Commentary
Cayman:
Economy Out Of Sync
The saying used to be "when Americasneezes Europe catches a cold." Is this true of Cayman economytoday, or are some of Cayman's problems also home grown?
"Economy under Review", "ConstructionSlump". Tourism Down", "Tourism In The Doldrums",these are newspaper headlines of recent publications, coupledwith editorials of similar subject matter.
In a weekend issue of the Cayman Net News,dated February 23, 2001, the Financial Secretary, the Hon. Mr.George McCarthy is quoted as saying: "we know that we arenot going to have a robust growth in certain areas, but we haveto be careful in coming to any conclusions about the economy."He went on to say that Government is looking to see what willstimulate the local economy and what is available to support capitalventures.
The Financial Secretary points out thatthe offshore financial sector is thriving and Cayman Net Newsreports that assets in the banking system exceed 700 billion dollars.So then, what is wrong? Why do these newspapers' headlines readlike a doomsday forecast? Again, quoting Cayman Net News, "accordingto one financial analyst Cayman seems to have two economies -domestic and offshore banking - and it now appears as if the domesticside is in a slump."
"Government was trying to streamlineexpenses to be in line with revenue", Mr. McCarthy said."So as demand against the government continues to grow, obviouslywe have to look at the expenditure side of the budget very carefullybecause, from 1994 to the end of 2000, revenues have increasedby 85 percent but the expenditure side has increased by 100 percent."
Based on the Financial Secretary's interviewwith Cayman Net News, this trend is not acceptable. "We willhave to introduce appropriate measures to deal with that,"says Mr. McCarthy, but then he goes on to say, "I cannotsee how this will be remedied."
Viewing the budget mainly from the expenditureside, one can see clearly the difficulty facing the government.A very high proportion of the elements making up the expenditure-sideof the budget are not programmes that can be easily removed, orcut; they perform vital functions in the society. In fact, someof these programmes only exist because they are carried on bygovernment. There are some services, however, of which the communityhas mixed feelings, for example Cayman Airways.
On Friday, March 9, 2001, the Governor ofthe Cayman Islands in his Throne Speech to the Legislative Assembly,raised the issue of the financially-troubled national airline.Cayman Airways is "a national concern" and "anindependent audit has been commissioned. The goal is to fine thebest business model to bring about a sustainable profitabilityat the national airline."
Now with the best of intentions and goodwill in the world, Cayman Airways proposition is not realistic.There is, perhaps, not even a middle ground between the realityof the national airline and the concept of profitability.
Doomsdayers in this country have for yearspredicted and continue to predict apocalypse (that Cayman Airwayswill bring about the downfall of the Cayman Islands). This isnot so, but it is clearly crunch time for the Government - eitherCayman Airways must be thrown out to sea to swim or drown, orthe Government must once and for all bring it in from the coldand clothe it with the curtain of social welfare decision making.After all, there are certain economic gain that Cayman Airwaysdoes bring as a national airline to the economy. Employment, benefitsto the local economy from advertising wherever Cayman Airwaysfly, and its presence in times of potential disaster are a fewexamples.
But what you see emerging here is that thejustification of a project or pursuance of certain public policiesmust also be done for welfare gain. Projects and policies abound,the only justification for which is the satisfaction of nationalobjective, of which success as future private enterprise comesonly after a gestation period of national control.
Where some sticky problems arise is whenGovernments believe - and successive Cayman Islands Governmentshave been guilty of this - in chasing the myth that there existsan equilibrium position at which public sector and private sectorsalaries equate, and that if public sector salaries increase tothat level then productivity in government will rise to balanceout incentives offered in the private sector. This is dangerousthinking because once you begin implementing the policy; you haveburned the bridges you crossed.
In an attempt to undo the initial policyerror, you initiate the next round of errors by increasing importduties to pay for salary increases that were supposed to pay foritself, through increased productivity that did not materialise.Invariably the import duties impact inelastic goods and services,prices of which are passed on to the consumer many times over.
The budget imbalance continues to escalatebecause of the new round of price increases, and the structureof the import tax regime is causing an inflationary cycle. Governmentis also purchasing goods and services at the new level of theprice cycle, a further contribution to price increase and surelya further divergence between revenue and expenditure flows.
But, this equation also has a revenue side,so let us see what happens there.
Mr. A.R. Prest, a former professor of economicsat the London School of Economics and Political Science says thatcountries with economic structures like the Cayman Islands arefound on average to raise 29 percent of total revenue from importduties. There are countries, however, with ratios as high as 48percent. Revenue figures of the Cayman Islands Government indicatethat it raises about 40 percent of total revenue from taxes oninternational trade.
