Jamaica: Start Jammin

After riding the global credit boom for the past decade, fate finally caught up with Jamaica. A prolonged process of deindustrialization and the shift to a services-based economic model led to a persistent series of current account and fiscal deficits that were financed by the debt markets. In two years, the country’s external debt to GDP ratio jumped to 105%, from 76% in 2008. At the same time, Jamaica’s central government debt, which includes all domestic obligations, reached 120% of GDP this year. Debt service was consuming 55% of the country’s fiscal revenues. The current account deficit is more than 10% of GDP, despite a sharp slowdown in economic activity. The Jamaican economy contracted 3.5% y/y in 2009. It was clear that the country’s economy was wrong footed and its debt load was unsustainable. This was the reason why Jamaican bond prices plunged during the end of last year. Still, there is a great deal of international support for the country. Jamaica is the third largest economy in the Caribbean, and closely aligned with the U.S. and Europe. Although the country was under a great deal of stress, the multilateral community was not going to allow it to collapse in disarray. Therefore, something was going to be done to get the country through a tough patch.

At the heart of the problem was the country’s domestic debt load. With $7.8 billion in domestic debentures, it represented the bulk of the government’s obligations. The coupons were as high as 24%, and the average was 18%. Most of the domestic debt was short-term. Global bonds totalled only $2.8 billion, or less than half the total stock of the domestic obligations. The coupons on the global bonds were also lower and the maturities were longer. Hence, the domestic debt was the main driver behind the country’s 5.5% of GDP fiscal deficit. The remaining balance of the central government’s debt consisted of multilateral obligations. Therefore, it was obvious that most of the adjustment was going to focus on the domestic instruments. Fortunately, the process was relatively mild. Last month, Kingston launched a debt exchange that reduced the coupons on the domestic debentures by 35% and extended maturities by two years. Most of the instruments were held by Jamaican banks, and they comprised a large chunk of the domestic financial system’s assets. Therefore, the adjustment could not be too radical—otherwise it would destroy the banking system. The debt exchange reduced the domestic bond’s NPV by 20%, but the fact that there was no reduction in principal meant that the impact on balance sheets was limited. The successful completion of the debt exchange allowed the IMF to agree to a 27-month $1.27 billion Standby Facility. The result was a major rally in Jamaican bond prices—despite the fact that the country was downgraded to selective default by the major credit rating agencies. The biggest move was on the long end of the Jamaican curve, where bond prices jumped as much as 10 points. Nevertheless, Jamaican bonds are still cheap. The Jamaican ‘38s and ‘39s are yielding almost 10%, but the best opportunities are in the short end of the curve. The Jamaican ‘12s yield more than 11%–in euros. The bond rally was primarily driven by local institutions, but they were sceptical about taking on euro-denominated paper. Nevertheless, these instruments provide interesting returns for international investors.

In addition to the restructuring of its domestic debt, Kingston also agreed to implement several other structural reforms in order to secure the IMF deal. It promised to implement an extensive fiscal reform which would reduce expenditures and raise taxes. It also agreed to divest itself of some state-owned assets, such as Air Jamaica. Therefore, the IMF deal will be painful, and the level of Jamaica’s economic activity will contract another 3.5% y/y in 2010. Nevertheless, it buys the country an important respite. However, the IMF program does not address the underlying flaws of Jamaica’s economic model. We believe that Jamaica will need to rethink its heavy emphasis on services, such as tourism. Successful service economies require a highly skilled workforce, which is still a challenge for Jamaica. At the same time, service economies often run large trade and current account deficits. Jamaica was able to do so during the past decade, when capital flows and liquidity was abundant. However, it will be much more difficult to continue with such an approach during the next decade, as the availability of capital becomes scarce. In the meantime, strong external sponsorship and support will make Jamaica’s short-term obligations a very attractive proposition.