US embassy cable - 05KINGSTON2053

UNCLAS SECTION 01 OF 02 KINGSTON 002053 
 
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: SOARING INFLATION THREATENS JAMAICA'S MACRO- 
ECONOMIC STABILITY 
 
REF:  KINGSTON 386 
 
1.  Summary:  Less than two months after the IMF gave 
Jamaica high marks for stabilizing the economy, spiraling 
inflation is again threatening macroeconomic stability. 
Inflation, which reached almost 14 percent last year and 
has already jumped to 7.4 percent for the first four 
months of the fiscal year (Note: Jamaica's fiscal year 
runs from April to March) shows no sign of abating, given 
the continued rise in food and oil prices and the pending 
increases in utility rates and transportation costs.  The 
price increases have prompted Finance Minister Omar Davies 
and Bank of Jamaica Governor Derrick Latibeaudiere to 
concede that the single-digit target for the fiscal year 
is unlikely to hold.  This admission has not gone down 
well with trade unions, which have signaled their 
intention to seek higher wage increases when the wage 
restriction agreement with the GOJ ends in 2006.  The 
galloping inflation and inflationary expectations have 
also halted efforts to reduce interest rates, which could 
have repercussions for the MOU and by extension 
macroeconomic stability and investor confidence.  End 
summary. 
 
2.  Just six weeks after the IMF gave Jamaica high marks 
for stabilizing its economy, spiraling inflation is 
threatening to throw the GOJ's financial program off 
track.  Although inflation galloped to 13.7 percent last 
year, the memorandum of understanding (MOU) between the 
GOJ and trade unions remained intact because the bulk of 
the price increases were blamed on the ravages of 
Hurricane Ivan, which dealt a serious blow to the economy. 
However, things show no sign of subsiding as inflation has 
jumped to 7.4 percent for April to July 2005 and 8.9 
percent for January to July 2005.  The price spiral has 
prompted Finance Minister Omar Davies and BOJ Governor 
Derrick Latibeaudiere to concede that inflation could 
surpass 15 percent this fiscal year (above 9 percent 
target).  This would be the first time since 1996 that 
inflation would surpass the 15 percent level.  Davies and 
Latibeaudiere have argued that a number of exogenous 
shocks have fuelled the latest bout of price instability, 
as core inflation (due to increased money supply) rose by 
a meager 1.7 percent during the period.  Chief among the 
reasons cited are increasing oil prices; higher food 
prices; rising transportation and electricity cost; and, 
the tax measures implemented in April and May. 
 
3.  The admission by Davies and Latibeaudiere has angered 
trade unionists, who were promised single digit inflation 
as a condition for agreeing to a wage restraint.  Unions 
have signaled their intention to seek double digit wage 
increases when the wage restriction agreement with the GOJ 
ends in March 2006.  Lambert Brown of the University and 
Allied Workers Union has suggested that workers' standard 
of living has been significantly eroded and, whenever 
salary negotiations commence, unions will push for 
sufficient adjustment in salary to meet the needs of 
workers.  He stated that most employers could afford the 
increases, pointing to the healthy profit of the Mirant- 
owned Jamaica Public Service (JPS), which reported profits 
of USD 8 million for the first three months of 2005, and 
most companies listed on the local stock exchange. 
However, the Jamaica Employers Federation has countered by 
arguing that employers cannot afford the increases 
contemplated, as the inflationary spiral was also 
affecting them. 
 
4.  Inflation could actually surpass the 15 percent mark 
suggested by the economic authorities, given that 
additional inflationary impulses are expected to emanate 
from increased utility rates.  The Office of Utilities 
Regulation (OUR) has agreed to grant JPS a 7.5 percent 
increase in electricity rates effective September 2005 and 
a seven-cent increase per kilowatt-hour effective October 
2005 to recover rehabilitation costs associated with 
Hurricane Ivan.  The OUR has also approved a 67 percent 
hike in bus fares effective August 2005 to cut the 
company's almost USD 41 million deficit, while taxi 
operators were granted a 25 percent increase in rates. 
There is also a request before the OUR for an increase in 
water rates later this year.  These announcements have 
drawn the ire of trade union leaders who met with GOJ 
officials to express their frustration with the general 
price increases and the bus fare increase in particular. 
The trade unions got the GOJ to agree to an exemption for 
public sector workers in the Kingston Metropolitan area. 
 
5.  The continued rise in international oil prices is also 
expected to provide further impetus for inflation, as 
studies conducted by the BOJ show that the country's 
inflation rate climbs by a quarter of a percent for every 
USD 1 jump in the price of oil.  Additionally, rising oil 
prices could have a negative impact on the balance of 
payments, the exchange rate and economic growth, thereby 
fueling another bout of macroeconomic instability.  Oil 
alone is expected to cost Jamaica USD 1.2 billion in 2005, 
and with exports falling this will put pressure on the 
stock of reserves (USD 2.1 billion).  The surge in prices 
will also militate against fiscal policy as the budget was 
predicated on oil prices of USD 47 per barrel, but prices 
are now USD 67 per barrel and climbing.  The runaway 
inflation is also hampering the BOJ's efforts to reduce 
interest rates, as evidenced by the most recent interest 
rate auction when the rate paid on benchmark 30-day 
repurchase agreement rose by 0.15 percent. 
 
6.  Comment:  The inflation spiral is not expected to 
subside anytime soon, as additional impulses will come 
from the increased price of agricultural commodities due 
to supply shortages arising from adverse weather 
conditions associated with the last two hurricanes; the 
lagged effects of increased taxes; and, increased water 
rates later this year.  This could impact negatively on 
the MOU, which hinges on the moderation in inflation.  In 
fact, most trade unions have already reacted negatively to 
approaches by the GOJ to extend the wage freeze when it 
expires in 2006.  This will have a deleterious effect on 
fiscal policy and investor confidence unless the GOJ can 
devise policies during the current fiscal year to temper 
the wage bill following the expiration of the MOU in 2006. 
However, even if a new pact is negotiated, workers not 
bound by the MOU will be clamoring for higher wage 
increases to compensate for lost purchasing power.  This 
will in turn feed into inflation and the attendant 
uncertainty will provide further impetus for inflationary 
expectations. 
 
7.  Comment (cont'd):  Rising prices will also impact the 
BOJ's plans to further reduce interest rates, as people 
will be unwilling to accept the current negative real 
rates of interest.  This could ignite a bout of 
macroeconomic instability, as investors shift from local 
to foreign assets building up demand pressure on the 
foreign exchange market.  The resulting depreciation would 
then provide further fuel for price increases.  On the 
positive side, the BOJ has over USD 2.1 billion in foreign 
reserves at its disposal to at least satisfy any build up 
in demand for foreign exchange in the short term. 
Additionally, if it is any consolation, the recent price 
instability has been driven by cost-push factors and not 
the problematic core inflation of the early 1990s.  End 
comment. 
 
TIGHE