Based on Mr. Prest's arguments, there isnot much more revenue the government could extract from imports.For example, with expenditures running 15 percent ahead of revenue,even with an import ratio of 48 percent - presenting the outerlimits in the Prest analysis - there is still a seven percentgap in increased spending the Government would be unable to bridge;and again, the resulting seven percent import revenue flow couldlead to another round of price inflation.
What the economy in this country desperatelyneeds is a significant reduction in the price level, especiallyprices of goods and services that are necessities (very unresponsiveto price increases).
1. Cut the rate of import duties by 40 percenton consumer goods over the next eighteen months.
2. Establish a committee to explore thepossibility of initiating a money and capital market for issuingshort and long-term Government of the Cayman Islands debt securities.
3. Introduce a variable rate fee on theliabilities of the banking system.
The idea of imposing some fee or tariff,or whatever you call it, on the banks gives the conservative establishmentnightmares; their words would be "we do not want to sendthe wrong signal." Fundamentally, you would be correctinga wrong signal sent before. Here is the scenario:
Revenue contribution of the banking systemas percentage of total Government revenues is only between 12and 16 percent. Banks in the Cayman Islands are not
required by law to maintain reserve requirementson deposit liabilities. By comparison, the banking system in theUnited States does maintain reserve requirement, and other formsof reserves against different kinds and quality of liabilities.
Let's say that reserve requirement of fivepercent is set aside against a deposit of 100 dollars; if thebank pays 10 percent interest to depositors, it is paying 10 percentfor the use of only 95 dollars, the cost of the fund is really10.52. As interest rates rise, the costs also rise.
The situation is different for a bank havingjurisdiction to do business in the Cayman Islands; there is nolegal reserve requirement imposed on banks as a part of overallpolicy - the only restriction on the amount banks can lend isthe amount of deposits the bank has on hand to lend. So, as theprevious example clearly shows, the absence of legal reserve requirementscould only mean that there is no need for local interest ratesto rise to the level that equates interest rates in the internationalmoney and capital markets. Then why are interest rates in theCayman Islands so high? The only truthful answer to that questionis that Governments of the Cayman Islands have failed to legislateinto being institutions and initiative policies to properly regulateand promote the financial interest of the country.
Critics would say, wait a minute, that isthe role of the Cayman Islands Monetary Authority (CIMA). Well,over the past months, CIMA has been in the news quite often, buteven after those rate cuts by the United States Federal ReserveBoard, nobody heard from the Monetary Authority on interest ratelevels in the Cayman Islands.
When the Monetary Authority was first established,it was initially seen by the public as a foundation layer forthe future central bank of the Cayman Islands. But if you lookat economic policy in the Cayman Islands today (if there is sucha thing), then you begin to wonder because here you are, havingread this interview, or excerpt of it in the Cayman Net News withthe Financial Secretary of the Cayman Islands, in February, andthe essence of his interview is that for some time now there isthis problem with the Government budget, where our expenditureoutflows are increasing and in an escalating manner, outpacingour revenue inflows, and that appropriate action is necessary.Financial Secretary Mr. McCarthy said, quote, "I cannot seehow this will be remedied."
Clearly, one cannot apply short-term solutionsto long-term problems. But what needs to change quickly in thepolitical philosophy of governing in the Cayman Islands is thestructure of official thinking that Government must exercise anever-decreasing role in economic affairs. There is a need to appreciatethat there is a more involved role that public policy must play,that private institutions will not 'self-monitor' for the benefitof the state.
The Bill presently coming before the LegislativeAssembly to bestow full independence to the Cayman Islands MonetaryAuthority, at a time when, in fact, what is needed is a CentralBank whose mission is to foster monetary stability and promotecredit conditions conducive to the growth of the Cayman Islands,underlines my point.
While the role of the Monetary Authorityhas been continuously upgraded as an oversight body, the absenceof an official monetary policy, as a direct potential hands-onapproach by government, is absent.
The present crisis in Government's financesin this country underscores the importance of ending the era ofanachronism inherent in the philosophy of a currency board system,where domestic currency must be backed 100 percent, because thereis not a domestic base money supply. The currency board systemis clearly deflationary and hinders economic development.
Instead of introducing a Bill making theMonetary Authority fully independent of government control, thebill should be written establishing a central bank with the legalauthority to conduct monetary and interest-rate and exchange-ratepolicy, initiating and effecting changes in reserve requirementsof the banks, so as to be able to expand and contract money supply,and act as a Government bank, obviating the need for governmentborrowing - at least in the short term - from the local bankingsystem at market rates and above.
In the end, if the Government is not preparedto look out for its own people, don't expect an independent MonetaryAuthority and offshore corporate interest to look out for you.