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The Jamaican dollar in perspective

BY DR KARELLE SAMUDA &
STEPHANIE ABRAHAMS

Sunday, August 12, 2018

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There has been much opinion and discussion in light of the recent depreciation of the Jamaican currency, much of which has been anecdotal, emotional and sometimes confusing.

It is not clear that the recent movement in the Jamaican currency represents anything more than what currencies do in a flexible exchange rate regime. When countries experience significant devaluations, it is usually a result of weak economic fundamentals, primarily a significant fall in foreign reserves, a substantial increase in inflation, a high fiscal deficit, or a precipitous growth in the current account deficit.

However, none of these are the case in Jamaica, which indicates that the fluctuations in the foreign exchange rate are not being driven by any fundamental weaknesses in the economy.

Much to the contrary, Jamaica's economic fundamentals are headed in a positive direction.

Our net international reserves have reached an all-time historical high of over US$3 billion and the percentage of “borrowed” reserves has also dropped significantly. Our annual inflation rate is currently less than three per cent, below the Bank of Jamaica (BOJ) target range of four per cent to six per cent. We are on target to achieve a primary account surplus of seven per cent for the sixth-consecutive year, so our fiscal house is largely where it should be. Our current account deficit has improved from highly unsustainable levels in 2013 to levels today where it is fully financed by foreign direct investment (FDI).

So, if our economy is fundamentally sound, what could explain the recent depreciation of the currency?

The first and easiest answer is that a depreciation is one of the directions of what should be expected in a flexible exchange rate regime — the currency sometimes goes up, sometimes goes down, and sometimes remains unchanged, all in response to supply and demand. Innumerable factors could influence supply and demand, including complex international events.

Jamaica is a small, open economy that is not insulated from global market forces. The international currency markets have experienced elevated movement over the past few months, with many emerging economies experiencing unexpected and, in several cases, historically unprecedented levels of depreciation.

Between March 31 and August 9, 2018 (the date of writing), the Jamaican dollar has depreciated from J$128 to J$136, a decline of approximately 6.3 per cent. This is exactly in line with the decline in the MSCI International Emerging Markets Currency Index — a basket of currencies in 25 emerging market countries, which does not include Jamaica — which has also fallen by 6.3 per cent over the same period.

In fact, several countries have fared even worse. For example, the Chinese yuan depreciated by 10 per cent over the same period, the largest such decline over a short period in China since 2015. Other examples of currency devaluations higher than Jamaica's over the same period include the Argentina peso (30 per cent), the Turkish lira (28 per cent), the Russian ruble (18 per cent), and the South African rand (10 per cent).

Unsurprisingly, the US currency has also strengthened over that period, vis--vis the currencies of developed countries, by the same relative amount, which also helps to explain the depreciation in the Jamaican dollar over the same period. The US Dollar Index — which tracks the value of the US currency versus six other major international currencies — has strengthened (or revalued) by 6.1 per cent over the same period, driven by several factors.

So, why is there a broad currency weakness across a range of developed and emerging market currencies? First, the US Federal Reserve has increased its lending rate in various phases from 0 per cent less than two years ago to approximately two per cent today. This has attracted inflows of capital from many other countries.

Second, the Trump Administration in the United States has taken an increasingly aggressive protectionist posture in both its rhetoric and its actions, including the actual or threatened imposition of tariffs on goods from several countries. The possibility of an international trade war, and the perception that the US would likely win such a war (or at the very least reduce its trade deficit as a result of the tariffs), has also led investors to withdraw capital flows from emerging markets in favour of the US.

Importantly, there are several market commentators who believe that this international appreciation of the US dollar may be temporary and that the fundamentals of the US economy — including a growing fiscal deficit associated with the recent tax cuts — and a widening trade deficit, may likely result in a subsequent depreciation of the US currency as early as Q3 or Q4 of this year. This strengthening and weakening of the currency is a feature of a flexible exchange rate regime.

Domestic factors also play a role in the driving supply and demand dynamics. For example, factors from the domestic side that can influence supply and demand include large imports for consumption, large imports of capital goods, or where large speculative positions are built up by the private sector.

Most market participants and commentators in countries with flexible exchange rate regimes have become accustomed to these movements in their currency; not getting anxious when the currency depreciates or celebrating when the currency appreciates.

As noted by our minister of finance recently, a flexible exchange rate regime is a prerequisite for the implementation of formal inflation targeting, which involves the explicit adoption of an inflation target as the primary objective of the central bank, all other objectives (including the exchange rate) being a subordinate goal. Importantly, the inflation rate incorporates the effect of exchange rate movements on the price of goods and services.

The purpose of inflation targeting is to facilitate low, stable and predictable inflation in the economy; eliminate political influence in monetary policy operations and decisions; inspire market confidence; strengthen financial markets; and help to foster sustainable, long-term economic growth and job creation. Inflation objectives are achieved primarily through central bank changes in interest rates and liquidity conditions.

It is important to note that even in a flexible exchange rate regime, however, the BOJ reserves the right to intervene in exceptional circumstances. In a press conference in November 2016, the International Monetary Fund Mission Chief to Jamaica Ms Uma Ramakrishnan noted that the Government of Jamaica was committed to a flexible exchange rate policy, which means that the currency moves, the BOJ does not set a targeted exchange rate level, and the BOJ does not intervene in the foreign exchange markets unless there are significantly disruptive and “disorderly market conditions” or conditions of “excess volatility”.

Going forward, it is expected that the implementation of inflation targeting coupled with related reform — such as the Foreign Exchange Intervention and Trading Tool in June 2017 to facilitate the buying as well as selling of foreign exchange and foster more competitive behaviour among authorised dealers and cambios of foreign currency — will help to provide the market with greater information and transparency that will support and strengthen our flexible exchange rate regime for the greater good of the country.

— Dr Karelle Samuda is a Jamaica House Fellow assigned to the Ministry of Finance and the Public Service

Stephanie Abrahams, MBA is a senior analyst in the office of the minister of finance and the public service.

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