- International Monetary Fund
- Published Date:
- August 2003
Jamaica faces serious challenges to long-term growth and development imposed by a substantial debt overhang. Like many other Latin America and Caribbean countries, Jamaica emerged from the 1980s with a heavy external debt burden. The focus then had been the effective management of the external debt portfolio. The combination of external factors—such as low export earnings, reduced access to long-term loans on concessionary terms, and the internal developments of weak output performance and low revenue intake—saw the government relying on domestic financing. Consequently, by the 1990s, the high levels of external debt and attendant issues combined with the cost of rehabilitating the financial sector after the crisis in the financial sector in the mid-1990s resulted in high and rising levels of domestic debt, high interest rates, and fiscal deficits.
Jamaica has taken steps to ensure that sound economic fundamentals are in place to address these issues. A major thrust of the government’s economic program has been the reduction of the overall debt. Given that the high levels of public debt and debt service severely limit the government’s ability to invest in physical and social infrastructure necessary to promote investment and growth, since the second half of the 1990s, the major challenge to the government of Jamaica has been the management of debt dynamics. Emphasis has been placed on management of the domestic debt, the larger and more expensive share of the public debt.
Macroeconomic Policy Framework
Jamaica accelerated its structural reform program in the early 1990s with, among other developments, the liberalization of the foreign exchange market, the removal of price controls, reduction in trade barriers, and the reform of the tax system. The containment of inflation and the maintenance of relative stability in the foreign exchange market became the focus of the macroeconomic stabilization program introduced in 1991. This was to be achieved through a combination of tight monetary and fiscal policies.
The government succeeded in reducing inflation to single-digit levels and maintaining relative stability in the foreign exchange market. However, one of the costs of the stabilization was the marked increase in the level of the domestic debt, beginning in fiscal year 1994/95. In addition to deficit financing, the increase in the stock of domestic debt was incurred largely to provide assistance to the central bank, the Bank of Jamaica (BOJ), in its liquidity management objectives and cover the BOJ’s losses. Increases were also due to the assumption of debt obligations of parastatal entities. The debt problem was exacerbated by the financial sector crisis, which emerged in 1996, and the cost to the government of rehabilitating and restructuring the sector. All outstanding contingent liabilities that resulted from the rehabilitation and restructuring of the sector (approximately 35 percent of GDP) were assumed by the government as of April 1, 2001.
Jamaica’s public debt–GDP ratio amounted to 130 percent at the end of fiscal year 2001/02 compared with 110 percent at the end of fiscal year 1994/95. Domestic debt as a percentage of GDP increased from 32.6 percent at the end of fiscal year 1994/95 to 63.9 percent at the end of fiscal year 2000/01. With the government’s assumption of the remaining liabilities associated with the rehabilitation and restructuring of the financial sector, the domestic debt increased to 87.5 percent on April 1, 2001. By the end of fiscal year 2001/02, domestic debt stood at 77.5 percent of GDP. Debt servicing accounted for 66.1 percent of budgetary expenditure for fiscal year 2001/02, with domestic debt-servicing costs accounting for 54.8 percent of budgeted expenditure.
Over the last 10 years, considerable progress has been made in reducing the level of external indebtedness and the attendant debt-service burden. Jamaica’s external debt has been reduced from 109.3 percent of GDP at the end of fiscal year 1991/92 to 52.4 percent of GDP at the end of fiscal year 2001/02. Jamaica’s external debt-service ratio (total debt service as a percentage of exports of goods and services) has fallen from 29.2 percent in fiscal year 1990/91 to 12.3 percent in fiscal year 2001/02.
The steady decline in the external debt and the improvement in Jamaica’s external debt indicators led to the World Bank’s 1999 reclassification of Jamaica from a severely indebted to a moderately indebted country. This achievement crowns a series of advances that includes
Jamaica’s exit from commercial bank restructuring in 1990,
its “graduation” from Paris Club bilateral rescheduling in the mid-1990s, and
its reentry into the international capital markets in 1997, which was subsequently buoyed by credit ratings from Moody’s Investors Service (Ba3) and Standard and Poor’s (B) in 1998 and 1999, respectively. Standard and Poor’s upgraded Jamaica’s credit rating to B+ in May 2001.
