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'Dollar depreciation highly unpopular domestically'

Published:Wednesday | June 25, 2014 | 12:00 AM

McPherse Thompson, Assistant Business Editor

The International Monetary Fund (IMF) said the remaining overvaluation of the Jamaican dollar appears modest, but its staff adjudged that it still requires to be depreciated by between three and 15 per cent.

That is less than the eight to 22 per cent overvaluation assessed in April 2013, but the IMF said ongoing depreciation of the nominal exchange will be needed, particularly given the sizeable inflation differential with Jamaica's trading partners.

The real depreciation of the exchange rate since mid-2012 opens up an essential but contentious path to restoring Jamaica's competitiveness, according to the updated letter of intent, memorandum of economic and financial policies submitted by the Jamaican government to the IMF, dated June 5, 2014.

The document notes that the depreciation of the exchange rate has been highly unpopular domestically and there has been little apparent recognition of the job-creating benefits of currency adjustment.

"This is in part fuelled by the slow responsiveness of exports (other than tourism) to the weaker currency and the clear near-term costs through imported inflation," it said.

"It is also a product of historical experience whereby past depreciations led to bursts of inflation with little benefit for the real economy," the report said.

"However, there are now promising signs that domestic production is beginning to replace imports for some agricultural goods and the impact on net exports (in particular, in agriculture and agro-processing) should continue to grow," the Government told the IMF.

The report said that "following the substantial adjustment that has taken place, the remaining overvaluation of the Jamaican dollar appears modest. Staff judge this overvaluation to be around 3-15 per cent relative to medium-term fundamentals and planned policies," the document said.

Restoring external competitiveness

According to the memorandum, policies to raise productivity and remove obstacles to investment and trade will be essential to complement exchange rate adjustment in restoring external competitiveness and lower the current account deficit toward its longer-term equilibrium of around five per cent of gross domestic product.

It said the Government has agreed on the merits of exchange rate flexibility, and noted the emerging shift to domestic production in response to the recent depreciation.

At the same time, the Government pointed to the economic uncertainty and adverse social implications generated by rapid exchange rate depreciation.

"Accordingly, they emphasised the case for limiting the need for nominal exchange rate changes through supply-side measures to improve external competitiveness and through a further reduction in inflation to more moderate levels," the memorandum said.

However, the executive board of the IMF said the return to a flexible exchange-rate has resulted in important improvements in price competitiveness and should be maintained.

It added that confidence in the coherence of policies will be critical for boosting investor sentiment, but said private investment will only return if efforts are also focused on removing pervasive red tape and bureaucracy.

The memorandum notes that the Bank of Jamaica (BOJ) agrees with IMF staff that substantial improvement in the price competitiveness of the Jamaican economy has been achieved over the last year as the exchange rate has moved in line with market fundamentals.

As a result, BOJ analysis indicates that the exchange rate is much closer to equilibrium than the staff's assessment of three to 15 per cent overvaluation would suggest.

It said that going forward, future movements in the nominal exchange rate are likely to be driven by macroeconomic and trade relevant variables, such as the inflation differential between Jamaica and its major trading partners, and the success of policies to raise productivity and remove obstacles to investment.