Jamaica
Selected Issues
Author:
International Monetary Fund
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Publication Date:
18 Feb 1999
eISBN:
9781451820065
Language:
English
Keywords:
ISCR; CR; foreign currency; private sector; fiscal year; monetary policy; liquidity support; commercial paper; economic growth; monetary base
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This Selected Issues paper presents an overview of financial system developments in Jamaica. The financial system experienced substantial growth over 1989–95 as a result of the liberalization of financial markets and the reduction in government involvement in the industry through the privatization of banks. The paper highlights that banks that had been acquired by the government in the 1970s were sold back to the private sector. This paper also reviews developments in monetary policy in Jamaica, and the role of the public sector.

Abstract

This Selected Issues paper presents an overview of financial system developments in Jamaica. The financial system experienced substantial growth over 1989–95 as a result of the liberalization of financial markets and the reduction in government involvement in the industry through the privatization of banks. The paper highlights that banks that had been acquired by the government in the 1970s were sold back to the private sector. This paper also reviews developments in monetary policy in Jamaica, and the role of the public sector.

Jamaica: Basic Data

article image

Calculated at J$36.5 per U.S. dollar.

For fiscal years which begin April 1.

Calendar year data.

Includes grants but excludes privatization receipts

Annual change as a percent of liabilities to the private sector at the beginning of the period.

End of period.

Including unallocated expenditure but excluding capital support to the financial sector.

I. Financial System Developments

A. Background

1. Since the establishment of the first bank in 1836 by English merchants, Jamaica’s financial system developed continuously and by the mid-1990s consisted of private and public financial institutions ranging from traditional commercial banks to merchant banks, building societies, credit unions, insurance and trust companies, finance houses, investment banks, and specialized institutions such as the Agricultural Development Bank, the National Development Bank, and the Jamaica Mortgage Bank.

2. The financial system experienced substantial growth over the period 1989–95 as a result of the liberalization of financial markets and the reduction in government involvement in the industry through the privatization of banks.1 Although a stock exchange was introduced in 1969, until recently, most of the allocation of savings continued to take place through traditional institutions of financial intermediation rather than capital markets. Only some 20 companies are regularly traded on the Jamaica Stock Exchange and total market capitalization amounted only to J$66.1 billion or about 30 percent of GDP in 1996. Most of the listed and traded instruments on the stock exchange are ordinary/common stocks; corporate bonds are practically nonexistent.2 Government bonds are not traded on the stock exchange but rather by the Bank of Jamaica (BOJ) in an over-the-counter market. However, an unregulated commercial paper market has been growing over the last couple of years through which enterprises access, with and without commercial bank guarantees, credit from private sources. There are no registration or regulatory requirements affecting transactions in this market. Private informal estimates place the size of this market at between J$20–40 billion (8–16 percent of GDP).

3. A few private companies have accessed international capital markets in amounts estimated at about US$200 million, and in 1997 the government for the first time placed a US$200 million Eurobond followed by an additional Eurobond issue of US$250 million in 1998. Prior to the most recent Eurobond issue, Jamaica received its first bond rating from Moody’s which rated Jamaica’s sovereign debt as a Ba3.

4. Since mid-1995, Jamaica’s domestic financial system has been in distress facing both liquidity and solvency problems which prompted the government to intervene on a large scale leading to a partial nationalization of the domestically owned financial sector at a gross cost of over 30 percent of GDP. The following sections describe some of the developments that contributed to the financial system collapse, the government’s response, and lays out the challenges that remain to be addressed.

B. Financial Crisis Developments

Privatization and liberalization of financial markets

5. In line with the government’s overall strategy in the mid-1980s to reduce the size of the public sector, banks that had been acquired by the government in the 1970s were sold back to the private sector. The ownership of the largest domestic bank, National Commercial Bank (NCB) was transferred in several stages to the private sector starting in 1986 when more than 40 percent of the shares were sold.3 Another formerly publicly owned bank (Workers Savings and Loan Bank) was privatized in 1991. The sale of banks was largely limited to domestic investors.

6. In addition to privatizing, the Jamaican Government liberalized both the foreign exchange and financial markets. In case of the latter, previously regulated interested rates were freed, credit controls were removed, and the BOJ switched to market-based instruments of liquidity management.4 While these measures were intended to contribute to a more efficient allocation of savings and hence to higher economic growth, the liberalization of financial markets took place without developing an adequate regulatory system and prudential requirements. As a result, supervision remained weak and some institutions, such as insurance companies unit trusts, and building societies remained de facto unregulated. The increased competition, in turn, encouraged institutions to search for ways to avoid costly regulatory requirements (such as high legal reserve requirements) and supervision, and to engage in deposit-taking activities that would give them access to cheaper funds. For example, when reserve requirements were lower for merchant banks than for commercial banks, the number of merchant banks increased from 6 in 1981 to 21 in 1990. Once reserve requirements were raised on merchant banks, building societies—which were not subject to reserve requirements—experienced substantial growth leading to an increase in the number of institutions from 6 in 1990 to 15 in 1995. Overall, the number of banking institutions increased substantially between 1980 and early 1990, especially in the latter part of the decade (Table 1). Since the Jamaican legal framework did not prohibit the creation of universal bank holding companies, the new institutions became part either of holding companies or larger financial conglomerates which often comprised a commercial bank, a merchant bank, a building society, an investment bank, and an insurance company, and the fact that different types of financial institutions were subject to different legal reserve requirements encouraged the growth of these conglomerates.

Table 1.

Jamaica: Financial Sector Developments

(In millions of Jamaica dollars; unless otherwise indicated)

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Source: Bank of Jamaica.

1993 data instead of 1995.

7. The dramatic increase in the number of building societies is illustrative of developments in the first half of the 1990s. While prior to liberalization most building societies were established as mutual societies owned by their respective savers, financial liberalization encouraged the creation of such institutions by larger conglomerates. Among the many privileges that these building societies enjoyed was the fact that neither the statutory cash reserve nor any liquid asset or loan loss reserve requirement applied to them. In addition to these implicit “tax breaks,” building societies enjoyed direct tax advantages since the corporate tax for building societies was 3½ percentage points lower than for banks and, unlike the case of commercial banks, interest earned by depositors on share savings were not subject to a withholding tax. Furthermore, the supervision of these institutions was not performed by an independent agency but rather by the sector’s own umbrella organization, the Jamaica Building Societies Association. In addition to the looser regulatory requirements, building societies benefitted from weaker prudential standards. For example, prior to March 1996 the initial amount of capital required to set up a building society amounted to J$10,000 (about US$250). While the banking sector witnessed a tightening of its legislation with respect to limits on investments in commercial companies and lending to single customers in 1992, building societies were not subjected to these limitations until 1994.

8. In effect, the larger conglomerates used the specialized banks as a means of increasing their deposit base and the distinction between deposit-taking banks and other institutions, such as insurance companies, became increasingly blurred as the latter created deposit-like instruments. Relatively shorter-term deposits captured by insurance companies and other financial institutions were then used to finance longer-term investment projects, especially in real estate and tourism development. The assessment of risk was also eroded as connected parties increasingly became the beneficiaries of additional lending by official institutions, in the face of weak supervision. The weakness of the financial system became apparent to the general public when the minister of finance and planning intervened in the Blaise Group in 1994 and subsequently established the Financial Institutions Services Company (FIS) to liquidate the group (Box 1).

Financial Institutions Services

The Financial Institutions Services (FIS) was established in October 1995 as an off-budget, wholly government-owned limited liability company, in the aftermath of the bankruptcy of the Blaise Financial Groups.1 FIS was initially charged with the implementation of a “scheme of arrangement” for the Blaise group, drafted in July 1996. FIS was later entrusted with the implementation of a similar scheme for the failed Century Financial Entities (comprising Century National Bank, Century National Building Society, and Century National Merchant Bank). FIS is responsible for paying creditors of the two institutions and for selling the assets acquired from Blaise and Century. FIS is empowered to issue debt in its own name to finance the payout of the depositors. In the case of Century, depositors are entitled to open accounts with National Commercial Bank (NCB), which, in turn, receives FIS notes as corresponding assets. As of April 30, 1998, FIS had issued debt amounting to J$9.3 billion (3.6 percent of GDP); an additional J$2.5 billion (1 percent of GDP) is scheduled to be issued in June 1998. The instruments are issued both in domestic and foreign currency with coupon rates ranging from zero to market-determined rates linked to treasury bill rates. Some FIS instruments include a provision that allows for the capitalization of interest. FIS is also empowered to pursue civil litigation against shareholders and directors of the Century group that contributed to the failure of the institutions and to assist the judicial system in its effort to investigate fraudulent behavior on the part of former managers and owners. If a judgement against the former owners and managers is issued, FIS would assist in identifying and obtaining the control of assets of the respective individuals. FIS is supervised by a board of seven directors.

1These comprised Blaise Trust & Merchant Bank, Blaise Building Society, and Consolidated Holdings Limited.

