Opposition Leader Edward Seaga. - Rudolph Brown/Staff Photographer
The following are excerpts from the presentation that Opposition Leader Edward Seaga made to Parliament at the 2004-2005 Budget Debate on Thursday.
AMONG THE factors that influence the cost competitiveness of Jamaican goods and services, none have wider application or deeper impact than the monetary and fiscal policies which determine:
In the decade of the 1990s to the present, the Jamaican economy has been a classical showcase of the use of inappropriate economic policies resulting in extensive monetary and fiscal instability. The first half of this period to 1995, saw extraordinary increases in money supply which flooded the system with excessive liquidity, inducing high inflation and prohibitive interest rates.
Money supply, inflation and interest rates are interactive.
HIGH INTEREST RATES
...The impact of high interest rates is pervasive, spreading damage throughout the entire economy. Until this weakness is corrected and competitive interest rates achieved, in a sustainable and credible macro-economic environment, competitively priced goods and services will not be achievable.
In this non-competitive scenario, participation in a CARICOM Single Market and Economy is of little or no value to the future prospects of development of the Jamaican economy. Indeed, it could be detrimental by opening the door wider to greater imports without compensating exports.
Several hit-and-run attempts have been made over the past few years by the Bank of Jamaica to reduce interest rates. The Bank of Jamaica, in keeping with the role of a central bank, pursues a policy of intervention by buying and selling foreign exchange to control demand and supply in order to adjust interest rates. The policy is implemented unevenly with sometimes sharp and unsettling changes in rates.
This hit-and-run approach produces a see-saw effect in trying to reduce interest rates without weakening the exchange rate. This is the classical dilemma of central banks: attempting to keep two variables, the interest rate and exchange rate in check at the same time. In Jamaica, the jugglers in this performance have been unable to keep both balls in the air simultaneously. Only one ball can be controlled at a time. If the policy priority is the lowering of interest rates then the exchange rate must be fixed to allow maximum control of interest rates to be realised.
There was a time when promoting a fixed exchange rate as a cornerstone of economic policy was heretical, certainly in IMF circles. But many countries have now adopted exchange rate policies which fix or peg the domestic currency to an internationally convertible currency, invariably the US dollar, but inclusive of the franc, Deutsche Mark and euro.
In the Caribbean region, 30 of 36 states fix their exchange rates to the US dollar, or, in the case of French states, the French franc. Eight of these 30 countries have gone further to substitute US dollars (dollarisation) or francs, for domestic currency.
Pegging the exchange rate has proven overwhelmingly popular in the Caribbean with very good results. A correlation of the exchange rate regime in force in 13 independent nations in the Caribbean and the average commercial bank (lending) rate, over 1994-1998, show unmistakably that those countries, except Belize, with pegged exchange rates have single digit or low double digit commercial bank lending rates. This is explicity outlined in an IMF occasional paper #201 entitled developments and challenges in the Caribbean region. table 8 below sets out the correlation: Please see table 8.
The impact of fixed exchange rates on inflation is also well established. A critical correlation is made between exchange rate regimes and average inflation rates over the period 1980-1998 establishing that countries with fixed exchange rates also had low inflation. Data on inflation rates, taken from the IMF occasional paper, was correlated with data on exchange rate regimes, as illustrated by Professor Alvin Wint in a well documented and insightful book Competitiveness in Small Developing Economies insights from the Caribbean. Table 8a sets out the comparison of 13 CARICOM countries. Please see table 8a.
Nine countries with rates pegged to the US dollar averaged 3.3 per cent-4.1 per cent per annum inflation rates. By comparison, four countries with flexible exchange rates averaged 95 per cent per annum inflation.
...It is clear that there is a positively established empirical correlation between a fixed exchange rate and:
Low interest rates
Upper middle high income per capita
on a sustainable basis.
This correlation is persuasive argument for a fixed exchange rate as the centre-piece of a macro-economic policy to stabilise the economy by a combined low interest rate low inflation strategy, a combination which has eluded the Jamaican authorities for more than a dozen years, since 1990.
The damage created to the economy by the over-burden of excessively high interest rates, cannot be over-estimated. Business and private household have been dislocated. Individuals have suffered from job displacements in failing enterprises and opportunities lost for jobs in a failing economy. Domestic production and exports have stagnated under crippling interest rates, among other factors, reflecting on the embarrassing failure of the low inflation, high interest rate policy of the past dozen or more years.
