VZCZCXRO0229
RR RUEHGR
DE RUEHKG #1001/01 3292001
ZNR UUUUU ZZH
R 242001Z NOV 08
FM AMEMBASSY KINGSTON
TO RUEHC/SECSTATE WASHDC 7002
INFO RUCNCOM/EC CARICOM COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 03 KINGSTON 001001 
 
SENSITIVE 
SIPDIS 
 
STATE FOR WHA/CAR (ACADIEUX) (VDEPIRRO) (WSMITH) 
WHA/EPSC (MROONEY) 
SANTO DOMINGO FOR FCS AND FAS 
 
E.O. 12958:  N/A 
TAGS: ECON ENRG EINV ETRD IADB IBRD IMF TRSY JM XL
SUBJECT: FINANCIAL CRISIS ROCKS JAMAICA 
 
REF: A) KINGSTON 936 
B) KINGSTON 883 
C) KINGSTON 704 
 
KINGSTON 00001001  001.2 OF 003 
 
 
SUMMARY 
------- 
 
¶1. (SBU) Jamaica's fragile economy has begun to feel the effects of 
the global financial meltdown, with the contagion effects already 
evident in the financial market. The local currency has depreciated 
by more than six percent since the beginning of October, due largely 
to margin calls from overseas creditors.  The increased demand for 
hard currency could not have come at a worse time, as the country is 
going through its traditional dry season for foreign exchange 
earnings.  Jamaica has also suffered from downgrades by three major 
rating agencies (S&P, Moody's and Fitch).  To stem the slide in the 
currency, the central bank hiked interest rates and increased the 
supply of foreign currency.  The Government of Jamaica (GOJ) offered 
an attractive US dollar indexed bond to the market.  These measures 
could have negative implications for fiscal policy as debt costs 
increase.  Although the pace of depreciation could slow in coming 
months, the pass through effect of depreciation could stymie the 
anticipated drop in consumer prices.  End summary. 
 
 
 
Financial Instability Emerges 
----------------------------- 
 
¶2. (SBU) Jamaica has begun to suffer the effects of the global 
crisis with the country's currency market in turmoil.  The Jamaican 
dollar (JMD), which depreciated 1.6 percent for the first nine 
months of the year, has slid by over six percent since the beginning 
of October, moving from JMD 72 to JMD 77.2 against the US dollar. 
The sharp depreciation has been underpinned by a confluence of 
demand and supply factors led by increased margin calls from 
overseas creditors.  With the value of Jamaican global bonds 
declining on the back of the financial meltdown, overseas brokers 
who had provided margin loans to local firms to buy these 
instruments demanded payment of the outstanding amounts to shore up 
their liquidity position.  Overseas suppliers faced with liquidity 
constraints also shut the credit window they traditionally provide 
to Jamaican importers, thus, requiring traders to secure foreign 
currency upfront in order to make purchases. 
 
¶3. (SBU) Demand pressures are also being compounded by increasing 
JMD liquidity as local financial institutions convert maturing debt 
instruments into hard currency.  The increased demand for hard 
currency could not have come at a worse time as it coincided with 
the slow period for inflows and the traditional demand spike for 
foreign currency to purchase Christmas supplies. (Note: Tourist 
arrivals tend to be slowest during the September quarter, commonly 
referred to as the tamarind or dry season. End note.)  Revenues from 
bauxite companies have also declined on the back of falling aluminum 
prices.  The large amount of foreign exchange invested (and now 
lost) in the infamous collapsed alternative investment schemes 
(reftels) have further reduced the supply of available hard 
currency. 
 
The Negative Ratings Trifecta 
----------------------------- 
 
¶4. (SBU) The single greatest shock to the foreign exchange market 
came from the ratings released by Standard and Poor's (S&P) Ratings 
Services (reftels).  On October 21, 2008, the agency revised its 
outlook on Jamaica to "negative" from "stable," although the credit 
rating was maintained.  S&P is particularly concerned about the 
country's weak fiscal position, narrow economic structure and rising 
external liquidity risks.  The S&P posits that external pressures 
could stymie already moribund economic growth, strain government 
access to credit, and weaken the country's external liquidity 
profile.  These factors could further weaken the currency, with 
attendant negative implications for fiscal performance and the debt, 
given the GOJ's reliance on external borrowing.  But worse yet, the 
S&P concluded that the negative outlook could lead to a downgrade if 
external pressures add to fiscal uncertainty, increase capital 
outflows or significantly impair external liquidity. 
 
