Jamaica 2008: Oil Peaks at US$147, Lehman Falls and the Economy Confronts Its Most Severe External Shock Since FINSAC

Jamaica Economic Intelligence | Annual Review 2008 | January–December 2008

Key Findings

• Oil soars to an all-time record of US$147 in July, then crashes to US$40 by December in the fastest commodity reversal in modern history
• GDP contracts for the first time in seven years as tourism declines, remittances fall and domestic demand weakens
• Jamaica’s inflation averages over 20% for the year — the highest since the FINSAC era — before easing sharply in Q4
• Tourism ends its three consecutive record-breaking years with the first year-on-year decline since 2001
• The Jamaican dollar loses approximately a quarter of its value against the U.S. dollar during the year
• The Golding government closes 2008 in active IMF programme negotiations as debt-to-GDP resumes its upward march

Two crises collided in 2008. The first was a commodity shock — oil and food prices surging to levels that hammered every import-dependent economy on earth. The second was a financial collapse of historic proportions, originating in the United States but spreading through every connected economy in the world. Jamaica, small and open and deeply tied to the American economy through tourism, remittances and trade, was caught squarely in the path of both. The year ends with the island in IMF negotiations for the first time in over a decade.

The Year in Two Acts

Calendar year 2008 divides cleanly into two acts separated by the eleven days in September when Lehman Brothers filed for bankruptcy and the global financial architecture cracked. In Act One — January through early September — the dominant economic story was commodity inflation. Oil crossed US$100 per barrel for the first time in February, climbed to an all-time record of US$147.27 on July 11, and drove food and energy prices to levels that provoked riots across the developing world and threatened social stability from Haiti to Bangladesh. Jamaica’s inflation surged above 25 per cent year-on-year by the middle of the year — levels not seen since the worst of the FINSAC crisis.

In Act Two — September through December — the commodity story was abruptly overshadowed by a financial implosion. The nationalisation of Fannie Mae and Freddie Mac on September 7, Lehman’s bankruptcy on September 15, the emergency rescue of AIG on September 16 and the seizure of Washington Mutual on September 25 — these events, compressed into less than three weeks, triggered the deepest global credit contraction since the 1930s. The immediate paradox for Jamaica was that the financial collapse sent oil prices into freefall — from US$147 in July to below US$40 by December — which unwound the commodity inflation shock with remarkable speed. But the forces producing the commodity price collapse were the same forces producing the global recession, and a recession is a far more damaging adversary than inflation for an economy that depends on tourists and diaspora remittances.

GDP: The Growth Streak Ends

Jamaica’s economy, which had sustained positive growth through the post-Ivan reconstruction period and the 2006–2007 tourism boom, contracted in 2008 for the first time in seven years. The Planning Institute of Jamaica estimates GDP growth for the full year at approximately minus 0.5 to minus 1.0 per cent — a modest contraction in absolute terms but a significant psychological break with the trend of the preceding three years and a harbinger of a considerably sharper decline expected in 2009 as the full effects of the global recession are absorbed.

The contraction reflects the convergence of several simultaneous headwinds: declining tourism receipts, falling remittance flows, sharply higher input costs in the first half of the year, tighter credit conditions, weakening domestic consumer demand and a deteriorating fiscal position. No single sector carried the economy forward as tourism did in 2005–2007 and construction did in 2004–2005. The agricultural sector, still recovering from the banana crop destruction inflicted by Hurricane Dean in August 2007, added little to growth. Manufacturing continued its long-term structural decline relative to GDP.

Inflation: The Spike and the Fall

The trajectory of consumer price inflation in 2008 traced an extraordinary arc. Opening the year at approximately 20.5 per cent year-on-year — itself already alarming — the CPI rate accelerated through the first half as oil and food prices surged, reaching a peak of approximately 27 per cent in the summer months. By the Statistical Institute of Jamaica’s December 2008 data, the year-on-year rate had retreated to approximately 16 per cent as oil’s collapse unwound the fuel and food components of the index. The full-year average inflation rate of approximately 22 per cent was the highest since the mid-1990s and represented a severe erosion of real household incomes, particularly for low-income families for whom food and utilities account for the majority of expenditure.

The inflation experience of 2008 exposed the structural vulnerability of an economy that imports virtually all of its energy and a significant share of its food. When global commodity markets move against Jamaica, the domestic price level has no effective insulation; the transmission from international price to local retail shelf is rapid and near-complete. The social cost — measured in nutritional stress, reduced spending on education and healthcare and increased reliance on public food programmes — will take years to fully assess.

