WASHINGTON, USA – In the decade preceding the pandemic Jamaica made good progress in restoring macroeconomic and financial stability. Aided by IMF financial support, the fiscal deficit was brought from 11 percent of GDP in 2009 to a surplus; public debt fell from 142 percent of GDP to 94 percent, and inflation and the current account deficit declined. Jamaica institutionalized hard-won fiscal discipline through a Fiscal Responsibility Law, moved to inflation targeting, allowed for greater exchange rate flexibility, and strengthened oversight of the financial system. These reforms are continuing. The recent passage of the amendments to the Bank of Jamaica Act and the legislation to establish a Fiscal Council are two of the latest achievements of the government’s ambitious reform program.
These improvements allowed Jamaica to implement a strong policy response, when it was hit hard by the Covid-19 pandemic. An early lockdown in the Spring of 2020 helped contain the number of Covid-19 cases but the impact on the economy was severe, with real GDP shrinking by 10 percent. To counter the social and economic effects of the pandemic, the government suspended the fiscal rule for one year and temporarily reduced the primary balance target from 6½ to 3½ percent of GDP, increased spending on health and social protection and reduced the GCT rate. At the same time, the central bank injected liquidity and encouraged banks to put in place loan moratoria to provide temporary support to the private sector.
The availability of buffers built-up pre-crisis and the calibrated policy response to the crisis ensured that – unlike in the past – the pandemic related shock was not followed by a fiscal, financial, or balance of payments crisis.
The economy is now recovering. Tourism has rebounded to near 70 percent of pre-crisis levels, despite two Covid-19 waves this year, and other sectors have picked up as well. Real GDP in 2021Q2 was 14.2 percent higher than the same quarter a year earlier. We project growth of 8¼ percent in FY2021/22, moderating to 3½ percent in FY2022/23.
But risks to the outlook are significant. The main risk is Covid-19. A third COVID-19 wave is abating, and vaccination has picked up pace, with one million people now having received at least one dose. But new Covid-19 waves in Jamaica or abroad could lead to a more prolonged disruption of tourism, trade, and capital flows. Another risk is posed by the uncertain duration of global inflationary pressures. The sharp rise in world food and energy prices has helped boost year-on-year inflation to 8.2 percent in September, well above the central bank’s target range of 4-6 percent. Natural disasters continue to be an ever-present risk. On the other hand, a faster pace of vaccinations at home and abatement of the pandemic in Jamaica’s main tourism markets are upside risks.
As the crisis recedes and the recovery advances Jamaica should restart debt reduction and rebuild buffers, given high susceptibility to external shocks and risks to debt sustainability. Policies should also focus on boosting growth which has been low in the last decades, enhancing institutions, and tackling the still high levels of poverty and crime.
Rebuilding fiscal buffers
The government’s goal to reduce debt to 60 percent of GDP by 2027/28 is appropriate. As a result of the crisis, public debt has increased to 109 percent of GDP, and assurances that it will be brought down over time are important for investor confidence and preservation of macroeconomic stability. Lower debt and debt service payments would also create more fiscal space to mitigate contingent and long-term fiscal pressures including creating buffers for natural disasters.
Although the Financial Administration and Audit Act Regulations only require publication of a fiscal framework for the next four years, publication of a fiscal framework for a longer-term period that shows how the debt reduction will be achieved would further increase the credibility of the government’s target.
For FY 2022/23, and in line with the Fiscal Responsibility Law, the government aims at an overall fiscal surplus of about 0.3 percent of GDP, the same as in FY 2021/22. The impact of lower BOJ dividends would be partly offset by lower interest payments. Public debt and interest payments are expected to decline faster as the authorities pay down maturing bonds from the debt exchange operation of 2010 and 2013.
Running fiscal surpluses of about 1 percent of GDP in FY 2023/24 and beyond would ensure smooth progress to the debt target and avoid the need to raise the fiscal surplus much sharper in later years in order to meet the debt target.
Rises in the wage bill risk crowding out other expenditure. The new public sector compensation system that will come into effect in FY 2022/23 will make the wage structure more transparent, standardized, and equitable, and reduce the large differences in pay with the private sector. But it will also further add to the wage bill, which is already one of the highest in the region, reducing the room for other expenditure. A reassessment of the various roles and responsibilities of government, as well as increasing efficiency in the provision of public services, that would facilitate a reduction in the size of the public workforce, could help offset the costs of the new wage structure.
At the same time, more resources are needed for infrastructure and other growth-enhancing expenditures. Infrastructure needs are significant, and better infrastructure would help boost private sector growth. More resources are also needed to entrench disaster resilience. To reduce the high crime rate (which deters economic activity and investment) more spending on police and crime prevention may be needed. And in health care, the number of hospital beds and doctors per person is relatively low.
