Managing flexibility


Managing flexibility

Bank of Jamaica governor shares his thoughts on the teething pains of a modern foreign exchange market

Sunday, January 19, 2020

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The Jamaica dollar closed 2019 at $132.57 versus the US dollar, an annual depreciation of 3.7 per cent. This year-over-year change in the exchange rate was moderate compared to annual depreciation of 2.1 per cent in the previous year and appreciation of 2.8 per cent in 2017.

Since the implementation of BFXITT (Bank of Jamaica's (BOJ) — Foreign Exchange Intervention and Trading Tool) in 2017, the exchange rate has exhibited regular two-way movement. During 2019, the exchange rate produced 119 days of depreciation and 132 days of appreciation. This compares to 137 days of depreciation and 114 days of appreciation during 2018.

An improving economy means the country is earning more foreign exchange (FX) than before, so the volume of trading in the market continues to grow. The moderate depreciation during 2019 occurred within a context of buoyant US dollar supply, which was marginally outweighed by demand.

Average daily purchases and sales were US$44.1 million and US$45.1 million, respectively, which compared favourably to US$40.2 million and US$41.1 million of purchases and sales, respectively in 2018, as well as the respective five-year averages of US$37.4 million and US$38.8 million.

Increased foreign exchange earnings and an improved economy presents new opportunities for the Jamaican business sector, and people taking advantage of those opportunities have increased demand pressure on the FX market. This is normal in a growing economy.

Despite the broad balance between supply and demand and regular two-way movements during 2019, there were temporary gaps between demand and supply, which resulted in six significant episodes of disorderly movement in the foreign exchange market.

These episodes were influenced by large business/investment-related transactions that occurred within a short time.

These transactions reflected liability management of companies, given the attractiveness of Jamaica dollar debt relative to US dollar debt.

Several firms also sought to borrow funds in FX from the local capital market, and this, combined with regular commercial demand, led to increased demand and disorderly price movements in response.

Two such periods were in February and in October to November 2019, in which the Bank of Jamaica sold US$80 million and US$140 million, respectively, to the market.

Subsequent to the November 2019 episode, after the seasonal demand and large investment-related transactions were satisfied, the market recorded a 2.4 per cent appreciation in the exchange rate for December, reflecting increased seasonal supply amidst subsided demand impulses.

As the Jamaican economy continues to improve, and more local businesses expand, which is obviously a good thing, incidents of increased demand of this nature are expected to continue.

The solution is simply for the economy to keep earning more foreign exchange to accommodate the needs of the market.

As long as our economy remains this healthy, two-way movement in the exchange rate, a standard feature of modern FX markets, is also here to stay.

The solution to the inconvenience of these fluctuations is for business people to use FX hedging instruments such as forward and swap contracts to protect themselves and their customers and ease market volatility.

These hedging instruments are effective tools that can be used to insulate businesses from the potential negative impact of exchange rate movements and allow them to plan their core operations more effectively.

During 2019, authorised dealers reported a total of 79 contracts of USD versus JMD forward transactions, consisting of 56 buy contracts totalling US$434.33 million and 23 sell contracts totalling US$391.62 million.

These contracts were across several industry segments, including the distributive, finance, and insurance and telecommunications sectors.

The use of forward contracts is, therefore increasing, but much more use of this tool is needed.

The bank is working closely with authorised dealers to standardise the protocols for pricing forward contracts, educate potential clients on their features, and report activity in that market as regularly as spot market trading. In addition, the use of currency swaps among dealers with some support from the Bank of Jamaica is also being developed. A more efficient, informed, and transparent system of foreign exchange trading will help to dampen much of the anxiety that participants have experienced under existing arrangements.

Over the course of 2019, the BOJ demonstrated its commitment to maintaining orderly conditions in the foreign exchange market by intervening via 16 B-FXITT foreign exchange sell auctions totalling US$395 million. This compares to 14 interventions via sales totalling US$200.5 million in 2018.

A flexible, freely accessible foreign exchange market is crucial to maintaining external competitiveness and the transmission of appropriate price signals to economic activity. Price uncertainty does generate anxiety, but a deep, transparent, well-functioning market with tools and products adaptable to different users will go a far way in making flexibility more manageable.

During 2020, the Bank of Jamaica intends to oversee the implementation of several improvements to the functioning of the foreign exchange market. An electronic trading platform for use by all authorised dealers and large cambios will be in place by the end of March 2020. This improvement in the architecture will facilitate greater transparency and competitiveness as all traders will be able to observe the rates prevailing in the market in real-time. The ability of large commercial clients to view trading activity will significantly enhance the information available to them and enable clients to make better decisions.

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