Despite these positive developments, Jamaica continues to face a heavy debt burden, the result of the acceleration in the rate of domestic debt accumulation. Thus, although the composition of the debt has changed markedly over the decade, with the share of domestic debt increasing from 26 percent at the end of fiscal year 1990/91 to 60.7 percent at the end of fiscal year 2001/02, the overall debt burden remains onerous.
Cognizant of the importance of reducing the debt to sustainable levels, the authorities took the necessary steps to strengthen Jamaica’s debt management capability and embarked on a path toward the implementation of debt reduction strategies and prudent debt management practices. In addition, steps were taken to facilitate the development of the domestic capital market.
Centralization of debt management functions
The need for institutional building and improvements in the government’s debt management capability was critical to the formulation and implementation of credible debt management strategy and policies. Since April 1998, there has been a centralization of the debt management functions in the debt management unit (DMU) of the ministry of finance and planning. Before that, the debt management functions were shared by the ministry and the central bank.
Responsibility for the core debt management functions—debt policy and strategy formulation and analyses, debt-raising activities, and the registrar and payment function for government securities and debt recording and monitoring—now fully resides within the DMU. The BOJ, in its agency capacity, is responsible for effecting external debt payments, conducting primary market issues, and issuing and redeeming treasury bills. The accountant general department, a department of the ministry of finance and planning, has responsibility for treasury operations, including the servicing of the debt.
At the operational level, the centralization of the core debt management functions within a single unit in the ministry of finance and planning has led to considerable strengthening of debt strategy implementation. Several factors explain this, foremost of which are increased capacity in debt management expertise, greater clarity of debt management objectives, and improved consolidation of debt management information.
Debt management objectives and coordination
Clear debt management objectives have been developed. The principal debt management objective is to raise adequate levels of financing on behalf of the Government of Jamaica at minimum costs, while pursuing strategies to ensure that the national public debt progresses to and is maintained at sustainable levels over the medium term.
The influences of debt management on and by monetary and fiscal policies in a situation of deficit financing and rehabilitation and restructuring of the financial sector have been far reaching, thereby reinforcing the need for strong policy coordination. In Jamaica, the coordination of debt management, fiscal, and monetary policies is undertaken within the context of a clear and consistent macroeconomic framework designed to lower inflation and achieve economic stability and sustainable growth and development.
The transfer of the shared debt management function from the BOJ to the ministry of finance and planning has also resulted in greater coordination of fiscal policy and debt management objectives. It also allows for a more clearly defined set of debt management objectives determined independently from monetary policy considerations. Despite these separate objectives, there is a high degree of coordination between the fiscal and monetary authorities.
At the policy level, there are regular meetings between senior officials of the planning authorities—the ministry of finance and planning, the BOJ, the Planning Institute of Jamaica, and the Statistical Institute of Jamaica—to ensure consistency in the government’s economic and financial program. At the technical level, there are regular meetings where information is shared on the government’s cash-flow requirements and financing program, as well as on current monetary conditions and developments within the money and foreign exchange markets. There are weekly meetings within the ministry of the DMU, fiscal policy management unit, cash management unit, and the accountant general department, as well as between the ministry and the BOJ.
A well-developed legal and institutional framework exists for the execution of debt management. Under Jamaica’s Constitution, all loans charged on the consolidated fund, including all external and domestic debt payments, represent a statutory charge on the revenue and assets of Jamaica. This provision allows for debt payments to be made without any requirement of parliamentary approval, and before funds are available for other policies and programs. In addition, the constitution and the Financial Administration and Audit (FAA) Act give the ministry of finance and planning overall responsibility for the management of Jamaica’s public debt.