The Exchange Rate: A Year of Depreciation

The Jamaican dollar, which opened 2008 at approximately J$71 to the U.S. dollar, ended the year at approximately J$89–90 — a depreciation of roughly 24 per cent over twelve months. The pressure was relentless and multidirectional: the inflation differential between Jamaica and its trading partners eroded the real value of the currency, the current account deficit widened as the oil import bill ballooned in the first half of the year, remittance inflows contracted, and the global risk-off environment of September-December reduced capital inflows as investors retreated from emerging and developing market assets across the board.

The Bank of Jamaica, which began the year with its benchmark overnight rate at 10.25 per cent — itself already a tightening from the 9.5 per cent trough of early 2007 — raised rates repeatedly through the year as it attempted to defend the currency and signal commitment to inflation control. By year-end the benchmark rate had been raised into the mid-teens, imposing a severe cost on borrowers and on the government’s debt-service bill. The interest rate tightening could moderate but not prevent the currency’s decline in the face of the external shock’s scale.

Tourism: Three Records, Then a Stumble

Jamaica’s tourism sector had achieved something remarkable in the three years before 2008: consecutive annual records of 1.35 million, 1.45 million and 1.51 million stopover visitors in 2005, 2006 and 2007 respectively. The 2007 figure was the first time Jamaica had crossed the 1.5 million mark. In 2008, that streak ended. Preliminary full-year data from the Jamaica Tourist Board indicate stopover arrivals of approximately 1.45 to 1.47 million — a decline of roughly 3 to 4 per cent from 2007’s record and a return to 2006 levels.

The causes are unambiguous. The U.S. recession, which was already depressing consumer spending before Lehman’s collapse, intensified sharply in the final quarter. American household wealth had declined by an estimated US$13 trillion by year-end — a contraction without precedent in the post-war period. Airline capacity to Caribbean destinations was reduced as carriers raised fares and cut routes in response to fuel costs that, even after their dramatic Q4 decline, remained structurally higher than the pre-2007 norm. The forward booking picture for 2009 suggests the decline will accelerate rather than stabilise.

Remittances: The Lifeline Contracts

Remittances to Jamaica contracted in 2008 for the first time since the September 11 shock of 2001. Bank of Jamaica full-year data indicate inflows of approximately US$1.78 to US$1.82 billion — a decline of 5 to 7 per cent from 2007’s US$1.9 billion. The contraction reflects the rapid deterioration of employment conditions in the United States through the second half of the year, particularly in construction — a sector that employs a disproportionate share of Jamaican-born workers in the U.S. tri-state area and South Florida.

The remittance decline has compound effects. It reduces household income directly in the communities that receive transfers. It reduces foreign exchange supply to the Jamaican banking system, adding to downward pressure on the dollar. And it reduces domestic consumer spending, which weakens the retail and service sectors that employ workers who themselves send money to rural communities. Remittances are not a line item in an economic model; they are the connective tissue of Jamaican family life, and their contraction is felt in ways that GDP statistics do not easily capture.

The Fiscal Position: Debt Resumes Its Rise

The government’s fiscal position deteriorated materially in 2008. Tax revenues underperformed budget projections as economic growth disappointed; expenditures on fuel subsidies, social transfer programmes and public-sector wage settlements exceeded projections; and interest costs rose as the BOJ tightened and the currency depreciated. The primary surplus — the government’s surplus before debt service, the key metric for debt sustainability in an economy where the cost of servicing prior obligations consumes more than half of every budget dollar — fell below target.

The consequence is that Jamaica’s debt-to-GDP ratio, which had declined from its FINSAC-era peak of approximately 145 per cent to around 130 per cent by 2007, has reversed course. Year-end 2008 estimates put the ratio at approximately 132 to 135 per cent of GDP and rising, as a shrinking denominator (lower nominal GDP growth in a currency that has depreciated) meets a growing numerator (fiscal deficits and rising interest costs). The trajectory, absent significant fiscal adjustment, is unsustainable.

The IMF: An Agreement Takes Shape

The most consequential policy development of 2008, in terms of its long-run implications for Jamaica, may prove to be the negotiation of a Stand-By Arrangement with the International Monetary Fund. The Golding administration, which entered office in September 2007 committed to a home-grown economic reform programme without IMF conditionality, has progressively acknowledged through 2008 that the external environment has made an external anchor necessary. The preliminary conversations of the spring became serious negotiations in the autumn, accelerated by the Lehman shock and its consequences for global capital flows.

