Jamaica Economic Intelligence | Q3 2008 | July–September 2008
Key Findings
- Fannie Mae and Freddie Mac placed into federal conservatorship on September 7, backstopping US$5 trillion in mortgages
- Lehman Brothers files the largest bankruptcy in history on September 15, triggering global financial panic
- AIG rescued by an US$85 billion Federal Reserve emergency intervention one day later
- Oil crashes from its July record of US$147 to below US$100 — falling faster than it rose
- Jamaica’s tourism decline deepens and remittances show first year-on-year contraction since 2001
- IMF discussions intensify as the Golding government acknowledges the scale of the external shock
In the space of eleven days in September 2008, the architecture of the global financial system was redrawn. Two government-sponsored mortgage giants were nationalised, the world’s fourth-largest investment bank filed for bankruptcy, and the world’s largest insurance company was rescued by public funds. For Jamaica — small, open and deeply dependent on the economic health of the United States — the earthquake that began on Wall Street is now being felt in every corner of the island economy.
The Week the World Changed
Historians will debate for decades exactly when the global financial crisis of 2008 became irreversible. The strongest candidate is the eleven-day sequence that began on September 7 when the U.S. Federal Housing Finance Agency placed Fannie Mae and Freddie Mac — the government-sponsored enterprises that collectively guarantee or own more than US$5 trillion in residential mortgage debt — into federal conservatorship. The two institutions, which had operated for decades under an implicit government guarantee that the market had always assumed would be honoured, had seen their equity value destroyed as mortgage losses accumulated; the U.S. Treasury committed up to US$200 billion in capital support to keep them solvent.
Eight days later, on September 15, Lehman Brothers Holdings Inc. filed for Chapter 11 bankruptcy protection — the largest corporate bankruptcy in American history, with US$613 billion in liabilities. Unlike Bear Stearns six months earlier, Lehman received no government rescue. The decision, contested in retrospect by those who believe it transformed a manageable crisis into a systemic one, sent immediate shockwaves through global credit markets. The overnight lending rates between banks — the Libor rates that underpin trillions of dollars of financial contracts worldwide — spiked to levels not seen since the early 1990s. Money market funds, long considered safe as deposits, experienced the first systemic run in their history when the Reserve Primary Fund “broke the buck,” falling below a net asset value of one dollar per share as its Lehman paper became worthless.
One day after Lehman’s collapse, the U.S. Federal Reserve announced an US$85 billion emergency credit facility to American International Group (AIG), the world’s largest insurer by assets, in exchange for a 79.9 per cent equity stake. AIG had written credit-default swaps guaranteeing hundreds of billions of dollars of mortgage-related securities; its failure would have triggered payouts across the global financial system that no institution was positioned to absorb. The week concluded with Merrill Lynch, itself facing insolvency, absorbed by Bank of America in an emergency merger, and Washington Mutual, the largest U.S. savings institution, seized by the Federal Deposit Insurance Corporation on September 25 in the largest bank failure in American history.
The U.S. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke subsequently presented Congress with a proposal for a Troubled Asset Relief Program (TARP) of up to US$700 billion, designed to remove toxic mortgage assets from bank balance sheets and restore the capacity of the financial system to function. The proposal, initially rejected by the House of Representatives on September 29 in a vote that sent the Dow Jones Industrial Average down 777 points — its largest single-day point loss in history — was revised and signed into law on October 3.
Oil’s Reversal: From Record to Retreat
One of the few economic developments in the quarter that works in Jamaica’s favour — at least superficially — is the collapse in oil prices. West Texas Intermediate, which hit its all-time record of US$147.27 per barrel on July 11, has fallen precipitously as financial market turmoil has forced the unwinding of speculative positions and as the scale of the coming global recession begins to depress demand expectations. By the end of September, WTI was trading around US$95 per barrel — a 35 per cent decline from its peak in less than three months.
The fall in oil prices will provide some relief to Jamaica’s import bill in the final quarter of 2008 and into 2009. Electricity tariffs, which had been raised sharply in the spring, may begin to ease. The fuel-surcharge component of airline ticket prices — which contributed to the decline in tourist arrivals — may moderate. But the fall in oil is a symptom of a demand collapse driven by the deepest global recession since the 1970s, and the economic forces destroying demand for oil are the same forces destroying demand for Jamaican tourism, Jamaican exports and the income of the Jamaican diaspora that underpins remittance flows.