¶5. (SBU) Moody's Investors Service also placed Jamaica's ratings on 
review for downgrade.  The agency stated that despite the GOJ's 
adequate policy response and continued strong commitment to 
servicing debt, the challenges imposed by the global financial 
crisis and economic slowdown are simply too severe for Jamaica to 
avoid an increase in credit risk.  According to Moody's "the 
combination of a fiscal deterioration and lower real GDP growth 
would lead to a worsening of Jamaica's debt metrics". 
 
 
KINGSTON 00001001  002.2 OF 003 
 
 
¶6. (SBU) This was closely followed by an even more negative rating 
from Fitch, which downgraded Jamaica's actual credit ratings from 
'B' to 'B+'.  The agency cited shocks from the global financial 
turbulence; the expected US recession; deteriorating external 
imbalances; and, high public debt as the underlying factors for its 
decision.  'The recent depreciation pressures on the Jamaican 
dollar, as well as sales of international reserves, signal rising 
challenges facing the island due to the worsening international 
environment," said Shelley Shetty who met with emboffs during her 
recent visit to Kingston. 
 
¶7. (SBU) These less than flattering ratings compounded an already 
tenuous situation, precipitating a further slippage in the JMD as 
local investors switched assets from local to foreign currency to 
hedge against any fallout from the report.  Bank of Jamaica (Central 
bank) Governor Derick Latibeaudiere, speaking at his Quarterly 
Monetary Policy Review briefing, said that the ratings agencies 
analysis was disingenuous.  He stated that the ratings were 
inconsistent and given the agencies' history of massive errors as 
being played out on Wall Street, their analysis if not their 
credibility was at best questionable.  A realignment of the currency 
was anticipated given the 16.8 percent spike in inflation from 
January to September which in effect represented an almost 15 
percent real appreciation in the currency.  High inflation was 
rendering near negative returns on local instruments, encouraging 
savvy investors to switch to foreign assets to hedge against any 
further erosion in real returns.  High commodities prices, led by 
oil imports, caused a USD 793 million deterioration in the current 
account balance to June 2008.  As foreign investment inflows dry up 
and the credit market are severely tightened there would have been a 
shortfall in the supply of foreign inflows required to finance the 
current account, forcing the exchange rate to adjust accordingly. 
 
Fiscal and Monetary Authorities Fight Back 
------------------------------------------ 
 
¶8. (SBU) The increasing instability is not lost on the authorities, 
as the BOJ draws from its arsenal of monetary tools to temper the 
demand pressures.  On October 15 the BOJ introduced a temporary U.S. 
dollar loan facility for institutions affected by margin calls.  In 
essence, the facility allowed securities firms facing the risk of 
losing credit facilities in respect of GOJ bonds to have these 
credit arrangements transferred to the BOJ along with the collateral 
formerly held by overseas creditors.  Two days later the bank 
complemented this response by hiking interest rates on its open 
market instruments by up to 1.2 percent.  The bank followed up by 
facilitating the flow of credit among financial institutions to 
moderate the pressures in the foreign exchange market, while 
assisting the continued functioning of the inter-bank credit market. 
At the same time, the bank sold over USD 400 million or 20 percent 
of its stock of Net International Reserves (NIR) to the currency 
market to shore up the supply of US dollars in the market. 
 
 
¶9. (SBU) However, these policy responses were not sufficient to 
alleviate the demand pressures in the currency market.  In fact, 
since the beginning of November, the rate of depreciation has 
accelerated due largely to a build up in Jamaica dollar liquidity 
stemming from maturing debt instruments.  To remove this excess 
liquidity, the bank embarked on an even more aggressive monetary 
program, offering an attractive short-term instrument with interest 
payable at 20.5 percent (per annum rate).  The BOJ also gave notice 
that when the new instrument matures on December 3, 2008, the cash 
reserve requirement would be increased by two percentage points to 
11 percent.  These monetary policies were accompanied by an 18-month 
GOJ USD indexed bond with a coupon of 11.5 percent.  In addition to 
moral suasion, Minister of Finance and the Public Service Audley 
Shaw has also been calming fears in the market by announcing a 
pending agreement for the IDB to provide liquidity support to 
commercial banks.  He also disclosed that the World Bank, the IDB 
and the Caribbean Development Bank have committed to providing the 
additional USD 250 million required to pay down a maturing Eurobond. 
 In addition, the Managing Director of the International Monetary 
Fund (IMF) Dominique Strauss-Khann is to visit Jamaica in early 
December. 
 
