Finsac commission of enquiry
Chen-Young'sofficial take on the financial collapse
Starting this week, the Financial Gleaner publishes the submission by former chairman of the Eagle Group of Companies, Dr Paul Chen-Young, presented to the FINSAC enquiry in the form of a book. The first chapter deals with 'The Economic Environment of the 1990s'.
This section addresses the impact of the 'Govern-ment's fiscal and monetary policies", as per paragraph 1(b) of the commission's term of reference.
It quantifies the consequences of such policies and shows the toxic conditions under which the financial institutions and businesses operated that made it difficult to succeed and helped to precipitate the crisis.
The test of success in measuring national economic and financial policies is whether or not accepted measures of economic progress are achieved.
If not, the policies have failed. This was the case of Jamaica in the 1990s.
By most measures, the economic conditions that prevailed could be described as hostile for business.
Consider, for example, the following statistics in the 1990s when the domestic financial sector and many businesses collapsed:
First, there was no economic growth between 1990 and 1998, with real gross domestic product (GDP) remaining at J$17 billion.
Second, high inflationary conditions and high interest rates created a false sense of strong balance of payments with the build-up in net international reserves.
Between 1991 and 1997, the average annual rate of inflation was 32.5 per cent and the average commercial bank lending rate was 51.6 per cent.
The Jamaica Government Treasury bill rate was about 50 per cent, compared with the United States Treasury bill rate of just over 4.0 per cent.
Given this widespread, short-term investors pumped money into Jamaica. This was used to build up the country's net international reserves, which were neither earned from exports nor from long-term capital inflows.
Third, devaluations occurred every year between 1991 and 1997 when the exchange rate moved from J$12.85:US$1, to J$35.58:US$1 during that relatively short period.
Fourth, jobs in the productive sector fell sharply. The manufacturing sector, which had an annual average growth rate of 5.6 per cent between 1998 and 1990, declined at an annual average rate of 2.3 per cent between 1991 and 1997 and lost about 50,000 jobs while 'agriculture, mining and fisheries' lost about 40,000 jobs.
Interest rates soar
Fifth, the fiscal account of Government moved from a surplus in the early 1990s to the high deficit of 8.1 per cent of GDP in 1996 - and that was before the financial crisis in 1997.
Large deficits and Government borrowings led to higher interest rates. As Dr Damien King wrote:
"Probably the most important factor in explaining the misfortune of the financial sector was the orthodox stabilisation policies ... . This impressive increase in public borrowing in the presence of a non-accommodating monetary policy had the effect of driving up interest rates. High interest rates not only increased the banks' bad debt portfolio, but also raised their cost of funds over a time when their asset mix, heavily into equity, could not adjust quickly to recover costs." ('The Evolution of Structural Adjustment and Stabilisation Policy in Jamaica', March 2007)
The World Bank wrote: "Jamaica's competitiveness has deteriorated substantially since the financial crisis began. Between 1995 and 1999, the real exchange rate (REER) appre-ciated almost 30 per cent ... . This has risen from high interest rates which created incentives to acquire and hold Jamaican (financial paper) assets that have resulted from tight monetary policy and government borrowing requirements." (Report 21187-j in 2006).
Appreciation in the real exchange rate in the 1990s was indicative of failed financial policies pursued.
In a high-inflation situation created by excessive government expenditure and fiscal deficits - a policy of protecting the exchange rate was aggressively pursued.
Jamaica's international compe-titiveness was severely impaired, making imports cheaper and exports more expensive, thus creating widening trade deficits and balance of payments pressure that impacted adversely on the exchange rate.
Additionally, in a high-inflation environment, as was experienced in the 1990s, interest rates remained high.
This, in turn, created a host of problems that affected investment and economic growth and the viability of the domestic financial sector and businesses.
Sixth, as the real exchange rate appreciated, the trade balance deteriorated dramatically from a surplus of US$502 million in 1990 to a deficit of US$1.78 billion in 1997.
Even within CARICOM, Jamaica lost its competitive advantage that contributed to the deficits, which moved from US$16 million to nearly US$270 million in 1998.
This figure increased dramatically in 2008, with Jamaica having a negative trade balance with CARICOM of US$1.61 billion, with imports of US$1.68 billion and exports of US$66.1 million.
Those negative statistical measures of what occurred in the 1990s were the result of failed financial and economic policies.
The main preoccupation of policy was to protect the value of the Jamaican dollar at the expense of economic growth.
Woes of government binge
At the same time, excessive government spending created deficits on the fiscal side and eventually on the external accounts, which by themselves were antithetical to stabilising the exchange rate.
Former Minister of Finance, Dr Omar Davies, said in his 1995/96 Budget presentation to Parliament: "The impact of monetary and fiscal policies ... on interest rates was not supportive of major expansion of the economy. But this is a deliberate choice."
Entities in the domestic financial sector, businesses, especially in the productive sector, and thousands of Jamaicans failed to survive these hostile conditions.
Ordinary people could not pay their mortgages, businesses became uncompetitive and exports and employment fell.
Premium income for insurance companies dropped dramatically with widespread encashment and cancellation of policies.
Bad debts for banks rose sharply and investments made by banks and insurance companies could not generate the level of returns to cover the cost of borrowing.
The domestic financial sector collapsed and the Government intervened on a massive scale to protect depositors and holders of short-term commercial paper.
The public debt increased substantially by about 20 per cent of GDP (not 40 per cent as Dr Davies has argued but it does not reflect any receipts from the sale of FINSAC assets), which was the figure arrived at by Damien King and myself, independent of each other.
The evidence is weak to suggest that the massive deficits created were caused mainly by the bailout in the financial sector.
It did contribute but, when separated from other massive government uncontrolled expen-ditures, especially for electioneering purposes - the infamous "run wid it" statement by Dr Davies - the facts will show that intervention in the financial sector was not the major cause for the massive build-up in Jamaica's debt.
Directors and managements of the failed financial institutions must bear some of the blame for having pursued investment strategies that led to the collapse of the sector.
But this alone cannot fully explain the widespread failure of the entire domestic financial sector and not just one or two enterprises.
There was a systemic problem, external to enterprises, that flowed from inappropriate financial and monetary policies.
This was a compelling reason for FINSAC to have acted within its terms of reference and make the effort to restructure financing over the five-year window to allow the troubled financial institutions to survive.
But it failed to do so.
Chapter Two next week looks at banking and insurance.
Directors and managements of the failed financial institutions must bear some of the blame ... but this alone cannot fully explain the widespread failure of the entire domestic financial sector and not just one or two enterprises.