Monetary policy and financial sector developments

9. Confronted with a weak banking system but also with a renewed acceleration of inflation rates that had reached 30 percent at the end of 1995 and the increased pace of devaluation of the currency, the government decided to target inflation as the primary objective of its economic program. Implementation of a tight monetary policy reduced the growth of money from over 45 percent in mid-1995 to less then 15 percent within the next 12 months (Figure 1). The sharp reduction in the growth of money balances, led to a contraction of real money balances, and real interest rates shifted from negative to positive 30 percent. Although economic activity was sluggish even in previous years—averaging about 1 percent per year between 1990 and 1995—aggregate demand contracted further leading to a decline in output of almost 2 percent in FY 1996.

Figure 1.
Figure 1.

Jamaica: Interest Rates and Financial Sector Crisis, 1995–98

Citation: IMF Staff Country Reports 1999, 002; 10.5089/9781451820065.002.A001

Sources: Bank of Jamaica; and International Financial Statistics.1/ Six-months T-bill rate.2/ Deflated by the observed six-months ahead inflation rate.

10. High real interest rates and the related recession affected the financial sector in several ways. While insurance companies had initially raised short-term financing to invest in long-term assets such as real estate, rising interest rates brought the maturity mismatch of assets and liabilities into the open, as insurance companies borrowed from banks (especially connected banks) to finance interest payments on short-term deposits. At the same time, the high real interest rates reduced the relative return on investments in fixed assets, thereby reducing their market price. Furthermore, as investors withdrew their funds, as the perceived risk of deposits increased, insurance companies became a major drain on the liquidity of the banking system as they resorted further to credit from institutions (especially banks) within the conglomerate for support. In addition to the adverse impact of insurance companies on banks, the loan portfolio of the banking system deteriorated as the return on the related projects declined. Furthermore, the recession and the resulting drop in sales reduced the ability of debtors to service the increasingly costlier debt service obligations contributing to the liquidity problems of banks.

11. The first commercial bank to run into substantial liquidity problems was Century National Bank in 1995 (Table 2), and an on-site inspection by BOJ revealed a shortfall in assets of over J$l billion. By mid-1996 Century had accessed overdrafts in an amount of J$4.3 billion (almost 2 percent of GDP).5 With real interest rates rising rapidly and after lengthy negotiations, the government finally intervened and assumed temporary management in July 1996. Although the earlier liquidation of Blaise did not undermine the general confidence of the public in the viability of the financial system, the assumption of temporary management in Century and the initial announcement by the government to limit payouts to depositors to 90 percent of deposits with a ceiling of J$100,000 (about US$2,500) contributed to a loss in confidence that was followed by runs on Citizens Bank in December 1996 and Eagle Bank in January 1997. In both cases, the BOJ provided substantial liquidity support, which in the case of Eagle amounted to some 6 percent of GDP.

Table 2.

Jamaica: Chronology of Financial Crisis and Government Response

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C. Government’s Response to the Financial Sector Crisis

12. The government’s response to the crisis has been to announce publicly that all depositors, life insurance policyholders, and pensioners are insured for their total exposure. Furthermore, it entrusted a newly established institution (the Financial Sector Adjustment Company, FINSAC)6 with the resolution of the problems in the financial sector, and pushed more forcefully for the passage of a number of amendments to strengthen the powers of supervision over the financial system. Through FINSAC the government has pursued a three-pronged approach to addressing the problems of the financial system:

13. First, it has provided financial institutions with liquidity support and capital injection in exchange for ordinary and preference shares. As of April 30, 1998, FINSAC’s overall support to the financial system amounted to some J$64.2 billion (24.9 percent of GDP). The largest amount of support, some J$40.3 billion (15.6 percent of GDP) was provided directly in form of FINSAC notes most of which carry an interest rate that is linked to treasury bill rates; some J$21.7 billion (8.4 percent of GDP) reflect FINSAC’s assumption of BOJ’s overdrafts extension to a number of financially weak institutions which took place in form of a paper transaction compensating the BOJ for its initial liquidity support, and J$2.2 billion (0.9 percent of GDP) in form of an actual cash injection. In the process of providing capital support, the government through FINSAC has gained ownership stakes in five commercial banks, seven insurance companies, three building societies, and three merchant banks (Table 3). In all cases, FINSAC negotiated the purchase of ownership stakes of at least 25 percent to obtain veto power over management decisions as in some cases the management of the institutions was retained. In the process of providing support, FINSAC severed the financial ties that existed between insurance companies and banks. The second part of the strategy has been to begin to restructure and rationalize the domestic financial institutions. Besides fostering the merger of institutions to create fewer but viable ones, FINSAC has started to purchase nonperforming loans from banks to create “good banks” and allowing managers to be evaluated the profitability of the bank. As part of the rationalization phase, FINSAC is requiring entities under its control to improve their internal accounting, credit evaluation, and loan portfolio management. Third, FINSAC is entrusted with the return of assets to the private sector which include, in addition to shares in banks and insurance companies, numerous collateral assets such as hotels and agricultural lands. Although FINSAC can initiate the privatization process, sales have to be approved by the minister of finance or the full cabinet depending on the price of the assets.

Table 3.

Jamaica: Acquired Ownership in the Financial Sector by FINSAC 1/2/

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Source: FINSAC.

FINSAC is a government-owned limited liability company. Holdings as of May 15, 1998.

As a result of the purchase of financial institutions, FINSAC has indirectly acquired 10 hotels and other real estate.

The Minister of Finance intervened and appointed a Temporary Manager.

Government ownership once the company has been demutualized.

14. In addition, the government has undertaking a number of changes to the legal framework aimed at improving supervision and prudential requirements encompassing among others the following:

a. provisions to make bank licensing procedures stricter,

b. a tightening of prudential limits on connected lending,

c. the introduction of Basle capital requirements—to be set at 10 percent of risk-based assets and to be implemented by end-1999,

d. restricting the ability of banks to use special debentures in meeting capital requirements,

e. allow for vesting of voting rights of intervened institutions with the minister of finance or legally provide for possible restructuring or mergers,

f. placement of external auditors under a positive obligation to report to BOJ any factor that materially affect financial viability,

g. the application of financial and criminal penalties on institutions and on relevant senior staff for failure to comply with regulatory requirements, and

h. changes in provident fund legislation to restrict their ability to act as deposit taking institutions.

15. Furthermore, in the first quarter of 1998, Parliament approved the Deposit Insurance Act aimed at protecting deposits of up to J$200,000 (about US$5,500). Although the legal framework has been created, the Deposit Insurance Scheme has not been set up yet.

16. The government’s decision to rescue the entire financial system by keeping all institutions open and insuring all depositors, life insurance policyholders, and pensioners has averted a widespread loss in confidence and prevented a major outflow of capital. At the same time, the financial system experienced a flight to quality resulting in a shift of deposits from domestic to foreign institutions. However, the government’s strategy has come at a high fiscal cost and a number of challenges still need to be addressed.

D. Future Challenges

17. In general, the operating environment for financial institutions continues to be poor and is not likely to improve in the coming months notwithstanding the intervention of financial institutions through FINSAC. A return to a more stable financial system is hampered by very high real interest rates and weak prospects for economic growth. In addition to these macroeconomic factors, the high interest rates reflect the inordinately high unremunerated cash reserve requirements currently in place.

18. High unremunerated cash reserve requirements and the fact that different types of financial institutions that are engaged in almost identical activities are still faced with differential cash reserve and capital requirements as well as different tax rates will continue to encourage market participants to engage in institutional arbitrage. Without a reduction in the cash reserve requirement to levels that are warranted for prudential reasons and the creation of a level playing field for institutions and markets that offer similar financial products, Jamaica will continue to be faced with the very conditions that contributed to the current financial sector crisis.

19. With respect to the legal framework and the implementation of new requirements, substantial progress has been made in tightening the supervision and prudential regulation of the banking system. However, other parts of the financial system remain virtually unregulated. The growing commercial paper market in particular poses substantial risk, and a default by a major lender could extend the crisis to the commercial paper market and even prompt the government to provide additional bailouts. Furthermore, while the capital adequacy ratio for deposit-taking institutions that is currently being considered would exceed Basle standards, the same would not apply to affiliated institutions at the consolidated level. Over-leveraged affiliates and an inadequate level of capital at the group level could continue to overburden banks even when they come into compliance with the new capital adequacy requirements. The same risk applies to the coverage of the new standards of “fit and proper” for owners, managers, and large creditors. Since many institutions are not covered by these requirements, decision-making processes could be shifted to individuals in unregulated institutions that belong to the same group making the tightening of the requirements ineffective. Furthermore, improvements in supervision in the insurance sector has been slow despite the fact that many institutions remain insolvent and the insurance sector continues to offer deposit-like instruments.

20. Concerning FINSAC, in the process of bailing out the financial system, the government has gained control over a large part of the domestic financial system. Since many of the institutions had investments in real estate, the government has also become the owner of numerous real assets such as hotels. Despite the initial announcement that FINSAC would cease to exist after seven years, a clear exit strategy has not been developed and the government has already announced that it would not engage in “fire” sales. Furthermore, FINSAC is pursuing multiple and potentially conflicting objectives. On the one hand, FINSAC provides financial support, assumes ownership, and purchases nonperforming loans. On the other hand, it is mandated to sell the acquired assets hence limiting the losses to the government. However, without a clear separation of the functions and clear mandates for the respective parts of FINSAC, it will be difficult to monitor the performance of FINSAC and hold directors accountable. In addition, while FINSAC acquired ownership stakes in financial institutions, it has replaced only a few senior managers. Without the replacement of managers that contributed to the failure of many institutions, it will be difficult to improve corporate governance and limit the cost to the government.