The government’s borrowing requirements for each financial year are determined by the ministry of finance and planning and set out in the budget presented to parliament at the beginning of the financial year.
The authority to borrow is established by statutes. The Loan Act, 1964, and subsequent amendments provide the government with the authority to borrow from the domestic and external markets. The Loan Act establishes overall quantitative limits on the amount the government can borrow. Increases in the ceiling have to be obtained by parliamentary approval.
For domestic borrowings, there are specific acts that govern the issuance of the various debt instruments. These are the Treasury Bill, Local Registered Stock, Debenture, Land Bond, and Saving Bonds Acts.
The borrowing powers of public sector entities are set out in the FAA Act and the legislation governing the corporations and are complemented by the new Public Bodies Management and Accountability Act. The board of directors of the public entity determines the extent of borrowing, and the ministry responsible for the entity must approve the borrowing plan. However, the approval of the ministry of finance and planning has to be obtained by all public sector entities needing to finance their operations through debt financing.
Considerable efforts have been made to increase transparency and accountability in debt management operations in recent years.
The government’s debt management strategy is presented to parliament at the start of the financial year. Since fiscal year 1999/2000, this strategy has been published in the form of a ministry paper that has widespread public distribution. The document is available through the Internet on the web site of the ministry of finance and planning, www.mof.gov.jm.
Comprehensive information on Jamaica’s debt is published on the ministry’s web site and routinely updated. In addition to information on past debt activity, including debt outstanding, debt-service payments, and debt structure and composition, the web site is also used as a vehicle to announce future debt operations especially as they relate to debt issuance in the domestic market.
The rules for participating in primary debt issues, specifically the auction of medium-term government securities, have also been widely disclosed. Notices for future domestic debt issues are also published in the print media. Similarly, the results of government debt issues are widely reported through the print and electronic media and on the ministry’s web site.
There is also regular dissemination of information to players in the international capital markets, credit-rating agencies, and international and regional financial institutions.
Establishing a Capacity to Assess and Manage Cost and Risk
Debt management strategy
The primary aim of Jamaica’s debt management strategy is to ensure that overall borrowing is kept within prudent levels and secured on the best terms available. Over the medium term, it is envisaged that debt management strategies will be supported by a continual fall in interest rates, a relatively stable exchange rate environment, a reduction of the fiscal deficit, and a return to fiscal surplus.
Jamaica’s public debt management strategy is defined within the context of a macroeconomic framework of fiscal balance, price stability, and growth. Consistent with this, the strategic objective is to bring total debt to sustainable levels over the medium term. Achieving sustainable levels of debt has necessitated the design and implementation of a comprehensive debt management strategy.
The government’s debt management strategy is intended to achieve five broad objectives over the medium term:
satisfying the government’s annual borrowing requirements,
minimizing borrowing and debt service costs,
achieving a balanced maturity structure,
building and promoting a liquid and efficient market for government securities, and
ensuring continued or wider access to markets, both domestic and external.
Risk management framework
Increased attention has been given to managing the government’s exposures to unexpected interest rate and currency movements in relation to both the domestic and external debt portfolios. At the end fiscal year 2001/02, more than 57 percent of Jamaica’s domestic debt portfolio was composed of floating-rate instruments. This has left the government vulnerable to increases in interest rates with the attendant increases in debt-servicing costs. To reduce interest rate risk, the current debt strategy has been to increase the proportion of fixed-rate debt in the domestic debt portfolio. Progress has been made in this direction, because all local registered stocks issued through auction have been issued on a fixed-rate basis. Fixed-rate debt will continue to be issued over the medium term, thereby redistributing the balance between fixed- and floating-rate debt to more prudent levels. Over the medium term, the government will seek to maintain the fixed-rate target of 60 percent of the domestic debt portfolio, in keeping with international best practice.
