Mon | Oct 23, 2017

Briefing | Currency depreciation bad for economic growth; J$ dollar arrives at $131 to 1

Published:Wednesday | September 20, 2017 | 12:08 AM
Economic Growth Council (EGC) Chairman, Michael Lee-Chin
Foreign currency
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The Jamaican dollar exchange rate is now at an all-time high of JA$131 to US$1, according to the Bank of Jamaica (BOJ). As of September 18, 2017, US$38.4 million was sold at an average rate of JA$131.10, while $43.7 million was bought at average price of $129.82.The fall in the value of the current against the US comes just one week after Jamaica borrowed approximately US$900 million from the International Monetary Fund (IMF) and other lending institutions. The IMF has forecasted that Jamaica will grow by 1.6 per cent this year, 0.4 per cent less than the previously forecasted two per cent and 3.4 per cent less than the country's targeted five per cent growth per annum by the next three years as project by the Economic Growth Council.

Why can't Jamaica grow how it wants to?

Jamaica is unable to improve its economic position due to several factors, including currency depreciation, which appears to be counter-intuitive to the nation's growth pursuits. A constantly depreciating currency, it appears, disadvantageously increases the cost of imported inputs and the cost of foreign debt-servicing payments, thereby reducing national savings, which impedes the economy's growth potential.

In this scenario, Jamaica and many other developing country that is in this position appear to be stuck in macroeconomic deadlock between proper foreign currency liquidity management, exchange rate determination, and gross domestic product (GDP) growth strategies needed for economic development. Read more in my book entitled Developing Sustainable Balance of Payments in Small Countries; Lessons from Macroeconomic Deadlock in Jamaica.

What does the theory say?

Traditionally, the effect of currency devaluation on economic growth in a country is examined within the predictions of the Mundell-Fleming model. In this model, GDP growth responds positively to currency depreciations through an increase in exports as a result of favourable domestic price advantage.

However, constant exchange rate depreciations in Jamaica over the last two decades have not resulted in any significant increase in aggregate output over time. This opens the issue to investigations beyond Mundell-Fleming.

Alejandro (1963), Krugman and Taylor (1978), Van Wijnbergen (1986), and Saibene and Sicouri (2012) found evidence to suggest that there might be channels through which currency devaluations may actually lead to losses in GDP growth. These include, through distributional channels, if the country uses, high proportion of imported inputs or through fiscal effects, and if a large percentage of the debt is denominated in foreign currency.

What does the empirical evidence show?

The results indicate that a one per cent nominal exchange-rate depreciation of the domestic currency in one year leads to a potential loss of 0.3 per cent to real GDP growth in the year that follows, constrained by a threshold of 3.7 per cent.

Over the last 25 years, Jamaica has lost more than US$4 billion in GDP output due to currency depreciation. Potential losses to GDP growth sum to little less than US$4 billion or JMD$480 billion over the 25-year period from 1990 to present. The findings suggest that pursuing policies to stabilise the exchange rate can lead to favourable growth in gross domestic product through a variety of channels identified in this chapter.

Importers of foreign inputs for production processes are more certain of the import prices they will pay. Constant depreciations, such as that which ensued after the liberalisation of the financial sector in 1992, have resulted in potential losses in GDP growth in the country.

What do the manufactureres have to say?

Manufactures believe that the problem can reduce if the Bank of Jamaica decreases the surrender requirement that commercial banks are obligated to hold as reserves. Currently, commercial banks are mandated to reserve 30 per cent of all foreign currency deposits with the BOJ. Manufactures believe that reducing the ratio to 20 per cent will free up more than US$2.5 billion worth of capital in the banking system, which will make more foreign currency available to borrow domestically.

Manufacturers also believe that the action/quota system used to sell large amounts of foreign currency is negatively impacting the cost of their inputs.

For example, one manufacturer needed US$100,000 within a specific time to purchase raw material, they were only given a fraction of that amount and that was not enough. They ended up losing the right to purchase and the goods were sold to manufacturers from other countries. By the time the US was ready from Jamaican banks, the cost increased from US $100,000 to almost US$160,000. Because of the delay in cash flow, the local manufacturer had to pay more than one and half time what they had originally bargained for the raw material.

- 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 editorial@gleanerjm.com.