Bruce Golding, Contributor
Left: United States Federal Reserve Chairman, Ben Bernanke. - REUTERS. Right: The Jamalco plant in Clarendon. - FILE
THERE HAS been much discussion about the prolonged slump in the Jamaican stock market. The pragmatists argue that what we are witnessing is merely a market correction. If all that we are seeing is an adjustment in stock values that would be a valid assessment. The performance of the stock market up to 2004 was as remarkable as it has proven to be unsustainable. When stock prices go far out of line with P/E ratios there is bound to be a rollback.
This is even more so when some of those P/E ratios themselves were driven by extraordinary, one-off transactions. Another development that impacted on the stock market is that as interest rates came down and with the expectations of further reductions, the demand for stocks increased but at the same time the reduced interest rates led to reduced earnings for cash-rich companies whose interest income contribute significantly to their profit line.
So, there is an element of market correction taking place. If that were the full story, there would not be much to worry about. Every market correction has a beginning and an end. But there are deeper factors that must be considered.
There is unmistakably a downturn in economic activity which is beginning to be reflected in the recent reported results of many companies. We must be careful not to ascribe that to the cement crisis. The downturn started long before the cement crisis and the full effects of the shortage of cement will be felt in the second quarter which has not yet ended and not yet reported. There is clear evidence of weak consumer spending. Retail sales are down significantly and Kingston Wharves is reporting a decline in tonnage handled at all nine berths.
ECONOMIC DOWNTURN
What, therefore, are the causes of this economic downturn? Remittances have remained strong; the construction sector was very buoyant up to the time of the cement debacle. I believe that some of the fall-off in consumer spending has resulted from higher energy costs which consumes a greater portion of disposable income through higher utility bills, transportation costs etc. I believe also that given the revenue shortfall last year and the failed macroeconomic targets, the Government has had to adopt a tighter than usual fiscal posture.
How long is this likely to prevail and what further impact will it have on the stock market? More importantly, what will be its effects on the Government's macroeconomic programme? If revenues again underperform this year the Government would have to increase its borrowing programme and since the overseas climate for emerging market bonds is turning sour, that additional borrowing would put pressure on interest rates, something that will only aggravate the situation in the stock market.
The answer to these questions depends on a number of other factors. One immediate concern is the possible impact on the foreign exchange market. The stock market is only one of a menu of options in the hands of an investor. The inclination will be to shift from the stock market to other means of investment, most notable U.S. dollar denominated instruments or U.S. currency itself. This would exert pressure on the exchange rate forcing the BoJ to tighten liquidity further leading to more upward pressure on interest rates.
Another factor to be taken into account is what this is telling us about confidence levels and their immediate prognosis. Up to the beginning of last year there was a strong mood of optimism. The market was firmly expecting a balanced budget by March of this year. That has now been put back for two years. The forecast for investment activity was strong with the building of new hotels, the expansion of the Jamalco plant and the LNG project which should have come on stream this year. There have been major fall-outs in these projections. As I have already stated publicly, the Jamalco expansion has been put on hold, ostensibly because there is still too much uncertainty surrounding the LNG project.
INVESTMENT ACTIVITIES
There may be other reasons that have not yet been disclosed having to do with Alcoa's investment activities in other countries, particularly Iceland and Guinea. If there is uncertainty about the Jamalco expansion, the LNG project, even if an acceptable price is agreed, will be in trouble because it was predicated on Jamalco utilising the majority of its supplies. The imbroglio surrounding the Bahia Principe hotel is hurting our investment prospects. I appealed for the Prime Minister's intervention to broker a resolution as a means of cauterising the damage that it is causing to our image as an investment destination.
There is one fortunate aspect of the current situation. This year we have programmed minimal external borrowing because of significantly reduced external amortisation requirements. In addition, the Government had secured from as far back as February US$250 million towards this year's financing requirements.
I say this is fortunate because, as I said before, the prospects for emerging market bonds is not good. Global interest rates are rising as central banks tighten liquidity to stave off inflationary pressures. This poses serious dangers for emerging markets. Over the last few years, billions of dollars - US$350 billion in 2005 alone - have poured into emerging economies. Any sudden outflow would devastate these economies. Moreover, this huge influx of cash has made the financial strength of many of these economies look better than it really is and has disguised macro-economic weaknesses.
The situation is not helped by the mixed signals being sent by the Federal Reserve Board. Two weeks ago the Chairman issued a strong warning against rising inflation sending a clear signal of further hikes in interest rates. Last week he softened that position, having seen the inflation outturn for May. A matter of concern is the fact that some of the excess liquidity in the major capital markets is not showing up in the inflation figures because of the dampening impact of cheap goods from China and India.
EMERGING MARKETS
So it is likely that the international capital market will not be as disposed to emerging market bonds as it has been over the last few years. It is likely to be far more selective in determining which emerging markets it will entertain and in that selectiveness we may not fare well. Keeping inflation down and our reserves high will be a plus but the market will also look closely at our current account and our debt burden which are and will continue to be in orange if not red alert. So, while it may not confront us this year because of the peculiar debt servicing circumstances that obtain this year, next year will be a completely different situation. Not only will significant amortisation payments become due next year but the downturn in economic activity and consumer spending is bound to have a negative effect on revenue collections necessitating budget cuts, increased borrowing, tax increases or a combination thereof.
The presentation above was made by Bruce Golding, Leader of the Opposition, at the Jamaica Money Market Brokers' investors briefing at the Terra Nova Hotel on June 21, 2006.