The management of the Jamaican debt portfolio’s currency exposure will include limiting the share of U.S. dollar exposure in the domestic debt portfolio. Jamaica’s issuance of U.S. dollar-denominated and U.S. dollar–indexed securities in the domestic market has led to an increasing share of the domestic debt portfolio exposed to U.S.-dollar currency risk. At the end of fiscal year 2001/02, these categories together made up 15.5 percent of the domestic debt, compared with 8.1 percent at the end of fiscal year 2000/01. Although the government is committed to providing an array of instruments to the domestic markets, maintaining a prudent domestic debt structure requires that the U.S. dollar exposure of the portfolio remain low. Consistent with this, the strategic objective will be to reduce the exposure over the medium term.
The currency composition of Jamaica’s external debt is changing after years of holding steady. The advent of the euro and the replacement of multiple European currencies by a single currency have significantly altered the composition of Jamaica’s external debt portfolio. In addition, success in diversifying the portfolio by raising funds in the international capital markets has influenced the currency composition of the debt. Although more than 75 percent of the external debt portfolio is denominated in U.S. dollars, a growing portion of the debt is denominated in euros. The euro is now the second largest currency component of Jamaica’s external debt, accounting for 14 percent of the external debt at the end of March 2002.
The seeming complexity of hedging instruments (swaps and options), with its specialized knowledge required to use such instruments effectively, and the costs of using such tools have tended to make Jamaica, like many other developing countries, shy away from actively employing these mechanisms. The notable shift in the currency composition of the public external debt makes it prudent for the government to adopt strategies to manage the currency risk associated with this exposure, because unhedged exposures can lead to significant increases in debt-service costs. As a result, steps will be taken to minimize the portfolio’s vulnerability to adverse movements in the euro by using hedging mechanisms, where appropriate, to minimize the portfolio’s foreign currency exposure.
The need to record and assess the impact of the government’s contingent liabilities has become increasingly important in recent years. The government is concerned not only with limiting the total face value of contingent liabilities, but also minimizing both the likelihood of contingent liabilities being called and the size of public outlays in the event that a call is made. In assessing the appropriateness of contingent liabilities, consideration is given to how these resources will be used to ensure that they will be used for developmental purposes and are in keeping with government’s economic strategy.
A number of measures to minimize the government’s risk exposure associated with contingent liabilities are being implemented. Foremost among these is the strengthening of the monitoring and analysis of contingent liabilities so that the potential future impact for debt servicing can be fully evaluated. Legislation designed to enhance accountability and transparency in public sector bodies has been enacted. Work is also under way to ensure the comprehensive data capture of contingent liabilities and the development of a proper risk management framework. Another means of limiting government’s risk exposure is to require some level of risk sharing in the issue of government guarantees.
Development and Maintenance of an Efficient Market for Government Securities
A core debt management objective is to ensure that funds are raised as cost-effectively as possible. One step in this direction, within the domestic market, has been to adopt a market-based mechanism for selling local registered stocks (LRS),2 the medium- to long-term instrument. A multiple-price auction system was introduced in October 1999. Previously, the government set rates on these instruments. This often created price distortions in the domestic market, which at times manifested itself in the government’s financing needs not being fully met from the market issues, necessitating private placements.
A more competitive pricing of medium- and long-term securities has been achieved through the use of the auction system. This mechanism has resulted in a significant narrowing of interest differentials between long-term and short-term domestic securities. Since the introduction of the auction system, LRS issues have been significantly oversubscribed. Over time, the price range for bids has narrowed. This policy shift has resulted in the government meeting its financing needs at competitive rates. When circumstances make it necessary for the government to raise funds through private placements, it is done through a competitive bidding process.
Another significant development has been the increased ability of the government to extend the maturity structure of its debt since the introduction of the auction system. As of March 2002, 35.1 percent of total domestic debt was scheduled to mature after five years. This compares favorably with the position one year earlier, when 23.3 percent of the total domestic debt was scheduled to mature after five years. At the same time, 17.5 percent of the domestic debt was scheduled to mature after 10 years, compared with 6.6 percent at the end of March 2001.
