August 12, 2020 will forever be a day etched in the minds of Jamaicans.

That was the day when the dollar hit the $150 mark against the United States dollar (USD).

There was a similar discussion on June 7, 2013 when the dollar hit $100. All these discussions lead to people erroneously concluded that the Jamaican dollar (JMD) was worthless and one of the worst performing currencies in the Caribbean as the Eastern Caribbean (XCD), Barbadian Dollar (BBD) and Caymanian Dollar (KYD) maintained a low nominal value against the USD. The major point numerous persons failed to understand was that the JMD value is determined by market forces (floating currency) while the other currencies were artificially pegged to the other currencies. If the exchange rate of an economy against the USD was a barometer of economic health, then how could South Korea have the 12th largest economy in the world by gross domestic product (GDP) with a rate of $1189.42 Won to $1 USD?

In a normal world, people have a preference to purchase higher quality goods especially foreign-made ones which have a brand and value attached to them.

As a small open market economy with the inability to produce some goods locally, there will be a need to import various goods for daily life. In order to complete these transactions, there is a need for the target currency to facilitate the purchase of these goods. For Jamaica, foreign exchange (FX) enters the country through remittances, exports, tourism and other associated services which represent supply. When people purchase the target currency, demand is created for that currency and as a result, you have a supply demand relationship.

Jamaica has a floating exchange rate which means that the FX rate against other currencies is determined by supply and demand in the FX market in addition to external market forces.

All this means is that if there is decreased demand and a similar level of supply for the currency, the rate should go down while the converse should see the rate going up.

In most Eastern Caribbean countries, their domestic currencies are pegged at a rate to the USD, which means that the Government in tandem with the central bank set the rate.

This ‘peg’ gives a perhaps false sense of a strong currency from a nominal perspective, but in order to defend that peg, a country would need a strong level of foreign reserves in order to keep this fixed exchange rate.

A consequence of this type of foreign exchange policy is that there are FX controls to limit how much FX can leave the country at any given point. This can lead to a possibly overvalued currency, a separate black market and other economic issues as firms struggle to repatriate currency or consider investing in that country.

Unlike in Jamaica where you can just go to a cambio or bank and purchase any amount of FX, you would have to make a request to that country’s monetary control personnel and give an explicit reason for needing the currency under a pegged system.

There’s no guarantee that one would get access to the currency either which would impede one’s ability in making certain decisions. This is what used to happen in Jamaica when we disastrously experimented with a pegged exchange rate.

If some of these pegged currencies were to operate on a floating exchange rate system, those currencies would probably have a similar or higher nominal rate than Jamaica.

The depreciation of a currency isn’t necessarily a bad thing once the economic fundamentals of that country are sound and the country isn’t extremely exposed to certain input costs for their major industries.

In the context of COVID-19 (external shock), the USD has appreciated against the basket of emerging market economies currencies (excluding China) index, but has lost value against the basket of G-10 currencies index which shows that there have been dynamic shifts in the world. As the world’s main reserve currency gains value against emerging markets, it lost ground against other currencies in the same breath.

A currency with a lower value makes the goods of that country more competitive on the international market which can be advantageous for small developing countries.

However, depreciation, out of context, can lead to unintended consequences for some industries or businesses which charge USD in the domestic market or need certain inputs for their goods.

This has become more evident in recent times as the JMD has depreciated by more than 12 per cent from the start of the year up to the end of August.

This has impacted the costs of some manufacturers and in turn affected those whose leases are quoted in USD but payable in JMD. A major reason for this decline has been due to the drop in tourism which is our largest FX earner and supplies different parts of the general FX market by various means. Despite this decline in tourism income, remittances have remained actually improved since April and are up year over year.

Due to years of reform, the Bank of Jamaica (BOJ) has moved away from trying to defend the currency as their main goal to inflation targeting. This shift to inflation targeting with some interventions has resulted in a two-way movement of the currency compared to the one-way depreciation that was typical in the past. This situation easily saw the FX rate in 2019 go to an extreme low of $128 at one point in the year and as high as $142 as well.

By attempting to defend a currency, a country’s international reserves decrease which leaves it exposed to supply shocks when there is an event which interrupts the flow of FX into the country.

At the end of July, Jamaica’s net international reserves were at US $2.8 billion with most of those reserves not being borrowed like in the past. This represented about 54 weeks of goods imports or 37 weeks of goods and services imports.

About US $150 million of these reserves was used in flash sales to the FX market between April to August based on what the BOJ deemed to be anomalies in the market space. Most of the FX sold to the market was done with a stipulation that end users be the targets for these interventions.

The BOJ has implemented several measures to help alleviate some of the pressure of the FX market barring a natural decline in certain imports. One of these measures was the restriction of certain mergers and acquisition deals from March which would have distorted the market and caused the FX rate to depreciate much faster. Other measures included restricting dividend payouts of certain financial companies, introducing swap agreements and reducing the reserve requirements for what deposit-taking institutions must keep with the BOJ. All of these actions helped to taper some of the potential spikes that would have led to a larger depreciation of the JMD.

Even though the JMD’s depreciation against the USD is seen as a very sensitive topic, the USD devaluing doesn’t implicitly mean that inflation (increase in goods and prices) will be rapid for basic goods. There will be a sustained increase in prices for some areas, but that doesn’t make the JMD worthless. In the 1990s, when we removed capital controls without adequate reserves without solid reserves saw the JMD depreciate by more than 100 per cent in less than 3 years. Imagine Trinidad and Tobago’s situation now where there is a risk of running out of foreign currency amid an environment where businesses would have to possibly wait up to 6 months to convert their TTD to USD.

Until tourism and general commercial activity in Jamaica returns to where it was before the pandemic, the FX rate will continue to depreciate at a relatively faster rate against the major currencies (USD, CAD, GBP) as supply remains lower than normal. If we’re able to find high value good or products we can export, Jamaica could potentially see a more stabilised rate when combined with lower imports.

Unlike the last recession where we were in a worse fiscal position, Jamaica’s economy had expanded for 20 consecutive quarters, economic activity is continuing and we’re able to restructure the economy for a brighter future.