Tourism: The Decline Deepens
Preliminary data from the Jamaica Tourist Board indicate that stopover arrivals in Q3 2008 were approximately 6 to 8 per cent below Q3 2007 levels, an acceleration of the year-on-year decline that first emerged in Q2. The North American market — the source of approximately 75 per cent of Jamaica’s stopover visitors — is weakening in direct proportion to the deterioration of U.S. consumer confidence and household balance sheets. The Conference Board’s Consumer Confidence Index fell to its lowest reading in sixteen years in September.
Forward booking data, which the industry uses as a leading indicator for the coming quarter, point to continued pressure through year-end and into the 2009 winter season. Several major tour operators serving the Caribbean have reported a shift in booking patterns toward shorter-haul, lower-cost destinations, and some have reduced their Jamaica allocations for the 2008–2009 winter season.
The impact is being felt not only in hotel occupancy rates — which have continued to decline from Q2 levels — but throughout the supplier network. Craft market vendors, independent taxi operators, tour guides, restaurant and entertainment businesses catering to visitors all report sharply reduced activity compared with the equivalent period in 2007. The Jamaican government, for whom tourism-related tax revenues represent a significant budgetary contribution, is beginning to incorporate lower tourism projections into its fiscal planning.
Remittances: The Lifeline Under Pressure
Remittances to Jamaica — which reached US$1.9 billion in calendar year 2007 — are showing the first year-on-year contraction since the aftermath of the September 11 attacks in 2001. Bank of Jamaica data for the first eight months of 2008 indicate that inflows are running approximately 4 to 5 per cent below the equivalent period of 2007. The decline reflects deteriorating employment conditions in the United States, where the unemployment rate has risen from 5.0 per cent at the start of the year to 6.1 per cent in August, with construction and service-sector employment — the sectors where a disproportionate share of the Jamaican diaspora works — contracting particularly sharply.
The significance of this decline cannot be overstated. Remittances have consistently exceeded Jamaica’s merchandise export earnings and foreign direct investment inflows, functioning as a structural stabiliser of both household incomes and the balance of payments. A sustained reduction of even 10 per cent would remove approximately US$190 million from the national income — enough to materially worsen both the current account deficit and the government’s fiscal position.
Monetary Policy: Tightening Into a Slowdown
The Bank of Jamaica faces a cruel dilemma that has no clean resolution. Raising interest rates to defend the Jamaican dollar and contain inflation — which remains above 20 per cent despite the recent moderation in oil prices — imposes costs on growth, employment and the government’s debt-service burden that are increasingly difficult to bear as the economy slows. The BOJ’s benchmark overnight rate, raised to 12.00 per cent during Q2, has been increased again during the quarter as currency pressures have intensified; the exchange rate has moved from approximately J$75 in early July to around J$78-80 by late September. Capital flows, which had sustained the dollar through most of 2007, are reversing as global risk appetite collapses in the wake of the Lehman shock.
The government’s fiscal position is deteriorating. Tax revenues are running below budget projections as economic activity slows; expenditures on fuel subsidies, social transfers and public-sector wage settlements are running above projections. The primary surplus — the government’s surplus before debt service payments, the central target of Jamaica’s debt management strategy — is at risk of undershooting the targets set in the May budget. With debt-to-GDP approaching 130 per cent and rising, the fiscal arithmetic is becoming critical.
IMF: From Conversation to Negotiation
The conversations between the Golding administration and the International Monetary Fund that were described, during the spring, as “precautionary” have taken on a different character in the wake of September’s global financial shock. The government has acknowledged to Parliament that it is in active discussions with the Fund about the terms and conditions of a potential programme. The IMF’s engagement would bring external financing support — likely through its Stand-By Arrangement facility — and would provide the confidence signal to international creditors that Jamaica’s debt sustainability is being actively managed.
The terms of any such programme will be consequential. IMF programmes typically require commitments on fiscal adjustment — tax reform, public expenditure restraint, potentially including public-sector wage policies — that are politically demanding. The Golding government, which came to power in September 2007 on a platform of economic reform, now confronts a test of that commitment at a moment when the external environment is as adverse as it has been at any point since the FINSAC crisis of the late 1990s.