II. Recent Developments in Monetary Policy in Jamaica

A. Background

Institutional developments

21. Before 1960 the only laws affecting banking business in Jamaica were the Stamp Duty Law of 1937, the Currency Notes Law of 1939, and the Bank Notes Law of 1942. The Stamp Duty Law prohibited banks from issuing any unstamped promissory notes for money, without an annual licence granted by the Stamp Commissioner. The Currency Notes Law provided for the issue of currency notes and coins of the Government of Jamaica, which was carried out by the Board of Commissioners of Currency. The Bank Notes Law made it unlawful for any person, except a banker, to issue bank notes. The volume of legal tender bank notes in circulation was restricted to a maximum prescribed by the Governor in Council, and banks were required to maintain deposits in legal tender coins and approved securities equivalent to the value of their notes in circulation. In 1954 the issuing of notes by all banks, except Barclays Bank, was prohibited.

22. Since 1960 monetary policy in Jamaica has been conducted by the central bank, the Bank of Jamaica (BOJ). According to the Bank of Jamaica Act (1960), the central bank’s objectives are to issue and redeem notes and coins; keep and administer the country’s external reserves; influence credit conditions in order to promote production, trade, and employment consistent with maintenance of domestic monetary stability and the external value of the currency; foster the development of domestic money and capital markets; act as banker to the government and the banks; and supervise the financial sector.7

23. In 1992 the BOJ was also allowed to act as banker to statutory bodies, local authorities, and certain government companies. The supervisory span of the central bank, initially confined to the commercial banks, was widened in 1973 to include near banks, such as trust companies, finance houses, and merchant banks, and in 1994 to include building societies. At the end of 1997 there were nine commercial banks, with assets totaling J$148 billion (US$4.1 billion), 26 near banks, with assets of J$18 billion (US$0.5 billion), and 11 building societies, with assets of J$38 billion (US$1 billion). Credit unions and insurance companies are supervised by the Registrar of Cooperatives and the Superintendent of Insurance, respectively.

Changing instruments of monetary policy

24. The central bank has made extensive use of its monetary policy instruments in an economic environment marked, especially since 1973, by balance of payments problems and large exchange rate fluctuations. The changing backdrop also included the transition in 1991 from a fixed exchange rate with trade and capital controls, to a flexible regime with full capital mobility and more liberalized trade. In this setting, initial reliance almost exclusively on nonmarket-based instruments of monetary control eventually gave way to more extensive use of market-based policy instruments (Box 2).

25. The central bank initiated a program to move to market-based instruments in 1985, and by 1989, interest rate controls were removed, the liquid assets ratio was significantly reduced, a program to remunerate reserve requirements was introduced, and open market type operations replaced credit ceilings as the primary instrument of monetary control. However, in response to a surge in credit and exchange rate pressures, there was a major policy reversal between 1989 and 1991 when credit ceilings were reintroduced, the LAR was raised, and payment of interest on a proportion of the reserve requirement was discontinued.8 In 1990 the central bank deregulated interest rates and in 1991 credit controls were abandoned.9 Cash and liquid assets ratios continued to be applied, being extended to foreign currency deposits at the end of 1991. After experiencing severe inflation in the early 1990s, averaging almost 40 percent per year, the Jamaican authorities decided to focus economic policy sharply on curbing inflation. In this restrictive monetary policy stance, open market operations played a prominent role.

Jamaica: Main Changes in Monetary Policy Instruments

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The liquid assets ratios include the cash reserve requirements.

Refers to merchant banks, trust companies, and finance companies.

26. In 1996 a liquidity crisis reflecting a generalized solvency problem in the financial system emerged. Although the crisis initially surfaced among insurance companies, it quickly spread to commercial banks, merchant banks, and building societies.10 In this climate, the BOJ provided liquidity support to several financial institutions in distress, and subsequently became involved in a major restructuring effort. The problems in the financial system also prompted a revision of legislation to strengthen the regulatory powers of the central bank.

B. Monetary and Credit Policy in FYs 1996 and 199711

Credit to public sector and to banks

27. Advances by the BOJ to the central government are constrained by legislation to a maximum of 30 percent of the government’s estimated revenue for that financial year, which must be repaid within three months after the financial year. There is also a limit to the acquisition by the BOJ of primary market securities issued or guaranteed by the government of 40 percent of the government’s estimated expenditure in the financial year of acquisition. However, there are no limits on the BOJ’s purchases of government securities in the secondary market, and on the drawdown of government deposits at the central bank.

28. In FY 1996 the BOJ increased its financing to the public sector by J$1.2 billion (0.5 percent of GDP) and by J$27.6 billion (11.5 percent of GDP) in FY 1997, including J$12 billion of the securities issued by a public sector agency, the Financial Sector Adjustment Company (FINSAC), set up to deal with restructuring of the financial sector.12 By March 1998 the BOJ held J$31 billion of government securities (equivalent to 36 percent of government expenditure in FY 1997) and a further J$13 billion in government-guaranteed securities.

29. As lender of last resort, the BOJ has provided liquidity support to financial institutions by discounting securities held by these institutions, usually for very short periods—overnight or a few days—or by providing outright loans.13 As major problems developed in the financial system in 1996, gross credit to the banks increased, reaching J$12 billion (5 percent of GDP) by March 1997. In the following month these loans were purchased by FINSAC, in exchange for its own interest-earning securities.14 Subsequently, the central bank provided additional support to banks, amounting to J$5 billion by March 1998.15

Cash reserve and liquidity requirements

30. Initially imposed solely for prudential purposes, cash reserve requirements (CRRs) have been changed quite frequently in Jamaica, but have been relatively stable since 1994 (see Box 3 for details).16 CRRs are a component of the liquid assets ratios (LAR)—the differential between the CRR and the LAR is the percentage that is required to be maintained in other eligible liquid assets, primarily government paper.17 This has made for a source of captive credit for the government. CRRs and liquid assets ratios on foreign currency deposits of commercial banks were introduced in 1991 and were extended to near banks in 1995. Building societies continue to be exempt from CRRs or LARs on foreign currency deposits.

31. Between FY 1996 and FY 1997, the major change in these requirements was the increase in the LAR of near banks from 30 to 35 percent on both domestic and foreign currency, with their domestic and foreign CRR unchanged at 17 percent. The CRR and the liquid assets ratio on building societies remained in the range of 1 to 11 percent, with differential ratios applicable depending on the structure of the societies’ portfolio.

Jamaica: Reserve Requirements and Interest Spreads

Use of domestic cash reserve requirements has featured prominently in the conduct of monetary policy in Jamaica. In 1962 commercial banks were required to deposit a minimum of 5 percent of designated liabilities in cash at the Bank of Jamaica; this ratio was raised progressively, and at mid-1998 stood at 25 percent. Near banks (merchant banks, trust companies, and finance companies) and building societies also need to satisfy cash reserve requirements, 17 percent for the former and between 1 and 11 percent for the latter at mid-1998.

Reserve requirements for commercial banks and near banks are calculated on the basis of prescribed liabilities, which include deposits, borrowings, and interest accrued on these liabilities. For building societies the relevant liabilities are deposits and withdrawable shares.

Cash reserves are a component of the overall domestic liquid assets ratios. The differential between the cash reserve and the liquid assets ratio is the percentage that is required to be maintained in other eligible liquid assets, which include Jamaican government treasury bills, local registered stock with nine months and under to maturity and (from December 1996) reverse repurchase arrangements with the Bank of Jamaica. Since May 1998, FINSAC securities are accepted as liquid assets.

Foreign currency reserve requirements and liquid assets ratios were introduced in 1991. Eligible liquid assets include short-term securities issued by the United States, Canadian and United Kingdom governments, certain deposits with prime overseas financial institutions, and designated foreign-currency denominated bonds issued by the Government of Jamaica.

As of mid-1998 the penalty for deficiencies on the domestic liquidity requirement for banks and near banks is 69 percent per annum, and 1/6 of 1 percent per day for building societies. For deficiencies in the foreign currency liquidity requirements, the penalty is 20 percent per annum.

The high cash reserve requirements have contributed to the large spread between deposits and loan rates: about 2,000 basis points in mid-1998. Figure 1 shows the strong relationship between rising reserve requirements and wider interest spreads since 1980. High reserve requirements have also contributed to the growing use of alternative financing facilities to bank loans, such as commercial paper and installment credit. The spread also reflects the high level of nonperforming loans, estimated at 24 percent of comercial bank loans at the end of 1997.

Jamaica: Requirements as a Percentage of Prescribed Liabilities As of June 1998

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The ratio is differentially applied based on the institutions’ portfolios.

uA01fig01

Jamaica: Commercial Banks

(In percent)

Citation: IMF Staff Country Reports 1999, 002; 10.5089/9781451820065.002.A001

32. The high CRRs have constituted a tax on the banking system and thereby contributed to the large spread observed between commercial bank loan and deposit rates. By mid-1998 the spread was about 2,000 basis points, with the CRR at 25 percent, compared to an average spread of 520 basis points between 1980 and 1983 when the CRR was 5 percent.18 Attempts to evade the reserve requirement have led to a burgeoning of credit facilities outside of the traditional loans offered by commercial banks and near banks. This includes a growing and largely unregulated market in commercial paper, and use of installment credit facilities. Although activity in the commercial paper market is under the ambit of the Securities Commission, it is not currently regulated, and the BOJ has made proposals to introduce regulation in this area.

