Nigel Clarke | The exchange rate, debt and the CPI
Jamaica has been undergoing profound change in economic policy and the accompanying institutional framework. However, Jamaica’s politics, as practised, has not always incentivised public discourse that edifies. Instead, the incentive has been to exploit gaps in both understanding and knowledge of relevant facts.
While this may serve narrow interests at a point in time, it does not serve Jamaica over the longer term.
Over the course of the past several weeks, there has been public interest, at various times, in the exchange rate, debt and the Consumer Price Index (CPI), and in this article I seek to add data, facts and information that improve public understanding and aid public discourse.
THE EXCHANGE RATE
Jamaica has been through another cycle of depreciation that is being followed by appreciation. The J$/US$ exchange rate has gone from 142.23 three weeks ago to 134.95 on December 4 – an appreciation of approximately five per cent. This two-way movement of our exchange rate is a departure from the “one-way slide” of the past, and represents the daily resolution of forces of demand and supply; that is, reflecting how markets are supposed to work.
Yet, the fact that we only speak about the exchange rate on the depreciation cycle, and often do so in panicked tones, without reference to underlying economic fundamentals, misinforms the public and distorts decision-making. Such rhetoric needs to change.
The central bank has gross reserves of US$3.6 billion and non-borrowed reserves in excess of US$2.5 billion, more than we have ever had. The data show that annual inflows of foreign exchange to Jamaica are more than sufficient to meet Jamaica’s needs (or else Bank of Jamaica’s foreign exchange reserves could not have increased).
Yes, we have a large trade deficit. However, this is just about compensated for by inflows from tourism, other services and remittances. The sum of all those items has resulted in a modest current account deficit of between two and three per cent of gross domestic product (GDP) for the past several years, which in turn has been more than adequately financed by inflows of foreign direct investment.
The challenge is that – like in every other country in the world – inflows and outflows are not balanced at every point in time. And this is where market forces are best able to resolve these short-term imbalances with price (that is, exchange rate) movements, without the need for excessive central bank intervention.
The resulting volatility that arises from two-way movement of the exchange rate presents an opportunity for private sector innovation, with central bank support, in developing a forward market and other hedging instruments that allow businesses to plan.
DEBT/GDP AND THE EXCHANGE RATE
With respect to the sustainability of debt, the parameter that matters is not the absolute or nominal debt per se, but the size of this debt relative to the size of the economy – that is, the debt/GDP ratio.
For instance, based on International Monetary Fund (IMF) data, Kenya’s 2017 debt is nearly three times as large as Jamaica’s but its economy is also approximately five times larger. Thus, Kenya’s debt/GDP of 52 per cent is smaller than Jamaica’s at 95 per cent, implying that Kenya can service its debt easier than Jamaica even though its debt is larger in nominal terms.
Jamaica has long had a majority of its debt denominated in foreign currency. For the past seven years, the proportion of our debt denominated in foreign currency has hovered around 60 per cent of our total debt. When the exchange rate appreciates (or depreciates), the absolute size of the FX-denominated debt converted to Jamaican dollars decreases (or increases). To be precise, at the current mix of foreign currency debt, a one per cent change in the J$/US$ exchange rate changes the total stock of nominal debt by approximately 0.6 per cent. But the story doesn’t end there.
Inflation and growth have a role, too. In the same way that exchange rate movements change the total stock of nominal debt, inflation and growth increase the nominal size of the economy. That is, the value of goods and services produced in Jamaica, in other words, Jamaica’s GDP, increases in size due to inflation and growth. As a result, exchange rate depreciation does not necessarily result in an increase of the debt/GDP ratio.
An example makes the point: although the J$/US$ exchange rate depreciated by 28 per cent from 99:1 in March 2013 to 126.5:1 in March 2019, our debt/GDP ratio actually declined from 145 per cent to 95 per cent over the same period.
The reduction in debt by 50 per cent of GDP over this time reflected many factors: fiscal consolidation, inflation, growth, exchange rate movements and also liability management actions.
In addition, Jamaica’s foreign debt is comprised of hundreds of loans that differ in interest and repayment periods. The times at which we pay interest and repay principal are diversified throughout the year. As a result, it is an average exchange rate over the year that affects Jamaica’s debt service and not the spot exchange rate on any particular day.
THE CONSUMER PRICE INDEX
The inflation rate is measured by changes in the CPI and the CPI is composed of a weighted measure of the prices of over 500 goods consumed in our economy. The identification of those goods and the weights applied are determined from an extensive Household Expenditure Survey (HES), conducted by STATIN, which measures the expenditure undertaken by households throughout the year. The HES is a rigorous undertaking, conducted over 12 months to capture seasonality, and ranks only second to the national census in scale, complexity and cost.
The weighting of a particular good or service in the basket is calculated by dividing the amount Jamaicans spend on that good or service, as determined by the HES, by the total consumption of all Jamaicans on all goods and services, also as determined by the HES.
STATIN endeavours to conduct a HES every ten years, consistent with international best standards for developing countries. A HES was conducted in 2005 and another was due in 2015. STATIN reports that a budget for the HES was submitted for consideration in 2014/15 but, presumably, due to fiscal constraints, it was not approved. STATIN was therefore unable to conduct the HES in the year in which it was due.
An allocation was made in the 2016/17 Budget for the HES to be conducted and it was completed over 12 months in 2017. STATIN is currently engaged in the data analysis process, with a projected release of the CPI based on the revised basket for April 2020 (published in May 2020).
Reference to history can provide more understanding and insight. Prior to the implementation of the current basket, which is based on the 2004/05 HES, the previous revision of the basket was undertaken in 1984.
Between both surveys, the data revealed that the top three divisions remained the same despite minor shifts in their weight. Generally food and drink, transportation and housing, electricity, gas and other fuels are the larger categories of consumption.
STATIN has benefited from substantial technical assistance over many years and is subjected to periodic reviews by regional bodies, multilateral agencies and by peers in other countries. These independent reviews have consistently indicated that STATIN’s work and output are technically robust, and consistent with international standards and best practices.
Jamaica’s market economy functions optimally with data, facts and information in the public domain and used for decision-making. Our public discourse serves Jamaica and the Jamaican people when it is based on data and facts. To do otherwise is a disservice to Jamaica and only has the potential of serving narrow interests.
Jamaica is entering an exciting new period, with initial conditions anchored on hard earned economic stability. Let our public conversation and rhetoric be based on facts and not misinformation.
- Dr Nigel Clarke is the minister of finance and the public service and member of parliament for St Andrew North Western. Email feedback to firstname.lastname@example.org