Dennis Morrison

Some financial analysts have cited speculative pressures as the reason for the increased demand for US dollars in the local foreign exchange market. This pressure has been evident since the end of last year and in the early days of the new year. The view about speculative pressure is based on the fact that brokers have been identified as the source of the increased demand. Simultaneously, end users have shown little sign of stepped-up activity.

That the pressure has come at a time when the foreign exchange market is usually either in a surplus or well-balanced position is why it is being regarded as being speculative. Moreover, the broader picture of significant growth in exports, both merchandise and services, as well as greater inflows of investment, suggests that supply ought to be adequate to meet demand in this period of the year. This is also a time when the peak of Christmas imports has passed, and therefore demand pressures fall off.

In response to the situation, the Bank of Jamaica has been intervening to boost supply, with the intention of allowing the market to clear, thereby maintaining stability. It has also been selling Jamaican dollar-denominated assets to local brokers to pull in any excess liquidity, which is what is helping to spur the demand for US dollars. Over recent times, this mopping up activity had become less prominent, as excess liquidity did not appear as the kind of challenge that it had been in the earlier period.

Putting aside any short-term exigencies or misalignment in our financial markets, the current situation is a reminder of the weaknesses in the transmission mechanism, which is to allow savings to be converted into investment. Financial institutions are the lynchpin, because they collect our savings and are supposed to direct them into investment activities so that returns can be earned from expanded economic activity. While high interest rates were used to fight inflation and to restore macro-economic stability, these institutions and individual investors became used to a diet of high returns from government paper.

Commercial bankers and merchant bankers, among others, had the easy job of collecting deposits, placing them in government paper, and then announcing huge profits at the end of the quarter. From a short-term, investor standpoint, this was the more attractive option, as one didn't need to worry about risks or even bother to structure financing deals for investments in the real sector. With the huge returns from this activity, it was also advantageous to keep money in high interest rate Jamaican-dollar instruments, rather than low interest foreign currency instruments. And this became even more attractive when US interest rates declined to very low levels in 2001.

The landscape has now changed, as Jamaican dollar interest rates have fallen to levels that are the lowest in over 20 years. Bankers and investors were being warned over the last two years that as interest rates fell they needed to begin to reposition their operations seriously if they were to continue to generate high returns. Lending to businesses and structuring financing deals for investments in the real sector had to be the priority activities, substituting for what had become the traditional dependence on government paper.

The response was not enthusiastic, although some institutions like NCB showed movement towards increased lending to businesses. In so many instances, investment opportunities were taken up by overseas lenders, even where the loans were to relatively low-risk projects. The appetite, drive and know-how for structuring investment projects seem to have been lost by our financial sector players. Meantime, foreign investors continue to lead the charge in the expansion of several sectors and in the drive to modernise our infrastructure. Our savings, rather than being used to expand the local economy and increase employment, are feeding speculative pressure in the foreign exchange market because government interest rates are not what they were. Changing this equation remains one of the main challenges of the Jamaican economy.

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