DEBT AND CAPITAL MARKET DEVELOPMENTS

INTRODUCTION

The challenges to debt management experienced in FY 2002/03 continued into the first half of FY 2003/04. The sharp increase in domestic interest rates and volatility in the foreign exchange market created uncertainty about the macroeconomic prospects. These developments, coupled with a lowering of Jamaica's credit ratings, impacted on the cost and structure of domestic financing as well as the timing of Government's access to the international capital markets.

During the second half of the fiscal year, the relative stability in the foreign exchange market and improvement in investor confidence contributed to a gradual and consistent reduction in interest rates. Externally, there was a resurgence of investors' interest in Jamaica and the Government successfully re-entered the international capital markets.

Despite the challenges, the Government maintained its impeccable record of honouring all domestic and external debt obligations.

The Government's Debt Management Strategy is designed to return the public debt to sustainable levels, ensuring that the overall borrowing requirements are met at minimum cost and consistent with a prudent degree of risk. This medium-term strategy is an integral part of the management of the fiscal operations and the Government's macro-economic programme. The Government achieved moderate success in the execution of its Debt Management Strategy in FY 2003/04.

Against this background and in keeping with the medium-term strategy, in FY 2003/04, the Government sought to maintain a prudent debt structure, use market mechanisms for domestic debt issuance, promote and build a liquid and efficient market for Government securities, increase the transparency and predictability of primary market debt issuance, finance the fiscal deficit and debt redemptions, and access the external markets for funds to the extent of gross external amortization.

At the end of March 2004, the stock of public sector debt stood at $693,885.6mn or 142.5% of GDP. This represented a 15.4% increase over the stock of $601,241.3mn or 143.9% of GDP recorded at the end of March 2003. However, the rate of growth in the total debt was slower than the 21.0% increase recorded in FY 2002/03 when compared with FY 2001/02. The main factors accounting for the increase in FY 2003/04 were:

The net issuance of bonds in the regional and international capital markets;

The issuance of securities to the Bank of Jamaica in lieu of accrued interest on BOJ/FINSAC LRS;

The sharp depreciation in the exchange rates;

The assumption of certain contingent liabilities;

Increased Government guarantees mainly to facilitate certain infrastructure development projects; and

The issuance of securities to cover Bank of Jamaica losses.

DOMESTIC DEBT

Performance Summary

During FY 2003/04, the Government continued its management of the domestic debt within the framework outlined in the debt strategy. Emphasis was placed on more efficient ways to finance the budget at minimum cost and to accomplish this amidst the many constraints and challenges. During the year, there was greater co-operation between the fiscal and monetary authorities on one hand, and the public and private sectors on the other, in a bid to reduce the country's debt burden. The increased dialogue and co-operation contributed to renewed confidence particularly in the second half of the fiscal year.

Stock

At the end of March 2004, the stock of domestic debt stood at $417,571.3mn or 85.8% of GDP. This represented an increase of 14.0% over the stock at the end of March 2003. The increase was attributable to:

The financing of a higher than projected fiscal deficit during the first nine months of the fiscal year;

The delay in external fund raising until the last quarter of the fiscal year;

The issue of securities to BOJ in lieu of accrued interest on BOJ/FINSAC Local Registered Stocks (LRS);

The assumption of $2,782.4mn in contingent obligations primarily in respect of the Jamaica Urban Transit Company Limited, the Metropolitan Management Transport Holdings Limited and for the road rehabilitation programme;

The sharp depreciation in the J$ vis-à-vis the US$ and the increased share of the foreign currency component of the domestic debt; and

The issue of securities to cover BOJ losses for 2002.

Gross new debt issued during FY 2003/04 amounted to $131,361.9mn, an increase of 7.7% over FY 2002/03 and 12.3% higher than the budgeted financing amount of $117,000.0mn. Of the total new issuance, $124,257.7mn or 94.6% was raised for budgetary commitments, and $7,104.2mn or 5.4% for non-budgetary purposes.

Although the stock of domestic debt increased by 14.0% over the March 2003 level, the rate of growth slowed from the 22.0% increase recorded for FY 2002/03 over FY 2001/02.

At the end of FY 2003/04, LRS, the Government's medium to long-term instruments, accounted for 52.9% of total domestic debt outstanding. This was a decline from the 65.8% share in FY 2002/03 and reflected the issuance of shorter-term securities such as Investment Debentures, in response to market conditions. The share of Investment Debentures rose from 11.3% in FY 2002/03 to 20.8% in FY 2003/04. The share of US$-denominated and US$-Indexed Bonds in the domestic portfolio increased from 20.0% in FY 2002/03 to 23.2% in FY 2003/04, reflecting increased issuance and adverse exchange rate movements. The increase in the US$-Indexed Bonds took place in the first half of the year in support of the efforts of the central bank to stabilize the foreign exchange market.

