Current IMF thinking on Jamaica's exchange rate and the state of public sector reform


Sunday, November 05, 2017

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Yesterday the IMF released its second review of Jamaica's current Stand-By Arrangement. The focus of the review included exchange rate and liquidity management, and ongoing wage negotiations, amongst other things.

With respect to the exchange rate, the IMF staff appraisal observed that, “Moving to inflation targeting requires making price stability the anchor for monetary policy alongside a flexible, market-determined exchange rate.”

It continued, “The accommodative monetary stance — with a loosening bias should weak growth persist and downside inflation risks materialise — is appropriate.”

Unsurprisingly, the appraisal added, “Pressure to use accumulated reserves to counter healthy two-way currency movements should be resisted; foreign exchange sales should be reserved for smoothing excess volatility. Reliance on foreign exchange surrender requirements should be gradually reduced, with reserve accumulation increasingly supported by foreign exchange buy auctions.”

In a video question and answer media session on the report, IMF Mission Chief to Jamaica Uma Ramakrishnan expanded on what that meant. She noted that the Government was committed to a flexible exchange rate policy — simply put, this means the currency moves. No exchange rate level of the currency is targeted, and interventions should be limited to “disorderly market conditions” or conditions of “excess volatility”.

Commenting on the Bank of Jamaica's recently announced reduction of surrender requirements by five per cent, she noted that the IMF believes the Bank of Jamaica should ultimately reduce its surrender requirements to zero. The Bank of Jamaica has reserve requirements to allow it to build reserves, so if surrender requirements go away, the central bank will need to have a mechanism to buy from the market. She does not expect this to “happen overnight”, and it will need to be “done carefully”.

As one builds the foreign exchange markets, the price discovery mechanism should improve and liquidity should slowly increase, ultimately reaching the point where the Bank of Jamaica simply becomes a player like everyone else.

She added that the IMF believes Jamaica should eventually move to inflation targeting, which means the Bank of Jamaica has the single mandate of price stability, rather than multiple mandates such as the exchange rate and growth. Now is a good time to start shifting to inflation targeting as the only mandate, thereby keeping inflation expectations well anchored, as inflation has come down dramatically.

In response to a specific comment that a spokesperson from a major private sector organisation had made about the exchange rate appreciating too rapidly in the past month, Ramakrishnan noted that two-way currency movements are “normal and healthy”, and that two-way movement is exactly what a flexible exchange rate system should be doing.

In answer to a question as to whether the IMF had “a policy of depreciation” with respect to the Jamaican dollar, Ramakrishnan said that the IMF did not have a policy of depreciation “per se”, and they did not monitor the exchange rate on a “daily basis”. When the Extended Fund Facility was agreed with the Jamaican Government in May 2013, the exchange rate was overvalued, but their last assessment suggested that it was now “broadly” correctly valued. This assessment took place last year and would be updated in the next few weeks.

However, in her view, this meant that the rate of depreciation of the exchange rate should be broadly in line with difference in inflation between Jamaica and our major trading partners.

In their analysis, the IMF looked at the real effective exchange rate, comparing the Jamaican dollar against a basket of the currencies of Jamaica's trading partners, and not just looking at the bilateral rate against the US dollar, which only represented 40 per cent of the basket, whereas 60 per cent of Jamaica's trade was with other countries.

The staff analysis also noted that “The Government's limited spending envelope needs to be better prioritised to support growth.”

Specifically, it noted, “The still high public sector wage bill continues to crowd out other spending given scarce public resources. There is a need to right-size the large and inefficient public sector, exert better control over wages and allowances (including as part of the ongoing wage negotiations), and create the space for growth — enhancing public spending on safety nets, citizen security and capital projects.”

Addressing the issue of public sector transformation, and in particular whether the IMF was anticipating cuts in employment, Ramakrishnan noted that public sector transformation is a catch-all phrase that needs to be broken down.

One aspect, she noted, is to look at the various public bodies and eliminate redundant functions or entities, or create shared corporate services. This was acknowledged by the prime minister in his January speech. Some lessons were learned in the first set of reforms (closures and rationalisation).

In addition, the overall central government wage bill is too large and, by law, has to reach nine per cent of GDP by March 2019.

“From everything we know so far, the Government is committed to meeting that goal,” Ramakrishnan said, adding, “What is the right size of the public sector? There is no magic number. The IMF is not saying there should be 3,000 job cuts, or 10,000. This is a social policy choice the Government needs to make.”

The IMF does not mandate any specific level of employment, but defines the overall spending envelope. So while the IMF believes the Government needs to accelerate public sector reform, this is within an overall gradual approach, as it understands the Government does not want to act so fast as to cause “disruption”. She noted that in 2010 there was a detailed Master Rationalisation Plan. Is it still relevant? Probably not, as it would need updating. The goal is not to create anxiety, but to achieve a gradual transition through attrition, or if there are redundancies, encourage a move to the private sector.

A key area of IMF concern is public sector allowances, whose the cost and complexity has grown over time. There are at least 174 different allowances, and these are neither equitable within groups of employees nor equitable across the 10 different groups of employees (allowances can make up between seven and 55 per cent of employee compensation). Compensation allowances total two per cent of GDP, and a further one per cent of GDP is disbursed each year as travel allowances. Some allowances raise wage costs — as sizable overtime payments made to health sector workers could imply that increasing the number of permanent staff may actually be cost-saving.

In the long term, Ramakrishnan observes the Government needs to address the problem of public sector wages being too low to retain quality people, or “pay for performance”. When the Government loses talented people, this impacts service delivery, and she herself had met many extremely hard-working people in government employment.

Summing up the current situation with respect to reforms, she noted in 2013 Jamaica had “deeply entrenched imbalances”, and now it had deeply entrenched macroeconomic stability.




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