Bullock

The Government of Jamaica has announced its intention to borrow from the International Monetary Fund, (IMF). It is now generally understood that Jamaica would have had to adjust with or without an IMF borrowing agreement. The need to adjust presents challenges regarding the likely social cost and how the burden of adjustment is to be shared among the various interest groups in society. The availability of funding increases opportunities to increase production and foreign exchange earning. This would ease the burden of adjustment.

The minister of finance has indicated a foreign exchange gap of US$600 million to US$800million for the current fiscal year. Some of this is caused by the decline in net foreign exchange inflows from merchandise exports and remittances. There has also been a significant decline in both official and private net capital inflows.

Jamaica's foreign exchange problem is a "flow" problem: the outflow of foreign exchange exceeds the inflow. The borrowing of money from abroad does not solve this flow problem. By itself, it only allows Jamaica, for a time, to use more foreign exchange than it can attract without borrowing. Unless Jamaica can correct this imbalance, it is hardly likely that external creditors will continue lending more money to Jamaica into an indefinite future. Eventually the lending stops and Jamaica then has a "stock" problem. It has to use its stock of official foreign exchange reserves to pay for the excess of outflow over inflow. Eventually the official reserves disappear and Jamaica faces the shock of forced adjustment.

inadequate domestic saving

The decline in net foreign exchange earning has a counterpart in inadequate domestic saving. A substantial element of this domestic "dissaving" is apparent in unmanaged fiscal deficits and in declining primary surpluses (the fiscal balance without including interest expenditure). These fiscal deficits contribute to both the external account deficit (decline in official foreign reserves) and to the increase in public sector borrowing and public debt. Public sector borrowing from domestic financial markets is the single most important factor causing interest rates to be at current levels that are generally conceded to be "unfriendly" to investment and economic growth.

A committed but realistic time path towards the substantial elimination of the fiscal deficit (significant increase in primary surpluses) must be a significant element of an adjustment programme. In this regard, the dominant components of Government expenditure, interest rates, wages, and pensions, will raise significant policy challenges.

While it often appears to be an "attractive" option, the adjustment process cannot begin from an arbitrary reduction of interest rates. To do this while the remainder of the fiscal accounts and the external accounts are still in imbalance, is to invite exchange rate depreciation, a resurgence of inflation and wealth holders demanding higher interest rates to compensate for higher inflation, or conversion to foreign currency.

It is conceivable that the promised strong foreign exchange inflows can provide some cover for interest rate reduction, but unless this is accompanied by other adjustments, these inflows will only have the impact of financing outflows without stabilisation of the foreign exchange market. There have been discussions of "voluntary" interest rate restructuring options, but while this may facilitate some reduction in public debt service expenditure, it does not by itself guarantee a general and sustained reduction in interest rates.

After payments for debt servicing the expenditure budget is dominated by public sector emoluments. There have been indications that the size of the public sector is not to be immediately addressed. Simultaneously, there is talk of "attrition" and not filling "non-essential vacancies". There are social issues here. If we contract by attrition, where do the potential new entrants work? There is a need for a rejuvenated private sector to "step up to the plate" with entrepreneurial innovation, investment and employment. At the same time, the scope of government in terms of ministries, agencies and activities is not likely to escape critical scrutiny.

Public sector pensions have represented a significant element of non-debt expenditure and an increasing cost to the budget. (The amount budgeted for this fiscal year actually represents a decrease relative to the previous fiscal year). In the present scheme, public sector employees have defined benefits, to be paid from the budget, but there is only very limited contribution. With an ageing population and a likely increase in the ratio of pensioners to active tax-paying public servants, the burden of pensions on the budget could continue increasing in the future.

There obviously will be no intention to interfere with the entitlements and protection of existing pensioners. Existing public sector employees that have been "appointed" are contractually entitled to the same provisions and any adjustment would demand a negotiated "buy-out" of the existing provision. In both this instance, and if redundancies in the public sector are to be considered, Government would have to find even more money in the short run, to buy out contractual obligations. There would have to be negotiated multilateral financial support for these specific objectives. Regarding pensions, the best opportunity for change would relate to new employees of the public sector.

Fiscal revenue has been underperforming. Despite the investments in the Bahl and Wallace report, and the efforts of the Matalon Committee, we have approached tax policy reform (the structure and incidence of taxes) haltingly and demonstrated greater enthusiasm for tax administration (making it easier to pay taxes and going after the "delinquents"). Both are important. Regarding tax policy, there are largely untested issues in making the tax structure more 'business friendly', and in enhancing equity in the incidence of taxation (who pays and who does not). Both of these issues are relevant to consideration of the significant amount of taxes foregone in tax incentives, and the largely unmeasured economic returns from these incentives. For fiscal sustainability, tax reform needs to define a system that will yield more revenue as the economy grows, avoiding the ad hoc and inefficient adding on of new measures and increased "sin taxes" (cigarettes and white rum) from budget to budget. There will have to be significant advances in fiscal transparency. In this regard, the fiscal budget has to abandon unbridled optimism (overestimating revenue and underestimating expenditure) for greater realism. Public enterprises have accumulated debt that they have no realistic chance of amortising. While we rationalise and divest public enterprise, it is possible that we may have to measure and report an overall public sector deficit that includes general government, public enterprises and the financial public sector. This is in recognition that government debt may arise from any of these sources. Along with public enterprise debt, there may have to be an explicit recognition of all other contingent liabilities (recognition of obligations that may have to be eventually paid by government) and an identification of all threats to the desired fiscal performance (e.g. possible closure of a systemically important tax paying company or sharp increases in the prices of basic social services that have to be provided by Government).

exchange rate depreciation

The IMF is no longer as dogmatic in pushing for exchange rate depreciation for every manifestation of an external account imbalance. If Jamaica's economic programme is designed to maintain relative exchange rate stability while lowering interest rates, then fiscal adjustment is unavoidable. To the extent that fiscal policy is unable to contract the deficit, economic programme consistency will still come back to exchange rate depreciation and the resulting inflation as a means of compressing aggregate demand. This would, however, increase nominal interest rates and inhibit the recovery of economic activity.

The entire programme and its funding will be wasted if it does not facilitate an eventual escape from economic stagnation to fairly robust economic growth. The IMF inflows may facilitate some reduction in interest rates but will add to the debt stock and, with all the other debt, have to be repaid. Growth is necessary to facilitate revenue generation for debt servicing and deficit elimination. Expenditure has to be managed to allow more room for growth supportive public investment while reducing the deficit. Our system is defined as being dependent on private-sector led growth and to the extent that fiscal adjustment underwrites the lowering of interest rates, private investment may be facilitated.

While the public policy may strive to create an enabling environment, however, government cannot be expected be the main entrepreneur. The broad private sector and all its constituent parts need to generate blueprints for private sector led growth, including risk-taking, equity investment, international standards and external market penetration.

As a final consideration, the success of adjustment and the facilitation of growth are dependent on social cohesion, but at least social stability. This means that the equity of the sharing of the burden of the inevitable adjustment, and perceptions of equity, have to be very carefully and sensitively managed.

Legally, the Government cannot publicise the day-to-day details of its negotiations with the IMF. It may still be possible to sensitise the public on the general directions of the emergent economic programme. Social cohesion may require as much transparency as is legally possible and, where sacrifices are inevitable, the minimisation of surprise.

Colin Bullock is senior lecturer in the Department of Economics, UWI, Mona. Feedback may be sent to columns@gleanerjm.com.