The main holdings/holders of Government securities remained the merchant banks, trust companies and brokers. However, their holdings decreased from 30.5% in FY 2002/03 to 29.5% in FY 2003/04. Holdings by public sector bodies, including the BOJ increased from 24.9% to 25.9%. Commercial banks' holdings, on the other hand, decreased from 25.9% to 22.2% during the year.

Maturity Profile
Market conditions during FY 2003/04 were not conducive to extending the maturity profile of the domestic debt. Against the background of unfavourable market conditions resulting from increased volatility in the foreign exchange market and sharp increases in interest rates, the appetite for long-term securities changed dramatically in favour of shorter-term securities. This was reflected in the altered structure of the maturity profile of the domestic debt.

Of total new domestic debt issued in FY 2003/04, 94.4% had maturities of up to 5 years compared with 45.1% in FY 2002/03. Only 4.2% of new domestic issues had maturities in excess of 10 years, compared with 37.6% in FY 2002/03.

Of the total domestic debt outstanding at the end of FY 2003/04, 73.1% had maturities of up to 5 years compared with 63.9% at the end of FY 2002/03, while 12.8% had maturities of 10 years and over, down from 16.9% at the end of FY 2002/03.

Debt Service
Debt service on domestic obligations for FY 2003/04 totaled $152,078.4mn, of which $80,617.7mn was principal payments and $71,460.7mn interest payments. Principal payments were $3,889.4mn or 5.1% higher than budgeted due mainly to prepayments of $3,763.6mn of FINSAC-related debt, payments on certain contingent liabilities and the repayment of unprogrammed short-term loans raised during the fiscal year given the market conditions.

Interest payments were $11,000.1mn or 18.2% higher than budgeted. The increase was attributable to the higher than projected interest rates, costs associated with the higher than programmed debt issues, depreciation in the exchange rate and unprogrammed payments on contingent liabilities.

Interest Rate Structure
Of the new domestic debt issued in FY 2003/04, 78.4% was contracted on a fixed rate basis, while 21.6% was contracted on a variable rate basis. The existence of high interest rates, uncertainties among investors and the need to ensure prudent management of interest rate risk were essential to the determination of the type, tenure and coupon of debt instruments issued during the year. Fundamental changes in market conditions exacerbated by higher than programmed financing requirements in the first nine months of the fiscal year also had an impact on the choice and structure of debt instruments.

Of the total domestic debt outstanding at the end of March 2004, 58.2% had been contracted on a fixed rate basis compared with 48.4% at the end of March 2003, 43.2% at the end of March 2002, 32.8% at the end of March 2001 and 7.0% at the end of March 2000. This has resulted in reduced sensitivity of the domestic debt portfolio to interest rate volatility.

Interest Rates
The cost at which domestic debt was contracted in the first half of FY 2003/04 was impacted by the combined effects of the sharp increases in interest rates in the last quarter of FY 2002/03, continued volatility in the foreign exchange market, uncertainties among the investing public about the macroeconomic prospects and the lowering of Jamaica's credit ratings by the rating agencies.

For the fiscal year, new fixed-rate debt was issued at an average interest rate of 29.7% compared with projection of 16.95%. The average interest rate for the benchmark 180-day Treasury Bill was 23.48% for the fiscal year, well above the projected 16.875%.

Improved market conditions in the second half of the fiscal year, relative stability in the foreign exchange market and closer collaboration between the public and private sectors resulted in a gradual and consistent reduction in interest rates. The gradual decline in the BOJ reverse repurchase rates contributed to the downward movement of other key rates in the market. At the end of FY 2003/04, the BOJ reverse repurchase rates on the 180-day, 270-day and 365-day instruments were 16.00%, 16.95% and 17.95%, compared with 33.15%, 34.50% and 35.95%, respectively, at the beginning of the fiscal year. The average yield on the benchmark 180-day Treasury Bill was down to 15.57% at the end of FY 2003/04 from 33.47% at the beginning of the year.

Domestic Debt Indicators
At the end of the FY 2003/04, domestic debt as a percentage of GDP was 85.8% compared with 87.3% at the end of FY 2002/03. Interest payments accounted for 54.5% of tax revenue and 41.1% of recurrent expenditure in FY 2003/04. This compared with 45.6% and 33.3%, respectively, in FY 2002/03.

EXTERNAL DEBT

Performance Summary
During the fiscal year, the Government satisfied its objectives of securing adequate external financing, extending the euro yield curve and widening its investor base, despite the challenges of the first half of the year. In response to the challenges, the Government positioned itself to take advantage of favourable market conditions when they emerged. In this regard, the Government held investor conference calls, embarked on a non-deal investor roadshow in the major European cities and completed the annual updating of the documents filed with the United States Securities and Exchange Commission. With the return of investor confidence during the second half of the year, the Government successfully tapped the regional and international capital markets.

