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'Jamaican dollar still over-valued'

IMF staff figures exchange rate slightly further from equilibrium than BOJ

Wednesday, June 25, 2014    

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THE International Monetary Fund (IMF) believes the Jamaican dollar could be over-valued by as much as 15 per cent.

The IMF staff's recent assessment indicated significant improvement in the exchange rate over last year May, when it figured the dollar was over-valued by a range of nine to 22 per cent.

Since May 2013, the dollar depreciated by over 11 per cent.

Bank of Jamaica (BOJ) Governor Brian Wynter recently suggested that the local currency was approaching a competitive rate, which means that there should be a slowdown in its slide against the US dollar.

But IMF officials think his projections were slightly too optimistic.

"The BOJ agrees with (IMF) staff that substantial improvement in the price competitiveness of the Jamaican economy has been achieved over the last year as the exchange has moved in line with market fundamentals," said a joint statement issued last week by Thomas Hockin, IMF executive director for Jamaica and Trevor Lessard, advisor to the executive director. "As a result, BOJ analysis indicates that the exchange rate is much closer to equilibrium than the staff's assessment (three to 15 per cent over-valuation) would suggest."

Assessment of the exchange rate using a macroeconomic balance approach, which compares the underlying current account balance with a norm derived from fundamentals, such as oil balance, fiscal position, remittances, and aid inflows, points to the lower end of the projected range.

"The current account balance norm is estimated at a deficit of five per cent of GDP against an underlying current account deficit of 5.5 per cent of GDP," said the IMF staff appraisal.

The current account deficit was 9.5 per cent of GDP in 2013/14, reflecting a reduction of two percentage points relative to the previous year. It is expected to fall below 5.5 per cent by March 2018 and to five per cent by March 2020.

Using the equilibrium real exchange rate (ERER) approach, adjusting for the impact of tourism, suggests an over-valuation of about 15 per cent now.

But the IMF noted that "this approach is purely backward looking and does not incorporate the programmed policy adjustments over the medium term".

The econometrically derived ERER is "poorly suited to providing an accurate assessment of the exchange rate during times of significant policy and exchange rate adjustment," said the IMF appraisal. "Excluding the ERER method, staff's assessment shows an exchange rate that is close to equilibrium, especially considering the substantial variability inherent in these assessments.

"Going forward, future movements in the nominal exchange rate are likely to be driven by macroeconomic and trade-relevant variables, such as the inflation differential between Jamaica and its major trading partners, and the success of policies to raise productivity and remove obstacles to investment."

Indeed, Richard Byles, co-chair of the Economic Programme Oversight Committee (EPOC) pointed to this outcome just two weeks ago.

Then, he reasoned that the local currency needs only slide roughly six per cent this year to maintain its competitiveness.

"Inflation in Jamaica in [fiscal year ending March 2013] was slightly over eight per cent while US inflation was about two per cent. This calculates to a competitive gain of approximately five per cent for the Jamaican dollar," he said.

The dollar traded at just over $111.90 to US$1 on average yesterday, which reflects depreciation of 4.5 per cent since January, according to Bank of Jamaica data.

Indeed, respondents to the central bank's survey on inflation expectations in April indicated that they expected the value of the Jamaican dollar against the US to fall to $112.20 by the end of June; $114.72 by the end of September; and $117.46 by next April.

— BO

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