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Moody's downgrade signals need for Jamaica to make tough decisions
By Keith Collister
Friday, March 06, 2009
On the 4th of March, international rating agency Moody's Investors Services downgraded Jamaica's foreign and local currency government bond ratings to B2 from B1 and Ba2 "to reflect deterioration in the country's fiscal and debt positions as a result of the global economic downturn" .Foreign currency country ceiling for deposits was downgraded to B3 from B2, whilst all other ratings were unchanged.
Keith Collister
Oppenheimer's Greg Fisher (who has probably traded more Jamaican bonds than anybody else) and his new colleague Dr.Carl Ross (one of the most experienced overseas economic analysts of Jamaica) both believe that the downgrade was expected. The Moody's downgrade essentially brings Jamaica's debt in line with the B rating of rival rating agency Standard and Poor's (S&P), and for some time the prices of Jamaica's bonds have been trading as though we had already been downgraded.
Encouragingly, Moody's has left our future outlook at stable, rather than giving Jamaica a negative outlook that would signal they believe a further downgrade is likely in the near term.
In Moody's rating scale, obligations rated Ba "have speculative elements and are subject to high credit risk", whilst obligations rated with the more lowly rating of B "are considered speculative and are subject to substantial credit risk". Moody's then adds numerical modifiers (1,2,3) to denote further differences in credit quality. Jamaica's foreign currency deposit ceiling of B3 is the lowest B rating.
An interesting question about the downgrade is why Moody's is no longer differentiating between the credit quality of Jamaica's foreign and local debt, with both now being ranked at B2. Normally debt denominated in local currency, in this case Jamaican dollars, would be rated more highly than debt denominated in foreign currency because of the sovereign's ability to "print money' in extremis to repay its debt. Another question is, why have they rated the deposit ceiling on banks more lowly?
Moody's had waited four months to downgrade Jamaica, having put the Government of Jamaica on notice for a downgrade on November 4, 2008.
Jamaica very vulnerable to shocks
Commenting on the downgrade, Moody's Vice President, Senior Analyst Alessandra Alecci, argued that "While Jamaica's high willingness to pay remains an integral element of its credit profile, the government's finances and the external position are simply too weak to face a shock of this magnitude without a worsening of credit risk."
In their report, Moody's noted that Jamaica's central government deficit is expected to reach close to 6% of GDP this fiscal year, leaving public debt to GDP well in excess of 100%, once direct guarantees are included. On the external side, despite a contraction in imports, the current account deficit could remain in the double digits in terms of GDP in 2009. Considering expected declines in capital inflows globally, funding the shortfall could prove to be difficult.
Alecci noted that "Despite policy initiatives aimed at restoring debt sustainability, the severity of the global downturn is taking a toll on the government's finances and on all key inputs affecting public debt metrics."
Unsurprisingly, a key part of the downgrade seems to be driven by Moody's anticipation that Jamaica's key macroeconomic indicators will deteriorate in 2009. Whilst admitting such deterioration is a global phenomenon, Moody's notes Jamaica is particularly vulnerable as a small, very open economy.
Moody's also reasonably argues that Jamaica's three main foreign exchange-generating sectors are expected to face what it describes as "important declines", arguing that tourism and bauxite/alumina are expected to face setbacks as the global recession takes hold, while remittances from abroad are also likely to suffer.
Alecci also refers directly to Jamaica's longstanding economic vulnerability in the report. "Because of a high debt burden and large fiscal and external imbalances, Jamaica is facing these significant challenges from a position of relative weakness." She also notes that "Such weaknesses are exacerbated by Jamaica's public debt structure, with over half exposed to foreign currency and a large proportion of the domestic debt stock linked to floating rates." Finally, she argues that "Although multilateral financing obtained in recent months is certainly positive in terms of alleviating short-term liquidity concerns, it does not, in and of itself, address the issue of debt sustainability."
The Moody's report had noted that Jamaica's previous ratings were based on the expectation that the fiscal and debt position would improve substantially, as set out by the various medium-term macroeconomic programmes designed by the government.
