Dollar will slide further if Government fails to act

Garth Taylor, Guest Columnist

There are several reasons why the Jamaican currency has seen sharp depreciation over the past several months. When a currency loses value, it is usually because of three broad factors, namely: (1) fundamental weakness in that country's competitive economy (otherwise called uncompetitiveness or market forces), (2) devaluation by government, and (3) speculation on that currency.

Whether the pundits have properly represented these to the public is another story. For the most part, they have alluded to natural market phenomena in the export/import market-bearing forces on our currency that has seen it move from US$1:J$70 to US$1:J$87 between September 2007, on the heels of the Jamaica Labour Party (JLP) victory, and December 28, 2011 when the party lost the elections.

It has subsequently worsened to more US$1:J$99 under the new People's National Party (PNP) administration. Enthralling as it may be, this does not tell the whole story.

However, such staggering figures tempt us to accept these arguments as wholesome since the Jamaican market seems to be a low-hanging fruit which is vulnerable to powerful international traders, and since it is common knowledge that in an open free-market economy, exchange rates are determined by the demand for, and supply of, relative currencies among trading countries.

OTHER FACTORS

The truth, though, is that all factors which affect the demand for currencies are determinant of the exchange rate. This means that prices of a country's goods, inflation rate, monetary policy, interest rates, budget deficits and money supply are all important in determining the exchange rate.

What is troubling is that some of these will be directly influenced by the austerity structural-adjustment policies of the International Monetary Fund (IMF), particularly interest rates which have been lowered because of the National Debt Exchange (NDX). It is in this context that we must subject the IMF conditionalities to microscopic scrutiny and avoid joining the well-wishers in their oversimplifications.

In stark contrast to their concern about structural-adjustment programmes, they seem mum on the possibility that the Government may have sometimes deliberately pursued a devaluation exercise, not in the strict sense since we do not operate a fixed exchange rate regime, but indirectly by lowering interest rates. This is not to suggest any contrivance on the part of the Government, since the debt exchange, coincidentally, is an IMF prerequisite for the agreement.

Whatever is true, it remains a law of economics that interest rates and exchange rates are correlated. Their relationship is such that higher interest rates attract foreign investment and their associated foreign currencies. This results in a lowering of the price of that foreign currency and an appreciation of the local currency. The converse is also true, which, at the moment, is our main cause for concern given the NDX effect.

DEBT EXCHANGE EFFECTS

The sharp falls of the currency which occurred when the NDX offer was announced on February 11, 2013 to when the offer closed on February 28, 2013 cannot, therefore, be ruled out as a direct consequence. In fact, this period saw the Jamaican dollar depreciate by approximately J$3.

Additionally, some governments voluntarily pursue currency devaluation, not as part of any IMF package but, instead, to mitigate negative market forces when the economy experiences turbulence. Indeed, a depreciating Jamaican dollar is thought by some to boost the economy by making exports from Jamaica more attractive to foreigners since their price becomes relatively cheaper. The Edward Seaga administration that came to power in 1980 voluntarily devalued the Jamaican dollar between 1984 and 1985, and it is believed that such was the reasoning behind it.

What has also seemed to be completely obliterated from the contemplation of commentators is the effect of speculation on the Jamaican dollar and the fact that speculators may not care whether it is IMF conditions or government intention to depreciate the Jamaican dollar.

To them, the clairvoyance of hindsight and our previously failed IMF programme of the 1980s is enough to create expectations that the Jamaican dollar will keep losing value. The fact that the Seaga administration of the 1980s, more or less, met all IMF conditions certainly doesn't help to disillusion them.

With full knowledge that time could prove them wrong, they risk borrowing money from local banks and buy large sums of foreign currency, an activity which itself causes further depreciation of the Jamaican dollar.

The Bank of Jamaica may feel the need to rescue the dollar by using up its foreign currency reserves to buy up the excess local currency and thereby deplete those reserves which are limited, as is perhaps contemplated with the latest bond offer available from June 12-18.

The end result is that either market pressure or debt exchange-induced low interest could encourage speculators to hoard foreign currency, which could result in further movement of the exchange rate.

Let's just hope the Government takes this possibility as its signal to impose tighter foreign currency policy as a preventative measure.

Garth O. Taylor is an economist/attorney-at-law based in Kingston. Email feedback to columns@gleanerjm.com and taylorp_2001@yahoo.com.