Open market operations

33. Open market operations are currently the main tool of monetary policy in Jamaica. Through the sale or purchase of government or central bank instruments, the BOJ influences the inflation rate principally through affecting the growth of the monetary base, the amount of liquidity in the financial system and interest rates (Box 4). In the late 1980s, the BOJ issued its own certificates of deposit for use in open market operations but, with mounting central bank losses due to the high interest cost, there was a program to phase out these certificates of deposits and since early 1995 no new ones have been issued. Open market operations currently rely primarily on use of the central bank’s holdings of central government treasury bills, and long-term securities (Local Registered Stock or LRS, and government investment debentures).19 The BOJ has also allowed banks to hold “special deposits” at the central bank at negotiated interest rates for short periods when its holdings of government securities were low.20

Jamaica: The Relationship between Prices and the Monetary Aggregates in Jamaica

  • Money base targeting

    The Bank of Jamaica since 1995 has focussed on changes in the monetary base as the principal intermediate variable in inflation targeting. This has evolved with the growing reliance on open market operations since 1994, and the monetary base is considered the appropriate target that is amenable to control by the central bank.

    Assuming unchanged reserve requirements, the Bank of Jamaica targets the monetary base to grow at approximately the expected rate of growth of nominal income. The extent of open market operations is then gauged based on forecasts of other factors such as the desired change in official reserves, and net credit to the public sector and to financial institutions. The figure on inflation and money shows that there is a relationship between price changes, base money, and M3. Defining the appropriate monetary variable that is related to inflation has been complicated by issues of causality, measurement, disintermediation caused by high interest rates (use of commercial paper, instalment credit, etc.), portfolio shifts associated with the banking crisis, and currency substitution (see “Inflation and Monetary Growth in Jamaica” in the 1996 RED report on Jamaica; SM/96/180).

  • Currency substitution

    Countries with high inflation generally experience some currency substitution as foreign currency usurps the functions of the domestic currency, as store of value, unit of account, and as medium of exchange, in that order.1 Some currency substitution has occurred in Jamaica, although a complete measure of the phenomenon is limited by lack of data on foreign currency circulating in the economy and on deposits by residents abroad.

    Holding of foreign currency accounts by residents was liberalized in 1990. The figure on foreign deposits and the exchange rate shows the share of foreign currency deposits in M4 (liabilities to the private sector including foreign deposits), along with changes in the exchange rate. The date give some support to the hypothesis that currency depreciation (itself strongly related to inflation) was associated with substitution out of Jamaica dollars. Foreign currency deposits are concentrated in time and savings deposits, although comparatively high interest rates on domestic instruments have worked to restrain the use of foreign currency deposits as a store of value.

uA01fig02

Jamaica: Inflation and Money

(Percentage change, quarter-to-quarter)

Citation: IMF Staff Country Reports 1999, 002; 10.5089/9781451820065.002.A001

uA01fig03

Jamaica: Foreign Deposits and Exchange Rate

Citation: IMF Staff Country Reports 1999, 002; 10.5089/9781451820065.002.A001

1/ See for example: Calvo, G. and C. Vegh, 1992, “Currency Substitution in Developing Countries: An Introduction,” Revista de Anàlisis Económico, Vol. 7, pp. 3–8, and Savastano, Miguel, 1996, “Dollarization in Latin America: Recent Evidence and Policy Issues,” IMF Working Paper 96/4, (Washington: International Monetary Fund).

34. In addition to outright sales/purchase of government securities, the BOJ engages in two types of arrangements: repurchases (repos) and reverse repurchases (reverse repos). Repos are used to inject liquidity into the financial system and involve the sale of securities to the Bank of Jamaica, under a contract to repurchase them at a pre-determined price and on a specified date. Liquidity accommodation in the form of repurchases is provided almost exclusively to commercial banks. Reverse repos, on the other hand, are generally used to tighten liquidity and involve a contract to purchase securities (mainly issued by the central government) from the BOJ’s inventory and resell them to the BOJ on a specified date at a predetermined price. The maturities of reverse repos are generally 30-, 60-, 90-, and 180-days; 1-year reverse repos were introduced in May 1998.21 The principal counter parties for reverse repos are commercial banks and “primary dealers.”

35. To be eligible to become primary dealers, firms must be commercial banks, merchant banks, money market or stock market brokers, with a minimum capital base (initially set at J$10 million), and must be licensed by the Securities Commission to deal in securities. A list of the primary dealers at mid-1998 is provided in Appendix I. The specific role of the primary dealers is to provide underwriting support for all new issues of Government of Jamaica treasury bills and Local Registered Stock and for Bank of Jamaica reverse repos. The dealers are to provide secondary market liquidity for these securities by being prepared to make active two-way markets in them. The system of primary dealers was started in April 1994 with the appointment of seven dealers, and in mid-1998 the number stood at 13. Primary dealers are granted access to credit at the Bank of Jamaica on a lender of last resort basis up to certain limits through a special sale and repurchase facility, intended to facilitate their occasional cash needs related to their market-making functions.

36. Open market operations are conducted regularly, with transactions occurring on a daily basis for the most part. A flowchart of the process appears in Box 5. While the base money target guides open market operations, in practice the day-to-day dynamics are heavily influenced by conditions in the foreign exchange market. For FYs 1996 and 1997 the BOJ did not announce explicit exchange rate targets but nonetheless acted to minimize exchange rate fluctuations. There was also an announced objective for the level of its net international reserves—equivalent to between three and four months of imports. Given the country’s open capital account, the short-term monetary policy focus at times shifted to the level of interest rates to influence the direction of capital flows. In general, once determined, the base money target for the fiscal year is not altered, but the volume of open market operations is adapted to deal with unexpected deviations in the BOJ’s credit to the public sector or to banks and its net international reserves.

Jamaica: Flowchart on the Conduct of Open Market Operations

1. Target

Fiscal year inflation target announced by the Minister of Finance in the government’s budget presentation

2. Benchmarks

Quarterly benchmarks for monetary base developed by BOJ in financial programming framework

3. Operational Indicators

Monthly and weekly forecasts of variables affecting central bank balance sheet

Main indicators are credit to public sector and to financial institutions, interest rates, exchange rates, net international reserves

4. Assessment of Open Market Operations Required

Weekly meeting of BOJ Economic Policy Committee to discuss the following week’s objective (Thursdays a.m.)

Weekly meeting of Economic Program Monitoring Committee (BOJ Governor & Minister of Finance) to finalize weekly objective (Fridays noon)

Daily specification of volume of open market operations needed for the day (or the interest rate desired) by BOJ Open Market Committee (8:30 a.m.)

Instructions given to trading room on the open market operations required

5. Trading Room Contact with Primary Dealers

Traders contact primary dealers by telephone (9:30 a.m.) to discuss new market developments, market sentiment, assessment of trading conditions, particularly potential market receptiveness to the day’s open market objective

6. Execution of Trades

Primary dealers and traders make binding commitment by telephone on the size and price of the trade consistent with the volume of transactions required for the day (12:30 p.m.)

Backroom Activity:

Settlement is made with book transactions (12:30 p.m.)

7. Commercial Banks Contact BOJ

Banks call BOJ and arrangements are made for credit to banks, repos, special deposits (4:00–5:30 p.m.)

8. Review of Trades and Adjustment to Next Day’s Objectives

Final report on trading activity is prepared for Open Market Committee (5:30 p.m.)

Objective for open market operations for the following day is adjusted (step 4) based on the outcome of trading

37. For FY 1996, base money was targeted to grow in a range of 11 to 15 percent, which the BOJ deemed to be consistent with the inflation target of 10–12 percent.22 As it turned out, the growth of base money was 15.2 percent. Inflation, as measured by the 12 month change in the consumer price index, was 9.5 percent in FY 1996, a sharp decline from the 31 percent of FY 1995 (Table 4). Achievement of the base money target required a sizable increase in open market operations to counter expansionary impulses emanating from BOJ liquidity support to financial institutions, a buildup in net international reserves, and the net withdrawal of government deposits at the central bank.

Table 4.

Jamaica: Bank of Jamaica Operations—Factors Affecting Base Money 1/

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In percent of base money at the beginning of the period.

38. Liquidity accommodation in the form of repurchases was provided to commercial banks frequently in FY 1996. These repurchases were issued for very short periods, usually one day. At the same time, the BOJ also participated in the reverse repo market almost daily in order to absorb excess liquidity from banks in a stronger position, thereby avoiding a rush toward foreign exchange. Net central bank credit to the public sector amounted to J$12 billion (5 percent of GDP) while the BOJ’s net international reserves increased by US$152 million.

