By Deon McLennon, ContributorCOMMENTARY
THE NEXT 30 days will be very interesting. Currently, interest rates are trending down, the FX market is stable, and confidence is being gradually rebuilt. There is good news (tourism growth, bauxite expansion, declining rates) but there are significant challenges (fiscal de-ficit, inflation, crime, unemployment). The liquidity burst that the money market is about to experience (approximately $37 billion in the next four weeks) has investors scratching their heads on what will be its real impact. Time will tell. Real interest rates have never been this low, dipping under five per cent this month for the first time since 1996. Here are two scenarios that could unfold:
Scenario 1: High J$ liquidity and falling J$ interest rates may tempt some investors to go long US$. This would put a halt on the downward trend in interest rates and create some unwelcome uncertainty. How this would play out is anyone's guess.
Scenario 2: Investors recognise and welcome lower rates, recognising the role that this will play in restoring our economic possibilities. Maturing J$ fixed-income investments do not largely flow into the FX market, paving the way for further gradual reductions in interest rates, relative currency stability and falling inflation. We think that institutional investor leadership will ultimately determine the direction in which interest rates and the exchange rate go. Our market has become addicted to and dangerously high on double-digit real interest rates. As desirable as the virtuous circle of lower interest rates, single-digit inflation and a balanced budget are, these objectives remain elusive. The trade union leadership and civil servants have stuck their necks out. Are others prepared to follow? Or, more importantly, to lead also?
ANALYSIS
1. The T-Bill weighted yield fell again in February. With a relatively liquid market, and BoJ's rate cut last week auction results aligned with BoJ rates (180 day repo = 16.25 per cent).
2. The BoJ cut rates 50-100bps for all tenors above 90 days. Influencing this discussion was an increased NIR, the wage agreement with public sector unions, continuing stability in the foreign exchange market and improving tourism prospects.
3. CPI moved 0.6 per cent in January, the third consecutive month with inflation under one per cent CPI increases are expected to continue to trend down given the currency stability and a competitive market.
4. Domestic interest costs ate a hole in the budget, $9 billion more than programmed. With SCT and GCT taxes under-performing by $4.9 billion, lower external debt expense helped along with reduced capital expenditure. The final quarter has historically resulted in a surplus and GOJ forecasts project $3 billion of net inflows.
Based on this deterioration on the fiscal side, S&P downgraded our domestic debt and changed its outlook to negative. Interestingly, Moody's re-affirmed our debt rating. Eyes will be focused on the Q1 of the new fiscal year for signs that will improve confidence or raise new concerns.
5. The NIR grew in January. At current levels, it represents just over 12 weeks of imports of goods and services. BoJ's published mid-February balance sheet indicates that Gross International Reserves exceeded US$1.5 billion.
6. Cruise ship arrivals continue to contribute strongly to overall visitor arrivals, and in particular MoBay, where cruise ship calls were up 68 per cent. Overall, cruise ship visitors jumped 30 per cent, while stopovers were up 6.6 per cent.
7. The BOP improved for Q1 of the fiscal year. Exports grew (+US$13 million) marginally more than imports (+US$10 million). Tourism (+US$72 million) and alumina (+US$25 million) offset sugar, rum and remittance declines for the period. Fuel costs were up US$36 million also but shrinking consumer durables and capital goods ameliorated imports for this period.
8. U.S. deposits in the banking system rose to US$1.67 billion, an increase of US$247 million when compared to November 2002.
9. The country's internal debt stood at J$417 billion at November 2003, up $66 billion from last year. The fiscal deficit and GOJ's debt assumption of a number of statutory companies contributed to higher debt levels.
10. External debt rose by US$175 million as the GOJ largely as a result of the Euro Bond issue.
Article written by Deon McLennon, Assistant Manager, Research & Analysis at Pan Caribbean Merchant Bank. Please call 9295583 for more information.