The appetite for longer-term securities has resulted in a positive shift in the maturity profile of the domestic debt. A milestone was reached in August 2000, when the first 10-year LRS instrument was successfully auctioned. Of the new debt issued in fiscal year 2001/02, some 86.4 percent of LRS issued through the auction system had maturities of five years or more, compared with 53.5 percent of new issues through the same process in the previous fiscal year. In fiscal year 2001/02, 15.5 percent of new domestic debt issued has maturities of 10 years or more. With continued improvement in macroeconomic conditions and renewed investor confidence, the government has been able to successfully auction LRS with maturities as long as 30 years.
The market’s appetite for longer-term securities is also reflected in the successful issuance of government-guaranteed, 30-year, inflation-indexed infrastructure bonds for the financing of Jamaica’s first toll road.
The conversion of the contingent liabilities associated with the rehabilitation and restructuring of the financial sector into tradable government securities provided an opportunity for further lengthening the maturity profile of the domestic debt. These obligations were converted into securities with maturities of up to 25 years.
To facilitate the development of an orderly and well-functioning domestic securities market, the approach has been to not only regularly access the market, but also to inform the market of upcoming issues. Considerable progress has been made in informing the market and increasing the predictability of the government’s debt operations. In addition to the publication of a calendar of treasury bill tenders and issue dates at the start of each fiscal year, announcements have been extended to include the publication of an issuance calendar for LRS auctions. This dissemination of information and the regular consultations with primary dealers have allowed for greater transparency and predictability in the domestic capital market.
The domestic debt portfolio comprises short-term treasury bills, fixed- and floating-rate medium- to long-term LRS, medium-term debentures, fixed-rate foreign currency domestic bonds, indexed bonds, savings and developmental bonds, and commercial loans.
Although a significant proportion of the domestic debt portfolio is made up of floating-rate instruments, the use of the auction mechanism to price the government’s primary debt-raising instruments, the LRS, has meant that over the medium term, an increasing share of the debt will be on a fixed-rate basis. This will insulate the portfolio from interest rate shocks and rollover risks.
The principal holders of government securities are the central bank, commercial banks, insurance companies, pension funds, and the money market fund managers. In recent years, the government’s debt issuance program has tried to meet the needs of the market players. A priority has been to introduce new instruments that are more closely tailored to meet the needs of different market segments. In addition to overall capital market development, the benefit to the government is a larger pool of resources from which financing can be tapped on improved terms.
The introduction of new instruments began in 1999, when, on a small-scale, Jamaica offered U.S. dollar–indexed bonds to the domestic market. These instruments have proven to be attractive to those institutional and retail investors uncertain about the future movements in the exchange rate and who are desirous of maintaining the value of their assets. It is intended to reintroduce savings bonds, which because of their structure and method of distribution are attractive to a wider cross section of investors, including household savers. In January 2002, Jamaica introduced 30-year, inflation-linked bonds in the domestic market for financing of the first toll road. These were purchased mainly by pension funds.
Portfolio diversification has also occurred with the external debt. Renewed access to funding from the international capital markets since 1997 has helped to broaden Jamaica’s investor base in terms of the geographic distribution and the type of investors participating in Jamaica’s international bond issues. In addition to the 1.375 billion in Eurobonds issued mainly to U.S. investors, Jamaica gained successful entry into the European capital markets in February 2000 and February 2001, issuing euro-denominated bonds totaling €375 million. This market has provided an excellent alternative and a relatively cheaper source of financing for the government of Jamaica and created greater flexibility and choice in meeting its financing needs. The U.S. dollar–denominated bonds were purchased mainly by institutions and fund managers, but the euro-denominated transactions involved widespread participation by retail investors. The registration of future Eurobond offerings with the U.S. Securities and Exchange Commission in February 2002 will also enable Jamaica to further broaden its investor base, because the registration allows for greater access to U.S. investors.
