Why the BoJ can't deliver growth - Pt IV
Published: Friday | March 20, 2009
Keith Senior looks through his bookshelf at home. - photos by Peta-Gaye Clachar/Staff Photographer
The accumulation of our net international reserves (NIR), because of its direct link to an ever expanding 'emergency' import index, and being funded by expensive 'open market' instruments/liabilities, if continued, will result in further financial burdens and operational inefficiences for the central bank.
On March 27, 1995, one year prior to the incumbent Governor's appointment, a BoJ news release reported an NIR balance of US$743.5 million. This amount represented 17 weeks of imports. However, 13 years later, January 2009, and with an increase of over US$1,000.0M (US$1 billion) in the NIR, the weekly import coverage has reduced from seventeen to less than 15 weeks. The total import bill of the country was US$2,177 million in 1994. The year 2008 was estimated at US$6226 million.
As long as the country's level of imports increases, the BoJ either has to create more 'printed' CDs and sterilise their proceeds, or reduce the number of weeks of imports. More CDs will likely impair the operating income of the bank because of the asset/liability mismatch in earnings. A static NIR will lower the number of weeks of imports held.
The BoJ describes the NIR as a monetary policy tool as follows:
"The Bank also controls liquidity through its intervention (direct sales/purchases) in the foreign exchange market."
The above is indeed practised; however, any large-scale sales intervention creates excess liquidity and if not reabsorbed and sterilised it becomes domestic hot money. The hot money scenario becomes very ominous if all current CDs are sequentially retired by their holders at maturity, and the bank has to liquidate assets for this purpose. Unfortunately, the only assets available to meet the maturity needs of the CD holders would be foreign assets. The foreign assets would have to be called because the bank's
balance sheet has shown a substantial annual negative Net Domestic Asset (NDA) position for the past eight years.
This liquidity burden is almost intractable and because of the negative consequences that will flow from exercising the options available, this central bank manage-ment is almost powerless in regard to delivering a growth oriented interest rate regime.
The Balance Sheetand Monetary Base
NDA is a critical variable in the bank's base money management. Its relevance is explained by the bank as follows:
"Management of the monetary base (MB) focuses on the balance sheet of the BoJ, in particular its NDA and net international reserves (NIR)."
The bank's balance sheet is represented by the following identity:
MB = NDA + NIR
(Where MB, the monetary base, is the sum of notes and coins issued by the central bank and commercial bank cash reserves).
BoJ publishes monthly, the totals and components MB and the NIR. The MB is reported in J$ while the NIR is in US$. However, when the NIR is converted to J$ and inserted in the standardised equation depicted above, the result for December 31, 2008 is as follows:
MB = NDA + NIR
J$71,498 = (-J$71,170)+ J$142,668
After eight consecutive years of negative NDA (an actual net domestic liability out-turn) the BoJ should rewrite the above formula and provide a detailed explanation for the use of the Bank's net domestic liabilities in calculating or controlling its monetary base.
The negative NDA is caused by the excess liquidity (CD liability obligations) called open market instruments on the bank's balance sheet.
The final questions
1. Is the BoJ unwittingly 'dollarising'?
2. Are the annual 'translated' exchange gains the sole sustenance for a 'viable' central bank?
The Balance Sheet and Monetary Base
Mathematically, if the bank adjusted the monetary base equation to its natural form by discarding the now irrelevant term, (NDA), and substituting the now permanent existence of net domestic liabilities (NDL) and reformulate as follows:
NIR = NDL + MB
Would this new equation be conclusive evidence of a process of 'dollarising' the bank's balance sheet, and ultimately a prelude to 'dollarising' the national economy?
The audited income statements of the bank for the past 12 years ('96-'07) tell a remarkable story. The results, if not scripted, are wholly coincidental. See the relevant highlights below:
From the table above, it can be observed that the dollar was revalued by $4.98 (between January 1 and December 31) and this resulted in an exchange loss of $1.3 billion in 1996. This has not occurred since. However, it can be observed that the exchange gains for eleven consecutive years were determined by the level of depreciation of the local currency and size of the bank's foreign assets. The years 2000 and 2001 are good examples. The foreign asset size doubled, the depreciation was down by 50 per cent and the exchange gain was roughly equal for both years. The year 2003 was a bumper year. The depreciation was $9.47 with an unprecedented $11.41 billion in exchange gains. Based on current available statistics for 2008, the local currency lost $9.85 for the year and the foreign asset balance was $144.0 billion on December 24, 2008. This combination should produce another bumper year.
