Letter of the Day | Jump-start market with forward contracts
THE EDITOR, Sir:
Allow me to congratulate the Ministry of Finance and the Bank of Jamaica (BOJ) for putting on an excellent symposium titled ‘Foreign Exchange Market Development’. I did not attend the event, but was able to view it on YouTube.
The most interesting part, for me, was the segment on the market for forward contracts. Over the last year, I’ve made the point in private communications/discussions that perhaps the BOJ needs to ‘jump-start’ the market for forward contracts since little activity is happening among the private institutions. This view of BOJ ‘intervention’ was supported by panellist Peter Higgins of the NCB. But why should the BOJ become a player in the market for forward contracts when it has adopted an inflation-targeting regime, and has been actively reducing its influence on the foreign exchange market?
1. Simply put, for there to be a market, there must be a buyer and a seller (or buyers and sellers). In the case of the market for forward contracts, the lack of activity, in my view, was more an issue of supply. To be clear, I’m sure a commercial bank would sell a forward contract once the price is right. However, how many commercial banks are willing to sell forward contracts that are within reach of most potential buyers, especially the small and medium-sized enterprises that lack the financial, technical and legal resources available to larger firms?
The price of contracts will reflect the risks involved, and for a relatively nascent market such as Jamaica’s, those costs will be relatively high. Further, there’s a lack of information on the part of market participants as regards the pricing mechanism and the standardisation of contracts.
While it’s possible that with time the market for forward contracts will become more sophisticated, deeper, and wider, the BOJ’s input could quicken the pace and, more important, reduce the current volatility. As it stands, the BOJ is still forced to intervene through flash operations. By operating in the forward market temporarily, it would help to build the forward market while still meeting its mandate of guarding against a ‘disorderly’ depreciation of the Jamaican dollar. Note that I deliberately did not use the term ‘devaluation’, which is often incorrectly used within the ‘current’ dispensation of central banking in Jamaica.
2. The BOJ is operating under an inflation-targeting regime, which necessitates the foreign exchange rate to be more market determined than obtained in the past. However, the BOJ can maintain its single nominal anchor mandate while jump-starting the market for forward contracts. As currently obtains under B-FXITT (BOJ Forex Intervention Trading Tool), an auction mechanism could be introduced for the sale, and even the purchase, of forward contracts. In this manner, market forces will be dictating the price of the exchange rate on the forward market and, by extension, the spot market.
3. Central bank involvement in the market for forward forex contracts is not new, and currently obtains in Nigeria, albeit under different macroeconomic policy arrangements, and macroeconomic realities.
4. Price stability, which includes stable exchange rates, can be seen as a ‘public good’, and like the more readily agreed upon examples of public goods, such as national security, the Government, through an independent central bank, has a mandate to deliver stable prices. In small, open economies, like Jamaica’s, where markets are incomplete and shallow, there’s a greater need for the Government to intervene where the private market lacks the will and technical knowledge to so do. In the case of the market for forward contracts, such participation need only be temporary and will complement the B-FXITT tool.
Lecturer, Department of