Primary dealers have played a critical role in building the securities market in Jamaica. In 1994, the BOJ created a new financial market arrangement involving primary dealers. The dealers were to be the medium through which the central bank conducts its open market operations. They were also expected to provide continuous underwriting support for new issues of government securities, thereby providing secondary market liquidity. Though not mandatory, dealers—currently numbering 14—are required to take up a total of 45 percent of all primary issues.
Secondary market development in Jamaica is constrained by the absence of exchange trading in securities. The Jamaica Central Securities Depository Ltd. (JCSD), a subsidiary of the Jamaica Stock Exchange, began operation in 1998. However, the depository currently trades equities only. The process to reduce the issuance of paper certificates for government securities has been initiated. This dematerialization of securities, which the central securities depositories provides, will increase the efficiency of secondary market trading and reduce the risk associated with the holding, trading, and settlement of securities. As part of the fiscal year 2002/03 debt strategy, steps will be initiated to reduce the issuance of paper certificates for government securities. This will involve, initially, consulting with market participants and the relevant institutions integral to the process involved in the holding of securities in electronic form. The immobilization of government securities will allow for the further development of the domestic capital market by increasing efficiency and reducing the risk associated with the holding, trading, and settlement of securities.
Although taxes on interest have been levied at a rate of 33.3 percent for corporations and 25 percent for individuals, before 1999, taxes were withheld only on savings deposits. In 1999, the government increased the number of financial institutions that were required to withhold taxes on interest as well as the range of financial instruments covered. Withholding tax on interest was increased from 15 percent in 1999 to 25 percent in 2000 on all financial instruments. Corporations are liable for the remaining 8.3 percent when tax returns are filed. In addition to the increase in revenue from this source, there has been a reduction in distortions in the domestic market. In an effort to encourage long-term savings by individuals, the government granted tax-free status to approved long-term savings accounts. These are deposits where the principal amounts are held for at least five years. If the deposits are redeemed before the minimum five-year period, then tax is payable at the 25 percent rate.
The introduction of new and improved technologies is also contributing to the development of the domestic capital market. One such development is the introduction of a new system that allows primary dealers and other financial institutions to electronically bid for securities. An immediate benefit is the greater efficiency in conducting auctions of government securities. Similarly, upgrades to debt management, monitoring, and payment systems are contributing to more comprehensive information being recorded, a greater selection of tools available for debt analysis, and speedier processing of debt payments.
Jamaica has recognized the need to adopt sound debt management practices. Although advances are still to be made, there has been considerable progress in recent years in strengthening the government’s debt management capacity. Clear debt management objectives have led to the articulation of a comprehensive debt strategy, and the increased reliance on market mechanisms to sell government securities has led to the issue of longer-term securities at lower interest costs. The availability of information, greater predictability of issues, and more frequent dialogue with the market have increased market confidence.
The imperative for the future is to build on these achievements, so that over time the culmination of sound debt management policies and practices is sustained economic growth and development for Jamaica. There are a number of factors that will facilitate the further development of the market. These include
The renewed health of the financial sector: Rehabilitation and restructuring efforts have resulted in a consolidation of the sector into fewer institutions with greater critical mass.
Further improvements in the legislative framework governing the financial sector: A new regulatory authority—the Financial Services Commission (FSC)—was established in April 2001. The FSC is responsible for the efficient regulation and supervision of entities dealing in securities, collective investment funds (e.g., mutual funds and unit trusts), investment advisers, the insurance industry, and pension funds.
Planned reform of the pension system: This will create a larger pool of funds for long-term investment.
Plans to reopen government debt issues to create benchmark securities across the yield curve: This will increase the liquidity of the instruments, further extend the maturity profile of the debt, and lower borrowing costs.
The case study was prepared by the Debt Management Unit of the Ministry of Finance and Planning.
LRS may be both fixed- and floating-rate securities.