"However, for a number of reasons, a meaningful fiscal consolidation was not achieved," said Alecci. "Given the adverse global environment, Jamaica's own structural weaknesses and limited room for manoeuvering, it is unlikely that such consolidation will be achieved in the near term." and that "Jamaica's borrowing requirements will continue to remain large relative to the size of the economy".
Clearly, part of the reason for the downgrade is that Moody's now believes the Government's debt reduction and budget balance programme has been overtaken by events.
Despite all these negatives, Moody's appears to assign high importance to the fact that local institutions have a high degree of incentive to collaborate with government.
Addressing the issue of default head-on, Alecci argues "despite considerable challenges and risks, at this stage, we expect Jamaica to avert a situation in which serious concerns about debt repayment arise. Because of the number of shocks the country has faced in recent years, policy-makers are accustomed to navigating through situations of high volatility."
Critically, she argues that the Government's debt is held primarily by local institutions, giving the Government a reliable funding source and local holders a high stake in collaborating with the Government as it undertakes painful fiscal measures. Essentially, she appears to be arguing that Jamaica's past successes in averting disaster, such as in 2003, are already priced into the rating, as are "a number of arrangements with multilaterals that could prove to be quite beneficial in a situation of extreme stress."
In the report, Alecci noted that both the Jamaican dollar and domestic interest rates are under considerable pressure, and noted that interest payments alone accounted for almost half of revenues. The fact that interest rates are rising, going into an already extraordinarily difficult budget may have been the trigger for the downgrade.
Her key comment however, perhaps decisive in the decision to downgrade Jamaica, is that with relatively inflexible government expenditures, policy options to deal with the ongoing shock are very limited.
What are Jamaica's policy options?
In 2003, Jamaica faced a very similar scenario to the one it faces today including a sharply rising budget deficit, high interest rates, a falling exchange rate and declining net international reserves. Whilst none of these indicators are yet at 2003 levels (even the recent exchange rate decline occurred over a much longer time period), the negative trend is very clear.
In a crisis guaranteed to be more severe and long-lasting than in 2003, the response must include much tougher measures than a freeze in the public sector wage bill. One of the measures Jamaica will need to take is much greater taxation on energy.
By Keith Collister
Friday, March 06, 2009
On the 4th of March, international rating agency Moody's Investors Services downgraded Jamaica's foreign and local currency government bond ratings to B2 from B1 and Ba2 "to reflect deterioration in the country's fiscal and debt positions as a result of the global economic downturn" .Foreign currency country ceiling for deposits was downgraded to B3 from B2, whilst all other ratings were unchanged.
Keith Collister
Oppenheimer's Greg Fisher (who has probably traded more Jamaican bonds than anybody else) and his new colleague Dr.Carl Ross (one of the most experienced overseas economic analysts of Jamaica) both believe that the downgrade was expected. The Moody's downgrade essentially brings Jamaica's debt in line with the B rating of rival rating agency Standard and Poor's (S&P), and for some time the prices of Jamaica's bonds have been trading as though we had already been downgraded.
Encouragingly, Moody's has left our future outlook at stable, rather than giving Jamaica a negative outlook that would signal they believe a further downgrade is likely in the near term.
In Moody's rating scale, obligations rated Ba "have speculative elements and are subject to high credit risk", whilst obligations rated with the more lowly rating of B "are considered speculative and are subject to substantial credit risk". Moody's then adds numerical modifiers (1,2,3) to denote further differences in credit quality. Jamaica's foreign currency deposit ceiling of B3 is the lowest B rating.
An interesting question about the downgrade is why Moody's is no longer differentiating between the credit quality of Jamaica's foreign and local debt, with both now being ranked at B2. Normally debt denominated in local currency, in this case Jamaican dollars, would be rated more highly than debt denominated in foreign currency because of the sovereign's ability to "print money' in extremis to repay its debt. Another question is, why have they rated the deposit ceiling on banks more lowly?
Moody's had waited four months to downgrade Jamaica, having put the Government of Jamaica on notice for a downgrade on November 4, 2008.
Jamaica very vulnerable to shocks
Commenting on the downgrade, Moody's Vice President, Senior Analyst Alessandra Alecci, argued that "While Jamaica's high willingness to pay remains an integral element of its credit profile, the government's finances and the external position are simply too weak to face a shock of this magnitude without a worsening of credit risk."