The Property Market: Credit Tightens
The residential property market has entered its most difficult period since the early 2000s. With commercial bank prime lending rates in the 14 to 15 per cent range and rising, mortgage affordability has deteriorated sharply. The National Land Agency reports that transfer volumes in the Kingston metropolitan area and the resort communities along the north coast are running well below 2007 levels. The diaspora buyer — historically a significant source of demand in the luxury and upper-middle segments — is absent from the market as asset values in the United States and United Kingdom have declined and uncertainty about the global economy has prompted caution.
New construction activity in the residential sector has slowed materially. Several planned developments that were marketed to investors in 2006–2007 are experiencing delayed starts, and in some cases revised designs to lower the entry price point. The commercial real estate sector faces similar headwinds, with new office and retail developments in New Kingston struggling to secure pre-let commitments from a business community conserving cash in an uncertain environment.
What This Means
Homeowners face a property market that has shifted decisively from seller to buyer territory. Those who do not need to sell have every reason to hold; those who must sell will need to be realistic about pricing. Variable-rate mortgage holders face the prospect of further rate increases before any easing cycle begins, and should review their capacity to service debt at rates materially above current levels.
Renters may find that the falling oil price provides modest relief on utility bills in coming months, but the broader economic deterioration — slowing employment growth, real wage erosion — means that any relief is likely to be partial and short-lived. The risk of landlords facing mortgage stress and seeking to pass costs to tenants is a secondary concern worth monitoring.
Developers with unsold inventory face the most immediate pressure. Access to bridge financing from Jamaican commercial banks has tightened alongside the global credit contraction. Those with completed projects and unsold units must balance the cost of carrying inventory against the risk of reducing prices in a falling market — a decision with long consequences for project economics and for setting price expectations in their markets.
Businesses should prepare for a materially slower 2009. The combination of declining tourism receipts, falling remittances, reduced domestic consumer purchasing power and tighter credit conditions points to weak aggregate demand through at least the first half of next year. Cash conservation, working-capital discipline and diversification away from U.S.-dollar-denominated revenue streams deserve priority attention.
Diaspora members in the United States face the greatest economic uncertainty in a generation. Those in construction and financial services — sectors at the epicentre of the U.S. crisis — face the highest risk of employment disruption. For those who regularly remit to Jamaica, building a buffer against possible income interruption is prudent; for those in stable employment, maintaining regular transfers supports family members who have no equivalent cushion.
Outlook
The events of September 2008 have fundamentally altered the baseline against which Jamaica’s economic prospects must be assessed. The Planning Institute of Jamaica’s projections from the May 2008 budget, already strained by the oil and food shocks of the first half of the year, are no longer a useful guide to what 2009 will bring. The global economy is entering a synchronised recession of a severity not seen since the early 1980s, and Jamaica — which has never, in its modern economic history, been able to grow when its principal trading partner and diaspora host is contracting — will not be able to decouple from that global downturn.
The most consequential decisions facing the Golding administration in the coming months concern the IMF. A programme that provides balance-of-payments support and a credibility anchor will impose difficult structural conditions but may be the only credible alternative to a disorderly adjustment. The government’s ability to secure broad national consensus for the necessary fiscal measures — across Parliament, the trade union movement and the business community — will determine whether the programme, if agreed, can be sustained through its full term.
The fall in oil prices, if sustained, will provide a meaningful reduction in Jamaica’s import bill and eventually in domestic inflation. But a commodity price crash driven by a global recession is a palliative, not a cure. As of early October 2008, the most plausible scenario for Jamaica is a difficult 2009 in which GDP contracts, tourism falls further, remittances decline and the government implements significant fiscal adjustment — all simultaneously. The resilience that Jamaica has demonstrated repeatedly in its post-independence economic history will be tested more severely in the coming months than at any time since FINSAC.
Jamaica Economic Intelligence is an independent data-driven journalism series publishing quarterly and annual reviews of Jamaica’s economy. Sources include the Bank of Jamaica, the Planning Institute of Jamaica, the Statistical Institute of Jamaica, the Jamaica Tourist Board, the National Land Agency and multilateral institutions including the IMF and World Bank. All figures are the best available estimates at the time of reporting.
Follow Jamaica Homes on Youtube @jamaicahomes and Instagram @jamaica_homes and on Facebook @jamaicahomesnews Send us a message or email us at onlinefeedback@jamaica-homes.com or editor@jamaica-homes.com
Visit our YouTube Community ↗