It's not an easy road growing out of debt

Colin F. Bullock, Contributor

For almost a decade, Jamaica has been one of the most heavily-indebted countries in the world. The ratio of debt to (nominal) gross domestic product (GDP) exceeded 140 per cent in 2003, and after a slow decline and a favourable data revision, we are getting back to that peak again.

The Jamaica Debt Exchange (JDX) has made a significant contribution in reducing debt amortisation and service as a percentage of total budgetary outlays in the rear term. At the same time, total public debt including that facilitated by the borrowing agreement with the International Monetary Fund (IMF), has increased by over 40 per cent over the past three years.

The increase in public debt has been accompanied by a protracted contraction in domestic output. By now, Jamaica would have experienced 11 consecutive quarters of contraction in GDP and the more optimistic outlooks are for a resumption of growth in the first half of 2012.

Fiscal year 2010/11 will record negative growth. While output has been contracting, nominal GDP would have increased significantly in fiscal years 2008/09 and 2009/10 due to the impact of double-digit inflation. Because the debt/GDP ratio measures debt against nominal GDP, double-digit inflation in increasing nominal GDP would have moderated any increase in the ratio of debt to GDP. In the current fiscal year, the continuing contraction in GDP has been accompanied by a marked reduction in the rate of inflation. The increase in debt, with the slower growth of nominal GDP, will see a substantial increase in the debt/GDP ratio.

The easing of the debt burden is very often approached through an effort to break the interdependence between fiscal deficits and debt. Fiscal deficits are financed by public debt and the requirements of debt servicing crowd out essential social and economic expenditure, and increase the likelihood of expenditure overruns and unprogrammed increases in budget deficits. The breaking of that circularity is then dependent on raising taxes and/or reducing non-debt expenditure, to eliminate the fiscal deficit and stabilise the stock of debt. With the stock of debt stabilised, the growth in nominal GDP will ease the burden of indebtedness. The potential problem here is that increasing taxes and reducing non-debt expenditure have the potential of reducing the rate of growth of output and even of nominal GDP, if there is sharp disinflation. Exclusive focus on fiscal compression may also compress the rate of growth of output and even nominal GDP, making it harder to collect taxes to reduce the fiscal deficit and debt burden.

Alternative approach

An alternative approach focuses more exclusively on the generation of stronger economic growth, perhaps allowing for higher inflation. In this vein, there is talk of fiscal 'stimulus' or monetary 'stimulus'. This concept of stimulus had its genesis in Keynesian economics, prescribing increasing net-government expenditure to increase aggregate demand to pull developed market economies out of the Great Depression of the 1930s. Fiscal stimulus relates to increasing non-debt expenditure to drive stronger growth. There are, however, constraints to using fiscal-demand stimulus to grow out of debt in an open, dependent economy like Jamaica's. These include the following:

1. Internal, economic expansion has historically been driven by external demand and is currently constrained by the weak and uncertain recovery of the international economy.

2. Domestic demand is for mostly imported goods and services rather than for domestic production.

3. Unless fiscal stimulus is financed by grants ('free money' from abroad), borrowing money to finance increased expenditure will increase the fiscal deficit and add to public debt.

An alternative to market-debt financing is monetary 'stimulus' by inflationary financing through money creation by the central bank. This, too, has its limitations, more severe than debt financing through financial markets. The limitations of inflationary financing include:

i. It may reduce the real value of domestic debt but through exchange rate depreciation, it increases the quantity of fiscal resources in local currency that has to be used to service external debt.

ii. Higher inflation will increase the level of nominal interest rates demanded by domestic buyers of government debt.

iii. Higher inflation may discourage private investment through higher nominal interest rates ('money illusion') and greater uncertainty about future prices of output and inputs (e.g. wages)

iv. Inflation redistributes income from relatively poor and fixed income people (e.g. pensioners) to richer people who are better able to protect themselves from inflation.

v. Central bank financing, logically done interest free or below market rates of interest, undermines the balance sheet of the central bank and its independent capacity to guarantee the integrity (value) of the currency it issues.

