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Currency devaluation - EU wants it but Jamaica dislikes it

Published:Friday | June 13, 2014 | 12:00 AM

Aubyn Hill,  Financial Gleaner Columnist

In September
2012, when I cautioned in my column that Jamaica would have to "default or devalue" and again urged the Government of Jamaica and the Bank of Jamaica (BOJ) in February of 2013 to "fix" the overvalued Jamaican dollar, there were many who disagreed - some were offended - with those positions.

As it turned out, both events have occurred.

The NDX 1 & 2 were technical defaults and on February 18, 2013 the Jamaican dollar was trading at J$95.5 to US$1. There has been a steady slide in our currency since 2012 to the current level of about J$111 to US$1.

What is remarkable then and now is how we jealously guard our overvalued currency, using scarce and borrowed hard currency to support the untenable position, while other, richer, currency zones and countries are trying to drive down the value of their currencies.

If Jamaica's economy was big enough to matter, and the weight of our currency of sufficient value to count, those countries trying to push down the value of their currencies would be looking at us with wry smiles.

Someone is going to ask what is the right value of the JMD. Well, just look at our trade imbalance with pretty much all our trading partners and the attendant current-account position, factor in our relatively high rate of inflation against that of our major trading partners, as well as our uncompetitive productivity rate and the answer will be evident that whatever that exchange rate is, we are not yet there.

Those policymakers and their avid followers who dislike devaluing the dollar must cut the nonsense and foot-dragging in terms of reducing our bloated government. Policymakers, led by the policymaking chief, must inject initially painful doses of efficiency into our largely inefficient government ministries and agencies, make the necessary policy changes in energy and the use of knowledge as a growth propellant, and redirect much of our imports through long-term contracts to local suppliers - manufacturers, please, not just importers - in order to prime private-sector-led growth.

When the much talked about and anticipated big ('Chinese?) projects finally arrive, they will add fuel to the already moving growth train.

No significant improvement in economic growth, more dollar depreciation.

ECB DEVALUATION PUSH

On Thursday of last week, in response to months of intense pressure to boost growth by making cheaper credit available to households and businesses, Mario Draghi, the boss of the European Central Bank (ECB), and his colleagues on the governing council, sanctioned an unprecedented interest rate, -0.1 per cent - a negative rate on deposits. This means that banks have to pay the ECB to keep deposits with it instead of the other way around.

The ECB is trying to prevent the 18-country Eurozone from sliding into a bout of deflation, the opposite of inflation, that could kill off a quite muted economic recovery. In the last quarter, GDP growth stumbled to just 0.2 per cent and only the strong performance by the German economy saved the Eurozone countries from economic contraction during the period.

There is no doubt that the ECB's venture into the negative interest rate territory is unorthodox and untested. It has made this move as a push on banks to keep money away from deposits with the ECB and lend the cash instead to non-financial institutions rather than hoard it.

Draghi also led the ECB to make other important changes aimed at sending a clear message that the ECB wants to make cash available and interest rates accommodating to faster economic growth.

The central bank's main interest rate was cut to a record low of 0.15 per cent from 0.25 per cent, and it announced a €400-billion package of cheap funding for banks on the condition the funds are used to lend money to companies outside the financial sector and not for mortgages.

The ECB was pushed down this road by another important consideration - the value of the euro in relation to other major currencies. The ECB has been successful in restoring confidence and stabilising financial markets - remember the international jitters caused by the near meltdowns in Portugal, Ireland, Greece and Spain?

THE PRICE OF OVERVALUATION

This stabilisation and confidence building has clearly gone too far especially when consideration is given to activities, policy initiatives and developments in currency markets such as the US, Japan and large emerging economies. The strength of the euro - 'overvaluation' - against its trading partners' currencies had become a real obstacle to converting Europe's financial gains into durable economic improvements.

Analysts concluded that the ECB policymakers had to join government officials' stated concern about the euro's 'over-appreciation' for, among other reasons, its effect on economic growth, competitiveness and jobs. These policymakers and officials worried that the strong and overvalued currency was contributing to 'lowflation', which is an inflation level that has been too low for too long.

Data published by the EU's statistics office revealed an unexpected fall in the annual rate of Eurozone inflation to 0.5 per cent in May from 0.7 per cent in April. This was a major trigger for the ECB stimulus package.

If people and companies in the Eurozone continue to lower their medium-term inflationary expectations they will delay spending and thus cripple demand, which will impede economic growth and increase the debt burden.

A week or so before the ECB decision, the expected policy shifts brought a desirable weakening in the currency. A euro bought just less than US$1.36 on May 28. That was down from the US$1.39 three weeks earlier.

Looser monetary policies tend weaken a currency and the ECB changes weakened the euro to US$1.3555 soon after the decisions. More slide is expected. As important, major European stock markets, led by Germany's, posted significant or record gains.

So while Europe, Japan and other major international economic players try to lower the value of their currencies and foster growth, we maintain policies that stifle growth and continue to put forth arguments which support an overvalued currency.

Aubyn Hill is the CEO of Corporate Strategies Limited and was an international banker for over 25 years. Email: writerhill@gmail.comTwitter: @HillAubynFacebook: facebook.com/Corporate.Strategies