US embassy cable - 05KINGSTON1256

UNCLAS SECTION 01 OF 03 KINGSTON 001256 
 
SIPDIS 
 
STATE FOR WHA/CAR/ (WBENT), WHA/EPSC (JSLATTERY) 
 
SANTO DOMINGO FOR FCS AND FAS 
 
TREASURY FOR L LAMONICA 
 
E.O. 12958:  NA 
TAGS: ECON, EFIN, JM 
SUBJECT:  GOJ PROPOSES BALANCED BUDGET FOR 2005/06 
 
REF: 04 KINGSTON 895 
 
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SUMMARY 
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1.  (SBU) Finance and Planning Minister Omar Davies proposed 
Jamaica's 2005/06 fiscal budget on April 14, 2005.  The 
budget, which is formulated within a medium term program 
aimed at eliminating the fiscal deficit, increasing growth 
and reducing the debt to GDP ratio, is forecast at USD 5.7 
billion.  This represents a decline of 5.8 percent over the 
2004/05 revised budget.  Debt-servicing costs of USD 3.7 
billion, will again account for the largest share (more than 
65 percent) of the budget. The new tax package is projected 
to yield about USD 153 million.  The budget has drawn mixed 
reactions, with opposition spokesman on finance Audley Shaw 
stating that Davies has again concentrated only on revenue 
earning measures.  However, a Jamaica Chamber of Commerce 
contact told emboffs that while the private sector was not 
happy with the budget process, he could not overemphasize 
the importance of eliminating the fiscal deficit.  While the 
new tax measures will be burdensome, the balanced budget 
objective is expected to reduce the GOJ's appetite for debt, 
further reduce interest rates and increase investment, 
growth and employment.  End Summary. 
 
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MEDIUM-TERM FRAMEWORK FOR 2005 TO 2008 
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2. (U) On April 14, Minister of Finance and Planning Omar 
Davies presented his twelfth budget formulated within a 
three-year macroeconomic program aimed at eliminating the 
fiscal deficit and generating moderate fiscal surpluses 
thereafter.  The medium-term program has also targeted an 
increase in the primary surplus, a gradual reduction in 
inflation and a rebound in real GDP growth.  The reduced 
borrowing requirements, in light of a balanced budget 
combined with higher levels of economic growth, are expected 
to result in a reduction of the debt-to-GDP ratio. 
                     2004/05 2005/06 2006/07 2007/08 
Inflation (%)         12.4     9.0     8.0     6.0 
Real GDP Growth (%)    1.0     3.6     3.0     3.5 
NIR (USD Billion)      1.9     1.9     2.1     2.2 
Debt/GDP (%)         136.6   125.7   113.9   103.0 
Fiscal Bal/GDP (%)    -4.8     0.0   0.5-1     1-2 
Primary Bal/GDP (%)   11.8    13.8    14.0    14.0 
Source: Ministry of Finance and Planning 
 
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EXPENDITURE BUDGET 
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3. (U) The expenditure budget for 2005/06 amounts to USD 5.7 
billion or 5.8 percent (USD 310 million) more than the 
revised budget for 2004/05.  This level of expenditure also 
represents a real decline of 6.6 percent, reflecting the 
GOJ's commitment to a balanced budget.  Of the total 
expenditure budget, USD 3.1 billion, or 54 percent, is set 
for recurrent or day-to-day spending, while the other 46 
percent (USD 2.6 billion) is slated for capital spending. 
While interest payments of about USD 1.4 billion will again 
absorb the lion's share of recurrent spending, the 
allocation represents a real decline of almost 19 percent. 
The contraction in interest payments is a direct result of 
consistent reduction in interest rates and has freed up over 
USD 627 million for social services.  Wages and salaries of 
USD one billion also declined by 15.7 percent in real terms 
due to the Memorandum of Understanding (MOU) between the GOJ 
and trade unions (reftel). 
 
4. (U) The reduction in interest payments has also freed up 
extra resources for the physical development of the country 
following years of neglect.  Capital projects will account 
for USD 284 million, or 11 percent, of the capital budget. 
This represents a 57 percent jump over the allocation for 
2004/05.  The remaining USD 2.3 billion of the capital 
budget will be consumed by principal payments, up 12.1 
percent due to the repayment of a USD 250 million Eurobond 
maturing in June 2005.  This allocation to principal 
payments, combined with the USD 1.4 billion in interest 
payments, will bring debt servicing costs to USD 3.7 billion 
or 66.3 percent of the budget.  This compares with USD 3.6 
billion or 67.3 percent of the revised budget for 2004/05. 
Of the remaining budget, only USD 2.1 billion, or about 23.7 
cents out of every dollar, will remain for non-debt 
expenditures.  In keeping with its commitment to improve 
education, the GOJ allocated USD 621 million (up 9.6 percent 
in real terms), or 32.5 percent, of the non-debt budget to 
the sector.  National security and health have been 
allocated USD 280.3 million and USD 220 million, 
respectively. 
 
