Public Information Notice No.  01/57

Public Information Notice: IMF Concludes Article IV Consultation with Jamaica

June 6, 2001

On May 30, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Jamaica.¹

Background

Jamaica experienced a crisis in 1995/96 that resulted from liberalization of the financial sector without a sufficiently robust prudential and supervisory framework in place. The bailout of the financial sector has been very costly, estimated at more than 40 percent of GDP by end-2000/01. Following the crisis, the government adopted a tight monetary policy stance and attempted to maintain a broadly stable nominal exchange rate in order to reduce inflation. Inflation declined to single digits by end-1996/97, but tight monetary policy, coupled with fiscal deficits, led to high real interest rates and an erosion in external competitiveness. This policy mix also created unfavorable debt dynamics in subsequent years and the stock of debt escalated sharply. In June 2000, the Jamaican authorities undertook a staff-monitored program (SMP) designed to tackle the heavy burden of public sector debt and the legacy of earlier periods of high inflation.

After a decline in 1999/00, real GDP is estimated to have grown by 1 percent in 2000/01, based on a recovery in agriculture and mining, as well as strong growth in tourism. Inflation fell to 6½ percent at end-2000/01, despite some depreciation of the Jamaican dollar early in the year and increases in oil prices. The overall public sector deficit declined by 6 percentage points of GDP over 1999/00 and 2000/01, mainly as a result of the stronger position of the central government stemming from one-time revenue increases and restraint in non-interest expenditure. The public sector primary surplus reached 12½ percent of GDP in 2000/01.

The real effective exchange rate depreciated by about 4 percent in 1999/00 and 2½ percent so far in 2000/01 (April through February), following a large cumulative appreciation (46 percent) between 1995/96-1998/99. The external current account deficit widened by about 1½ percentage points of GDP in 1999/00 to 4½ percent of GDP, mainly as a result of a decline in bauxite exports, and is expected to remain broadly unchanged in 2000/01. Net international reserves increased by over US$700 million in 1999/00-2000/01, on the basis of direct investment inflows, multilateral support, and official borrowing. At end-March 2001, net international reserves stood at US$1.3 billion, equivalent to over 4 months of next year's imports.

Despite these advances, domestic interest rates are above levels projected under the SMP and the public debt to GDP ratio stabilized at slightly below 140 percent at end-2000/01, rather than declining as earlier projected. These developments, together with the need for some recovery in expenditures from low levels in 2000/01, have led to some relaxation of the fiscal targets under the SMP for 2001/02, although the targeted primary surplus would still be large at over 11 percent of GDP.

The authorities have made progress on structural reforms in recent years. Union Bank has been privatized and the restructuring of National Commercial Bank (NCB) has progressed. Four of the five FINSAC-intervened insurance companies institutions have been sold and sale of the fifth one is expected this year. Parliament approved the Financial Services Commission Act in March 2001, which is designed to strengthen financial sector supervision. Also, the authorities have sold a major public enterprise (the electric company).

The authorities' revised program for 2001/02 includes continued fiscal consolidation and a build-up in international reserves, while lowering inflation. Their revised program calls for a central government deficit of about 3 percent of GDP—about 1 percentage point of GDP higher than envisaged earlier, reflecting higher interest payments and larger current and capital expenditures. Also, an accumulation in net international reserves of US$100 million is targeted, while continued tight monetary policy is planned to achieve a reduction in inflation to 5-6 percent. On structural policies, the authorities plan to: (i) implement legislation designed to strengthen prudential supervision; (ii) continue sales of intervened financial institutions; (iii) complete reforms to improve the management and accountability of public enterprises; and (iv) enhance labor market flexibility.

Executive Board Assessment

Directors commended the authorities for the progress achieved over the past two years, and more recently under the staff-monitored program, in strengthening the public finances, reducing inflation, strengthening the net international reserve position, and adopting structural reforms, particularly in the financial sector. The reemergence of economic growth after four years of stagnation or decline was seen by Directors as praiseworthy. Directors noted in particular the very high public sector primary surplus of 12½ percent of GDP in 2000/01, which has been achieved through rigorous expenditure restraint, with social safety net expenditures maintained in real terms. They urged the authorities to build on these successes through maintaining strong policies so as to make further progress toward raising living standards and creating employment in the coming years.

Directors noted that, despite these successes, the stock of public debt in relation to GDP remained roughly unchanged in 2000/01, instead of falling significantly as envisaged, and that interest rates did not decline as rapidly as projected. They underscored that reducing the heavy public debt burden remains a key challenge facing the Jamaican economy. Directors welcomed the authorities' determination to meet their fiscal target for 2001/02. They noted that this will require continued expenditure restraint, including on public sector wages—while maintaining social safety net expenditures in real terms—as well as the expeditious implementation of revenue-enhancing measures, especially measures aimed at strengthening the enforcement of the tax code. Some Directors saw the case for an even stronger fiscal stance so as to permit faster debt reduction. Other Directors, however, noted that the primary surplus is expected to remain at a very high level and did not see a higher surplus as a realistic objective at this stage. Directors urged the authorities to persevere with fiscal restraint over the medium term to ensure a lasting decline in the public debt to GDP ratio as well as to help lower real interest rates and promote faster growth. They welcomed the measures taken by the authorities to improve debt management and the additional steps envisaged. Several Directors expressed concern over the guaranteeing of new debt by the government, and welcomed the authorities' commitment to exercise restraint in this regard.

Directors supported the authorities' tight monetary policy and its emphasis on reducing inflation. They were of the view that continued monetary restraint is appropriate. A number of Directors expressed concern at the authorities' plan to renew the scheme under which the banks agree to channel part of their resources resulting from lower reserve requirements via the Development Bank at concessional interest rates to priority sectors, noting the distortive effects of such a scheme. Directors considered the authorities' cautious approach to exchange rate management to be broadly appropriate, but a number of them saw scope for somewhat greater exchange rate flexibility without reigniting a wage-price spiral; this would be helped by a deepening of the exchange market through abolition of the 5 percent surrender requirement. They noted the importance of continued wage moderation and the removal of labor market rigidities to strengthen competitiveness. In this regard, Directors welcomed the continued dialogue between the government and labor unions to develop consensus and ownership on economic policies.

Directors welcomed the new legislative framework to strengthen prudential supervision of both banks and other financial institutions. They urged the authorities to implement quickly the framework, to establish effective cooperation between the new Financial Services Commission and the Bank of Jamaica and other international supervisors, to extend the framework to pension funds, and to strengthen the operational effectiveness—including the funding—of the bank deposit protection scheme.

Directors supported the assets disposals made by the Financial Sector Adjustment Company (FINSAC) last year, including the sale of Union Bank as well as the payment of cash interest on FINSAC securities in the 2001/02 budget. They endorsed the continued rapid privatization of other intervened financial institutions, and encouraged the authorities to identify other public enterprises for privatization.

Directors welcomed the proposed move to replace artificial reference prices by actual prices as the basis for the calculation of import duties for certain agricultural products, but concern was also expressed that this move is to be accompanied by a large rise in nominal duties. While supporting the objective of reducing rural poverty, several Directors questioned whether an increase in protection, even if small in effective terms, would be the best means of achieving this goal. Overall, they emphasized the benefits to the Jamaican economy of further trade liberalization, and urged the authorities to resist actions that would intensify existing trade restrictions.

Directors welcomed the authorities' intention to strengthen their statistics and, in particular, to improve their knowledge on the size and activities of the informal sector. It was noted that improvements in this area would require technical assistance, including from the Fund.