The effects of Jamaica's macroeconomic policies

Neville Swaby, Guest Columnist

This is the final instalment of a three-part series on Jamaica's financial-sector meltdown of the 1990s.

In the case of Jamaica before the financial-sector crisis in 1996, the primary economic thrust of the Government was exchange-rate stability, since it was assumed that a stable exchange rate would bring about the desired sustained economic growth and developments within the economy.

The rationale for this was that, within Jamaica, the import content of sales for the manufacturing sector ranges from 65 per cent to 75 per cent, and, as such, unwarranted levels of devaluation of the local currency would create higher levels of inflation within the domestic economy, thereby distorting real economic growth.

The Government was therefore adamant in its defence of the non-devaluation of the Jamaican dollar. The government model for maintaining exchange-rate stability centred on control of the growth in money supply, strong fiscal management, and restrictive credit policies.

The Government's macroeconomic policies during the 1990-96 period resulted in several negative consequences:

1. Overall sluggishness in economic activities;

2. Very high interest-rate structure to the point where commercial banks were charging as much as 120 per cent per annum interest rate to their customers who operated overdraft facilities beyond their prescribed limits;

3. The economy experienced marginal economic growth at best, and negative growth in economic activities. Real gross domestic product (GDP) declined from 5.5 per cent in 1990 to 1.0 by 1994, and since then has recorded negative growth, 1997 through 1999, of -1.7, -0.3, and -0.4, respectively.

4. Despite the policy of attempting to achieve exchange-rate stability, the rate of exchange has moved considerably. Between 1990 and 2002, the exchange rate fell from US$1:J$8.04 in 1990 to US$1:J$50.97, an effective devaluation of 7.5 per cent per annum.

5. Although Jamaica has made measurable progress in stabilising the economy since suffering from a financial crisis in the mid-1990s, the economy has not yet returned to the path of sustainable growth. The crisis of 1996 and its aftermath have presented significant new challenges for the country's Government and its citizens. The Government adopted a tight monetary policy to stabilise the exchange rate and contain inflation, which declined from 80 per cent per annum in 1990 to 25 per cent in 1995 in the period before the crisis, to single digits of between six and seven per cent after the crisis. Gross domestic product growth has nonetheless remained very weak, having averaged less than one per cent annually over the last decade and less than 0.2 per cent per year over the last five years (Statistical Digest, 2002).

6. The three reasons why individual banks fail are credit risk, interest rate and foreign-exchange risk; bank runs and fraud are additional potential sources of failure. The epidemic of insider fraud and abuse contributed to the sharp increase in the failure of commercial banks and savings and loan associations in the late '80s and '90s. Bank runs occur when depositors or other creditors fear for the safety or availability of their funds and large numbers of depositors try to withdraw their funds at the same time.

The key financial-sector crisis factors during, before and after the 1996 crisis were high interest rates imposed to reduce inflation exacerbated by fiscal deficits, increased foreign competition, weak financial condition of business in general, and a shift in investment portfolio to non-productive, short-term, high-yield instruments. A widening merchandise trade deficit and growing internal debt for government bailouts of various ailing elements of the economy, particularly the financial sector, combined to create a poor environment for economic growth and development.

The Government's high interest-rate policy has similarly been devastating on the manufacturing community. Various government policies have made local manufacturers uncompetitive when compared to the other Caribbean regions and international partners, and has resulted in factory closures and other dislocations in the sector.

Beginning in 1993, Jamaica's commercial banks began to suffer the consequences of high liquid asset reserves, and lending rates were excessively high, ranging from an average of 63 per cent per annum in 1993, to 44 per cent four years later. The high interest-rate structure tends to increase unit cost of operation in the productive and manufacturing sectors, militating against those companies that attempt to become low-cost producers.

Negative impact

The high interest rates in 1993 and high inflation rates in 1990-95, ranging from 80 per cent to 35 per cent, only worsened the imbalance between the commercial banks' operations and the slowing economy. Although there were adverse economic and banking conditions, commercial banks continued to take deposits, and continued to pay excessively high rates of interest on these deposits with Time and Savings deposit rates averaging 39.8 per cent per annum. The high interest-rate operations, coupled with economic stagnation from 1993-1996, impacted negatively on commercial banks' performance, as the receivables of commercial banks increased from $1.5 billion to $3.9 billion. At the same time, unappropriated profits of commercial banks moved from $335 million in 1993 to minus $6.1 billion in 1997.

For a safe-and-sound banking system, it is a fundamental error to rely on regulation and supervision alone. If the banking system is structurally vulnerable, and if the economic environment is highly volatile, no amount of regulation and supervision can prevent banking problems. Minimising macroeconomic volatility through sound fiscal and monetary policies is the basis for a sound financial sector.

The failure of the regulators to enforce the regulations and accounting standards on capital or solvency was an even greater concern. Despite clear regulatory violations and repeated warnings from others in the industry, the Jamaican regulators failed to act, despite the fact that the five insolvent banks represented more than one-third of the country's depositors' savings under their jurisdiction. Irrespective of the management style, failure of the regulatory bodies to insist on compliance with accepted rules and standards, the management of commercial banks in their own right have an ethical, financial and business obligation to their shareholders, depositors and other customers to operate and effectively manage these institutions viably and prudently.

Dr Neville Swaby is the acting vice-dean, College of Business and Management, and executive director, UTech/JIM School of Advanced Management. Email feedback to columns@gleanerjm.com and naswaby@hotmail.com.