But At What Cost 
---------------- 
 
¶10. (SBU) Although these measures should bring improvements in the 
short term situation, they could have serious consequences for both 
monetary and fiscal policy.  While the latest monetary actions could 
halt the slide of the currency, it has eroded a significant portion 
of the BOJ's stock of NIR, reducing it to just over USD 1.7 billion 
from a peak of USD 2.5 billion in June.  Effectively this steep 
decline has reduced the country's import cover to about 11 weeks or 
returning to levels last seen in 2003.  The increased indicative 
 
KINGSTON 00001001  003.2 OF 003 
 
 
interest rates combined with declining liquidity have already 
induced a response from financial institutions, which have adjusted 
rates by up to three percentage points.  This is bound to crowd out 
private credit and investment and by extension growth as investors 
find it more attractive to hold cash in relatively low risk 
government paper.  Worse yet, the GOJ which is already reeling under 
high debt costs, could see its fiscal indicators deteriorate on the 
back of rising domestic interest rates.  Even though the GOJ has met 
its fiscal targets for the first half of the year, rising debt cost 
will make it difficult for the GOJ to continue on a positive fiscal 
trajectory. 
 
Measures Appearing to Work 
-------------------------- 
 
¶11. (SBU) All is not lost as the strict monetary policies appear to 
be working, with over half of the liquidity from maturing 
instruments already mopped up.  In addition, only USD 170 million of 
the USD 300 million has been accessed by financial institutions, 
suggesting that signs of confidence are emerging.  The temporary 
window has also had the effect of tempering the price movement of 
GOJ bonds while at the same time easing the demand for foreign 
exchange by the institutions affected.  Even though the NIR has 
fallen to just above USD 1.7 billion it is still above December 2007 
levels.  Most importantly, there is no apparent systemic risk to the 
financial sector, with most of Jamaica's prudential indicators still 
above international standards.  The capital adequacy ratio is 
currently at 16 percent, well above local and international 
benchmarks of 10 percent and 8 percent, respectively. 
 
Comment 
------- 
 
¶12. (SBU) While the monetary actions implemented by the BOJ appear 
to be working, it should still be noted that Jamaica is one of the 
few countries to have introduced such measures in response to the 
meltdown (other countries have opted for stimulus packages).  The 
fear of high interest rates and slow economic growth could explain 
why the confidence required to stabilize the local system remains 
elusive.  But waning confidence and uncertainty are not new to the 
Jamaican economy, as in 2003 a similar sequence of events unfolded, 
suggesting the country is locked in a vicious cycle of instability. 
Therefore, unless deliberate attempts are made to address the 
structural problems facing the economy, and in particular the twin 
deficits (fiscal and current account), it is almost safe to assume 
bouts of instability will reoccur.  Prime Minister Bruce Golding and 
his Jamaica Labour Party (JLP))-led government are facing increasing 
pressure from a populace that question Golding's leadership. 
Golding has not been able to secure major victories on his campaign 
promises and appears reluctant to have a frank discussion with the 
public on the serious economic challenges facing the country. 
 
¶13. (SBU) That said, some positives are emerging: even though the 
pass through effect of depreciation will feed inflation, the recent 
moderation in commodities prices in general and oil prices in 
particular, will more than offset this increase.  Declining 
commodities prices combined with the depreciation should also 
correct the current account imbalance, even if remittances and 
tourism receipts wane. Tourism will likely benefit from the currency 
correction, as American visitors find Jamaica a more cost 
competitive destination.  Add to this the fact that the GOJ's 
external debt servicing cost will moderate next year, and the 
outlook brightens slightly. 
HEG