IMF Executive Board Concludes 2005 Article IV Consultation with JamaicaPublic Information Notice (PIN) No. 06/43
April 25, 2006
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On March 24, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Jamaica.1
Economic activity has been adversely affected by shocks. Real GDP contracted sharply in late 2004 following the devastating effects of Hurricane Ivan. Thereafter, while output recovered, it was dampened by the poor performance of agriculture, which suffered from adverse weather conditions, including a number of major hurricanes during July-October 2005. The hurricanes also caused infrastructure damage and led to a sharp temporary drop in tourist arrivals. Recent data indicate, however, that the agricultural recovery is firmly underway and tourist arrivals have picked up strongly.
Inflation remains high and volatile. Consumer prices registered a marked increase in the aftermath of Hurricane Ivan, reaching 13¼ percent at end-2004. Thereafter, annual headline inflation continued to pick up, reaching a high of 19 percent in September 2005, before falling back to 12.4 percent in February. Agriculture, which weighs heavily in the consumer price basket, was responsible for most of the surge in prices. The upward spiral in energy prices also played a part since changes in international oil prices are fully reflected at the retail pump in Jamaica.
The external current account balance weakened on account of the shocks, with some reversal in capital flows occurring during the second half of 2005. Export performance weakened because of crop damage while imports shot up mainly due to higher oil prices. As regards the capital account, the government successfully tapped global financial markets to finance the budget at relatively favorable spreads and private inflows also strengthened in early 2005. As a result, net international reserves (NIR) increased rapidly through June 2005, before reversing course in the third quarter of 2005 as capital outflows led the Bank of Jamaica (BOJ) to step up market interventions to support the Jamaican dollar.
The nominal exchange rate has depreciated in recent months. After remaining relatively unchanged for about a year, the Jamaican dollar depreciated briskly during June-November 2005 and continued to weaken during February-March, 2006. In real effective terms, however, given the high inflation, the Jamaican dollar appreciated by 9 percent on average during 2005.
Fiscal targets have been missed. Hurricane Ivan was largely responsible for the failure to achieve both revenue and expenditure objectives in FY 2004/05. Relative to the authorities' targets, the revenue shortfalls have widened during FY 2005/06 as revenue collections have fallen. As regards expenditures, notwithstanding the flooding and infrastructure damage associated with the 2005 hurricanes, spending was kept under tight restraint—in particular, capital expenditures were squeezed further. Revised budget estimates recently approved by parliament, envisage, however, some increase in expenditures for the year as a whole, including on account of allowances and pensions. The budgetary shortfalls have been financed successfully, including through the very successful placement of several Eurobonds.
Monetary policy has been geared at containing inflation while also seeking to engender a sustainable reduction in interest rates. These policies, combined with successive rounds of monetary tightening in the United States, have narrowed the Jamaican-U.S. interest rate differential by about 330 basis points since end-2004. Nevertheless, with strong capital inflows, foreign exchange reserves increased rapidly through mid-2005. The reserve build-up was fully sterilized by sales of central bank bills. Foreign exchange reserves have however fallen modestly in recent months.
Executive Board Assessment
Executive Directors noted that, since late 2004, Jamaica's economy had experienced a series of major natural disasters, as well as external shocks arising from increases in oil prices and global interest rates. Output growth had slowed, inflation had risen more than envisaged, and the external current account balance had weakened. At the same time, revenue collection had also fallen sharply. These developments had put considerable strain on the authorities' medium-term socio-economic policy framework, whose aim of reducing the public debt burden was centered on balancing the budget for the current fiscal year—a goal that now appears out of reach. Directors noted that the near-term economic outlook remains vulnerable to shocks, and that the debt dynamics remain highly sensitive to macroeconomic volatility and market sentiment.
Against this background, and given the extraordinarily high level of public debt, Directors cautioned that the authorities have very limited room for policy maneuver, and urged them to remain steadfast in implementing the policies necessary to achieve the objectives of their macroeconomic strategy. Directors considered that ambitious fiscal consolidation and a prudent debt management strategy will be required to create a virtuous cycle of reduced debt, low inflation, and improved living standards for the Jamaican population. It will also be important to make further progress on structural reforms aimed at reducing the economy's vulnerabilities and improving long-term growth potential.
Directors noted that the authorities' strategy to reduce the debt-to-GDP ratio requires a strong, sustained fiscal effort. They considered it imperative to achieve a balanced budget as soon as feasible and to avoid recurring fiscal slippages. In this regard, Directors welcomed the authorities' continued commitment, despite difficult circumstances, to limit the size of deviations from fiscal targets and to eliminate deficits over the medium term. Most Directors concurred that the authorities' fiscal objectives should be more ambitious than currently envisaged. Moreover, if the economy improves more than is currently envisaged, Directors encouraged the authorities to target a balanced budget for FY 2006/07. Some Directors cautioned that there is not much scope for postponing infrastructure investment and social and poverty-reducing programs. Directors encouraged the authorities to develop contingency plans to deal with possible further shocks.
Directors noted that realizing the budgetary objectives for FY 2006/07 and beyond will require both revenue measures and expenditure discipline, while the medium-term fiscal outlook depends critically on the outcome of wage negotiations. They encouraged the authorities to consider measures to broaden the tax base, eliminate exemptions and preferences, and pursue tax delinquents in a more vigorous manner. Directors also underscored the importance of broader fiscal reforms aimed at increasing the productivity of the public sector, and at reforming public enterprises to limit the debt burden arising from off-budget entities. Directors urged the authorities to use new concessional debt to replace costlier financing, instead of expanding the overall expenditure envelope.
Directors emphasized the need for careful conduct of monetary and exchange rate policies in the period ahead, in view of the recent slowdown in growth and the narrowing interest rate differentials, which could exert pressures on the capital account. They noted that a gradual, preemptive tightening of monetary policy is likely to prove more supportive of fiscal and growth objectives than an accommodative and reactive approach. A number of Directors viewed the recent portfolio shifts as transitory in nature, as financial market conditions have remained favorable and inflation expectations have fallen. In any event, Directors welcomed the authorities' readiness to increase interest rates, if warranted by the prevailing economic conditions. They underscored the importance of maintaining a flexible exchange rate regime, aimed at safeguarding the external competitiveness of the economy.
Directors noted that robust and sustained economic growth is critical to the authorities' macroeconomic strategy. To this end, they urged the authorities to accelerate structural reforms, with a view to ensuring that the current high levels of investment translate into greater productivity and efficiency, and to improving the business environment in general. Tax reforms should be implemented in a comprehensive manner, aimed particularly at creating a level playing field and increasing transparency. In addition, efforts should be continued to improve access to credit, enhance labor market flexibility, and strengthen law and order. Given Jamaica's exposure to both adverse natural events and changes in financial market sentiment and the limited scope under the authorities' strategy to accommodate such risks, Directors emphasized the importance of persevering with efforts to strengthen institutional capacity to withstand such adversities.
Directors welcomed the authorities' participation in the Financial Sector Assessment Program and their commitment to continue to strengthen the resilience of the financial system in line with the recommendations. They welcomed improvements in recent years in the quality and structure of supervision and increases in capital levels in most financial institutions. Directors nevertheless saw scope for further developing supervisory capacity, strengthening the oversight of financial conglomerates, and tightening prudential requirements for securities dealers. They encouraged the authorities to continue to upgrade the statistical systems, with a view to subscribing to the Special Data Dissemination Standard. Expanding financial surveys to cover nonbank entities will be an important step in that regard. Directors also recommended that the authorities address remaining gaps in the AML/CFT framework.