Borrowing arrangements

Jamaica's current efforts to escape its treadmill of fiscal deficits and debt are defined by its borrowing arrangement with the IMF. The programme specifies quarterly performance criteria, largely centred on fiscal performance and the capacity of the Bank of Jamaica to accumulate domestic assets (which could include accommodation of the Government). There are also structural performance criteria, including 'rationalisation' of publicly owned companies, to enhance the likelihood of meeting fiscal targets. With relatively flat revenue/GDP, a reduction in interest/GDP and wages/GDP, and the elimination of the consolidated deficit of public enterprises, the overall deficit of the public sector is expected to approximate zero by fiscal year 2014/15. By then, the debt/GDP ratio should again have fallen to 120 per cent of GDP (not an overwhelming improvement).

It is recognised that the primary responsibilities of the IMF are macroeconomic and financial-sector stability. In this context, the IMF programme documentation has not dealt extensively with how to gene-rate growth. The executive summary of the January 2010 IMF Staff Report on Jamaica's proposed programme begins: "The core objectives of the proposed programme are to achieve fiscal sustainability and reduce financial-system risks". The 'Background and Recent Economic Developments' of the same document speaks of Jamaica that: "Its anaemic growth (less than two per cent per year over the past two decades) and recurring bouts of financial instability are rooted in part in an elevated public debt." This concedes that debt is a constraint on growth, but does not explore the reverse impact of growth on capacity to ease the burden of debt. The outlook envi-saged growth of 0.5 per cent in the current fiscal year increasing to 2.0 per cent for FY 2011/12 and beyond, linking this to the prospects for international economic recovery.

The first review of the programme reported success in meeting quantitative performance criteria (though recognising emergent spending overruns) and structural benchmarks, and an outlook for stronger growth related to international economic improvements with concerns about drought and the internal security situation.

The second review reported general success with quantitative and structural targets and stated that: "Further progress in structural reforms will be necessary to resolve underlying economic imbalances and strengthen the basis for strong and sustained growth." The press release for the third review expressed concern about the attainment of structural benchmarks and based on weather, internal security and a stalling international economic recovery, revised Jamaica's growth outlook downwards. "The mission discussed macroeconomic reforms that could help spur growth, including tax policy, the environment for doing business, and expenditure management, to secure the fiscal space for priority social and infrastructure projects."

There appears to be an increasing awareness that stronger growth is essential to the easing of the burden of public debt. A lot of reliance is being placed on the attainment of structural benchmarks in public sector and financial-sector management to facilitate that stronger growth. For example, from the quotation above, tax reform and an improved "environment for doing business" are seen as potential contributors to the process. Tax reform, along the lines of the ageing and largely neglected report of the Committee for Tax Reform, would, inter alia, reduce corporate tax rates to equality with personal rates, reduce transfer and inheritance taxes and substitute indirect for direct taxes. These proposals are worthy of critical engagement.

Expenditure management

The positing of 'expenditure management, to secure the fiscal space for priority social and infrastructure projects' represents an important advance beyond the conception of fiscal responsibility as relating only to ensuring that politicians and bureaucrats operate transparently and meet their stated objectives. There is a validation of the burden of this article that merely meeting quantitative fiscal targets may be necessary for easing the debt burden, but it is far from sufficient. It also goes beyond a superficial rendering of fiscal 'stimulus' as spending more to create demand 'stimulus' for output. There is a recognition that in an open, depen-dent economy like Jamaica's, the larger problem may be severe deficiencies in the productive structure rather than an insufficiency of aggregate demand.

The press release following the IMF's third review of the Standby Agreement also says that the authorities "are updating a draft Letter of Intent, to include measures to address the spending overruns." It would also be entirely appropriate to also re-examine the structure of debt constrained public expenditure with a view to facilitating stronger growth. Reform of the structure of expenditure will be challenged by interest groups, vested and political interests. Reform is unavoidable if the debt burden is to be resolved.

Colin F. Bullock lectures in the Department of Management Studies, UWI, Mona. Feedback may be sent to columns@gleanerjm.com.