G. Russell Kincaid
For a detailed account of developments in Jamaica see the “Fund’s assistance to Jamaica” by the same author in the IMF Survey (December 15, 1980).
Policies related to the use of Fund resources (its conditionality) have evolved as a result of the Fund’s experience with its diverse membership and of changes in the international economic environment. The main objective of the Fund’s financial assistance has always been to help a country attain a viable medium-term external position, a sustainable level and rate of growth in economic activity, and reasonable inflation rates. The precise economic policy actions required to achieve these objectives may vary from year to year and from one country to another according to the priorities of the authorities and the structure of the economy. The only overriding constraint on policy is the necessity to match the demand for resources with available financing. The application of this principle can often encounter difficulties, and has, at times, generated considerable publicity. The chronicle of the Fund’s recent relationship with Jamaica is an example of such an episode.
In the difficult years from 1977 through 1979, the Fund had a particularly close relationship with Jamaica, providing it with a high level of financial assistance. These resources were extended under a series of programs to support the authorities’ efforts to reverse the economy’s falling real income—a trend which began in 1974. These programs and resources were aimed, in particular, at increasing both imports and exports to levels essential to restore sustainable growth. This article shows how the design of policies undertaken to achieve economic objectives—and even the objectives themselves—were altered over time, in response to both the priorities set by the Jamaican authorities and the changing economic circumstances of the country. This collaboration was especially important because the volume of support extended by the Fund was unprecedented at the time in terms of the size of the Jamaican economy.
A period of rapid economic growth in Jamaica (averaging 6 per cent a year in the 1960s and early 1970s), associated with the expansion of the bauxite and tourist industries as well as with substantial private foreign investment inflows, came to an end in 1972. The Jamaican authorities responded to slackening aggregate demand by embarking upon expansionary economic policies that resulted in a rise in the central government deficit from 5 per cent in 1972 to 19 per cent of gross domestic product (GDP) in 1976 (see Chart 1). Substantial increases in wages also took place, with nominal wages doubling and real wages rising by 30 per cent between 1973 and 1976. These developments promoted a shift in expenditure patterns toward consumption and away from investment, with consumption’s share of GDP rising to over 90 per cent in 1976 from 81 per cent in 1972, while investment declined to 19 per cent from over 27 per cent. During the last three years of this period economic activity steadily declined, which produced a cumulative reduction of 11 per cent in GDP (or nearly one fifth in per capita terms) over a three-year period (see Chart 2).
Chart 1.Jamaica: selected economic indicators, 1972–79
Source: Jamaican authorities and Fund staff estimates.
1 Fiscal year basis (April-March).
Chart 2.Jamaica: real GDP, 1972–79
Source: Jamaican authorities and Fund staff estimates
By the end of 1976, after years of extensive official external borrowing to finance substantial current account deficits, both Jamaica’s foreign reserves and its access to foreign commercial bank credit were virtually exhausted. Jamaica was then confronted with the urgent need to adjust its living standards to accommodate the severe constraint imposed by the reduced inflows of foreign resources.
At this point Jamaica turned to the Fund and in August 1977 negotiated a two-year stand-by arrangement with the Fund for about US$75 million (that is, SDR 64 million, or 121 per cent of its quota) to support a program to stabilize the economy. The program sought to bring the budget deficit into line with projected available real resources. The aim was to attract foreign funds to allow a more gradual adjustment in the balance of payments (BOP) than Jamaica was in fact experiencing and thereby to arrest the rapid decline in economic activity. Substantial net foreign assistance (equivalent to 5.5 per cent of GDP) was expected to help finance the budgetary and current account deficits, thus permitting the adjustment process to be spread over time. Under the program, a high degree of fiscal restraint and the establishment of a tight incomes policy were adopted to ensure that the overall measures would be consistent with the Government’s preference for limited exchange rate action.
The combination of wage moderation, fiscal adjustment, and external financing was not achieved. By December 1977, the performance criteria for the stand-by arrangement had not been met, and Jamaica’s drawings from the Fund were interrupted. The fiscal deficit reached 16.3 per cent of GDP, compared with a target of 9.1 per cent. This deficit was primarily financed by expanding domestic credit, which led to additional wage-price pressures and to a further weakening of Jamaica’s external competitiveness.
