Jamaica - Third Highway Project

FILE COPY DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1476-JM REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO JAMAICA FOR A THIRD HIGHWAY PROJECT June 24, 1974 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  Currency Unit Jamaica Dollar US$1.00 3 J$.909 J$1.00 US$1.10 Fiscal Year = April 1 to March 31  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO JAMAICA FOR A THIRD HIGHWAY PROJECT 1. I submit the following repolt and recommendation on a proposed loan to Jamaica for the equivalent of $13.5 million to help finance a pro- ject for the construction of arterial roads. The loan would have a tenm of 25 years, including four years of grace, with interest at 7-1/4% per annum. PART I - THE ECONOMY 2. Economic Report (No. 257a-JM) entitled "Current Economic Position and Prospects of Jamaica" was distributed to the Executive Directors on March 12, 1974. Country data sheets are attached as Annex I to this report. 3. During the decade 1962-72 the economy has expanded rapidly with the annual rate of growth accelerating from about 4.5% to about 5.5%. At the same time the economy has undergone major structural changes. Mining, alumina production and tourism' all supported by large private capital inflows, have expanded, while agriculture has stagnated and agricultural exports, notably of sugar, have declined. This shift in the production pattern has been accompanied by rapid urbanization, and by the emergence of severe and persistent unemployment and of sharp disparities in income distribution. Large-scale emigration abroad during the decade has resulted in the loss of significant numbers of skilled and semi-skilled workers; the consequent shortage of technically qualified personnel has been aggravated by deficiencies in the academically oriented educational system. 4. As a result of its limited resource endowment and the small size of its domestic market, Jamaica has a very open economy heavily dependent on the external sector. Until 1972 a widening current account deficit in the balance of payments had been offset by substantial private capital in- flows for expansion of the bauxite/alumina industry. These inflows fell off sharply in 1972 with the completion of major investments in alumina capacity. Partly as a consequence, but also due to some weakness in monetary and fiscal programs, Jamaica for the first time since independence experienced serious balance-of-payments difficulties. Corrective action taken late in 1972 and early 1973, including devaluatiors, the imposition of import restrictions and a tightening of credit policy, was successful in temporarily reversing the reserves drain during the middle of 1973. However, subsequently exchange reserves have fallen again and by the end  - 2- of 1973 were down to about one monthst imports. The situation has been aggravated by the tripling of petroleum prices at the end of 1973 which will cost Jamaica about US$100 milli-n extra in 1974, equivalent to about , of 1973 export earnings. To conserve fo:-eign exchange reserves the government in early 1974 took additional mea;ures including an increase -n gasoline taxes, further restrictions on imports and credit availability and an increase in interest rates. Jamaica has recently obtained increases in the prices of its sugar and banana exports to the United Kingdom and in May of this year announced increases in taxes and royalties on the U.S. and Canadian-owned bauxite companies, estimated to yield an additional $155 mil- lion in 1974. The greatly increased revenues in prospect from bauxite taxa- tion would provide substantial relief to Jamaica's balance of payments during the rest of 197h and in ensuing years. The government action followed the failure to reach negotiated agreement with the ccmpanies on new tax measures. The companies have objected to the tax increases announced and indicated that they would take legal action; three US-owned companies have requested arbitra- tion before the International Centre for Settlement of Investment Disputes (ICSID). In addition to the issue concerning the taxes and royalties, there are other outstanding issues (such as land ownership, government participa- tion in companies, and guaranteed supply of bauxite for companies), on which the companies and the government have indicated their willingess to negotiate. 5. In recent months there has been a sharp increase in Jamaica's donestic price level which during 1973 increased by an average of 19% over the previous year and by February 1974 the consumer price index had inrerased by about 27% over February 19730 In part the increase can be attributed to recent increases in world prices and higher import prices resulting from devaluation. However9 under the pressure of active trade unions, wage settlements in recent years have outstripped increases in productivity and have been particularly high during the last few months, reaching 25% in the construction industry and even higher levels in other sectors. The government is considering the early implementation of a iices and incomes policy which, if effective, would help Jamaica retain its international competitiveness. The government is keeping under review action to progressively increase interest rates, which have becoms negative in real terms as a result of recent price inflation. This would encourage savings, and help reduce the present interest rate incentive to invest funds abroad rather than in Jamaica. 60 Without a sustained rate of economic growth of about 7% annually it will bs difficult for the country to achieve its principal objective of a significant reduction in the high rate of unemployment, currently about 15%. The need for increased job creation will become even more acute in the years ahead since the growth rate in the total population of working age is expected to rise from 0.5% to 3% during the period to 1980 due to falling emigration and an increase in the birth rate in the 1950so For the immediate future the potential for increased growth and employment is encouraging. In agriculture, a comprehensive review of the sector has recently been undertaken with assistance from the Bank; government initia- tives are already under way to rehabilitate the important sugar industry, and other government plans to revitalize the sector include land-use reorganization to increase productivity and employment, and measures to stimulate other export crops and domestic food production. In the mining sector, bauxite and alumina output should increase substantially as a result of recent investments. A substantial investment in an oil  refinery is in prospect with the possibility of associated investments in retro-chemicals; and in manufacturing, there is potential for increased contribution to export growth. However, the sxtent to which Jamaica's agricultural and industrial growth potential can be realized will depend in large part on how successful the government is in implementing policies to improve Jamaica's competiti-v position and to overcome existing insti- tutional constraints. 