Jamaica's PL480 section 108 auction program : past successes and future directions

480 Section 108 auction program in Jamaica for the period FY 1985 to FY 1990. Under the program, USAID auctions Section 108 funds to private intermediary financial institutions (IFIs) for onlending to productive private enterprises. To date, USAID has held eight auctions, which will result in total lending over 5 years of J$357 million to qualified IFIs. Reflows of principal and interest to date amount to J$263 million, of which part has already been auctioned. J$136 million is available for future auctions. To have a developmental impact on the country, a subloan project must have the potential to do one or more of the following: create employment; earn foreign exchange or save foreign exchange; bring new technology or processes to the country; bring new entrepreneurs into the sector; and contribute to implementation of sectoral or macroeconomic policy objectives. In Jamaica's case, all outstanding subloans have at least one of these characteristics; most have two or more. More funds are now flowing to the agricultural sector than in 1991. The bulk of current subloans are in the construction sector (housing and office buildings), whereas tourism received most of the funds in 1991. IFIs are passing along the advantages of the long-term fixed rate Section 108 funds much less than in 1991. A considerable number of the "first-tier" subloans are now revolving credits rather than term loans, and, with the exception of one subloan, interest rates are variable and quite high. This is due to the Bank of Jamaica's tight monetary policies, which have pushed average lending rates to over 60%. Because Jamaica currently has an inverse yield curve, IFIs are treating Section 108 long-term funds as they treat short-term funding sources. When interest rates fall, they will repay the loans which carry rates above their marginal cost of funds. USAID has held seven auctions for "first tier" IFIs, with a total of J$359.94 million auctioned, of which J$55 million was repaid early. Several trends have emerged from these auctions. (1) The amount of Jamaican dollar funds has increased steadily, due to the steady depreciation of the Jamaican dollar vis-a-vis the U.S. dollar. The U.S. dollar equivalent remained at around US$25-29 million except in the eighth auction, when the amount demanded dropped sharply. (2) The spread in interest rates at the auctions has increased sharply, reflecting the differing marginal costs of funds between institutions. (3) The newer, smaller and more aggressive banks are willing to bid higher rates of interest and thus win all the funds. One banking group alone holds 68% of outstanding Section 108 loans. The sixth auction to "second tier" institutions was intended to expand Section 108 subloans to the agricultural and rural sectors and pass on the advantages of the long-term fixed interest rate money to the end borrowers. Development banks in Jamaica are the only institutions that typically will make long-term fixed rate loans, and even they are moving to variable rates due to Jamaica's volatile interest rates. In general, the "second tier" auction was successful in fulfilling these objectives. Only J$3 million was auctioned because USAID wished to test the "second tier" institutions' absorptive capacity. One institution, Trafalgar Development Bank (TDB), captured J$2.3 million. National Development Foundation won the rest. Several issues arose from this auction. (1) The "second tier" group includes fairly disparate institutions. TDB is by far the largest, and other institutions felt it dominated the auction. Credit unions themselves vary greatly in size and financial strength. The question is whether USAID should divide these institutions still further in future auctions. Because the Section 108 guidelines stress administrative simplicity, this is not advisable. (2) The borrower risk of "second tier" institutions is greater. Many credit unions and cooperative banks are financially weak. USAID should make certain that auction participants are well-vetted for financial viability. (3) In lending to small business, it is often advisable to lend on shorter terms to minimize default rates, but Section 108 objectives favor longer term lending. Thus, some program contradictions may arise. For the immediate future, the two competing uses for reflows are relending to IFIs and payment of U.S. obligations. Because the auction program has been successful in meeting program objectives, USAID should continue auctions for the foreseeable future. (Author abstract, modified)