Adjustment policies, 1978–80
In mid-1978, a new adjustment program oriented toward increasing domestic production and supported by a three-year extended arrangement—for about US$250 million (SDR 200 million or 270 per cent of quota)—replaced the stand-by arrangement. The new program emphasized the goals of reviving economic growth and reversing the substantial fall in investment of the past few years: additional resources were to be allocated to stimulate production and investment, and Jamaica’s reliance on foreign savings was to be gradually replaced by greater domestic savings. To restore incentives in the traded goods sector, the overvalued Jamaican dollar was devalued and a schedule of small monthly depreciations was instituted. This exchange rate action was also designed to permit a less restrictive domestic financial stance. Because the depreciation would increase the prices of essential imported foods, additional subsidies—equivalent to about 2 per cent of GDP—were introduced in the budget to soften the impact on prices. Notwithstanding these new current expenditures, it was planned that the public sector’s deficit would decline from 16.3 per cent to 11 per cent of GDP in order to bring aggregate demand and supply more into balance and to ensure adequate financing for the private sector.
The results of the first year with the extended arrangement were mixed. Production continued to decline, although more slowly than previously, and investment activity remained weak. Equally worrisome were the deviations in fiscal policy from the program target. The overall central government deficit exceeded the target by 2.3 percentage points of GDP. Jamaica continued to rely on foreign resources to finance its current budgetary expenditures, a situation that was clearly not sustainable. On the external side, the further accumulation of arrears on international payments meant that the anticipated private external capital flows did not materialize (including trade credits), which had the effect of hampering Jamaica’s productive effort and intensifying its requirements for BOP assistance.
For the second year of the extended arrangement, the Jamaican authorities proposed, and the Fund agreed to, a change in the mix of economic policies and a revision of the program targets set in June 1978, both in order to respond to the growing social tensions and in an effort to stimulate a more rapid recovery of the economy. Among the policies adopted was a suspension of the monthly currency depreciations that was to be combined with greater moderation in both wage demands and price adjustments in order to diminish the upward pressure on prices; there would be no increase in taxes. Program targets were revised to permit higher recurrent and overall fiscal deficits and a greater current account deficit, which would accommodate a further expansion of imports required to foster economic growth. To support the latter effort, and to reduce external payments arrears, the Fund doubled its commitment for the remaining two years of the arrangement to about US$330 million (SDR 260 million).
In 1979, Jamaica, like the rest of the world, was buffeted by higher oil prices and rising interest rates. The country also experienced severe floods in mid-year that damaged export crops and entitled Jamaica to obtain US$42 million from the Fund under the compensatory financing facility. While these external shocks jeopardized the objectives of the second extended facility program, major difficulties in the management of economic policies, particularly fiscal policy, resulted in the nonfulfillment of the quantitative criteria employed to monitor progress.
Two major factors—greater than agreed wage increases granted to public sector employees and an inability to contain other expenditures—led to a recurrent budget deficit of 4.0 per cent, instead of a balance, and contributed to the overall public sector deficit expanding to 13.7 per cent of GDP, compared with the target of 8.9 per cent. The deficit was financed primarily by domestic credit expansion, with bank credit to the Government growing by three and a half times the amount envisaged in the financial program. Excess demand pressures led to a widening of the current account deficit to 6.8 per cent of GDP, an increase in the overall external deficit, and a doubling of international payments arrears from their mid-year level. These divergencies from program targets led to an interruption in Jamaica’s right to make purchases under the extended arrangement, pending a review of the conditions under which access to the Fund’s resources would be restored.
In September 1979, when the slippages were recognized, attempts were made to develop new policies to return the economy to its agreed stabilization path. The Fund was willing to modify the program’s quantitative targets relating to Fund purchases in order to accommodate the changes arising from unforeseen and exogenous developments, just as it had under the 1978 program for that year’s export shortfall and purchase under the compensatory financing facility. However, domestic consensus on economic policies did not emerge quickly. During this period of discussion from September 1979 to February 1980, the loss of policy momentum resulted in such departures from the program’s targets that the original objectives clearly became unattainable. Moreover, weakening social and political cohesion further complicated development of an agreed economic policy. Conscious of the need to have the broadest possible support of the Government’s programs, the Prime Minister, in an address to the nation on February 3, 1980, stated:
“I believe that the country needs to settle and decide its economic strategy and that when that is settled, it will be easy to understand what part the IMF should play; or whether it should play any part at all. What must be brought to an end is the present state of confusion, because the country has to settle down on a path and understand the efforts, the discipline, and the sacrifices that are necessary to that struggle.”
