Jamaica’s resilience to inflationary shocks unprecedented — WynterWednesday, August 27, 2014
BY Keith Collister
IN a quarterly press briefing essentially devoted to the issue of inflation, Bank of Jamaica Governor Brian Wynter argued that the Jamaican economy is becoming more resilient to inflationary shocks because of the transformation taking place under the economic reform programme, even going so far as to describe the environment for inflation as showing an "unprecedented resilience".
Annual headline inflation has been trending down since September, falling to eight per cent at the end of June 2014, from 8.8 per cent at the same point last year, and 8.3 per cent at the end of March 2014. Although annual inflation to July had ticked up to nine per cent this was due to July’s higher inflation of 1.4 per cent caused by the drought increasing agricultural commodity prices.
He cited two main reasons for the increased reslience. First, strong fiscal conditions, meaning the elimination of the fiscal deficit, had reduced the "stimulation" of the economy normally created by "excess domestic demand" from fiscal deficits. This reduction in demand had reduced the ability of producers and retailers to pass on to consumers the impact of some shocks. Not the least of these shocks has been the 13.3 per cent and 10.8 per cent depreciation in the exchange rate in the last two fiscal years, respectively. However, the pass-through impact of a falling exchange rate into higher inflation has been much lower than in the past, although the inflation expectations of businesses still remained higher than the actual outturn, no doubt due to their continued use of historical "rules of thumb".
Secondly, he argued that in the productive sector, especially in agriculture, there had been significant improvements in efficiency due to such supply side initiatives as agro parks.
Additionally, he noted that there was the 25 per cent increase in bus and taxi fares last year. Historically, such a combination of shocks would have been enough to send inflation spiralling into double-digit territory, but this traditional spiral did not happen "as the ability to pass on price increases was now much lower".
Answering a topical question about the impact of the current rise in bus fares on inflation, the Governor argued that although the rise in bus fares could push inflation to the top end of their target range of seven to nine per cent for the September quarter (the same range as their full fiscal year projection), he expected the impact to be temporary, and therefore his full-year forecast range remained the same. Increases in the price of bus tickets were a "one-time event", as although it raised the rate of inflation (transportation represented about nine per cent of the Consumer Price Index (CPI) basket), there would be no increase in subsequent months.
Looking further ahead, the governor stated "we are aiming to keep inflation in the six to eight per cent range over the next two years, while our longer-term objective is an inflation environment in line with our main trading partners", or in the region of two per cent to four per cent.
Addressing a question about why historically devaluation had had no positive impact on exports, he noted that in the past the positive impact of devaluation on competitiveness had been offset by higher inflation, so Jamaica had seen frequent bouts of devaluation without any lasting improvement in competitiveness. He observed, "Frankly, Jamaica has had an overvalued currency for a long time, captured in a current account deficit of nearly 15 per cent of GDP three years ago." There had since been a sharp correction in the exchange rate and current account deficit, and he now believed that the overvaluation of the exchange rate had "basically been corrected" and the foreign exchange market was now "reasonably in balance". Obviously, they would need to continue to "keep an eye on it", particularly as they entered a period of seasonally weak supply and increased demand for foreign exchange. However, he noted that he was making this point less definitively than usual, as the traditional "patterns we have had have in part been disrupted", apparently referring to the reduction in imports and the associated fall in the current account deficit. The current account deficit was now projected at 6.8 per cent of GDP for this fiscal year (below the original forecast), with foreign direct investment very conservatively projected at two to three per cent of GDP, which combined with the success of the recent bond issue meant that Jamaica’s borrowing needs were essentially covered for this fiscal year.
Indeed, the governor added, the bond issue had "eased pressure on the programme" and created "more flexibility". Amongst other things, this appears to mean that the Government now has the funds to execute the limited refinancing of the debt outlined in the budget, and that although there would be a temporary increase, of say, three to four per cent in the debt to GDP ratio as a result of the overseas bond offering, the debt-to-GDP ratio was expected to be in line with the programme by the end of the fiscal year.
Answering the question of when there would be a positive export response to devaluation, rather than just a fall in imports, the governor described a fourstep process. Firstly, there was a need to correct the exchange rate overvaluation, a process that is only just in its final stages. Secondly, entrepreneurs must believe this is a sustainable correction in the level of exchange rate overvaluation, and will not be reversed. Thirdly, they need to mobilise capital and other resources for investment. Finally, they need to actually penetrate export markets. These steps will take time.
Finally, addressing prospects for growth, the governor noted that growth in the June quarter should be around one to two per cent on an annualised basis, making it the fourth consecutive quarter of economic growth, and in line with the one to two per cent projected for the full fiscal year. Growth in the September quarter may be slower due to the impact of drought on agricultural production, although the governor expected growth to rise to the two to three per cent range in the medium term.
Due to the continued low growth environment, he didn’t think there was a need to tighten monetary policy and believed it was now much easier to build international reserves while keeping the Bank of Jamaica’s "signal rate" unchanged. The recent decline in market interest rates, as expressed by the six-month treasury bill, back to around 8 per cent, was also reasonable in view of their expectations of future inflation.