Jamaica Gleaner
Published: Sunday | February 1, 2009
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The paralysis of high interest rates

Edward Seaga

The following article is the concluding section of a presentation made at a Jamaica Stock Exchange conference on January 27.

History is now repeating itself in the advent of another episode in the boom-and-bust cycle of the world economy. The current global crisis has been wreaking havoc on the New York and world stock exchanges. From the current plunge in stock prices, it is estimated that more than 50 per cent of the asset value of stocks on the NY Exchange will be lost by the time this credit crisis is over. In the Great Depression of 1929-30, 90 per cent of the asset value of listed stocks was wiped out on the New York Stock Exchange. Although the impact of the global recession on the Jamaican economy is not yet being fully felt, only time will determine how much worse is to come.

exchange rate slipping

Already the rate of exchange is slipping, having lost 14 per cent in value over the past year. This is a result of the increasing demand for US dollars which, based on the conventional wisdom, can only be stemmed if the supply of Jamaican dollars is dried up by monetary policy measures, or the Jamaican dollar becomes expensive too so as to discourage the purchase of foreign exchange. In both cases, increased interest rates hold the key to cutting demand as the economy is forced to contract.

This strategy to compress the economy by driving up interest rates has several negative consequences:

The cost of debt will increase;

So will consumer and other


Higher interest rates will attract investment away from the stock market reducing investment on the exchange;

Economic growth, which is already marginal, will falter and slide.

Fortunately, the recent new signing of loans from the World Bank, Caribbean Development Bank, Inter-American Development Bank and the Bank of Nova Scotia, to come, totalling US$533 million is enough to pay out the overseas loan of US$200 million due this month, and provide a significant package of US$300 million liquidity to bail out hard-pressed institutions which are unable to service foreign debt, or purchase new inputs. This should effectively stabilise the exchange rate over the near future. But there is still the daunting hurdle of meeting the foreign exchange requirement for the new financial year beginning April 1.

Failure to do so will result in a re-run of the present foreign- exchange crunch and all the attendant horrors of increased interest rates, increased prices, increased debt and stagnation of economic growth as the exchange rate falls. This predicament has haunted the economy for 25 years except for the 1987-1989 period when, after a battle with the International Monetary Fund, I took the bold step to peg the rate at J$5.50 equal to US$1.00 in 1987, creating the only window for significant economic growth over the previous dozen years.

Is this not a statement that instead of watching the economy slip and slide still further again, the prospects of a pegged exchange rate should be studied to determine if it can do for Jamaica what it has done in lifting all the economies in the English-speaking Caribbean to greater prosperity?

only alternative

The only alternative to the pegged rate is to substantially increase inflows of foreign exchange earnings by establishing new export earning enterprises.

In the mid-1980s, after the economy had experienced three years of compression to severely cut expenditure, ending in 1985, an investment surge in export apparel production followed. With a pegged rate of exchange, it created the second highest period of growth to occur since Independence. But where is the new investment surge to increase foreign exchange inflows and at this time to close the foreign exchange gap on a sustained basis? Where is the next Spanish-type investment bonanza? This does not exist, as far as is publicly known.

It is unlikely that the investment stimulus required to lift the economy will be a "Spanish-type" or export apparel-type surge. In the absence of a new investment surge, the stranglehold of high interest rates will have to be loosened to allow growth and prosperity. Nowhere else in the English-Speaking Caribbean do lending rates of 20 per cent exist, plus or minus a few points, with spurts of significant enough increases to jolt the entire economy. Small- and medium-sized businesses will never be able to expand, or be created on a meaningful scale to help to lift the economy out of its stagnation. Studies have indicated the vital importance of these unheralded smaller investments in lifting the economy and employment.

Two of the major banks enjoy extraordinarily high return on equity 28 per cent and 30 per cent. A 2004 Bank of Jamaica paper, on Interest Rate and Commercial Spreads in Jamaica, indicates an industrywide spread of 11.6 per cent for Jamaican banks, the highest in the region.

Luis Alberto Moreno (left), president of the Inter-American Development Bank (IDB), shakes hands with Prime Minister Bruce Golding while Audley Shaw, minister of finance and the public service and Don Wehby, minister without portfolio in the finance ministry, look on during the signing of a contract for US$329 Million in loans between the Government and the IDB at Jamaica House in St Andrew on January 19. - Rudolph Brown/Chief Photographer

The paper notes "All the key operating ratios for the commercial banking industry in Jamaica fall short of international benchmarks. Operating cost, for instance, as a proportion of total assets are twice as high as comparable institutions elsewhere."

It is easy to blame the banks but Government persists in issuing debt instruments at extraordinarily high rates, which set the bar for the banking industry.

It is time to come to grips with this dilemma by thorough study and effective action. I believe lower interest rates will attract more customer response and could compensate for the reduced margins of the banks. An empirical study is needed to determine what steps could be taken.

super-profits gained

The many years of super- profits gained from high interest debt instruments issued by government as monetary policy to stem demand for foreign exchange and stabilise the exchange rate, has created an unhealthy 'Las Vegas' investment culture in Jamaica that no longer accepts moderate investment returns as sufficient. This led to Cash Plus and Olint being very attractive investment models. It reinforced a banking system, now structured on super-spreads with super-profits.

Nowhere else in the English-speaking Caribbean does the banking system enjoy prohibitive lending rates as in Jamaica. These high rates are a great impediment to investment and, by extension, economic growth, because few investments can tolerate mega-rates.

relieve cash flow

The IDB loan of US$300 million to the private sector to relieve cash flow and foreign exchange debt is to be loaned by the Development Bank of Jamaica through the commercial banks. The results could be disappointing. The banks are likely to maintain that the reduced spread offered for these loans are too small a margin of profit compared to the usual super margins. This has been the sad experience over the past 25 years. But there is a solution: include a stipulated percentage of such loans to replace other deposits in the prudential reserves held by banks in the BOJ, as approved securities. These deposits can then be loaned, providing an incentive for the banking system, as was done in the 1960s, to encourage agricultural loans.

In the absence of new and additional export earnings, the future of the economy will rest on growth in tourism, mining and remittances, precisely the three areas of vulnerability now under pressure from the global crisis. It will come back, therefore, to how the economy weathers this global disaster.

crisis to hit Jamaica

The global crisis is yet to hit the Jamaican economy. When it does, new pressures will arise, and in the absence of an available and willing capital market for customary loans, the economy will take another step backward with devaluation, paving the way towards the waiting arms of the IMF.

The stock market in the meantime will be caught in another depression, as 25 per cent high-yield government bond issues attract capital from investing on the exchange.

Is it not odd that while other countries are reducing interest rates Jamaica is not? Is it not odd that while other countries are seeking economic expansion to grow their way out of the recession Jamaica is contracting its economy? Something is wrong. The policy mix needs urgent review.

Edward Seaga is a former prime minister. He is now a distinguished fellow at the UWI and pro chancellor at UTech. Email: odf@ uwimona.edu.jm or columns@gleanerjm.com.

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