternative from a social-welfare point of view. Five years after Russia restructured its domestic debt, it is now investment grade.
In Jamaica's case, the policymakers "objective function" is heavily tilted toward respect for the rule of law, the sanctity of contracts, reputational gains, and other willingness-to-pay parameters.
Therefore, Jamaica under the current government and economic team will continue down the orthodox path of trying to gradually reduce the debt burden through lower interest rates, stable currency, higher economic growth and fiscal stability.
Finance Minister Omar Davies confirmed this in a conference call with investors on November 6. It is possible that the government will succeed.
Ireland and Indonesia are two countries where the debt-to-GDP ratio exceeded 100 per cent, and these countries have managed to stabilise their debt dynamics using this general policy model. However, these countries had special conditions that do not seem to be present in Jamaica.
MASSIVE DEVALUATION
Ireland had a structural boost to economic growth and the policy discipline that EU convergence brought. Indonesia, after a massive devaluation that "re-priced" the country, has been generating sizeable current account surpluses that have stabilised the rupiah. In the case of Jamaica, structural forces are arguably exerting negative economic impulses at this time namely, secular declines in manufacturing and loss of protected markets for sugar and bananas, among others. Moreover, the Jamaican dollar displays some signs of being overvalued - namely, the current account deficit is huge for a country that has not grown above trend in a very long time.
The major risk with the orthodox approach is that the fiscal and debt imbalances grow, making the ultimate debt restructuring process much more destructive than if some pre-emptive debt restructuring had been achieved. With the benefit of hindsight, this is what happened in Argentina in 2001, with the process ending in a major financial and social disaster.
Equally unworkable for Jamaica is the "unorthodox" approach of a pre-emptive debt restructuring. Many investors have asked us if Jamaica could effect a restructuring of its domestic debt, since the domestic debt, rather than the foreign debt, is the most burdensome from a debt-servicing standpoint.
There are many problems with this solution. The fundamental problem is that the public debt is so huge that even if the domestic debt were written down by 100 per cent, the debt ratios in Jamaica would still look like double-B comparables.
A restructuring of the domestic debt would likely technically bankrupt most of the financial institutions in the country, opening up another major problem.
It is inconceivable that this option could be achieved without the benefit of external support from the IMF, because such a restructuring would have to be structured to provide the necessary debt relief for taxes to be lowered and growth to resume, while backstopping the banking system, and also preventing the Jamaican dollar from collapsing due to capital outflows.
There may also have to be a decision on whether to "Jamaican-dollarise" the domestic debt that is linked to the US dollar. Five years after defaulting on domestic debt, Russia is now investment grade, but Jamaica is not Russia. The domestic debt risk in Russia was spread out more amongst domestic and foreign investors, and Russia has benefited from a major positive shock in higher oil prices, the equivalent of which is difficult to identify for Jamaica.
THE BOTTOM LINE
The bottom line is that we cannot answer how and when Jamaica will emerge from its debt problem. However, we can say that there are enormous costs to both the orthodox and unorthodox approaches. The government seems firmly committed to the orthodox approach, but we point out that the same could be said of Argentina in 2001.
With economic growth resuming in Jamaica, and the primary surplus target looking achievable, we are highly confident that policymakers will stick to the orthodox approach for the time being. Variables to watch continue to be the path of domestic interest rates, the exchange rate, and the fiscal outcomes.
Two identifiable crunch periods will be the fourth fiscal quarter (Jan.-March 2004), when the fiscal performance for the year will become clearer, and August 2004, when the next external bond maturity comes due (Eur175 million).
The research analysts who prepared this research report hereby certify that the views expressed in this research report accurately reflect the analysts' personal views about the subject companies and their securities. The research analysts also certify that the analysts have not been, are not, and will not be receiving direct or indirect compensation for expressing the specific recommendation(s) or view(s) in this report.