39. In order to maintain the target for base money in such a context, the volume of reverse repos outstanding more than doubled, from J$8 billion at March 1996 to over J$20 billion a year later. The rapid expansion of open market operations led to a severe tightening of liquidity in the banking system. It also contributed to a nominal appreciation of the domestic currency, completely reversing by June 1996 the depreciation that had occurred during the September 1995–March 1996 period.23 The nominal interest rate on 30-day reverse repos declined from 44 percent to 18 percent over the fiscal year. This decline corresponded closely with the downward trend in inflation and there was little change in real interest rates (Figure 2).

Figure 2.
Figure 2.

Jamaica Selected Financial Indicators, 1996–March 1998

Citation: IMF Staff Country Reports 1999, 002; 10.5089/9781451820065.002.A001

Sources: Jamaican Authorities; and Fund staff estimates.

40. The inflation target for FY 1997 was a range of 8–9 percent, with the associated base money target growth at 9.8 percent.24 Both targets were met: inflation was 8.8 percent and base money grew by 9.4 percent. As in 1996, there was heavy reliance on open market operations. The principal expansionary influence in FY 1997 came from the growth of credit to the public sector arising from the need to finance a widening fiscal deficit. There was a great deal of pressure in the foreign exchange market in FY 1997, with heightened expectations of depreciation of the Jamaica dollar related to the crisis in the financial sector and later surrounding the general elections held in December 1997. In attempting to limit exchange rate movements, the central bank sold foreign currency and simultaneously raised the rate paid on its reverse repos. The BOJ’s net international reserves declined by US$53 million and the 30-day reverse repo rate rose from 18 percent to 29 percent implying a real increase of 11 percentage points.

41. The central bank was quite aggressive in its open market sales during FY 1997, particularly during the first and final quarters, to counteract, respectively, the impact of the drawdown in government deposits and the instability in the foreign exchange market. The value of outstanding reverse repos and “special deposits” that the BOJ utilized for its open market operations expanded by 60 percent to J$32 billion, equivalent to the value of base money.25

C. Recent Changes in Legislation

42. Prompted by the problems experienced in the financial sector, legislation was amended in 1997 aimed at improving the supervisory power of the BOJ over commercial banks, near banks and building societies.26 In addition, capital requirements of these institutions were raised, and further limits were placed on their granting of unsecured credit and credit to related parties. The existing prudential requirements in relation to the Basle Accord standards are summarized in Box 6. The BOJ has also prepared draft regulations which will set the minimum risk-based capital standards required of licensees. The regulations would introduce the concepts of Tier I and Tier II capital, define the eligible components, and provide the framework for assigning risk weights to on- and off-balance sheet items.27 Money laundering legislation was passed in 1997, and an Act to provide for deposit insurance was approved in March 1998, covering deposits up to J$200,000 (about US$5,500).

D. Conclusion

43. The BOJ’s success in reducing inflation in FY 1996 and FY 1997 has fortified its reliance on the targeting of base money as the appropriate monetary variable. The BOJ will continue to use this framework in FY 1998: the target range for inflation is 6 to 8 percent and base money will be constrained to grow by 8 percent.28 Open market operations are intended to remain the cornerstone of monetary policy.

44. In the context of high real interest rates, continued reliance on open market operations on the scale that the BOJ has been dealing is a very costly undertaking. It ultimately represents a fiscal cost, irrespective of whether the interest expenses initially appear on the books of the government or the central bank (through transfers to the government of net profits).29

Jamaica: New Financial Legislation in Jamaica

In 1997 amendments were made to the Banking Act, the Financial Institutions Act, the Building Societies Act, and the Industrial and Provident Societies Act which govern the activities respectively of commercial banks, near banks (merchant banks, trust companies, and finance companies), building societies, and registered small business societies. The main thrust of the amendments was to increase the supervisory powers of the Bank of Jamaica on these institutions, tighten capital requirements, further restrict credit to related parties, and improve auditing. Fees for breaches of the acts were also increased. In March 1998 a Deposit Insurance Act was passed, providing for insurance for deposits of banks and near banks up to a limit of J$200,000 (US$5,500), to be funded by premiums paid by these institutions. The Bank of Jamaica has issued guidelines for the review of loan portfolio, the classification of loans, loan loss provisioning, loan renegotiating, the suspension of interest accrued on past due loans, and write-off procedures.

The minimum capital required for commercial banks is J$80 million (US$2.2 million) and J$ 25 million (US$0.7 million) for near banks. Minimum capital adequacy is stated in relation to deposit liabilities and other indebtedness for borrowed money which together with all accrued interest should not exceed 25 times the capital base (20 times for near banks). Reserve funds are to be established that should receive at least 15 percent of net profits of each year (prior to the distribution of dividends), if the reserves are less than 50 percent of the assigned capital, and subsequently at least 10 percent of net profits per year until the reserves equal total paid-up capital.

There are limits on concentration of credit, the size of unsecured loans, and loans to related parties. Commercial banks, near banks, and building societies are subject to a reserve requirement on domestic deposits in the form of non-interest-bearing deposits at the central bank and additional liquidity requirements which can be satisfied with certain types of government securities. Reserve and liquidity requirements are also applied to foreign currency deposits of banks and near banks.

Jamaica: Commercial Bank Prudential Requirements, as of May 30, 1998

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Sources: Carl-Johan Lindgren, Guillian Garcia, and Matthew I. Saal, 1996, Bank Soundness and Macroeconomic Policy (Washington: International Monetary Fund); and Bank of Jamaica.

45. On the legislative front, a Parliamentary Committee is currently considering BOJ proposals for a more autonomous central bank, which include putting further restrictions on the credit that can be provided to the government, and making the Governor of the BOJ accountable to Parliament, as opposed to the Minister of Finance.30

III. The Role of the Public Sector

A. Introduction

46. From the early 1970s to mid-1980s, Jamaica experienced a poor economic growth performance as the government took over an increasing role in the economy in an attempt to control the “commanding heights” of the economy. At a time when private sector activity diminished, the Jamaican economy was faced with the adverse terms of trade shocks of the 1970s and early 1980s. The situation improved in the late 1980s in the wake of successful stabilization efforts coupled with large scale privatization programs and other structural reforms aimed at reducing government intervention. By 1990 Jamaica was considered to be a leader among the countries in Latin America and the Caribbean in terms of the number of enterprises that had been privatized or earmarked for privatization.31 Other advances on the structural front in the early 1990s also were substantial, including the liberalization of the foreign exchange market, an elimination of nontariff barriers, a liberalization of prices and interest rates, and a rationalization of the tax system. Nevertheless, despite some successes in the second half of the 1980s, average output growth over the last 25 years has been dismal and total measured output in real terms in 1997 was almost equivalent to that in 1973 implying a large decline in per capita terms (Table 5).

Table 5.

Jamaica: Macroeconomic Indicators, 1962–97

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Sources: IMF. International Finance Statistics; Planning Institute of Jamaica; Economic and Social Survey Jamaica.

Current account in U.S. dollars times average exchange rate. Averages cover the period 1976–97 only.

Refers to fiscal year balances as a percent of calendar year GDP. Averages cover the period 1979–97 only.

47. The causes for Jamaica’s poor growth record seem to be twofold. On the one hand, Jamaica’s poor growth performance is associated with relatively high and varying inflation rates, external and internal imbalances (Figure 3) and frequent changes in fiscal, monetary, and exchange rate policies that prevented a resumption of long-run economic growth. On the other hand, it appears that some of the structural reforms have not fully been implemented, raising the key questions of whether and to what extent the government remains a key player in the economy. This note concentrates on the analysis of how the role of the government has changed over time, to what degree the government continues to be a major player in the economy, and analyses some of the more recent interventions.

Figure 3.
Figure 3.

Jamaica: Selected Indicators, 1979–97

Citation: IMF Staff Country Reports 1999, 002; 10.5089/9781451820065.002.A001

Sources: Ministry of Finance; Bank of Jamaica; Planning Institute; International Financial Statistics.1/ Fiscal year outturn as a percent of calendar year GDP.

B. Background

48. Prior to Jamaica’s independence in 1962, the role of the government in the economy was limited to the provision of traditional public services such as health and education, and assistance to the agricultural sector and small businesses in the manufacturing sector through a number of publicly owned development finance institutions, such as the Jamaica Industrial Development Corporation. After independence, the role of the government remained limited focusing on the establishment of regulatory agencies such as the Public Utilities Commission, the enforcement of property rights, and a stable fiscal and monetary policy. During the first decade of its independence, Jamaica experienced relatively high overall growth rates averaging almost 6 percent a year. However, growth was not balanced across sectors concentrating largely in the capital intensive mining sector while output in the labor intensive agricultural sector declined leading to an increase in unemployment from 13 percent in 1962 to 23 percent in 1972 and a greater skewness of the income distribution.32

49. In the latter part of the 1960s and especially after the then socialist-oriented People’s National Party (PNP) won the 1972 national elections, direct government involvement in the allocation of resources increased substantially, justified by the perceived need to address the issue of income disparity and high unemployment, and later—as private sector activity contracted—also to prevent failing companies from going bankrupt. Throughout the 1970s and early 1980s, the government acquired a large number of key industries—such as bauxite, sugar, textiles, cement—and took over banks and hotels. According to the 1984 Public Sector Registry, the government then owned 199 public enterprises.33

C. The Role of the Government Since the 1980s

The divestment of public ownership

50. In the mid-1980s Jamaica began a privatization program that lasted for a decade (Figure 4). From 1984 to 1997, the Jamaican Government sold its holdings in 66 public entities generating gross receipts amounting to 13 percent of GDP (for Jamaica’s current privatization program see Box 7)34. The divestment effort was not limited to any particular sector but ranged from tourism to banking and agriculture, including large public service monopolies such as the Telephone Company of Jamaica (TOJ) and the national airline carrier AirJamaica (see Appendix II for a summary list of privatized enterprises and sale of lands). Although employment data for the overall public sector is not available, the retrenchment of the government during the 1980s is mirrored in the reduction of people directly employed by the central government. While in the late 1970s, almost 12 percent of the total labor force was on the payroll of the central government, this percentage had fallen by almost 50 percent in 1987. In addition, the reduction of government activity in the economy was also reflected in a fall in central government expenditure as a percentage of GDP; while in the early 1980s government expenditure amounted to more than 40 percent of GDP it had fallen below 30 percent by the early 1990s.