Stock
At the end of March 2004, the stock of public and publicly guaranteed external debt stood at $276,314.3mn (US$4,529.0mn) or 56.7% of GDP. While this represented an increase of 17.5% over the stock at the end of March 2003, it was less than the 19.4% growth recorded for the previous fiscal year. In US$ terms, the external debt increased by 8.3%. The increase was due largely to:

The issuance of approx. US$352mn in bonds in the regional and international capital markets which exceeded gross amortization for the fiscal year;

Adverse movements of the Euro vis-à-vis the US$ and the J$ vis-à-vis the US$; and

Increase in Government guarantees mainly in support of infrastructural development projects.

Among the new project loans disbursed during the year were loans for the rehabilitation and building of bridges under the Rural Bridges Programme, construction of a netball court facilities at Independence Park and for the natural disaster management project.

Debt Service
External debt servicing for FY 2003/04 totaled $33,770.9mn of which $17,047.1mn was principal repayments and $16,723.8mn interest payments. This compared to total external payments of $52,319.5mn in FY 2002/03 when two eurobonds totaling $23,244.6mn matured.

Creditor Composition
The share of loans from official creditors, comprising multilateral and bilateral creditors, has declined steadily over the past 10 years, except in FY 2002/03 following disbursements for the financial sector restructuring programme. At the end of March 2004, loans from official creditors accounted for 47.1% of the external debt compared with 53.4% at the end of March 2003. The decline in loans from bilateral sources arose against the background of Jamaica's reclassification by the World Bank since 1999 as a middle-income country and the shift in focus on the part of the bilateral creditors to providing assistance to countries from the former Soviet Union and to the Heavily Indebted Poor Countries (HIPC).

Concomitant with the decline in loans from official sources was an increase in borrowing from private creditors, including bondholders, as Jamaica continued to access the international capital markets. Eurobonds issued in the international capital market represent a significant component of the external debt stock, accounting for 43.8% of the stock at the end of FY 2003/04 compared to 38.6% at the end of FY 2002/03.

Loans from commercial banks as a percentage of the external debt increased from 2.0% at the end of FY 2002/03 to 3.6% at the end of FY 2003/04. The increase was due primarily to increased use of commercial bank facilities by certain guaranteed entities.

Currency Composition
Despite a marginal decline, the US$ remains the predominant currency in which external loans are denominated. At the end of FY 2003/04, 72.7% of the external debt was denominated in US$, compared with 78.6% at the end of FY 2002/03. Increased issuance in the European capital markets resulted in the Euro replacing the Japanese Yen as the second largest currency component of the external debt portfolio. The Euro's share increased to 17.3% up from 12.0% at the end of FY 2002/03, reflecting the issue of the €200mn bonds in February 2004.

Interest Rate Structure
The loans from bilateral and multilateral creditors were contracted at highly concessional interest rates with long tenures. The average interest rate on these loans ranged from 2% to 4% p.a. The average interest rate on bonds was 10.79% p.a., declining marginally from the average interest rate of 11.40% p.a. for FY 2002/03.

Of the external debt outstanding at the end of FY 2003/04, 72.3% had been contracted on a fixed rate basis, while 27.7% had been contracted on a variable rate basis, insulating the portfolio from adverse interest rate movements. During FY 2003/04, the portfolio benefited from the continued downward movement of interest rates internationally. Base interest rates such as the US 6-month LIBOR trended downward reaching an all-time low of 1.2% p.a. from May 2003.

Maturity Structure
The external debt portfolio remains predominantly long-term. This, coupled with its concessional nature has effectively reduced the cost of the stock in present value terms and also the potential financing risk.

The issuance of the 5-year euro-denominated bonds in February 2004 resulted in the Government extending the maturity profile of its Euro curve. Of the total external debt outstanding at the end of FY 2003/04, 23.0% had maturities of up to 5 years, compared with 22.4% at the end of FY 2002/03; 26.6% had maturities of 5-10 years down from 27.0% in FY 2002/03; and 45.0% had maturities in excess of 10 years down from 51.0% in FY 2002/03.

Debt Forgiveness
Over the years, the Government of the United Kingdom, the Netherlands, Canada and the USA have provided debt relief to Jamaica under various debt initiatives. During FY 2003/04, the Government of the United Kingdom provided debt forgiveness to the value of £2.1mn under the renewed Commonwealth Debt Initiative (CDI). This amount covered principal and interest payments falling due on eligible loans during the fiscal year. Jamaica was granted this debt forgiveness having satisfied the CDI criteria in recognition of its commitment to the internationally agreed Millennium Development Goals and Policies promoting transparent and accountable governance, and economic policies that promote sustainable development. The funds were used to support the Government's budgetary programme.