In assessing 2008, however, it would be interesting to know if the BoJ's profits are usually generated during the last quarter of each financial year. The published balance sheets for 2008 showed accumulated losses as follows: March 26, $2.15 million, June 26, $1.91 billion, and September 24, $4.2 billon. In the final quarter the results were: October 8, $3.45 billion losses, October 22, $1.4 billion losses, November 12, $$1.9 billion profit, November 26, $2.19 profit, December 10, $4.52 billion profit, and December 24, $6.6 billion profit. Would a profit of $10.8 billion ($6.6B accumulated plus $4.2B absorbed) for October to December make 2008 a bumper year? Coincidentally, there was significant downward pressure on the local currency during the last quarter of 2008 when it depreciated by $8, from $72 to $80.
Also, the above table shows thatin the first six years, exchange gains were $4.7 billion (net). However, over the next six years ('02-'07), exchange gains improved by 700 per cent to $33.51 billion for a total of $38.2 billion
While these exchange gains were being recorded over the second six-year period, the bank was incurring massive operating losses. Commencing in 2001, the audited statements revealed seven consecutive years of operating losses as follows:
The above losses were calculated on the basis of the format used by the external auditors in 1998 and prior years.
The current format was not used because of the following Note (24) from the auditors on exchange gains in 2007:
Net unrealised gain on translation of foreign-currency assets and liabilities and realised gain on settlement of foreign assets and foreign liabilities.
The quote appearing above is similar to Note (22) in the financial statements of 1998 when foreign exchange gain was not grossed into the total operating income of the bank. Note 22 of 1988 is the preferred treatment because 'translation' involves nothing operational.
For the years 1996 to 2000, the bank generated operating profits of $10 billion. When adjusted with the losses of $35.16 for 2001 to 2007, the bank would show operating losses of $25 billion since 1996. This amount was covered by $38.2 billion in unrealised (translated) foreign exchange gains. If the domestic currency (J$) had had remained stable since 2000, which would mean that no exchange gains could be 'translated', then the Government would have had to make good those losses.
Without a change in the structure of the bank's balance sheet (the asset-liability mismatch) the chronic net interest margin/net operating loss performances will continue. And, further deterioration will ensue as the bank continues to build the NIR to meet an expanding emergency import requirement.
The present balance sheet structure also poses a 'financial paradox' for the Treasury in the Bank's current financial year (Jan-Dec.09). The Jamaican dollar opened trading on January 2 at 80.47 to US$1.00. If the current initiatives by the Treasury should stabilise and ultimately improve the exchange rate, all things being equal, the bank's exchange gains could be reduced significantly or disappear totally. Ultimately, the Treasury would be required to fund the resulting losses.
The central bank has fallen short on its legal mandate as well as all the operational indicators examined
Of all the breaches observed, however, the most far-reaching is the bank's apparent assumption of unlimited powers to issue certain debt instruments based on its guarantee and without reference to its portfolio ministry or Parliament. These instruments are putting severe pressures on the bank's ability to perform effectively. Without timely and appropriate remedial action, the bank will drift into a state of disutility.
Adjusted OperatingLosses ($Billion)
Dollar Exchange Foreign
Change Gains Asset
'96 +4.98 (1.32) 30.1
'97 -1.58 0.75 24.6
'98 -0.83 0.30 26.1
'99 -4.17 1.34 22.8
'00 -4.04 1.71 47.8
'01 -1.93 1.92 90.0
Dollar Exchange Foreign
Change Gains Asset
'02 -3.50 4.96 82.8
'03 -9.47 11.41 71.8
'04 -1.02 1.81 115.8
'05 -2.96 4.23 139.2
'06 -2.55 4.53 160.6
'07 -3.46 6.57 134.2