Whither Jamaica’s interest and exchange rates?
The Sterling ReportSunday, September 15, 2013
With Marian Ross
Last Week, we addressed the uncertainty surrounding the direction of the US monetary policy. Pundits on either side are busy lobbying, modelling and hypothesizing the US Federal Reserve's next move. However, despite the apparent uncertainty, the US Federal Reserve has clearly articulated its fundamental position: interest rates must remain low until at least 2014 and quantitative easing will taper when the labour market indicators improve. The US Federal Reserve has communicated its intention, objective and the indicators that matter to them. In developed markets, investors and business people rely on the credibility of the Central Bank and base important decisions on the pronouncements of the entity.
Monetary policy has an immense impact on the decisions that must be made by investors and business people. For example, with lower interest rates, businesses can refinance their more expensive debt or even use cheaper debt to finance expansion. Similarly bond investors use the anticipated direction of interest rates to inform their investment strategy. Bonds typically rise in value during periods of lower interest rates. Depending on how long the low interest rate period is anticipated to last, some bond investors may wish to sell some of their holdings and realise the capital gains that have accrued. Indeed the past four to five years have been lucrative for bondholders, as low interest rates coupled with weak global economic performance significantly increased the demand for and prices of fixed income assets. However, as interest rates rise, bond investors will need to rotate their portfolios and select instruments that are more conducive to a high(er) interest rate environment. For example, variable rate bonds and equity linked fixed income notes can provide attractive returns to bondholders in times of rising interest rates.
Other factors affected by monetary policy such as the level of inflation and the exchange rate inform many aspects of a business model. The inflation and exchange rates affect a company's cash management strategy, investment portfolio, the terms of engagement with its creditors and suppliers, the specific products it produces, where it sells those products etc. Similarly, investors may want more equity investments during inflationary periods and may also wish to hedge their currency exposures depending on the anticipated movement in exchange rates. All these decisions must be based on credible information and policies from the monetary authorities.
Locally, business people and investors in Jamaica's fragile environment are struggling to find the comfort they need to make basic decisions. In spite of a benchmark interest rate of 5.75 per cent and consistent pronouncements by the Bank of Jamaica that it is committed to a low interest rate policy, the six month weighted average Treasury Bill yield has inched above eight per cent. The Government of Jamaica is now paying more on some of its variable rate debt than it was before the National Debt Exchange thanks to the higher Treasury Bill yields. Throughout the year, the BOJ has actively issued a series of instruments in their quest to contain the slide of the Jamaican dollar. As a result, interest rates have risen significantly. The contradictions in the implemented and pronounced monetary policy make it difficult for investors and businesses to formulate a strategy for survival or growth. In this context, it is difficult to predict the direction of interest rates in Jamaica, and prudent investors have relied on historical patterns and interest rate levels to inform their investment strategy.
While many Jamaicans are aghast by the devaluation in our local currency it is worth noting that many growing economies across the world are currently pursuing or have pursued policies aimed at devaluing the local currency. The US Dollar for example, depreciated against the Japanese Yen by over 27 per cent between 2008 and 2012 as a direct result of the US Federal Reserve's expansionary monetary policy which sought to boost economic growth in the US. The weaker currency no doubt helped to boost demand for US exports and the lower interest rates encouraged more people to spend and invest. Additionally, China has, for many years, been criticised by other developed nations for purportedly suppressing the value of its currency in a quest to maintain the competitiveness of its exports. Most recently in December 2012, Japan's new Prime Minister took a bold step in the direction of aggressive monetary policies which ultimately had the effect of devaluing the currency significantly. In April 2013, Japan reported economic growth of 0.9 per cent or 3.5 per cent annualised for the first quarter of the 2013 calendar year.
The exchange rate and interest rates are powerful tools that can chart the course of any economy or investment portfolio. Investors should stay close to the expectations of and movements in these variables.
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