Does Finance Minister Dr Nigel Clarke have more credibility than Chancellor of the Exchequer Kwasi Kwarteng?

Along time ago, when I lived in London, I was working in the same UK merchant bank that global hedge fund manager George Soros happened to begin his career with many decades earlier. Indeed, I was actually watching a Reuters screen at that same bank the same day when Soros supposedly “broke the Bank of England”, making a one billion pound profit by selling sterling short (pounds he did not own to buy them back later) forcing the pound out of the European exchange rate mechanism, which it had been shadowing through a target range for the pound against the currency basket that would ultimately become the euro, at that time expressed more simply as a target against the German Mark. A couple of months earlier, I had written a forecast for the bank stating that the pound would likely be forced out of the exchange rate mechanism (a note I still have), amongst other things quoting Thatcher’s then former economic adviser Sir Alan Walters that the UK’S then policy was “half baked”.

During that day, which was named Black September, there had been two emergency base rate (equivalent to our policy rate) hikes by the Bank of England, the first from 10 to 12 per cent, and the second to 15 per cent. Neither had sufficed, as by that time, the UK was already in a recession, and the financial markets did not believe that the UK could withstand higher interest rates. You could literally see the currency moving several percent in real time, up and down within seconds as the Bank of England intervened, itself very unusual in a devel- oped foreign exchange market, before it was busted out of the range with a large devaluation. Of course, the markets were right, as after they forced the pound out the band, the Bank of England reversed both hikes the next day.

The reason to tell this story is of course the UK’S brand new Chancellor of the Exchequer, Kwesi Kwarteng, has seen a sharp fall in the pound to a new low against the dollar after delivering a package of fiscal measures judged by some, including London School of Economics Professor Charles Bean, to put the UK on what he calls an “unsustainable fiscal path”. Subsequent to Kwarteng’s announcements, the UK has seen a sharp rise in the yield on its bonds, traditionally called Gilts. Since the beginning of the year the pound has fallen by between 25 and 30 per cent (depending on which of the past few days you use as volatility has been very high) against the US dollar, although it is worth mentioning that for the first 20 per cent of its fall the pound had actually tracked the Euro quite closely, which had fallen a very similar amount, and the US dollar had been rising sharply against virtually all world currencies, with the notable exception of the Russian rouble, and of course the Jamaican dollar.

Kwarteng’s problem is that, again according to Professor Bean, in the Spring the UK was reckoned to have “fiscal space” of between 30 and 45 billion pounds, but a combination of economic slowdown reducing revenues (relative to forecasts at the beginning of the year), and particularly the actual and potential enormous energy subsidies announced (let us use a range of 100 billion to 150 billion pounds although this is almost impossible to forecast as it depends so closely on the geopolitics of the Ukraine war), used up the previously estimated fiscal space for Kwarteng’s proposed tax cuts. So despite including such business friendly things as the reduction in stamp duty, amongst a number of other supply side type measures, the overall “unfunded” package was seen as lacking in fiscal credibility coming so soon after the energy subsidy announcement.

In contrast, Dr Nigel Clarke’s entire policy focus as finance minister has been to achieve credibility, partly through the creation of institutions that will last, such as finalising the creation of an independent central bank during the COVID-19 crisis, which as he noted provided the perfect excuse not to finish the job. In a recent speech at the first Sygnus Day last week at the AC Hotel (seemingly destined to become an annual event), Dr Clarke noted that despite emerging markets generally being in turmoil, Jamaica’s spread over treasuries (meaning the extra yield demanded by global investors to hold Jamaican US dollar debt rather than that of the US treasury) was lower than many much bigger investment grade countries, and surprisingly below such more highly rated regional peers as the Dominican Republic and Trinidad and Tobago. A quick look at emerging market investment grade countries globally reveals that Romania and Hungary (both part of the European Union), as well as Mexico, Peru, Panama and Chile all trade at a higher spread to treasuries than Jamaica’s roughly 120 basis points or 1.2 per cent premium.

As Minister Clarke put it, he is not talking about “basket cases”. If we arbitrarily assume a 15 per cent premium over treasuries as a reasonable definition of a “basket case”, then in addition to the two countries at war (Ukraine and for sanction reasons Russia), Argentina, Sri Lanka, and Pakistan are all in crisis, and El Salvador and Ecuador look very shaky.

Oppenheimer emerging market expert Thomas Jackson agrees, noting “Finance Minister Clarke’s opening remarks highlighted the challenges Jamaica has historically faced given its elevated susceptibility to external shocks. Addressing the capacity to navigate these shocks has clearly been a point of focus from the government and maybe more importantly, there appears to be clear buy-in locally. Jamaican bond prices reflect this as they continue to trade well above the country’s credit rating despite the turbulent global backdrop.”

In short, while the UK has much greater institutional credibility, which Jamaica is now trying to earn, and is fortunate that virtually all its debt is borrowed in its own currency (roughly 60 per cent of Jamaica’s government debt is in foreign currency), our long programme of balanced budgets and high primary surpluses seems to have paid off. So far, Jamaica has neither suffered a foreign exchange or funding crisis, nor seems likely to do so, while the UK pound, perhaps unfairly, is now being compared to an emerging market currency. A turnaround indeed.