Dangerous dollar wine

Devaluation without reforms is madness

Chris Tufton, Contributor

Despite the knowledge that we are inching closer to a deal with the International Monetary Fund (IMF) and the other multilaterals, and an announced Estimates of Expenditure showing a reduction in government expenditure for the 2013-14 fiscal year, Jamaica's economic prospects are delicately poised.

We are on a tenuous economic path, with more people in the country thinking we will eventually fail again to turn the economy, instead of overcoming the challenges of debt and anaemic economic growth. We are, for the most part, a country of non-believers in government's capacity and proposed economic policy. Negativity and pessimism have long been embedded in the psyche of the Jamaican people, and this is not good for any government programme going forward.

All Jamaica knows we have tough times ahead, even with the proposed IMF rescue plan. So even while things are a bit clearer on the way forward, Government has a major task to make believers out of infidels on the road to recovery.

CONFIDENCE AND THE DOLLAR

The consistent slippage of the Jamaica dollar against the United States (US) currency is primarily caused by a market that is more confident in the US currency than it is in the Jamaican dollar. As a result, Jamaicans are demanding, and converting where they can, their Jamaican dollars into United States currency. That demand is driving up the price people are willing to pay and sellers are negotiating to get for the greenback. The net effect is a scarcity of US dollars and local importers complaining about their inability to get and afford US currency.

The Government seems to have a concern that part of the slippage of the Jamaican dollar is due to speculators who are hedging their bets or seeking to profit from the uncertain environment. Only this week the IMF, apparently seeking to counter negative perceptions around the absence of a board imprimatur, released a statement suggesting that an agreement was imminent. Meanwhile, the Government, through the minister of finance and the central bank governor, has made public statements aimed at improving confidence in its economic programme.

But there seems not much else the Government can do in the short term, at least, until the IMF board gives its formal approval to Jamaica's programme.

DEFEND OR NOT TO DEFEND

With our net international reserves under US$900 million, declining from more than US$2 billion just over two years ago, the capacity of the central bank to defend the currency is greatly reduced. Additionally, it seems the motivation to do so may not be as intense, in part because of a belief by the multilaterals, the IMF being the chief proponent, that adjustment in the exchange rate will be good for Jamaica's economic management going forward.

So in one sense the Government is on record, through the central bank, as saying that it will defend the Jamaican dollar through periodic interventions; and on the other hand, there is a strong view that the IMF is insisting that there is an exchange-rate adjustment to support the achievement of its debt-to-GDP ratio and growth targets over the next four to seven years. This apparent difference of opinion is expected to spill over into the wider society in the months to come, with strong arguments on both sides of the discussion.

Public distrust and discontent is likely to heighten over the next year or two if this dollar depreciation is not identified with some tangible benefits to economic activity. The pro-depreciation economists and policy strategists may have several reasons to support this type of adjustment in the exchange rate, but they must always be mindful that this must be a means to an end, and the end must be economic growth for the country and tangible benefits for the Jamaican people. Otherwise, disaffection will set in fast and the process becomes counterproductive, expanding and entrenching the army of non-believers.

IN SUPPORT OF DEVALUATION

The value of the Jamaican dollar against its US counterpart, which is currently approaching J$100 to US$1, has long been argued to be a potential source of competitiveness for the Jamaican productive sector and its export prospects.

Those proponents who argue in support of depreciation of the Jamaican dollar argue on the basis that the country will benefit because its debt in Jamaican dollars would be easier to service, while Jamaican exporters and prospective exporters would be able to offer cheaper prices to the international market and, hopefully, in the process, increase the demand for exports, increase business activity and job creation related to increase demand.

Additionally, proponents of devaluation argue that the increased costs of imports because of a devalued dollar will dampen imports and encourage more local production and consumption, which would support critical sectors such as agriculture and, at the same time, would stifle demand pressures for foreign exchange, primarily the US dollar.

While these may be desired features of the sliding Jamaican dollar, many are not convinced that the history of devaluation in Jamaica has shown a net gain in international competitiveness, increase in export activity, job creation, or significantly less debt.

Proponents against devaluation make the case that Jamaica has too many systemic and structural deficiencies to realise any net benefit from further devaluation, while devaluation is certain to increase hardships on the general public because of inflationary price increases.

They argue that any benefits from this type of exchange-rate adjustment are likely to be overtaken by the lack of efficiencies in the public sector critical to facilitate private-sector motivation and expansion, as well as incomplete tax reform.

Similarly, other critical cost issues that would need to be simultaneously addressed would include energy and security risks, which contribute significantly to the costs of doing business. Of note, too, is the high import content of direct and indirect inputs for local production. Jamaican-dollar devaluation will likely mean greater costs for these inputs, such as raw materials and electricity rates.

DEVALUATION WITHOUT REFORMS IS MADNESS

If devaluation is a policy option that the Government has to pursue, IMF or no IMF, it must at the same time move speedily to address efficiency gains in the public sector to reduce transaction time and costs of business that would likely motivate entrepreneurs to expand and take advantage of improved export competitiveness.

It is also true that manufacturers and exporters should also recognise they have an important role to play, in improving their competitiveness in a devalued currency context. The argument about high import content and higher costs resulting from a devalued dollar would be less relevant if manufacturers and exporters sought to create greater value propositions to attract higher prices in their targeted export markets.

In other words, importing giant rolls of toilet tissue or drums of dishwashing liquid and converting to consumer sizes may not be sufficient value created in this high-cost environment to attract greater demand and better prices from a devaluation strategy. The multilaterals would likely argue that with an enabling environment, entrepreneurial activity must step up to the plate and create greater value for the opportunities that exist both for local and international demand.

TARGETING THE MOST VULNERABLE

On the social-impact side, devaluation will lead to increased prices, which could have severe consequences for the most vulnerable in the society, primarily pensioners and Jamaicans living at or below the poverty line. For them, it will be a painful adjustment, as their incomes are primarily fixed or declining in real terms. History has shown, also, that dollar depreciation can lead to social pressures for wage increase demands, which could have a further destabilising effect on the economy. We know too well the cost of strike action and sickouts on production and productivity.

So in light of the sliding dollar, the Government, as a policy prescription, must assess its social safety net such as PATH to improve the efficiency of its targeting to cushion the impact of increase prices on the most vulnerable, even while it carries through reforms that will encourage businesses to be more efficient and expand.

Exchange-rate adjustment can be a double-edged sword. It will certainly impact prices for both consumers and producers. As Jamaicans, we must all seek to understand the impact and implications of this adjustment, and lobby our policymakers to sharpen their policy focus to respond particularly to hastening the growth prospects in the country. This can be achieved through the key institutional reforms related to taxes and doing business.

Depreciation only makes sense when other reforms are taking place to encourage businesses to expand and export. Additionally, reforms must also include targeted intervention for vulnerable groups in the society.

Dr Chris Tufton is a senator, opposition spokesman on foreign affairs and trade, and investments, and co-executive director of CaPRI. The views in this column do not necessarily represent those of the above-mentioned entities. Email feedback to columns@gleanerjm.com and cctufton@yahoo.com.