Briefing | Jamaican exchange rate fluctuating to rock bottom
The Jamaican dollar (JMD) exchange rate depreciated to a new all-time value of $137 to US$1 at the end of trading day on Monday, August 19, 2018. This comes after the JMD showed signs of improvement when it appreciated by approximately four per cent, moving from $131 to $126 to US$1 between October 2017 and February 2018. Now at $137, the debate has reopened about what is the true value of the currency, as well as whether the depreciating trend is a cause for concern.
More volatility, more risk
Any signs of depreciation are met with scrutiny from importers, whose real-world business experience appears to belong to macroeconomic theory that a depreciating currency improves the terms of trade of the country. For businesses, as the currency depreciates, their cost of production increases.
The overshooting can lead to an increase in volatility, which is sometimes synonymous with risk; the more volatility, the more associated risk. The new landscape appeared to be a mechanism to reduce speculative hoarding of the currency as an asset, by reducing the ability to predict the value of the currency over the short to medium term. As a result, it also reduce the ability to predict purchasing prices of imported raw material and final goods that are not produced locally.
Fix the fundamentals
Surely these businesses are not producers," claims the International Monetary Fund (IMF).
They are merchants
From their theoretical view point, business ought to benefit from depreciations because their goods appear cheaper, providing that all the fundamentals are in place. These fundamentals, including the ability to expand production to benefit from economies of scale, appear to be among the innate structure of small island developing state. Jamaica, for example, has a better chance of improving its terms of trade through the sale of niche products with inelastic demand where the price is irrelevant, instead is trying to achieve this through the hospitality and tourism sector that is not yet large enough to catapult GDP growth.
Depreciating currency not a concern to the Bank of Jamaica
The Bank of Jamaica (BOJ) has outlined that they are aware of the new lows and new highs that the currency is experiencing. They outline that the new depreciating trend beyond the original $131 to $1 that Jamaican are used to should not be a cause for concern to local businesses and consumers. The BOJ reasons that Jamaicans should be more concerned about inflation because it impacts the real value of their
purchases rather than the exchange rate. It is the inflation rate that signals the average change in the price of a weighted basket of goods purchased by the average consumer.
What is inflation targeting?
Inflation targeting is the situation where the central bank has a specific inflation target for the short to medium term. In the case of Jamaica, the inflation target for the 2018-2019 FY is close to five per cent. This means that the BOJ, through market-intervention strategies, will try to usher the country to this five per cent rate of inflation for the year. The BOJ outlined that the main focus should be on the rate of inflation, as the country is now practising inflation targeting. As long as core inflation remains low, then Jamaicans will not feel the real effects of a depreciating currency when they buy domestically. However, domestically, the prices of some agricultural food items have increased beyond the Government's actual as well as predicted inflation target. This can be attributed to shortage due to lack of output. How many of these items from my weekly market basket are included in the basket of goods used to calculate Jamaica's inflation.
What are the implications?
The nominal exchange rate is a market occurrence. We cannot expect to sell good with a lesser value than that of which we purchase from the rest of the world and expect our terms of trade to improve. It is obvious that the economy lacks competitive output. This can improve through increased productivity. The very nature of small island developing states does not allow them to benefit from economies scale in the contemporary manner. We will discuss these issues and more at the launch of my book Developing Sustainable Balance of Payments in Small Countries: lessons from Macroeconomic Deadlock in Jamaica. at the UWI, Mona, on Thursday September 27, 2018, beginning at 6:30 p.m., all are welcome to attend.