Public Information Notice No. 98/55

Press Information Notice: IMF Concludes Article IV Consultation with Jamaica

August 10, 1998

On July 15, 1998, the Executive Board concluded the Article IV consultation with Jamaica¹.

Background

During FY 1997 (fiscal years begin April 1) the Jamaican Government continued the anti-inflationary program launched at the end of 1995, relying on a tight monetary policy and the maintenance of a relatively stable exchange rate. In particular, the authorities’ macroeconomic program for FY 1997 aimed at an inflation rate of 8–9 percent while achieving output growth of 2–3 percent. The overall public sector deficit was to be reduced to 1.5 percent of GDP in FY 1997 and the government targeted an increase in net international reserves of US$110 million.

In the event, the authorities succeeded in bringing inflation down to 8.8 percent in FY 1997, and maintaining relative exchange rate stability. The overall public sector deficit widened to over 9 percent of GDP, financed mainly by the banking system and net external borrowing. The government successfully tapped international markets for US$300 million in FY 1997 and received a Moody’s sovereign bond rating of Ba3 in March 1998. An increase of over 50 percent in the stock of open market operations kept the growth of base money broadly in line with the targeted inflation rate, and the Bank of Jamaica lost US$50 million in net international reserves. The Jamaica dollar depreciated by about 4 percent against the U.S. dollar during FY 1997, but in real effective terms it appreciated by about 10 percent. The external current account deficit increased to about 5.5 percent of GDP in FY 1997 as most exports declined, the value of nonbauxite imports increased substantially, and transfers fell. While net official capital flows increased, this was more than offset by a decline in private capital inflows.

As a result of the tight monetary policy, real interest rates rose to almost 20 percent. Combined with a severe drought that affected agricultural production and the continued problems in the financial system, this led to a decline in output of 2.4 percent after a decline of 1.9 percent in the previous year.

The government continued to deal with the crisis in the financial sector by intervening and otherwise supporting financial groups with capital insolvency and liquidity problems largely through its Financial Sector Adjustment Company (FINSAC). Most of the support to the financial sector—reaching some 30 percent of GDP—took place in the form of floating rate interest notes. In addition, the Bank of Jamaica improved the supervision over the banking system and the legislative framework was amended to strengthen prudential regulations. The intervention in the financial sector has resulted in a substantial increase in public ownership both in terms of financial institutions and other assets such as hotels and real estate.

The government’s macroeconomic program for FY 1998 is part of a three-year strategy to achieve output growth of 4–5 percent, a return to fiscal surpluses, inflation rates similar to those of trading partners, and net international reserves equivalent to 14 weeks of imports. Within this context, the government’s program for FY 1998 targets output growth of 2–3 percent, an inflation rate of 8 percent, and a fiscal deficit of about 4.5 percent (excluding interest payments related to debt issued in support of the financial sector). Base money growth would be limited to the growth of nominal income, and net international reserves would increase by US$15 million.

Executive Board Assessment

Executive Directors noted that since the last extended arrangement with Jamaica expired in March 1996, inflation had been reduced sharply through the implementation of a tight monetary policy and the maintenance of a stable exchange rate. However, Directors expressed concerns that, over the same period, the public sector balance had shifted from a surplus to a large deficit, and the mix of policies had resulted in very high real interest rates, a substantial real appreciation of the currency, and declining output. In the circumstances, long standing problems in the financial system were brought to the surface.

Directors were of the view that the current mix of policies risked undermining the authorities’ objective of achieving output and employment growth over the medium term. In that regard, they stressed that the adoption of a comprehensive macroeconomic program and a further deepening of structural reform efforts would be critical for achieving lasting macroeconomic stability and for placing the Jamaican economy on a path of sustainable economic growth over the medium term.

Directors agreed with the authorities that restoring a stronger fiscal position would be a central element in rebalancing the anti-inflation effort. To that end, the government would need to contain spending and press ahead with its efforts to improve tax administration in order toachieve the targeted central government deficit. However, Directors shared the staff’s concerns that the revenue projections in the budget are very optimistic, and that wage and interest payments may be underestimated. They urged the authorities to stand ready to reinforce their announced fiscal actions by introducing additional tax measures, eliminating tax exemptions, and taking steps to reduce expenditures so as to adhere to their fiscal objective. Directors also noted that a stronger fiscal effort was needed to help meet the interest obligations stemming from the difficulties of the financial system.

Directors noted the authorities’ recent success in raising medium-term resources from international capital markets, and underlined the importance of using those resources to amortize existing debt. They stressed that prudence would need to be exercised to avoid an increase in Jamaica’s external debt burden—including by guaranteeing private sector borrowing—a shortening of its maturity structure, or an undue increase in its cost. Directors indicated that Jamaica needed a strong fiscal position to meet its debt-service obligations, together with an aggressive privatization program to reduce the stock of debt.

Directors noted that the government had managed the problems of the financial system in a way that had avoided a collapse of depositor confidence, but at a very high cost in terms of the public sector’s support to the system. Directors were of the view that the Financial Sector Adjustment Company (FINSAC) needed to complete the process of dealing with weak financial institutions so as to proceed to the stage of returning a sound financial system back to private sector management. Directors noted the planned reduction in the cash reserve requirement and that continued reductions of legal cash reserve and liquidity requirements would increase the interest of new investors and facilitate the restructuring of the system. Directors welcomed the progress that had been made in strengthening banking system supervision and encouraged the Bank of Jamaica to strengthen supervision of institutions controlled by FINSAC. The supervision of insurance companies also needed to be strengthened.

Directors noted that the Jamaican economy faces serious competitive problems, as reflected in the current account of the balance of payments and the stagnation and decline of output in recent years. In addition, the current mix of policies has placed a heavy burden on monetary policy and has led to the high level of interest rates. While interest rates might need to stay high for some time as part of a comprehensive program of adjustment, the success of the government’s strategy will ultimately be reflected in a decline of interest rates to levels conducive to the sustained growth of output and employment. While Directors agreed with the authorities that gradual adjustment of the exchange rate, combined with improvements in efficiency and productivity, could help improve the competitiveness of the Jamaican economy over the medium term, some Directors expressed the view that greater exchange rate flexibility would be desirable, emphasizing that such a policy, combined with strengthened fiscal policy and wage restraint, would be essential to safeguard competitiveness over the medium term.

Directors were of the view that to achieve a lasting improvement in competitiveness, the government would need to address the critical issue of controlling nominal wages in the economy, especially in the public sector. In the end, Jamaica must find the right combination of political, social, and economic mechanisms to ensure that nominal wage setting in the economy was fully consistent with all aspects of its economic program.

To achieve medium-term viability, Jamaica would need to support short-term economic measures with a deepening of structural reform efforts. Those reforms, in addition to those affecting the financial system, should encompass decisive actions on the public sector, including the reactivation of the privatization program and the facilitation of private foreign investment. Actions to reduce employment in the public sector, accompanied by a reassessment of the economic role of the state, would be critical to that effort. Financing the short-term costs of a reduction of employment in the public sector would pose an additional challenge, which could be met in part by using part of the proceeds of the privatization effort for that purpose. Facilitating the participation of foreign investors in the privatization process would increase demand for the assets of entities to be privatized and improve the returns to the government.

Directors noted the weaknesses in Jamaica’s economic data, especially with regard to the national accounts, and urged the authorities to strengthen the statistical base, including through the use of technical assistance from the IMF and other sources.

Directors encouraged the authorities’ intention to monitor closely developments in key economic variables with a view to strengthening policies, as warranted, and to maintain a continued close policy dialogue with the staff.