The statement concluded with the announcement that elections would be held as soon as feasible.
Even though efforts under the extended arrangement had collapsed and the Fund’s further role in Jamaica was in question, the Fund and the Jamaican authorities agreed to negotiate an interim stand-by arrangement. This was viewed as a holding operation and, as such, the arrangement sought policies consistent with those previously agreed by the Government for fiscal year 1979/80. The Fund was to maintain the same annual level of financial support (US$185 million, or about 6.1 per cent of GDP) as under the extended arrangement and to solicit, on behalf of Jamaica, expanded foreign assistance. But negotiations were broken off by the Jamaican authorities on March 23, 1980 prior to the completion of the financial program.
Along with the modifications in the adjustment strategies just outlined, the Fund participated in developing a supporting financing package in order to smooth the adjustment process and make it less costly both economically and socially. Given Jamaica’s extreme dependence on imported materials for production, every program had sought an expansion of imports in an attempt to achieve the program’s economic growth targets. To finance greater imports between 1977 and 1979, the Fund agreed to provide access to its resources in unprecedented amounts (about US$516 million, or 537 per cent of Jamaica’s quota). Actual Fund assistance was greatest in the two years of the extended arrangement, when purchases were over US$260 million (about 270 per cent of the quota); the Fund also helped to mobilize additional official BOP support (about US$193 million), as well as supporting efforts to obtain a medium-term refinancing of the bulk of amortization payments due to foreign commercial banks (US$141 million), along with an increase in short-term commitments of US$39 million. Resources of this magnitude—totaling about US$630 million, or about 12.25 per cent of GDP a year during 1978-79—could only be provided on a temporary basis in the expectation that they would be used to build an economic base that would make further massive assistance unnecessary and ensure the revolving nature of Fund resources.
For the Fund’s contribution to assistance on this scale could only be of limited duration, with repayments beginning three to four years after each purchase. Between 1977 and 1979, the Fund was by far the largest single source of external resources (see Chart 3). In fact, the level of Jamaica’s purchases from the Fund increased from 0.8 per cent of GDP in 1977 to 7.5 per cent of GDP in 1979—representing US$188 million—reaching a peak equivalent to 10.4 per cent of GDP in the second half of 1979.
Chart 3.Jamaica: selected sources of external financing, 1972–79
Source: Jamaican authorities and Fund staff estimates
In that year, Jamaica’s drawings on the Fund were far greater than its borrowings from other sources, whether private or official. Net flows from foreign commercial banks were actually negative in 1979, by about US$11 million, while assistance from other international organizations was about US$61 million.
A number of observations can be drawn from the Jamaican experience concerning the application of conditionality—especially regarding the strategy adopted for adjustment and financing, the flexibility in selecting the mix of policy measures, and the importance of timely action to correct imbalances. Jamaica experienced substantial imbalances that had persisted over a protracted period prior to the Jamaican authorities’ approach to the Fund in 1977. By then, foreign sources of financing and international reserves were depleted. The repercussions of this combination of developments on economic performance were adverse. Imports had to be cut sharply and domestic production was disrupted due to shortages of imported inputs. External resources were no longer available to cushion the severity of the adjustment process, extend the time period over which it must take place, or increase the range of policy options open to the authorities. This demonstrates the desirability of approaching the Fund at a timely stage. However, unfortunately, this was not the path pursued by Jamaica.
The magnitude of the financing gap, associated with an economic and financial program designed to secure a balance between aggregate demand and supply at the highest possible income level, clearly indicated that actions to increase the supply of and curtail the demand for foreign exchange were necessary. To help bridge this gap, the Fund assisted the Jamaican authorities to develop a financing package that included new loans from governments and international lending institutions, and refinancing by foreign commercial banks. The Fund also provided Jamaica with access to its resources that was unprecedented in terms of the size of the economy. If the resources committed under the revised two-year extended arrangement had been fully disbursed, they would have amounted to about five times Jamaica’s quota. Actual disbursements in 1979 were more than three times the net amount obtained by Jamaica from foreign commercial banks, governments, and other international organizations.