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FINANCING THE BUDGET 
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5. (U) The financing of the 2005/06 expenditure budget took 
place within the context of a review of the tax system by a 
committee appointed by the GOJ and headed by businessman 
Joseph Matalon.  The review, which highlights deficiencies 
in the tax system, suggested a re-engineering from direct to 
more indirect taxation.  Given these recommendations as well 
as the need to balance the budget, the GOJ proposed 
borrowing only USD 2.3 billion (equivalent to principal 
payments), 4.7 percent less than in 2004/05.  The GOJ also 
projected a 14 percent increase in revenues and grants to 
USD 3.2 billion.  Higher revenues are predicated on the 
trend during the last three years when revenues averaged 
18.7 percent.  The remaining USD 153.3 million is to be 
covered by a new tax package.  In keeping with the proposal 
to shift the tax burden from income to consumption, most of 
the new taxes (USD 153.7 million) will be sourced from 
changes to the General Consumption Tax (GCT) regime.  The 
income tax threshold will be initially increased by over USD 
800 per person and then by USD 400, costing about USD 25 
million in revenues.  Higher taxes on cigarettes will 
provide USD 5.2 million.  Additional revenues will flow 
from: a two percentage points increase in the GCT on the 
tourism sector, which brings it to half the 16.5 percent to 
be charged on all other goods and services (USD 10 million); 
a gross profit tax on gaming (USD 5 million); and, a revised 
property transfer tax on death (USD 5 million). 
 
6. (SBU) The GOJ frequently misses its targets, so emboff 
asked Senior Fiscal Economist at the Ministry of Finance 
(MOF) Courtney Williams about the robustness of the current 
estimates.  Williams said that, given the data the Ministry 
is privy to, the estimates are "pretty realistic".  Keith 
Collister of the Jamaica Chamber of Commerce (JCC) in 
supporting this position said the key factor was that most 
of the underlying assumptions were credible.  He opined that 
the tax measures might well be understated to provide a 
cushion in the event of a shock to the economy.  These 
positions are also similar to those espoused by Ralston 
Hyman of the Sunday Herald, who argues that increased 
compliance could result in the GOJ collecting more revenues 
than expected, since the forecast, given recent trends, is 
conservative. 
 
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COMMENTS ON THE BUDGET 
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7. (SBU) While the 2005/06 budget has been well received by 
most stakeholders, the private sector has been less than 
happy with the process.  Collister told emboffs that, 
following the last tax hike, Davies had promised 
consultations with the JCC, but this did not happen. 
However, Williams said that consultations are never a good 
approach.  Following the last tax hike, lobbyists convinced 
Davies to cut the package by up to 50 percent.  He said that 
the Minister's decision to meet with hoteliers peeved with 
the small increase (two percent) in taxes on the sector was, 
therefore, out of courtesy.  "Given the recommendations in 
the Matalon Report, hoteliers should have expected, and 
planned for, an increase", he continued.  When asked about 
the position being taken by hoteliers, Collister said he was 
not sympathetic to the sector as it was already under-taxed. 
In his response to the budget in Parliament, Audley Shaw, of 
the opposition Jamaica Labor Party, stated that Davies has 
concentrated primarily on the revenue earning measures, 
while delaying those aimed at easing the income tax.  Shaw 
bashed Davies for increasing the tax burden, since the 
mandate of the tax reform committee was to simply the tax 
system without changing the tax intake (tax neutrality). 
"The taxation strategy cannot be limited to the constant 
need for financing corruption and waste and the ever 
widening stock of debt," Shaw concluded. 
8. (SBU) However, Hyman, who focused more on the balanced 
budget objective, argues that balancing the budget is not 
just an accounting exercise, but demonstrates to creditors 
that the GOJ is serious about reducing borrowing and debt. 
He said this should further reduce interest charges and free 
up resources for education and national security.  "A 
balanced budget puts the banking sector in a better position 
to free up resources to the private sector at lower rates, 
leading to higher levels of investment, growth and 
employment," he continued.  Hyman also opined that a 
balanced budget will help to maintain investor confidence in 
the country at a time when external funds are getting more 
expensive.  Collister shared this view, telling emboff that, 
while he was not sure if increasing GCT was the right 
approach, he could not overemphasize the importance of a 
balanced budget.  When asked about the importance of a 
balanced budget, Williams said the GOJ had little choice, 
since creditors have been promised this outcome since 2003. 
He said any other approach would have been catastrophic. 
 
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COMMENT 
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9. (U) Following the decline in investor confidence and the 
subsequent steep decline in the local currency at the 
beginning of 2003, Prime Minister Patterson in a bid to stem 
the hemorrhaging promised investors a balanced budget by 
2005/06.  The Patterson-led administration has made good on 
its commitment so far, and a success in tax reform would 
have many positive impacts on the country. 
 
10. (U) The country still faces some pressing issues, chief 
among them the neglect of essential services (fire 
departments in particular).  While reduction in interest 
rates has freed up some resources, the debt-to-GDP ratio of 
125.7 percent still places Jamaica among the most indebted 
countries in the world.  The MOU with trade unions (reftel), 
which caps annual wage increases at three percent, will come 
to an end in March 2006, and workers are expected to agitate 
for higher wages and salaries to compensate for the period 
under the MOU.  Indeed, Collister told emboff that there has 
to be some payback at the end of the period, especially 
given the proximity to the general elections 
constitutionally due by October 2007. In the final analysis, 
barring shocks, the GOJ should be able to navigate through 
the challenges and deliver a balanced budget in March 2006. 
End Comment. 
 
TIGHE