In their report, Moody's noted that Jamaica's central government deficit is expected to reach close to 6% of GDP this fiscal year, leaving public debt to GDP well in excess of 100%, once direct guarantees are included. On the external side, despite a contraction in imports, the current account deficit could remain in the double digits in terms of GDP in 2009. Considering expected declines in capital inflows globally, funding the shortfall could prove to be difficult.
Alecci noted that "Despite policy initiatives aimed at restoring debt sustainability, the severity of the global downturn is taking a toll on the government's finances and on all key inputs affecting public debt metrics."
Unsurprisingly, a key part of the downgrade seems to be driven by Moody's anticipation that Jamaica's key macroeconomic indicators will deteriorate in 2009. Whilst admitting such deterioration is a global phenomenon, Moody's notes Jamaica is particularly vulnerable as a small, very open economy.
Moody's also reasonably argues that Jamaica's three main foreign exchange-generating sectors are expected to face what it describes as "important declines", arguing that tourism and bauxite/alumina are expected to face setbacks as the global recession takes hold, while remittances from abroad are also likely to suffer.
Alecci also refers directly to Jamaica's longstanding economic vulnerability in the report. "Because of a high debt burden and large fiscal and external imbalances, Jamaica is facing these significant challenges from a position of relative weakness." She also notes that "Such weaknesses are exacerbated by Jamaica's public debt structure, with over half exposed to foreign currency and a large proportion of the domestic debt stock linked to floating rates." Finally, she argues that "Although multilateral financing obtained in recent months is certainly positive in terms of alleviating short-term liquidity concerns, it does not, in and of itself, address the issue of debt sustainability."
The Moody's report had noted that Jamaica's previous ratings were based on the expectation that the fiscal and debt position would improve substantially, as set out by the various medium-term macroeconomic programmes designed by the government.
"However, for a number of reasons, a meaningful fiscal consolidation was not achieved," said Alecci. "Given the adverse global environment, Jamaica's own structural weaknesses and limited room for manoeuvering, it is unlikely that such consolidation will be achieved in the near term." and that "Jamaica's borrowing requirements will continue to remain large relative to the size of the economy".
Clearly, part of the reason for the downgrade is that Moody's now believes the Government's debt reduction and budget balance programme has been overtaken by events.
Despite all these negatives, Moody's appears to assign high importance to the fact that local institutions have a high degree of incentive to collaborate with government.
Addressing the issue of default head-on, Alecci argues "despite considerable challenges and risks, at this stage, we expect Jamaica to avert a situation in which serious concerns about debt repayment arise. Because of the number of shocks the country has faced in recent years, policy-makers are accustomed to navigating through situations of high volatility."
Critically, she argues that the Government's debt is held primarily by local institutions, giving the Government a reliable funding source and local holders a high stake in collaborating with the Government as it undertakes painful fiscal measures. Essentially, she appears to be arguing that Jamaica's past successes in averting disaster, such as in 2003, are already priced into the rating, as are "a number of arrangements with multilaterals that could prove to be quite beneficial in a situation of extreme stress."
In the report, Alecci noted that both the Jamaican dollar and domestic interest rates are under considerable pressure, and noted that interest payments alone accounted for almost half of revenues. The fact that interest rates are rising, going into an already extraordinarily difficult budget may have been the trigger for the downgrade.
Her key comment however, perhaps decisive in the decision to downgrade Jamaica, is that with relatively inflexible government expenditures, policy options to deal with the ongoing shock are very limited.
What are Jamaica's policy options?
In 2003, Jamaica faced a very similar scenario to the one it faces today including a sharply rising budget deficit, high interest rates, a falling exchange rate and declining net international reserves. Whilst none of these indicators are yet at 2003 levels (even the recent exchange rate decline occurred over a much longer time period), the negative trend is very clear.
In a crisis guaranteed to be more severe and long-lasting than in 2003, the response must include much tougher measures than a freeze in the public sector wage bill. One of the measures Jamaica will need to take is much greater taxation on energy.