Special BOP assistance would only bridge part, but not all, of the financing gaps confronting Jamaica during this period. Domestic policy measures then would have to close the remaining external resource gap in order to make the program viable. Therefore, the domestic adjustment effort needed was a result of both the resources required to make the program viable and those that were available. Nevertheless, it is also clear that, throughout the period, the selection and combination of domestic policies undertaken to achieve the objectives of the programs supported by the Fund—and indeed, even the targets of the programs—varied in response to priorities set by the Jamaican authorities themselves. Thus, the Fund remained conscious of the country’s circumstances and social priorities. The particular structure of policies developed was based on the authorities’ understanding of the relative social costs and benefits, while the Fund staff provided technical assistance as to the likely economic impact on the balance between resource demands and available resources.
Jamaica’s experience with the Fund during the period 1977-79 has been used to support the claim that the Fund’s conditionality is politically impractical and applied in a rigid fashion. With regard to the latter, the adaptations in the policies and targets of the programs supported by the Fund indicate the degree of flexibility that the Fund is able to bring to coping with a country’s economic difficulties. For example, when external shocks buffeted the island’s economy in 1979, the Fund was prepared to modify the program’s ceilings relating to purchases just as it had done under the 1978 program to accommodate the changes arising from unforeseen and exogenous developments. However, major difficulties also existed in the management of economic policy, particularly fiscal policy, which meant the quantitative criteria employed to monitor progress were not fulfilled. The emphasis placed on various policy instruments also varied from program to program. This flexibility enables the authorities to construct a package of policy measures that best suit their country’s political and economic circumstances but within existing financial constraints.
On the first point, that the adjustment effort required under Fund programs is politically unrealistic, it is important to recognize that, in most circumstances, adjustment will take place with or without the Fund. Eventually claims on resources must be reconciled with limited supply. When a country has delayed corrective policy actions until foreign financing has dried up—as Jamaica did—then adjustment tends to be unduly large and swift with relatively large social welfare costs. Even unprecedented Fund financial support and assistance from governments and other financial institutions may not be sufficient to lessen the constraints imposed by this adjustment process. In any case the adjustment with Fund support was less, especially in the case of Jamaica, than it would have been without its substantial financial assistance.
After elections in October 1980, the new Government announced that it would initiate negotiations with the Fund on an economic program to revive the economy. In December 1980, staff from the Fund and other international organizations, such as the World Bank and the Inter-American Development Bank, visited Jamaica to join the Jamaican economic team in developing a framework for economic policies and in estimating external resource requirements. Thus, the process of designing a policy mix capable of meeting the social and economic objectives of the authorities, while balancing the resultant resource demands with available resources, was resumed.
As with previous programs, the Fund assisted the Jamaican authorities in developing a financing package, consisting of new loans from governments, multilateral lending agencies, and foreign commercial banks, that would permit the new program to achieve its objective of resuscitating economic activity. In March 1981, at a meeting of the Caribbean Group for Cooperation in Economic Development, chaired by the World Bank, official lenders pledged to disburse at least US$350 million (excluding Fund resources), or 8.8 per cent of GDP, in new resources during the next year to support Jamaica’s adjustment efforts. Later in March, meetings were also held with commercial banks to further progress on arrangements for deferral and refinancing of amortizations due them and for new credits. The Fund staff described to both groups the details of the stabilization effort and gave an assessment of the prospective economic situation, focusing on the financing requirement, to provide a framework for their contributions. The Fund’s direct contribution will be access to its resources over the three-year period of the extended arrangement of about US$625 million, or equivalent to 450 per cent of Jamaica’s quota—the maximum permissible under the new policy for enlarged access. In the first year, Jamaica will be eligible to draw about US$250 million, or equivalent to about 6.3 per cent of GDP, plus a purchase of about US$45 million under the compensatory financing facility, or about 1.2 per cent of GDP.