Figure 4.
Figure 4.

Jamaica: Privatization and Public Sector Developments

Citation: IMF Staff Country Reports 1999, 002; 10.5089/9781451820065.002.A001

Sources: Ministry of Finance; and Planning Institute.1/ The series covers the period 1978–82, 1985–87, and 1990–97.2/ Employment financed through the consolidated budget of the central government.3/ Central government.

51. Despite the formal retrenchment of the government and the reduction in public ownership since the mid-1980s, the questions arise whether and to what extent the government is still involved in economic decision making that could adversely affect the allocation of resources and hence prevent the economy from moving toward a higher long-term growth path. The required analysis is, of course, hampered by the very fact that formally the structure of the economy has changed and standard measures such as the number of totally government-owned enterprises, the share of public sector output in total value added, and the ratio of public sector employees in terms of the total labor force, etc., are potentially misleading because they do not reflect the considerable influence the government exerts directly through its remaining holdings and indirectly by providing financial support to selected economic activities. Hence, the following attempts to provide mostly qualitative evidence.

Jamaica: The Government’s Current Privatization Program

Formally, the current privatization program is based on a Ministry Paper published in 1991. It establishes the institutional responsibilities, defines the objectives of the program, as well as the modalities of privatization. The direction and the approval of the privatization program is determined by Cabinet and does not require parliamentary support. A cabinet committee advises cabinet on which enterprises to privatize, on how the government should divest of its assets, and makes recommendations on whether cabinet should accept or reject an offer. The privatization strategy is developed in the Prime Minister’s Office and subsequently submitted to both the cabinet committee and Cabinet itself. The National Investment Bank is charged with the execution and implementation of the privatization program. The Ministry Paper suggests that privatization is part of a general strategy to liberalize the economy and to promote the market forces. Formally, the objectives of privatization are to increase efficiency, to reduce the fiscal burden of the government, to optimize government management resources, to obtain access to international capital and technology, and to broaden ownership.

Continued government influence

52. As the 1997 public registry indicates, the portfolio of government entities is still substantial (Table 6). Although some of these entities have some public policy function and hence are not likely to be divested, the list still includes large public monopolies such as the local petroleum refinery (Petrojam), the electric utility (JPSCO), the water company (National Water Commission), and smaller commercial entities such as the Ocho Rios Commercial Centre. In addition, the recent collapse of many of the domestically owned financial entities has resulted in the de facto renationalization of many of the financial companies (see the section on financial sector developments in this paper) and to the government acquisition of related assets, such as hotels and real estate. In addition, most of Jamaica’s industry and marketing boards have neither been abolished nor privatized. In the past, many developing countries such as Jamaica relied on industry or marketing boards as a means of executing public policy, such as setting producer prices for export products.35 Despite the fact that Jamaica has privatized export industries, the government continues to name board members and set policies for most key export industries through marketing boards such as the Coffee Industry Board, the Banana Board, the Cocoa Industry Board, the Coconut Industry Board, the Sugar Industry Authority, the Agricultural Marketing Board, as well as the Jamaica Tourism Board. The continued involvement of the government through the boards has prevented some of the industries from competing freely and from facing hard budget constraints, generating losses with no apparent benefit. Moreover, most of the subsidies provided by the government are aimed at the largest producers within each sector, in which the government generally has an interest, stifling the development of the smaller producers, and limiting efficiency gains.

Table 6.

Jamaica: Stock of Public Enterprises, 1997 1/

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Source: Ministry of Finance and Planning. 1997. List of Government Entities and Portfolio Ministries (preliminary).

Excludes holdings acquired as a result of support to the financial system.

53. Furthermore, even in the case where public entities have been privatized, a closer analysis reveals that in many cases, the government continues to hold substantial ownership stakes ranging from 10 percent in the case of the Jamaica Broadcasting Company to 95 percent in the case of the Kingston Waterfront Hotel Company. According to the Jamaican company law, owners controlling more than 25 percent of the shares in a company have veto power over management decisions and hence, indirectly, the government can exercise substantial control over the management and operation of companies.

54. In addition to maintaining partial ownership stakes in “privatized” enterprises, in critical instances the government has bailed out recently privatized private companies that have run into financial difficulties. Failing to impose “hard budget constraints” leads to moral hazard or rent seeking behavior. Two recent examples of bailouts are the national airline (AirJamaica) and the sugar industry which were privatized in 1994 and 1993, respectively. When the airline ran into financial difficulties, the government provided foreign creditors with guarantees and letters of comfort for about US$140 million (about 2 percent of GDP) of which US$114 million were eventually assumed as debt by the central government. In addition, the government provided direct loans to cover cash-flow shortfalls of US$30 million.36

55. In the case of the Jamaica Sugar Company, which accounts for about 70 percent of Jamaica’s annual sugar production and enjoys preferential access to the European market under the Lomé agreements, the company has been running losses due to production costs that are reported to be twice as high as world market prices. Intentions by the company’s management to reduce the work force by 16 percent were stopped by the government, which instead appointed a tripartite (labor, company, government) task force to prevent any layoffs.37 To compensate the company, the government has chosen to provide government guarantees for loans of US$100 million in fiscal year 1998.38 Furthermore, during the wage negotiations of early 1998 in which the sugar companies initially declined to provide wage increases, the government brokered an agreement that resulted in wage increases of 10 percent a year for two years, of which the government will pay 2.5 percentage points in year one and 5 percentage points in year two. Other industries in distress have received substantial financial government support among them the Coffee Industry Board and the local citrus industry.39

Incentive schemes and budgetary support

56. The government also relies on a multifaceted system of tax incentives. Many of these incentive schemes are nontransparent, are based on numerous pieces of legislation, and are highly discretionary. The effectiveness of some of these incentive schemes is questionable—it appears that many companies cease to exist after the incentive period expires while the same owners establish new companies to request new tax breaks—while they encourage rent seeking behavior rather than the establishment of commercially viable enterprises by the private sector and generate a substantial fiscal burden in the form of revenue forgone. Although no official data are collected on the fiscal implications, estimates suggest that the revenue loss due to tax incentives could have amounted to some J$7 billion (3 percent of GDP) in 1996.

Increased government employment, spending, and financial support

57. Central government employment has increased substantially and it appears that the government may become an employer of last resort. After reducing employment in the central government (as a proportion of wage earners) from 19 percent in 1990 to about 15 percent in 1994, the proportion increased to almost 18 percent in 1997. The trend toward a growing public sector also is reflected in government non-interest expenditure as a percent of GDP, which has grown from an average of about 21 percent of GDP for the period 1990–95 to about 26 percent of GDP in 1997.

58. The increased involvement of the government in the economy is often justified on the grounds of the stagnation of output which gave rise to the government’s National Industrial Policy (Box 8). The new policies are reflected, for example, in the National Development Bank of Jamaica (NDB) which since 1997 provides direct lending to the industrial sector of the economy.40 Initially, the mandate of NDB had been to channel funds to approved financial institutions (AFIs) such as commercial and merchant banks as well as other financial institutions which, in turn, would engage in the actual lending operations and bear the resulting credit risk. Enterprises that seek funds from NDB directly are likely to be those that could not pass the AFI’s requirements in terms of their expected return on investment, or their equity base.

59. Along the lines of the NDB, another public agency, the National Investment Bank of Jamaica (NIBJ), has also changed its policies to support of the National Industrial Policy. While during the early 1990s NIBJ was officially responsible for implementing Jamaica’s privatization program and functioned as the privatization agency, since 1996 it has been given the mandate of providing equity capital to private enterprises. In addition to developing a bailout program for hotels, NIBJ intends to inject capital into medium-sized businesses in agriculture, mining, tourism, and manufacturing. Such equity investments will require the presence of government representatives on the boards of these enterprises. During the last budget presentation, the government announced that it would step up interest subsidy programs through the Export-Import Bank, the Agricultural Development Bank, NDB, and NIBJ.

