Bank of Jamaica Says U.S. Downgrade has Increased Uncertainty

KINGSTON, Jamaica — Governor of the Bank of Jamaica (BOJ), Bryan Wynter, says that the downgrade of the United States’ credit rating, and the debt crisis in the Euro area, have increased uncertainty in global financial markets.

“There have been wild fluctuations in global stock indices, particularly those of the developed countries,” Mr. Wynter told the Bank of Jamaica’s media briefing on the Monetary Policy Report for the April to June 2011 quarter, on Thursday August 25 at the BOJ.

He added that the market’s response was exacerbated by the worse-than-expected U.S. GDP outturn for the quarter, and downward revisions to GDP estimates for the past two years.

Mr. Wynter used the briefing to reflect on the August 5, Standard and Poor’s Rating Agency (S&P) downgrade of the credit rating of U.S. federal government debt to AA+, from its top rank of AAA. The agency’s negative outlook on the US economy adversely impacted perceptions about the global economic standing of the U.S., which had maintained an AAA credit rating at S&P since 1941.

Governor of the Bank of Jamaica, Bryan Wynter

He observed that the negative economic publicity also resulted in a flight to safe-haven of assets such as US Treasuries.

“As a result, the yields on 5-year, 10-year and 30-year U.S. Treasuries have fallen to all-time lows. At the same time, U.S. consumer confidence has fallen to the lowest in three decades,” Mr. Wynter noted. He also pointed out that commodities market prices have been fluctuating, particularly crude oil prices which plunged initially, but have since shown some marginal recovery, while the price of gold has hit all-time highs.

He noted that the impact of developments in the U.S. and the Euro area on emerging markets could be negative, in the medium to long-term, in the context of increased risk aversion.

Mr. Wynter announced that, given these developments and the increased uncertainty about the prospects for the world economy, the Central Bank has considered “an extreme scenario of the possible near-term impact on the Jamaican economy, if the downgrade of the U.S. federal government bond rating, and the factors which led to it, were to result in markedly slower growth for the U.S. economy in the short-term, leading in turn to a slowdown in the global economy”.

He noted that the slowdown in activity would stem from a contraction in Government spending, and higher borrowing costs in the US economy.

Against this background, the Bank’s assessment suggests that the Jamaican economy would still record growth in the range one per cent to two per cent for Financial Year 2011/12.Mr. Wynter noted that this growth would likely be at the lower bound of the forecast range.

“This would be in contrast to our previous forecast, which indicated growth towards the upper bound of the range for the fiscal year. The moderation in output would stem from a general contraction in external and domestic demand,” he opined.

He also explained that the impact of the slower global growth on Jamaica would be reflected, predominantly, in the mining, travel and transportation industries.

“The mining industry, in particular, could see the largest fallout from reduced international demand for aluminium. In addition, in light of reduced global income, particularly in the USA, Jamaica’s largest source market for visitors, value-added in the hotel and restaurantsector could also expand at a significantly slower rate in FY2011/12, relative to the growth previously expected,” he said.

A slower rate of expansion in these industries, in addition to increasing uncertainty, would also affect non-tradable sectors such as wholesale & retail trade.

In the context of a moderation in world demand and domestic economic growth, the Central Bank Governor said that Jamaica’s current account deficit would improve, relative to the previous forecast.

“This is against the background that a contraction in spending on imports would fully offset the possible fall in earnings from exports of goods and services. Financing for the current account would be adversely affected by lower levels of both foreign direct and portfolio private investment inflows relative to the previous forecast. Nonetheless, in the context of these changes, the NIR at end-FY2011/12 would not change materially, relative to the previous forecast of approximately US$2.0 billion.”

Mr. Wynter also addressed the likely impact on the cost of living in Jamaica. He said that headline inflation for FY2011/12 could also be at the lower bound of the forecast range of six per cent to eight per cent.

“The most significant impact would emanate from the decline in international oil prices. This would result in a direct moderating impact on inflationary impulses in key divisions of the Consumer Price Index (CPI) such as Transportation and Housing, Water, Electricity, Gas & Other Fuels due to lower petrol and household energy and fuel prices. There would also be second-round effects on the cost of services and other consumer goods. In particular, the cost of producing processed foods, such as baked goods which utilise a significant amount of energy, would decline. The decline in other international commodity prices would also have a moderating impact on prices in the domestic economy,” he explained.

The price of crude oil has already declined at a sharper rate than the Bank has forecasted. This, he observed, will have a moderating impact on inflation in the current quarter.

“Accordingly, the Bank is forecasting inflation in the range 1.5 per cent to 2.5 per cent for the September quarter, marginally lower than the outturn in the previous quarter. Reduced imported inflation should temper the impact of expected increases in the prices of domestic crops, as well as inflation pressures from back-to-school expenses,” the Governor stated.

The Bank of Jamaica expects that this will be supported by the continuation of excess domestic capacity conditions, as well as relative stability in the foreign exchange market. However, given recent international developments, the risks to the inflation forecast are largely on the downside. On the upside, the major risk is extreme adverse weather conditions.

Given the continued positive outlook for inflation in FY2011/12 and the increased downside risks to economic growth, the Central Bank stated that it will maintain its accommodative policy stance.

“In fact, on 01 July 2011 the Bank reduced its 30-day rate by 0.25 basis points as the concerns about the impact of higher commodity prices waned. In the June quarter the Bank had maintained its signal rate at the end-March level of 6.75 per cent in the context of a possible risk to the achievement of the inflation target due to the then intensification of uncertainties about the direction of international commodity prices,” Mr Wynter explained.

He said that the recent developments emphasize Jamaica’s vulnerability to external shocks.

“The economic programme that we are pursuing with the support of the Stand-by Arrangement with the International Monetary Fund is designed to reduce these vulnerabilities over the medium-term. In particular, the primary objective of the economic programme is to create the fiscal space to allow the country to respond to such shocks when they occur. The recent award of wage increases to public sector workers represents a permanent increase in the obligations of the Government in a context where the means of affording these claims over the medium-term without resorting to borrowing are not assured.”

He disclosed that a close re-examination of the prospects and the policies to enable the Government of Jamaica to achieve long-term debt sustainability and macroeconomic soundness for the country was now underway.

“The gains that have been achieved to date are real and cannot be denied. Holding on to the gains and building on them, demands a disciplined approach to forward planning. The Government is deeply engaged in this process, which also involves the Bank and Jamaica’s international development partners,” he emphasized.

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