The question is not whether a fixed exchange rate to stabilise the economy is desirable but how and when, and where does this strategy fit into prospects of the Caribbean Single Market and Economy?
...To facilitate trade and investment in the CSME, it is proposed that a Caribbean Monetary Union (CMU) be established within the framework of the Caribbean Single Market and Economy. The CMU would be regulated by a Caribbean Monetary Authority (CMA). This concept originated among regional central bank governors in 1990 with a target date for implementation in 2000.
Central to the concept of a CMU is the creation of a single Caribbean currency to replace regional currencies.
The criteria, framed for participation in the CMU, require member countries to maintain a minimum of:
(1) Three months import cover in foreign exchange reserves for at least 12 months;
(2) A stable exchange rate against the us dollar for 36 months;
(3) An external debt service ratio of no more than 15 per cent of the value of exports.
A number of the proposed participating countries in the CMU, including Jamaica, cannot meet these criteria.
Several problems surround the concept of a CMU and a single currency. Basically, it is misconceived. The replacement of all regional coinage with a single currency is intended to facilitate regional trade in the CARICOM single market. But the level of intra-regional trade in this market is so small that the creation of a currency to facilitate a relatively miserly volume of intra-CARICOM trade is ridiculous.
A second reason for a Caribbean Monetary Union is that the Caribbean Monetary Authority (CMA) would be introduced as a regional monetary institution to administer a fixed exchange rate regime with a single currency. This would enable monetary and fiscal stability to be established for the region. But with the exception of Jamaica, Guyana, Haiti and Suriname (and possibly Trinidad), this macro-stability already exists, based on the fixed exchange rate of the OECS countries and the pegged currencies of Barbados, Bahamas and Belize. What incentive will exist then for these stable economies to be involved in a CMU which offers nothing better than what they have already achieved? Worse yet, the distinct possibility of weakening their own macro- credibility, by involvement with the instability of Jamaica, Guyana, Haiti and Suriname, would be a real threat.
...A strong case exists to examine the option of either a currency board with a fixed rate of exchange or an independent central bank with a special regime to maintain a pegged rate, as the means of ending the frustrations of a stagnant, debt ridden economy.
These options have far greater potential for the Jamaican economy than being shackled to a Caribbean Single Market and economy in which the market size is insignificant; or to be further shackled with a Caribbean Monetary Union which is likely to be still-born; or if surviving birth, would be pointless and futile in promoting the adoption of a whole new currency regime to satisfy a tiny fragment of Jamaica's trade.
In Jamaica's case, the benefit of a fixed rate of exchange would be the capability to drive interest rates down without impact on the rate of exchange. With a fixed exchange rate liquidity could accumulate in the banking system without the need for central bank intervention to sop up the liquidity in order to ensure that the extra funds are not used to depreciate the exchange rate. As liquidity accumulates, banks would have to reduce rates, as in the case of any commodity in surplus where prices are lowered to move the goods.
A regression analysis of the correlation of interest rates and commercial bank liquidity, done by Dr. Omri Evans, consultant economist, shows that every one per cent, increase or decrease, in bank liquidity, would induce, an increase or decrease, of a:
(i) Three per cent change, in 6-12 months deposit rates;
(ii) Five per cent change in average lending rates;
It follows that a two per cent increase in liquidity in the banking system could induce a 10 per cent reduction in the current commercial bank lending rate, from 25 per cent to 15 per cent, subject to prevailing market conditions.
A decrease of 10 per cent in the commercial bank lending rate would not only be a giant stimulus to consumer demand and business dynamics, but a corresponding substantial reduction of five per cent in the transaction rates of bank investments in public bond issues would have a dramatic impact on reducing the cost of Government borrowing and debt service. Every one per cent decrease in the transaction rate of Government domestic bond offers and other debt instruments, would result in $4.5 billion dollars in reduced borrowings or debt service payments. A reduction of five per cent in Government borrowing could realise savings to the budget of $22.5 billion. Needless to say this could transform the fiscal budget dramatically, reducing the deficit from the proposed $22 billion to zero, if accomplished in one year.
This scenario can be easily sketched, but is not as easily implemented. Great care would have to be taken to ensure that the programme of reduction was timely and synchronised with the existing debt maturities to avoid the dislocations which played a central role in the near demise of the financial system when money supply was precipitously reduced in 1996.