Keith Collister, Contributor
COLLISTER
ONLY A month ago, Finance Minister Omar Davis described Jamaica as having a 'solid economic outlook' in a presentation to international investors based on our "continued macroeconomic stability," which was a prelude to Jamaica's extremely successful Eurobond issue. In that presentation, he outlined the five main components of this macroeconomic stability as being :fiscal programme on track, inflation on a downward path, interest rates trending down, liquid and stable foreign exchange market and positive economic growth.
However, the recent spike in inflation for the month of May of 2.2 per cent at minimum calls into question whether inflation can still be described as being on a downward path. Year to date, the combined inflation rate for the first two months of the fiscal year - April and May - is estimated at 4.2 per cent. Therefore, in order to meet the inflation target of nine per cent for fiscal year 2005/2006, the overall inflation rate for the remaining ten months of the fiscal year can be no more than 4.8 per cent.
In his article last Sunday, economic commentator Ralston Hyman argued that as a result of this higher than anticipated inflation" The central bank, could therefore, be forced to halt its aggressive interest rate reduction policy in order to contain core inflation, if the country is to have a chance of meeting the targeted rate for the fiscal year." He further argued in his article that "both agricultural and crude prices are likely to continue climbing on the back of supply bottlenecks during the current quarter, therefore headline inflation is expected to accelerate."
Mr. Hyman's also expressed concern about the destabilising effects on the economy of negative real interest rates. He cited the example of the return on passbook savings, which using last year's inflation rate would have been significantly negative for smaller savers. He adds that the "failure to tighten policy could lead to an acceleration of inflationary pressures, a reduction in savings and investment and a sharper slowdown in growth than would have been necessary."
Clearly these are legitimate concerns, particularly if the still restrained core rate of inflation for the March quarter of 1.1 per cent (which excludes the more volatile food and energy component) begins to rise sharply. A prolonged period of severely negative real interest rates as Jamaica has seen in the past would certainly not be good for macroeconomic stability.
CORE INFLATION RATE
However, the continued good performance of the core inflation rate suggests that the current spike in inflation is not a result of "too much money chasing too few goods," which would clearly require a monetary policy response. Instead, it appears to be as a result of cost push factors, including higher local food prices, energy prices and particularly the first and second round effects of the rise in GCT which should be of a one-off transitory nature, leading to a much lower inflation rate over the next few months.
Assuming this is indeed the case, in the short run I would encourage the Government to continue to err in the current direction of historically low real interest rates. This is because I would argue that due to our very high level of indebtedness, and the consequent enormous impact the level of domestic interest rates has on the budget, Jamaica's key priority at this time must be to continue lowering domestic interest rates on a sustainable basis. I believe that only in this fashion can we meet this year's key balanced budget target while maintaining what has to be a minimum of programme spending.
As the Jamaica Chamber Commerce (JCC) said in its mid-year Economic Outlook released last week:
"The budget for 2005/2006 shows continued expenditure restraint, with a decline in projected interest costs making room for a badly needed increase in programme expenditure, particularly in the areas of crime and education."
MODEST REDUCTION
Governor of the Central Bank Derek Latibaudiere appears to agree that interest rates need to fall further, as in our recent conversation he advised of his continued "commitment to deliver interest rates consistent with that assumed in the fiscal programme," which he described as a commitment to a modest reduction in interest rates, certainly compared with last fiscal year.
The governor also confirmed my view, expressed in previous articles around the time of the budget, that the Government had hoped to cut interest rates more than what had been agreed in the fiscal programme. Governor Latibaudiere advised that in fact they had already "reached in May where we were programmed to be in June," of what he further described as a not very "heroic programme of interest rate cuts". The implication is that while the Government is still on track to meet its target for a modest further reduction in interest rates, it looks increasingly difficult to exceed this target.
As is his normal practice, the Minister of Finance has not released an interest rate target for this year. I believe, however, that the target is in the low double digits for the current fiscal year, and that the intention would have been to spend any additional money that would have been saved on faster than projected interest rate cuts on priority programmes. My view is that rates are likely to be lowered somewhere between one to two per cent from their current level of 12.6 per cent on the benchmark 30-day repo rate of the Central bank, in line with rather than exceeding what was programmed in the budget. A faster cut in domestic interest rates would require good news on the inflation front. The Governor currently believes meeting the nine per cent inflation target for the fiscal year will be 'extremely challenging', suggesting this is unlikely.
KEY ELEMENT
In conclusion, it is the substantial decline in projected interest costs this year that is the key element in achieving the balanced budget target this year. The achievement of this balanced budget target is also the crucial element in ultimately achieving further interest rate cuts, particularly single digit interest rates, as to quote last weeks JCC's mid year Economic Outlook again:
"The rate at which we borrow internationally provides a floor beneath which local interest rates are unlikely to fall. We believe this means we will require a rating upgrade for our domestic interest rates to fall into single digits."
Ultimately, it is imperative to reach single digit interest rates if we are to raise the rate of economic growth sufficiently to create the jobs Jamaica needs. Unfortunately, the recent rise in inflation currently makes this look unlikely for this fiscal year. To quote Mr. Hyman again, it looks like "the pace of reduction will have to be slowed."
