On Wednesday, Scotia Capital’s New York based analyst Joe Kogan, in a piece entitled “Jamaica: Last opportunity to move it or shake

it”, noted.

“After 3 days of meetings in Kingston, we return more bullish in the short term than the ratings agencies. Despite repeated delays, we think the Government will get an IMF loan. In addition, the liability management that would likely accompany such an agreement could be a lot more benign than many investors fear.”

Despite his uncertainty as to whether this is a turning point in our decades of slow growth and high debt, he argues that the current state of affairs may have spurred the government to action. “The terms of the IMF agreement should force at least some policy changes and make it easier for the Government to justify those policies to the public.”

His piece came out less than one day after the smallest of the US big three rating agencies, Fitch, had downgraded Jamaica to CCC from B, with a negative outlook.

In their rating Fitch referred to “the country’s increased macroeconomic pressures and a sharp fiscal deterioration, which has resulted in unsustainable debt dynamics and heightened the risk of some form of debt restructuring.”

Fitch projects that Jamaica’s fiscal deficit could reach over nine per cent of GDP compared to the original budgeted target of 5.5 per cent of GDP for 2009/10. In their view, general government debt could reach over 120 per cent of GDP in 2009/10 with our interest burden exceeding 55 per cent of revenues.

Fitch’s senior director, Shelly Shetty, noted, “While the government’s willingness to service its massive debt burden has traditionally been high, its capacity to do so is being seriously jeopardised by the magnitude of the macroeconomic and fiscal shocks the country faces.”

Whilst they projected Jamaica’s current account deficit to improve, declining to close to 10 per cent of GDP in 2009 (rising to 13 per cent in 2010), they noted that delays in negotiating the IMF stand-by continue to weigh on investor confidence.

Kogan notes that “all Government efforts at this point are directed at completing the agreement”, quotes the prime minister’s remark at Sunday’s annual JLP conference that “there is no alternative to borrow from the IMF”, as well as his description of the Government’s commitment to its bond holders as “inviolable”.

Moody’s clarification

Fitch’s downgrade of Jamaica followed that of Moody’s last week. It is therefore worth exploring why Moody’s has a higher rating for Jamaica than either S&P or Fitch. Commenting on their rating for the Caribbean Business Report, analyst Alessandra Alecci notes that market commentary following Moody’s decision to downgrade Jamaica’s government bond ratings to Caa1 suggested that “we are expecting a forced, involuntary debt restructuring within 12 months. It is important to clarify that nowhere in our publications we have expressed this view”.

In their original report, Moody’s had noted that “the current Caa1 rating takes into consideration that as the majority of the debt is held by local financial institutions, a potential restructuring would likely attempt to strike a balance between a meaningful cash flow alleviation and preserving the health of the financial system. Accordingly, our decision to place Jamaica’s rating at the top of the Caa range reflects the expectation that, if a debt restructuring were indeed to materialise, it would likely involve limited losses.”

In her comment to CBR, Alecci states: “The reason is because Jamaica’s creditors are its own people. Local financial institutions own the vast majority of the Jamaica’s debt and it is in their interest to actively engage in negotiations with the Government. “

Alecci notes that the important distinction for Moody’s ratings is estimating the losses incurred by investors in the event of default. There are defaults that are very messy, such as the one experienced by Argentina in 2001, and others that are quite orderly, such as Uruguay in 2003. Losses to investors can vary tremendously. In the case of Argentina, they were around 70 per cent. In the case of Uruguay, they were close to zero.

She adds, “We have clearly expressed in our press release accompanying the downgrade that we expect losses to be limited in the case of Jamaica. For this reason, the rating is at Caa1, at the very top of the range for countries nearing a restructuring. What this rating says is that we are expecting some type of rescheduling that is orderly and where losses are likely to be small.”

No haircuts

In his own analysis, Kogan echoes Alecci by noting that whilst recent ratings language invites memories of Argentina-style restructurings among some foreign investors, “no such restructuring is under consideration. All the officials we spoke with insisted that no principal haircuts were under consideration, and that more market-friendly methods would be employed. In addition, the focus was on the internal debt, not external debt.”

Given the financial sector’s exposure to government debt, Kogan argues, “There is a clear recognition in the Government that any type of debt management exercises will require, at minimum, liquidity support to the financial sector, which may ultimately prove just as costly as the savings from restructuring.”

Kogan notes that two options for mild restructuring have achieved attention locally.

The first was a voluntary net present value neutral swap, whereby the Government would work with the financial sector, decreasing payments in the short term, and increasing them in the long term, in order to gain breathing room to make the necessary fiscal changes. Noting the Government’s consideration of this proposal as one of the factors that led to the S&P downgrades, Kogan argues against this approach, as it “merely creates a bigger problem later”. Despite being voluntary, he believes this approach “would probably be perceived as a default by the agencies, and reasonably so, given the difficulty the Government would have in servicing debt with the current profile”.

Kogan prefers what he calls the “call-option” approach or what has been termed locally as refinancing. In his view, once the IMF deal is approved, the improvement in local investor confidence should allow the central bank to drop rates. By taking advantage of the imbedded call option in most of the domestically issued debt that has “never been exercised before”, Kogan believes the government could repay some of the debt, and issue new debt, to “yield substantial savings to the Government”.

Comparing the two

options, Kogan says the arguments in favour of the latter are overwhelming.

“Unlike the debt exchange, a call option would not be viewed as a default by foreign investors, who are used to embedded call options in US corporate debt and know how to price them accordingly,” he says. It would also preserve Jamaica’s reputation for debt repayment.

Kogan notes that this option may impose a greater cost on the financial sector at the outset. “Unlike the NPV – neutral approach, this option explicitly forces the financial sector to bear some of the cost of the country’s economic difficulties. Yet, we think that in the long term, it represents a win-win situation for both the Government and the financial sector. If this option is indeed the method chosen for the “restructuring”, we think it would be a positive surprise for the international markets.”