External Debt Indicators
At the end of FY 2003/04, external debt as a percentage of GDP was 56.7 compared to 56.3% at the end of FY 2002/03. Debt service as a percentage of export of goods and services declined to 11.6% from 22.4% at the end of FY 2002/03. The current debt service ratio remains well within the internationally accepted benchmark of 20%.

International Capital Markets Developments
During the first half of FY 2003/04, events externally coupled with macroeconomic developments locally, had an impact on the trading levels of the Government's eurobonds. The eurobonds traded at very low levels during the period with the prices of all the bonds trading below par in April and periodically in May.

More favourable market conditions in the second half of the fiscal year combined with improvements in the fiscal operations contributed to positive market sentiments from investors. This was evidenced by the improved trading levels of the eurobonds particularly towards the end of the fiscal year. Of particular note, is the performance of the US$300M bonds due 2017. Since issue in June 2002, these bonds have always traded well below the other bonds in the portfolio. For a protracted period, the 2017s traded well below par. However, since mid-March 2004, they have been trading at or above par.

In the second half of FY 2003/04, the Government successfully raised funds in the regional and international capital markets. In October 2003, the Government widened its investor base with the re-entry into the regional capital market and issued a US$50.0mn 9.0% bond due 2008. In March 2004, the Government again raised US$50.0mn bonds in this market. The bonds carry a coupon of 9.5% and will mature in September 2008.

The European markets were successfully tapped in February 2004 with the issue of Jamaica's longest dated and largest euro-denominated bond. Due to overwhelming demand for the issue, the original size of €100mn was increased to €200mn. The bonds which mature in February 2009 carry a coupon of 10.5%. The bonds have traded at premium levels in the secondary market since issue. In February 2004, Euromoney, a world recognized investment magazine. highlighted the transaction as the deal of the month, competing with high profile issues such as Turkey, Brazil and Venezuela. Deutsche Bank and Commerzbank Securities were the joint-lead managers for the transaction.

Jamaica's credit ratings were reviewed by the rating agencies Moody's Investors Service (Moody's) and Standard and Poor's (S&P) during the fiscal year. In May 2003, Moody's lowered Jamaica's long-term foreign currency credit rating from "Ba3" to "B1". The long-term local currency rating was also lowered from "Baa3" to "Ba2". Moody's maintained its "Stable" outlook.

In July 2003, S&P lowered Jamaica's long-term foreign currency rating from "B+" to "B" and maintained its "Stable" outlook. In February 2004, S&P lowered its long-term local currency credit rating from "B+" to "B" and revised its outlook on Jamaica's long-term ratings from "Stable" to "Negative".

DEBT STRATEGY FY 2004/05

In 1998/99, the Government formulated its comprehensive medium-term Debt Management Strategy designed to return the public debt to sustainable levels. The core objective of the strategy has been modified over the years to broaden the focus from minimizing borrowing costs to include risk management. Hence, the overall medium-term objective of the Government's Debt Management Strategy continues to be the achievement of the lowest possible borrowing costs, while ensuring that the associated risks are kept within acceptable levels.

The policies pursued in each fiscal year are consistent with achieving the core objective. The appropriate modifications are made in response to prevailing domestic and external market developments.

In keeping with the core objective established since FY 1998/99, aimed at:

Maintaining a prudent debt structure;

Further diversifying the debt portfolio;

Using market mechanisms for domestic debt issuance;

Promoting and building a liquid and efficient market for Government securities; and

Increasing the transparency and predictability of primary market debt issuance;

The Debt Management Strategy in FY 2004/05 will seek to:

• Maintain a mix of fixed-rate and variable rate debt to further diversify and minimize interest-rate risk;
• Seek to extend and smooth the maturity profile of the debt to better manage refinancing risk; and
• Continue to increase the transparency and predictability of debt issuance.

MEDIUM-TERM TARGET

The Government remains committed to reducing the debt in nominal terms and as a percentage of GDP over the medium term. This is a fundamental aspect of the Government's overall medium-term macro-economic programme. Reducing the debt stock and improving the debt dynamics will be facilitated by the return of the fiscal operations to a balanced position by FY 2005/06 and surplus thereafter, as well as by accelerated economic growth. Within this context, and supported by the already improving fiscal operation and macroeconomic environment, the debt stock and the debt to GDP ratio are projected to decline over the medium-term.

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Performance of GOJ US$ Eurobonds

Progress in Extending the Maturity Profile of the Debt

HOLDINGS OF GOJ REGISTERED INSTRUMENTS

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