Tue | Jan 23, 2018

Briefing | The effects of depreciation

Published:Wednesday | June 8, 2016 | 12:00 AM


What is the value of the exchange rate now?


The Jamaican dollar exchange rate is currently $125 to US$1, coming from as low as approximately J$7 to US$1 at the beginning of 1990. Local consumers and producers have been expecting less depreciation, but the Jamaican dollar continues to lose value against safe haven currencies, for example, the US dollar, over the last 25 years.

Although the rate of depreciation per annum has not been severe enough to cause a currency crisis, the depreciating trend has been a national topic for discussion, given its impact on prices, imports, consumption, production, output and exports and the nation's standard of living. It is more questionable, given that over the said 25-year period from 1990 to present, GDP growth has averaged just over 0.5 per cent per annum.


Why is it a cause for concern?


Imagine a local producer who employs a high percentage of foreign inputs (oil and others that cannot be produced locally) in his production process. When the currency depreciates, he faces a higher import price for his raw material. With a higher cost of production, he receives less from the sale of his outputs.

As a result, he produces less. If he increases the selling price of his finished product (in an attempt to transfer the cost to consumers), they face a higher price each time the currency depreciates. In this case, depreciation might have a negative impact on productive profit and the value of consumer's real wage. These will have a negative impact on the country's growth and developmental objectives in the long run.

Even when goods produced are re-exported, the exporter finds it difficult to fully recover cost disadvantages encountered from purchasing more expensive imported inputs arising from depreciation.


How is the country's foreign currency flow?


From a current account point of view, the US dollar value of the nation's import is consistently more than the value of its export. Despite high remittance inflows, Jamaica continuously operates a current account deficit. This shortfall has been supported mainly by capital account surpluses, along with borrowed reserves.

Foreign currency inflows to the island have come from foreign currency borrowings from bilateral and multilateral institutions. Other inflows range from the sale of foreign currency bonds and other instruments to the global financial market and from capital investment by foreigners in the domestic economy.

A small amount of inflows arise from the sale of domestic manufactured goods to the global marketplace. Meanwhile, outflows of foreign currency from the island stem mainly from Jamaican investment abroad, foreign debt servicing repayment, the purchase of oil, other commodities and services from abroad.


Are there possible foreign currency issues?


Strong reliance on foreign capital inflow can easily jeopardise the country's objectives if there is a sudden pause or reduction of inflows at a critical point where debt obligations are pending to be satisfied. The possibility of reduction in inflows or increase in outflow of foreign currency from the island exists if emerging markets and developed countries were to increase their interest rates and broaden their bond offers. To the extent where these economies are more stable than Jamaica's, foreigners will hastily repatriate their capital, resulting in huge foreign currency obligations that Jamaica might not be readily able to meet. This is so because Jamaica does not have proper long-term foreign currency liquidity management strategies.


What are the operative questions?


It is important to understand what amount of the inflows are from income-earning sources, what amount arises from net transfers, what amount from borrowings, what amount from investment - direct or indirect - will be expelled from the country over time? The former must be able to sustain the latter in the long run. Holding all other factors equal, Jamaica's foreign currency earnings must be able to satisfy its short and long run foreign currency obligations. Otherwise the country's foreign currency dilemma will continue. Having received continuous balance of payment support from the International Monetary Fund and other international lending agencies, questions arise, if Jamaica's foreign currency flows are sustainable in the long run. Can Jamaica sustainably repay its foreign debt? What is the optimal level of reserves? What impact does foreign currency flows have on GDP growth? How effective is the monetary policy transmission mechanism? And most important, how should Jamaica strategise to increase economic stability to enhance its anaemic economic growth, needed if the country wishes to develop.

These questions will be answered in a book titled Third World Deadlock - Lessons on foreign currency liquidity management, exchange rates and GDP growth in Jamaica. Continue reading 'The Briefing' for more each week and look out for the launch of the book.

- Dr Andre Haughton is a lecturer in the Department of Economics on the Mona campus of the University of the West Indies. Follow him on Twitter @DrAndreHaughton; or email feedback toeditorial@gleanerjm.com.