By Dennise Williams, Staff ReporterMINISTER of Finance and Planning, Dr. Omar Davies, and the Bank of Jamaica have been attempting to drive interest rates down to cut the country's debt servicing burden.
The latest six-month Government of Jamaica Treasury Bill is paid an average of 16.31 per cent, compared to 29.9 per cent in June of last year. The Bank of Jamaica (BoJ) has just cut the rate on its 365-day open market instruments to 18.50 per cent while the rate on the 30-day instrument is 14.85 per cent.
"The Bank of Jamaica remains committed to the long-term reduction of interest rates, as it simultaneously remains committed to maintaining stability in the foreign exchange market, and will continue to pursue both objectives as best as possible within the context of prevailing market conditions," the Bank of Jamaica said in written statement to the Financial Gleaner.
"The path is clear, interest rates are heading down," Dr. Davies stated on March 2. But many investors are not so certain.
INTEREST RATES NEARING INFLATION RATE
For the April 2003 to January 2004 period, however, inflation has been booked at 15.3 per cent. Interest rates are coming closer to the rate of inflation and investors are facing diminishing returns on their fixed interest investments.
"The direction of interest rates depends on the authorities and how much they are prepared to live with the consequences," explains Charles Ross, managing director of Sterling Asset Management Ltd. "If I were a betting man, I would say that interest rates will go up."
Dr. Wayne Henry, lecturer in the Department of Economics at the University of the West Indies, agrees. He said, "The reduction in interest rates is short-term. But in fairness to the Minister, if conditions are favourable, the low interest rates experienced could stretch out and become long-term."
Bear Stearns, an international credit rating agency, has a contrary opinion. It stated on March 1: "The good news is that if interest rates remain at or below current levels, the interest bill should be more moderate next year. We believe there is moderately more scope for interest rate declines, which should continue to provide a positive
sti-mulus for local markets."
In published statements, Pan Caribbean Financial Services Ltd. summed it up this way. "The next 30 days will be very interesting. Real interest rates have never been this low, dipping under five per cent this month for the first time since 1996."
Pan Caribbean said the high Jamaican dollar liquidity and falling Jamaican dollar interest rates may tempt some investors to go long in United States dollars. This would put a halt on the downward trend in interest rates and create some unwelcome uncertainty.
A HUGE COST TO BEAR
The alternate scenario for Pan Caribbean was that investors recognise and welcome lower rates. In this case, maturing Jamaican dollar fixed income investments do not largely flow into the foreign exchange market, paving the way for further gradual reductions in interest rates, relative to stability and falling inflation.
Mr. Ross said failure to cut interest rates would mean, "there will be a huge cost to bear."
Bear Stearns estimates that for every reduction of 100 basis points in interest rates, the cost savings to the Government should amount to roughly 0.4 per cent of Gross Domestic Product (GDP). If the current interest rate path holds, the lower rates could yield as much as 3.2 per cent of GDP for the Government in lower debt service.
"The International Monetary Fund (IMF) states that for every 100 basis points the savings is one per cent of GDP," Mr. Ross said. "I use this as my benchmark."
Pan Caribbean stated that ultimately, institutional investor leadership will determine the direction in which interest rates and the exchange rate go.
But, "Institutional investors cannot go against the market," Mr. Ross said. "Their clients' demand make up the market and clients will take their money where they can get a higher return. It's a free country and people will go with there money where they can get the return they want."
Mr. Ross admitted that pension funds did have a degree of discretion as to where they invest funds.
"Right now, the demand for U.S. dollars is being satisfied even though we are seeing pressure on the currency," Dr. Henry said. "But the real test will be mid-year. If the demand for foreign exchange is not satisfied, then interest rates will go up. While low interest rates are good for sectors such as manufacturing, it will pressure the U.S. currency."
If the government is to continue on the set path of stabilising the foreign exchange market and keeping interest rates moderate, there must be a continued growth in the performance of the economy, especially in sectors that generate foreign currency, Dr. Henry said. Inflows of foreign currency can then be used by the BoJ to halt any slide in the local dollar.
There also needs to be investor confidence in the credibility of the Government and the budget that will be presented, the UWI lecturer stated.