7. The increased rate of growth necessary to make a significant impact on unemploy1mnt will reciuire substantially higher inflows of private and public capital than in the recent past. Such inflows are in prospect over the next few years and given continued progress in public policies, it is likely that they could be maintained for the rest of the decade. The source and direction of commitments of external public loans (including government-guaranteed loans) from 1965 to 1972 are given in the table in Annex I and have averaged over $40 million per annum. For the five-year period 1974-78, public capital inflows, including guaranteed loans to the private sector, could reach J$450 million. From existing indications, about 60% will be raised from official sources - the Bank, IDB and bilateral aid sources, while the remainder would consist of medium-term loans from suppliers and financial institutions. Private capital inflows in the form of equity and loan payments are also forecast to be substantially above the recent past, mainly because of private loans projected for the proposed oil refinery. Jamaica will also need to mobilize increased domestic fi- nancial resources, both public and private. It will thus be necessary for the government to take measures to restrain the growth of government current expandit.ures and to achieve a further growth of revenue relative to GDP. A recovery in private sector savings can also be expected provided the govern- ment maintains fiscal discipline and discourages consumption by the appropriate use of monetary policy. 8. Jamaica will need to take prompt and determined policy measures in the critical areas of the economy outlined above, and discussed at greater length in the Economic Report, to maintain economic stability and achieve a reasonable rate of sustained economic growth. Assuming sound policies are pursued, public debt service as a ratio of export earnings is projected to rise from about 4.0% in 1972 to perhaps 7.5% by 1980. Given the importance of exports in Jamaica's GNP, this ratio is high but not unmanageable, and the country remains creditworthy for further borrowing on conventional terms. Although no special terms of Bank lending appear justified on country grounds, the foreign exchange component of projects in sectors such as agriculture, urban development and population planning, may be relatively small; in order, therefore, to help achieve an adequate level of external capital inflows some local currency financing would be justified in these cases. While it has not yet been possible to assess fully the impact of recent higher petroleum and other commodity import prices on the Jamaican economy., the rise in tax revenues and export earnings in pros- pect from bauxite, alumina and sugar may largely offset the increased costs of petroleum and other imports (paragraphs 4 and 6 above), The Bank is currently reviewing the situation more closely, with particular emphasis on the external sector, following a recent economic mission to Jamaica in mid-June.  _4- PART II - BANK GROUP OPERATIONS IN JAMAICA Introduction 9. Since the country's independence in 1962, the Bank has made ten loans to Jamaica totalling about $90.0 iaillion. Of this amount about $h0.0o million has been for infrastructural investments in electric power, water supply and highways; the remainder has gone into education, family planning? agricultural credit and a sites and services project. The proposed loan would be the third for highways investment. The first highways loan (loan 408-JM) of $5.5 million, also for the construction of arterial roads, was made in 1965; this was followed by a road improvement and maintenance loan (loan 899-JM) of $9.3 million in 1973. There have so far been only two IFC operations; a loan in 1961 to a pre-mix concrete company, and an equity/loan investment in 1968 in a hotel project. Annex II contains a summary statement of Bank loans and IFC investments as of May 31,1974 together with notes on the execution of ongoing projects. As noted in the Annex, the Bank has experienced problems in the execution of projects in Jamaica, although the situation has improved in recent months. Future Direction of Bank Lending 10. The case for continued Bank lending rests on the need to provide some of Jamaica's external financing requirements and to support appropriate policies in critical areas of the economy mentioned in Part I of this report. As in the past, Bank lending will also be directed towards achieving improve- ments in infrastructure, at contributing to the alleviation of the unemploy- ment problem and to assisting in the wider distribution of the benefits of growth. After a lull in Bank lending 1972/73 - due largely to institutional constraints and slow project preparation - the pace of Bank operations is expected to accelerate over the next two years. The Bank's share of ext.ernal public debt is projected to increase from an estimated 15% in 1974 to about 20% in 1978 and its share of external public debt service to increase from about 10% to 12% over the same period. 11. In infrastructure, the Bank plans to continue to lend support to high priorlty investments in the transportation sector which were identified by a transportation survey financed by CIDA and carried out in 1968/70. The project now before you constitutes the first phase of the government's 1974-79 arterial road construction program and includes heavily used sections forming part of the important east-west and north-south road systems; it is expected that the govern- ment will seek further Bank assistance for the second phase of the program to start in about two years time. An airport development project has been prepared, which will shortly be submitted to the Executive Directors for consideration; lt would help relieve constraints upon the fure growth o.f international air traffic and provide a more sound financial and ir titutional base for managing Jamaica's two international airports.  12. Other infrastructure investments being considered by the Bank would have as a primary objective improving essential facilities for the rapidly expanding Kingston Metropolitan Area (KMA), which itself ac- counts for over one-quarter (about 550,000) of the total population of Jamaica and a large proportion of its industry and commerce. A proposed sewerage and water supply project would provide limited extension of Kingston's sewerage system to meet its most urgent needs, and also additional water so as to avoid shortages which would otherwise develop over the next three to four years. The project would also include engineering studies and preparatory work necessary for the next major water supply project for Bank financing. More widely the proposed infrastructural investments would help strengthen the in- stitutions concerned. 13. In the social areas, in addition to the re