An agreement, expected to be finalised in the early weeks of 2009, is anticipated to provide approximately US$1.2 to US$1.3 billion in balance-of-payments support over 24 months and to carry conditions relating to fiscal adjustment, public-sector efficiency and the management of the public debt. The political challenge of implementing those conditions in a democracy, against the backdrop of a contracting economy and a cost-of-living crisis that has already stretched household budgets to breaking point, will be the defining test of the Golding government’s second year in office.

The Property Market: A Necessary Pause

The residential property market ended 2008 in a significantly different condition from where it began. Transaction volumes declined materially from 2007 levels. Mortgage lending slowed as commercial bank prime rates rose toward and above 15 per cent. New development activity contracted sharply as developers struggled to finance projects and sell completed units to buyers whose purchasing power had been eroded by inflation and whose financing costs had risen steeply. The north coast resort market, which had attracted significant foreign investment in 2005–2007, quietened as diaspora buyers retreated and tourism’s decline removed confidence from the short-term rental segment.

The pause is painful in the short term but may prove necessary. The price appreciation of 2005–2007 had begun to price Jamaican property out of reach for middle-income domestic buyers, and a period of consolidation that resets affordability could lay the foundations for a healthier, more broad-based market when the economic cycle turns. The fundamental supply constraint — chronic undersupply of formal housing relative to household formation rates, particularly in the Kingston metropolitan area — has not been resolved and will reassert itself when conditions improve.

What This Means

Homeowners who purchased at the peak of the 2006–2007 market on variable-rate mortgages are under the most pressure. Those with equity and stable employment should prioritise keeping up with payments as the worst of the cycle passes; those in distress should engage their lenders early, as restructuring is almost always preferable to default in Jamaica’s legal environment. For those who purchased before 2005, the equity position remains comfortable despite the market cooling.

Renters have experienced the sharpest real income compression of any group — wages have not kept pace with a 20-plus per cent inflation rate, utility costs have risen sharply and the labour market is softening. The partial reversal of inflation in Q4 2008, driven by falling oil prices, provides a modest foretaste of relief, but full recovery of purchasing power will take several years even in an optimistic scenario.

Developers who entered 2008 with leverage, unsold inventory and pipeline projects face the most difficult decisions. The combination of high financing costs, weak demand and a market where buyers have leverage not seen since the early 2000s argues for conserving cash, completing only the most advanced projects and deferring new starts until the credit environment clarifies. The IMF programme, if it stabilises macroeconomic conditions, should provide a platform for eventual recovery.

Businesses should plan their 2009 operations around the assumption of lower revenues and tighter credit than 2008, not 2007. The businesses that will emerge strongest from this period are those that enter it with strong balance sheets, low leverage, loyal customer bases and flexibility in their cost structures. This is not the environment for expansion; it is the environment for resilience.

Diaspora members carry a heavier burden than usual. Their own economic security is under pressure from the U.S. recession, and the need of family members in Jamaica has simultaneously increased. Those who can maintain their remittance flows — even at reduced levels — perform an act of economic solidarity with consequences that extend well beyond any individual family. The community networks that support Jamaicans in the diaspora will be tested in 2009 as they have not been tested since the post-September 11 contraction.

Outlook for 2009

Jamaica enters 2009 in the most difficult external environment since the early years of the FINSAC restructuring. GDP is expected to contract more sharply than in 2008 as the full depth of the global recession becomes apparent. Tourism arrivals are likely to fall further as American and British consumers retrench. Remittances will decline as diaspora employment weakens. The fiscal position will face continued pressure even as the IMF programme provides an external financing anchor and a framework for adjustment.

There are, however, grounds for cautious longer-term optimism. The fall in oil prices, if sustained through 2009, will meaningfully reduce Jamaica’s import bill — potentially by several hundred million dollars relative to 2008. Inflation, having peaked, should continue to decline toward more manageable levels, eventually enabling the Bank of Jamaica to ease interest rates and reduce the cost of borrowing. The IMF programme, whatever its political costs, provides a framework within which fiscal adjustment can be pursued in an orderly rather than a disorderly way.

The lesson of Jamaica’s post-FINSAC decade is that patient, disciplined macroeconomic management — sustained even when it is painful — can restore debt sustainability and create the conditions for growth. That lesson was learned at great cost in the 1990s. The question for 2009 and beyond is whether a government, a legislature and a society that have also weathered Hurricane Ivan, the 2001 global recession and now the worst external shock in a generation have the collective endurance to apply it again.

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.

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