Changing rationale for high interest rates

Dennis E Morrison
Wednesday, March 24, 2004. Jamaica Observer


Dennis E Morrison

As the level of government borrowing on the domestic market has receded the argument about interest rates and what are the factors determining whether they go up or down have switched. To financial advisers who double up as analysts, they are now about the preferences of investors and anticipated inflation problems related to oil price movements. This is the new line of attack as portfolio managers attempt to find weak points to reverse the downward path of interest rates so that their clients can enjoy another bout of high rates.

According to the proponents of these arguments, with the market now awash with Jamaican dollars flowing from maturing instruments, investors are seeking to place their funds in ways that will afford them the returns that they have become accustomed to, never mind that these represented a windfall. One possibility is GOJ/US dollar bonds with interest rates of 8.89 per cent to over 10 per cent. But, not only are these instruments hard to come by, the returns on them cannot really be compared with typical one-year Jamaican dollar instruments which are now maturing as they have much longer tenures.

The analysts postulate that investors will reject GOJ/Jamaican dollar instruments at the rates being offered and if GOJ/US dollar bonds are not available, then they will enter the foreign exchange market and create instability that will cause interest rates to have to go back up. The fact, however, is that savings rates in the USA and other developed markets are now very low and hence the net returns [after allowing for expected local inflation rates in the coming year] on Jamaican dollar instruments are not really out of line at current interest rates. But, of course, if one can manipulate the foreign exchange market such as to create pressure for interest rates to be increased, why accept the current rates? And if there is any uncertainty at all about the inflation rate, why not exploit it for good measure?

Where the inflation rate problem is concerned, it is being assumed that the spike in international oil prices, which has occurred in recent weeks, will be sustained for the rest of the year. On the basis that the West Texas Intermediate price, which is the reference for Jamaica, will remain at the rate of US$38 per barrel reached last week, analysts have begun to assume that the inflation target of 9 per cent for 2004 will not be met since the BOJ Governor had indicated that this target was linked to oil price of US$30 per barrel. The fact is that the price of US$38 represented the spot price, which is not the basis on which oil is purchased by Jamaica. Jamaica buys oil from its major supplier on the basis of the average price of several weeks prior to the purchase, less a discount. And in any case, the price of US$38 reflects a market that was very uncertain and hence, it is not expected to be sustained. Indeed, it has already fallen.

In the worst case, therefore, we are unlikely to exceed significantly the US$30 per barrel threshold used in establishing the inflation target. Furthermore, there is evidence to suggest that strong competition in the gasolene retail market has led to tight margins and a lessening of the inflationary pressures that have been seen in the past. This is revealed in surveys carried out by the Consumer Affairs Commission since the second half of 2003, which show that gas stations are reluctant to pass on the full increases in Petrojam's billing price to consumers for fear of losing customers. Like the liberalisation of food distribution, we are beginning to see the effects of greater competition on margins in the petroleum business.

Consumers in both households and commercial enterprises can, of course, take steps to reduce the impact of high energy prices on their costs of living and operations. To do so, they must cut down on the amount of electricity and other forms of energy that are consumed, by conserving and/or using energy more efficiently. Other countries, both oil-producing and non-oil-producing, have made great progress since the 1970s in reducing the inflationary effects of oil price increases by just these measures. To the extent that we act to restrain consumption, we can change the ratios indicated by the BOJ Governor so that each dollar increase in oil prices will have a lesser effect on our costs.

In this regard, the financial institutions that have the job of investing the savings of the public now have the opportunity of using some of those savings to finance modifications to our energy systems. At current oil prices, the reductions in costs would be sufficient to provide attractive rates of return on such investments. Unfortunately, none of our financial institutions have so far seen this area as an attractive one for investment and our businesses have also ignored the benefit to their profits that would be derived from energy-efficiency measures. From my vantage point, it would appear that the returns from energy-saving measures in the tourist industry are, in the jargon of economists, low hanging fruit. Both hotel operators and bankers should seize the opportunities as the industry has hardly begun to institute serious energy-efficiency measures.


People's National Party

89 Old Hope Road

Kingston 6, Jamaica W.I.



Website: pnpjamaica.com