Jamaica’s National Industrial Policy

The government’s current view on the role of the public sector is reflected in its 1996 National Industrial Policy whose official focus is to foster economic growth and development. The objective of the strategy is to grow by 6 percent a year so as to more than double the current level of income per capita to US$4,000 by the year 2010. Although the program expresses the commitment to a “market-driven economy” and acknowledges that the private sector is the main engine of growth, it calls on the government to spearhead the development effort by adopting “focused policy interventions.” Jamaica’s Industrial Policy is summarized in the following statement: “The strategic focus of the [National Industrial] Policy is (i) export push, through building and sustaining targeted areas of competitive advantage in the national economy, and (ii) efficient import substitution, consistent with the focus on international competitiveness as the key element of the policy” (JIS 1996:4).

D. Conclusions

60. Compared to the structure of the economy in the late 1970s and early 1980s, the Jamaican economy has been drastically transformed. Nevertheless, the Jamaican Government continues to be omnipresent either through direct or partial ownership of productive enterprises and marketing boards, a nontransparent system of incentives, selective support of entities, and increased employment.

61. In the past two years, the government has bailed out inefficient and undercapitalized industries through subsidies, government guarantees, or equity participation. The subsidies, increases in government debt, and assumption contingent liabilities in the form of government guarantees and letters of comfort, can have substantial macroeconomic implications, lead to a reduction of the net worth of the government, and eventually result in higher taxes. The growing share of wage earners working in the public administration also seems to indicate that the government is becoming an increasingly important employer in the context of a stagnant economy.

62. A resumption of sustainable economic growth will require—in addition to a stable macroeconomic environment—a substantial rationalization of public sector activities, a revitalization of the privatization program, and the enforcement of hard budget constraints on the private sector.

STATISTICAL APPENDIX

Table 7.

Jamaica: Gross Domestic Product by Final Expenditure

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Sources: Statistical Institute of Jamaica; and Fund staff estimates.

Includes public enterprises.

There is no data on the distribution of capital formation between the public and private sectors.

Table 8.

Jamaica: Savings and Investment

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Sources: Statistical Institute of Jamaica; and Fund staff estimates.

There is no data on the distribution of capital formation between the public and private sectors.

Table 9.

Jamaica: Gross Fixed Capital Formation

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Sources: Statistical Institute of Jamaica; and Fund staff estimates.
Table 10.

Jamaica: Gross Domestic Product by Sector at Current Prices

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Source: Statistical Institute of Jamaica.
Table 11.

Jamaica: Gross Domestic Product by Sector in Producers’ Values at Constant 1986 Prices

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Source: Statistical Institute of Jamaica.
Table 12.

Jamaica: Output of Selected Commodities

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Sources: Statistical Institute of Jamaica; and Planning Institute of Jamaica.
Table 13.

Jamaica: Selected Information on the Bauxite/Alumina Sector

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Source: Statistical Institute of Jamaica.

Millions of metric tons; unless otherwise indicated.

Table 14.

Jamaica: Employed Labor Force by Industry 1/

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Source: Statistical Institute of Jamaica.

Population, labor force, and employment data are averages of April and October sample labor force surveys.

Defined as the ratio of the total labor force to the population 14 years old and over.

Defined as the proportion of the labor force that is not employed.

Job-seekers as a proportion of the labor force.

Table 15.

Jamaica: Average Weekly Earnings in Large Establishments 1/

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Source: Statistical Institute of Jamaica.

Excluding agriculture, government, and employees in Free Zones.

Table 16.

Jamaica: Consumer Price Index

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Source: Statistical Institute of Jamaica.

Fiscal years begin on April 1.

Table 17.

Jamaica: Public Sector Balance and Financing

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Sources: Bank of Jamaica; and Ministry of Finance and Planning.
Table 18.

Jamaica: Consolidated General Government Operations 1/

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Source: Table 12.

Includes the central government, the National Insurance Fund, the National Housing Trust, and the Human Education and Resources Training Unit.

Table 19.

Jamaica: Operations of the General Government 1/

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Sources: Bank of Jamaica; and Ministry of Finance and Planning.

Includes the central government, the National Insurance Fund the National Housing Trust, and the Human Education and Resource Training Unit.

Table 20.

Jamaica: Operations of Selected Public Enterprises 1/

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Source: Ministry of Finance and Planning.

In FY 1997/98, the selected public enterprises consisted of the Airport Authority of Jamaica, Jamaica Commodity Trading Company Limited, Jamaica Mortgage Bank, Jamaica Public Service Company, Jamaica Railways Corporation (presently defunct), National Housing Corporation, National Water Commission, Petroleum Corporation of Jamaica, Petrojam Limited, Port Authority of Jamaica, Urban Development Corporation, and the National Investment Bank of Jamaica.

Table 21.

Jamaica: Bank of Jamaica Operating Balance

(In millions of Jamaica dollars)

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Source: Bank of Jamaica.
Table 22.

Jamaica: Central Government Revenue 1/

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Source: Ministry of Finance and Planning.

Excludes grants.

Includes transfers of profits of public entities and royalties.

Table 23.

Jamaica: Central Government Expenditure

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Source: Ministry of Finance and Planning.

Guaranteed on-lending to the private sector.

Table 24.

Jamaica: Central Government Financing

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Sources: Bank of Jamaica; and Ministry of Finance and Planning.

Excluding Bank of Jamaica losses.

Excluding project lending.

Including government-guaranteed loans.

Table 25.

Jamaica: Central Government Securities and the Bank of Jamaica Certificates of Deposits

(In millions of Jamaica dollars)

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Source: Bank of Jamaica.
Table 26.

Jamaica: Summary Accounts of the Banking System

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Source: Bank of Jamaica.

In April 1997 the central bank received securities from the rest of the public sector (J$l1.2 billion) in exchange for credit that the central bank had provided to commercial banks. The rest of the public sector took over claims that the commercial banks had on other financial institutions.

Includes foreign currency deposits.

In terms of liabilities to private sector at the beginning of the year.

Accounting rate at end of period.

Table 27.

Jamaica: Summary Accounts of the Bank of Jamaica

(In millions of Jamaica dollars; stock at end of period)

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Source: Bank of Jamaica.

In April 1997 the central bank received securities from the rest of the public sector (J$l1.2 billion) in exchange for credit that the central bank had provided to commercial banks.

Table 28.

Jamaica: Summary Accounts of Commercial Banks

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Source: Bank of Jamaica.

In April 1997 the central bank received securities from the rest of the public sector (J$l1.2 billion) in exchange for credit that the central bank had provided to commercial banks.

Table 29.

Jamaica: Statutory Liquidity Ratios of Commercial Banks and Near-Banks

(In percent)

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Source: Bank of Jamaica, Statistical Digest.

Financial institutions regulated under the Protection of Depositor Act (PDA). This Act was replaced by the Financial Institutions Act in December 1992.

Includes cash reserves.

Table 30.

Jamaica: Selected Interest Rates

(Percent per annum)

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Source: Bank of Jamaica, Statistical Digest.

On three- six-month deposits under US$100,000.

Average discount rate on 6-month bills.

Bank of Jamaica certificates of deposit were introduced in November 1985, and phased out in February 1995.

Table 31.

Jamaica: Distribution of Commercial Banks’ Loans and Advances

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Source: Bank of Jamaica, Statistical Digest.
Table 32.

Jamaica: Summary Accounts of Nonbank Financial Intermediaries

(End of period)

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Source: Bank of Jamaica.

Consolidated accounts of merchant banks, trust companies, and finance companies. These institutions operate under the Financial Institutions Act which, in December 1992, replaced the Protection of Depositors Act, enacted in 1974.

Table 33.

Jamaica: Balance of Payments Summary 1/

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Source: Table 28.

Fiscal year.

Includes medium- and long-term as well as short-term capital inflows.

Table 34.

Jamaica: Balance of Payments

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Source: Bank of Jamaica.
Table 35.

Jamaica: Exports, f.o.b.

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Source: Statistical Institute of Jamaica.
Table 36.

Jamaica: Value, Volume, and Unit Price of Principal Exports 1/

(Value in millions of U.S. dollars; volume in thousands of metric tons)

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Source: Statistical Institute of Jamaica.

Value may not be equal to volume multiplied by price because of rounding.

Table 37.

Jamaica: Summary Bauxite Sector Operations 1/

(In millions of U.S. dollars)

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Sources: Bank of Jamaica; and Statistical Institute of Jamaica.

Does not include operations at the Clarendon Alumina Plant (CAP) by the Government of Jamaica under a leasing arrangement that began in 1985/86. Figures based on companies’ income statements differ from balance of payments data.

The sum of production levy, royalties, and local production costs represents the net foreign exchange earnings arising directly from domestic production.

Total export value less production costs (including levy and royalties) equals imputed profits.

Table 38.

Jamaica: Imports, c.i.f.

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Source: Statistical Institute of Jamaica.
Table 39.

Jamaica: Foreign Trade Indices

(Index 1982/83 = 100)

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Sources: Bank of Jamaica; and Fund staff estimates.

Excluding re-exports.

Table 40.

Jamaica: Direction of Trade

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Source: Statistical Institute of Jamaica.

Higher than balance of payments data due to inclusion of payments for freight and insurance.

Predominantly imports of Mexican oil refined in Curacao.

Table 41.

Jamaica: Selected Tourism Data

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Sources: Ministry of Tourism; and Fund staff estimates.

Long stay refers to three days or more; short stay refers to less than three days.

Table 42.

Jamaica: Capital Account of the Balance of Payments

(In millions of U.S. dollars)

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Source: Bank of Jamaica.
Table 43.

