Andre Haughton | Exchange rate volatility and risks

The Jamaica-US dollar exchange rate has depreciated from an average of J$128.50 to US$1 in December 2018 to $137 to US$1 as of trading day on Tuesday February 5, 2018. This is quite the opposite of what occurred last year, when the currency appreciated by approximately four per cent to value J$125 to US$1 in February 2018. At that time, we thought that a new exchange rate landscape might have been on the horizon, where the exchange rate would remain less volatile to signal a more stable financial sector to entice more investments in the country’s world-leading stock market. But this was not so. Since then, the currency depreciated to an average of J$137 in August of 2018, appreciated to a low of approximately J$127 in November, and now it’s back to J$137 to US$1.

What is exchange rate volatility?

Exchange rate volatility is the risks associated with unexpected upward and downward movements in a country’s exchange rate relative to its trading partners. It can be considered as short-run deviations of a particular exchange rate from its long-term trend. The up-and-down movements in the Jamaican dollar exchange rate, without a clearly defined trend, can be considered volatility and might contribute to exchange rate risk that might have implications for business and the economy in general.

How was it last year?

During the 2017 to 2018 fiscal year, the currency appreciated from an average of approximately J$130 to US$1 in May of 2017 to approximately J$125.50 to US$1 at the end of December 2017 and remained until about June 2018, when it depreciated to an average of $130, then spiked to $136 by August 2018, and is back to a similar value in February 2019. This exchange rate volatility is one of the most basic risks that traders and investors encounter in merchandise trade or the movement of financial assets and investment instruments across countries. Economists have found mixed evidence to suggest that exchange rate volatility reduces merchandise trade in some instances but increases it in others.

How has the volatility impacted imports and exports?

In retrospect, the Statistical Institute of Jamaica (STATIN) reported that expenditure on total imports to Jamaica from January to November 2018 was 12.8 per cent more when compared to the similar period in 2017. According to STATIN, domestic exports over the similar period increased by 31.6 per cent, while re-exports increased by 21.2 per cent when compared to the similar period in 2017. It will be interesting to see the effect of the current spate of depreciation on imports and exports.

What is the expected effect on the economy?

Sometimes a more stable nominal exchange rate signals a more stable economic financial landscape. However, this might be difficult to maintain because market forces beyond the control of monetary authorities play a more definitive role in the nominal value of the currency. Most times, the impact of currency appreciation or depreciation on investment and trade will depend on the elasticity of demand for investment instruments as well as exports and imports. A more stable currency, though, would contribute to more certainty in the cross-border financial sector, especially transactions. It would also send a positive signal that Jamaican dollar investments are relatively stable and will not lose value due to exchange rate risk over the medium term. This would be good, especially given the fact that the Jamaican equity instruments are providing the best returns in the world. Investors’ minds would be more at ease when they make a Jamaican investment and the country would be sending a strong, positive signal that the domestic stock market and domestic economy are robust. Exchange rate volatility might be seen as risky and might have implications. The interest rate differential between Jamaica and other countries will also play a role in the volume of investment that the country attracts.

Dr Andre Haughton is a senior lecturer in international finance at The University of the West Indies, Mona.