Under the new Stand-By Arrangement between the International Monetary Fund (IMF) and the Government of Jamaica, the IMF recommends deepening the forex market by phasing out the Bank of Jamaica’s (BOJ’s) use of surrender requirements and making interim use of an auction system as the market moves towards robust interbank trading.

With that new arrangement intended for roll-out in July 2017, the idea of the auction system has caused some concern, with private sector members asking for greater clarity.

CEO of the Private Sector Organisation of Jamaica Dennis Chung said this week that under a previous auction arrangement in the 1980s, the result was the creation of a black market for foreign exchange.

“When we had the auction system you could only carry US$56 legally out of the country and you had to have BOJ approval. It never really worked from the point of view of really finding the true value of the dollar; what it did was exchange control,” he told the

Jamaica Observer earlier this week.

However, both the IMF representative to Jamaica and central bankers have come out to say that the new system will be an improvement on the open market system which currently exists and should lead to less volatility in currency movements.

IMF resident representative in Jamaica, Constant Lonkeng, told the Caribbean Business Report yesterday, “the current construct of the market is that the presence of the BOJ is a bit high because it is using the surrender requirement to build reserves.

“If anything, the reform is intended to make the system even more market based. The worry that this is a return to the past isn’t justified at all.”

Senior deputy governor in the Bank of Jamaica John Robinson, explained that foreign exchange dealers now sell an approved proportion about 25 per cent — to the BOJ, which is used to satisfy demand from the private and public sector and also sell funds to the market.

“Commercial banks, building societies, merchant banks, cambios and forex dealers now sell to us roughly 25 per cent of every purchase made. We intend to phase out the practice of purchasing a fixed proportion and buy from them at the price they offer to sell to us. What we are considering has nothing to do with the old system, which was a centralised mechanism for allocating foreign exchange to users.”

Robinson recalled that under the old auction system, importers for example, would bid for funds through the banks and after approval would have access through the bank.

“This system was abandoned years ago. At the time we had exchange controls and purchases had to be approved. There was a limit to how much you could travel with and importers had to present documents.

“We now have a free open market-determined system in which any one can buy without seeking approval. All that will be changed is the method by which the Bank of Jamaica purchases funds from dealers, cambios and others and sells back to them.”

Constant Lonkeng, in a more technical look at changes to come, explained, “the interbank market for foreign exchange is currently not well developed, making price discovery very hard.

“The idea is to deepen the market by limiting the participation of the BOJ. Now there is a lot of volatility partly because of the surrender requirement. The intervention of the central bank will also be limited to periods of high volatility.”

He said the auction itself will be a transitional tool which will also be phased out as the market develops.

Lonkeng said that, over time, the BOJ will wean itself from borrowed reserves which are currently based on the issue of certificates of deposit ranging in tenor from three months to seven years and which amount to US$1 billion in borrowings.

“They need to reduce borrowed reserves. That is why you need a [functioning] market,” he commented.

Under the transitional auction system, banks will supply as much as they are able to — on demand, with supply and demand determining pricing. The BOJ will keep its trading platform — but eventually the forex department in its current form will also be phased out.

“There will be no rationing. Because you trade in a market you still need authorisation, but price will be determined by the market. If demand is more, the dollar will depreciate. If demand is less it will appreciate. The bank will be able to intervene in exceptional movements which could be disruptive. The bank will still need to have reserves,” Lonkeng commented.

The IMF representative admitted that BOJ reserves will be expected to be higher than their current level, a target he implied will not be hard to achieve with a deeper market functioning.

“We at the IMF have a reserve adequacy metric which reflects the type of shocks which are possible. The objective under the programme is that for the bank, when it reaches that level — which is a bit higher than current level of about US$2.5 billion — accumulation will stop.”

Longken said the extent of reserve accumulation will be nothing near that of levels seen under the Extended Fund Facility, in which reserves went from US$1.5 billion to US$2.5 billion.

“Reserves are expected to be higher than they are now, but the rate of accumulation will not be as much. The metrics are to reach reserve adequacy levels and secondly to reduce dependence on borrowed reserves. The thrust of the reform is to reduce the BOJ presence and to get market participants to trade freely among each other.”

Senior Deputy Governor Robinson told the Caribbean Business Report, “what we contemplate is a system which is more transparent and subject to less volatility. We already have a free, open system which we do not intend to change.

“However, right now dealers have to sell one-quarter of inflows to the central bank, so we have customers competing with the central bank. There is less available for the rest of the market, and price might also be affected with less to go around. Leaving more liquidity to their discretion can help to smooth out supply and demand. Inflows will remain the same, but we will have more efficiency and transparency.”