Jamaica: Net Official International Reserves

(In millions of U.S. dollars, end period)

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Source: Bank of Jamaica.

Change from the same date a year ago. A minus sign indicates increase in net reserves.

Table 44.

Jamaica: Medium- and Long-term External Public Debt Outstanding

(In millions of U.S. dollars end of period)

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Source: Bank of Jamaica, External Debt Management Department.
Table 45.

Jamaica: External Public Debt Service

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Sources: Bank of Jamaica; and Ministry of Finance and Planning.

Based on scheduled payments; includes changes in Bank of Jamaica reserve liabilities (other than those to the Fund).

Includes interest payments on short-term public sector debt.

Includes amortization of a 1982 advance out of bauxite levy receipts.

Table 46.

Jamaica: Exchange Rates

(Period averages)

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Source: IMF, Information Notice System.

Monthly data are for the end of the month; Jamaica dollar per U.S. dollar.

1990 = 100; increase in index represents appreciation of Jamaica dollar.

Appendix I: List of Primary Dealers as of February 1998

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Banks or affiliated companies.

Near banks or affiliated companies.

Appendix II: Jamaica: Summary of Privatizations, 1981–97

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Source: Ministry of Finance; NIBJ, 1997.

Appendix III: Jamaica: Summary of Tax System as of March 31,1998

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1

Prior to the liberalization of the financial sector, the government had introduced a number of reforms in the context of the Financial Sector Reform Program that was launched in 1985.

2

Two different corporate bonds were listed in 1997.

3

NCB was purchased in 1977 from Barclays Bank International, Limited.

4

For details on developments in the monetary policy area refer to the note on recent monetary policy developments in Jamaica included in this paper.

5

In the clearing system, managed by the BOJ, banks which are unable to cover their clearing obligations are provided with an automatic and unsecured overdraft by the BOJ, at penalty interest rates.

6

While FIS was initially established to wind up the operations of failed institutions, in January 1997, the government set up an additional entity, FINSAC, whose objective it is to restructure, merge, and recapitalize the remaining institutions in the system. The company, like FIS, is a government-owned limited liability company which operates as an extrabudgetary institution which is set to cease operations in seven years. Although FINSAC executes instructions by the minister of finance and planning and coordinates interventions with other institutions, such as the BOJ and the Superintendent of Insurance, it does not have the powers to intervene and has to rely on negotiated agreements with the owners and directors to acquire ownership and control of institutions.

7

The government also maintains deposits, in local and foreign currency, at commercial banks.

8

See Marston, David, 1990, “Financial Sector Reform in Jamaica During 1985–92: Possible Lessons for the Caribbean,” IMF Working Paper 90/95 (Washington: International Monetary Fund).

9

Guidelines issued in 1984 relating to installment credit, which stipulated minimum down payments and maximum repayment periods, were removed in 1994.

10

Earlier in 1994, there were problems in a local financial conglomerate which led to government intervention and subsequent liquidation of the group. See section I on financial system developments in this report for more details.

11

Fiscal years begin April 1.

12

The FINSAC securities were given to the central bank in replacement of overdrafts that the BOJ had provided to commercial banks.

13

In some cases the penalties for breaches of the reserve requirements have also been waived. There is no legislated limit on the size of the overdraft that the BOJ can provide to financial institutions.

14

The securities include a clause that allows for interest to be paid with additional securities, effectively providing for automatic capitalization of interest.

15

This was similarly sold to FINSAC in exchange for interest-earning securities in April 1998.

16

Certain borrowings are exempt, including designated wholesale borrowings specifically for on-lending and certain borrowings from the central bank.

17

The BOJ in May 1998 accepted the use of FINSAC securities to meet the LAR.

18

The spread (SP) attributable to the CRR can be computed as follows:

SP = (id*CRR)/(l-CRR) where id is the deposit rate. SP rose from 60 basis points (just over one-tenth of the actual observed spread) in 1980–83 to 500 basis points (one quarter of the actual spread) in mid-1998. The actual spread also reflects the large proportion of nonperforming loans in the loan portfolio of commercial banks, estimated at 24.4 percent at December 1997.

19

In a program to eliminate the losses of the BOJ, attributed in part to the servicing of BOJ certificates of deposit, the BOJ acquired interest bearing government securities, which formed the basis for open market operations while the certificates of deposit were simultaneously being phased out.

20

During the financial system crisis, there was a “flight to quality” in the sense that depositors moved their funds from weak banks to banks that they perceived as strong, mostly foreign owned. At times, several of the stronger banks consequently found themselves with excess liquidity which they converted into the “special deposits” at the central bank.

21

The profile of outstanding maturities of the reverse repos as of end-March 1998 was as follows: 49 percent under 30 days, 20 percent between 30 and 60 days, 28 percent between 60 and 90 days, and 3 percent between 90 and 180 days.

22

The BOJ is currently developing a measure of “core inflation” to guide monetary policy, which abstracts from non-monetary influences on inflation.

23

The weighted average selling rate for a U.S. dollar had moved from J$35.28 at the end of August 1995 to J$40.02 at the end of March 1996.

24

The point estimate for base money growth was based on the lower end of the target range for inflation and included allowance for the expected growth of output.

25

The “special deposits” were introduced in April 1997 when pressure on the exchange rate was building, to complement use of the central bank’s holdings of government securities which occasionally fell below the volume of open market operations desired.

26

Amendments were made to the Banking Act, the Financial Institutions Act, the Building Societies Act, and the Industrial and Provident Societies Act.

27

The Basle Committee divides total capital into two tranches (Tier I and Tier II). Tier I capital includes paid-up capital (common stock) and disclosed reserves. Tier II capital includes undisclosed, revaluation, and general loan-loss reserves, subordinated debt, and hybrid debt instruments. See Carl-Johan Lindgren, Guillian Garcia, and Matthew I. Saal, 1996, Bank Soundness and Macroeconomic Policy (Washington: International Monetary Fund).

28

The base money target is consistent with the upper end of the inflation range, which the BOJ considers more appropriate in light of the anticipated effect of new indirect tax rate increases on the price level.

29

Assuming an interest rate of 26 percent, the annual interest cost on the value of open market securities outstanding at March 1998 would amount to J$8.4 billion or 3.5 percent of GDP.

30

Government deposits at March 1998 amounted to J$19 billion (8 percent of GDP) which can be drawn down without technically breaching the legal limits. The limit for advances is 30 percent of government’s estimated revenue. Drawdowns of deposits do not technically constitute advances.

31

See Stone, Carl. 1992, Pushing Enterprises to Work: The Jamaican Divestment Experience. In: Caribbean Affairs (Trinidad) 5: 12–13.

32

See Danielson, Anders, 1993. Economic Reforms in Jamaica, Journal of Interamerican Studies and World Affairs 93:97–108.

33

See Hutchinson, Gladstone and Schumacher, Ute. 1991. Privatization in Developing Countries: The Case of Jamaica. In Ott, Attiat F. and Keith Hartley, (eds). 1991, Privatization and Economic Efficiency, Brookfield, VE.

34

Some entities were sold to local economic groups with little or no capital who were to pay for the company with the expected profits from overly optimistic business plans. This approach also raised the sale price making it more difficult for potentially interested foreigners to participate. For example, the privatization of the refinery failed when the local buyer could not raise the US$60 million offered and the next highest bidder had offered only US$5 million.

35

In general, such government intervention was justified on the grounds that it would protect domestic producers of export products from fluctuations in world market prices or to protect small producers from monopsonistic (often foreign) buyers. Since export prices in domestic currency depend on the world market price of the particular product and the exchange rate, a producer price that is fixed by a marketing board could generate surpluses or deficits which, it was expected, would be offsetting over time. However, marketing boards often ran losses or taxed producers beyond reasonable levels, and many developing countries have eliminated their marketing boards.

36

Moreover, bonds issued by the airline were given tax free status.

37

The government said that the intervention was necessary to prevent large increases in rural unemployment (see The Gleaner, November 11, 1996).

38

See The Gleaner, April 21, 1998.

39

The Coffee Industry Board is expected to receive funds in excess of US$15 million and the local citrus industry will receive funds of some US$6.6 million (The Gleaner, March 12, 1998). These exclude support to the financial system which is reviewed in Section I of this paper.

40

NDB’s predecessor, the Jamaican Development Bank (JDB), failed as a result of making poor loans and was subsequently liquidated.

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Cover IMF Staff Country Reports
Jamaica: Selected Issues
Author:
International Monetary Fund
Volume/Issue:
Volume 1999: Issue 002
Publisher:
International Monetary Fund
ISBN:
9781451820065
ISSN:
1934-7685
Pages:
112
DOI:
https://doi.org/10.5089/9781451820065.002
Figure 1.

Jamaica: Interest Rates and Financial Sector Crisis, 1995–98

Jamaica: Commercial Banks

(In percent)

Jamaica: Inflation and Money

(Percentage change, quarter-to-quarter)

Jamaica: Foreign Deposits and Exchange Rate
Figure 2.

Jamaica Selected Financial Indicators, 1996–March 1998
Figure 3.

Jamaica: Selected Indicators, 1979–97
Figure 4.

Jamaica: Privatization and Public Sector Developments