Re-orientation of existing expenditure and increasing revenue could create additional resources in the near term, while declining debt and interest payments would do so over the medium term. Lowering the wage bill could free up scare resources for spending in growth critical areas. Revenues could be raised by reducing exemptions. Lower debt and interest payments would create significant scope to scale up social spending in health and education.
There is also scope to make existing expenditure more effective. Spending on primary and secondary education is in line with other countries in Latin America and the Caribbean, but education test scores and the number of years of schooling are relatively low.
Inflation has risen above the central bank’s target range of 4-6 percent. Rising inflation is mainly the result of rising global food and energy prices, but other import prices and shipping costs have increased as well – the result of global supply-chain shortages.
We expect inflation to increase to 8.8 percent at end-2021 and then recede to 6.7 percent at end-2022, but there are significant risks that inflation may be higher, Global inflationary pressures may last longer and be more intense than we currently expect, and pass-through of global food and energy prices to local inflation (which has weakened in recent years) may be stronger than projected.
The BOJ has raised policy rates by 100 bp. (to 150 bp) effective October 1, but depending on inflation developments, further tightening may be needed, to firmly anchor inflation expectations, underline the central bank’s commitment to its inflation goal, and bring inflation to within the target range by end-2023. Even if the current shocks are transitory and longer-term inflation expectations have not been affected (which is hard to gauge as no survey of inflation expectations beyond 12 months exists), further rises in inflation that is not accompanied by a monetary policy response could de-anchor the expectations and jeopardize the inflation’s return to the BOJ target range. Moreover, monetary policy is still accommodative as evidenced by the policy interest rate in real terms continuing to decline this year.
Financial stability indicators indicate that the financial system is well-capitalized and liquid. Deposit taking institutions balance sheets have been helped by regulatory forbearance and liquidity support by the BOJ. Their Capital Adequacy Ratio at the end-2020 was 14.3 percent (well above the regulatory minimum of 10 percent) and NPLs have remained below 3 percent. Non-deposit taking institutions are also more than sufficiently capitalized, profitable and stable. The BOJ’s macroprudential assessment suggests that financial sector risks are contained.
The supervision of financial conglomerates needs to be strengthened. The financial sector is dominated by complex financial conglomerates that operate in multiple jurisdictions. Some large groups’ headquarters are based in jurisdictions that have different oversight practices, and cross-border and financial subsectors linkages are concentrated in a few entities. Risks arise from concentrated ownership, related party and large group exposures, and off-balance sheet positions. Even with proper separation between bank and nonbank group members, direct and indirect exposures could be a source of contagion.
Strong efforts are needed to finalize adoption of a legislative framework for the special resolution regime for the orderly resolution of distressed financial institutions and group-wide supervision and continue advancement with data gathering and analytics particularly of inter-institution linkages and cross-border exposures.
Further strengthening of the AML/CFT regime and a swift implementation of the action plan agreed with the FATF will support timely exit from the FATF grey list and strengthen correspondent banking relationship. The recently adopted national risk assessment provides the government with a better understanding of the country’s ML/TF risks and will help to address key priorities identified together with the FATF.
Removing supply-side constraints to boost growth
Even before the pandemic, growth in Jamaica has been anemic. Average growth in 2010-19 was only 0.6 percent, barely keeping pace with population growth. Real GDP per capita is at the same level as in 1970. Low growth was partly due to repeated crises, but growth has also been low during expansions, and in the last 25 years, growth has exceeded 2 percent only twice.
From a growth-accounting perspective, low growth is not the result of low investment or low employment growth, but of declining productivity. Investment in Jamaica is relatively high, and the employment-to-population ratio has increased sharply in the last few decades. But this has been offset by a steady decline in labor productivity, the result of a decline in total factor productivity.
Low growth can partly be explained by the decline of Jamaica’s traditional export industries. Sugar, bananas, and textiles exports have all declined following the expiration of preferential access agreements, while aluminum and bauxite exports have lost market share to more effective competitors.
But growth has also been held back by supply-side constraints. These include low levels of human capital, high rates of crime; infrastructure deficiencies, particularly in logistics and energy; and high costs of production (electricity costs in Jamaica are the fourth highest in the world, access to finance for SMEs remains a challenge, cross-border trade and paying taxes is cumbersome, import tariffs are relatively high, and neighboring competitors enjoy enhanced access to the U.S. market from Free Trade Agreements.
Removing supply-side constraints to growth should be among the central policy priorities in the coming years. Education and training need to become more effective and linked to labor demand; infrastructure, logistics, and digitalization would benefit from an upgrade; crime needs to be contained, and energy sources shift towards renewables. Policy reforms should aim at enhancing governance and reducing vulnerabilities to corruption; increasing the SME sector’s access to finance; simplifying business procedures, particularly speeding up customs clearance, and advocating for a bolder CARICOM approach to open trade policies and overall economic integration with other regions.