A fixed exchange rate will be more beneficial for Jamaica

Kirkland Anderson's picture

Exchange rate is the amount of local currency required to purchase one unit of foreign currency. For example at the end of 2013 and on June 16, 2014, the average exchange rate between the Jamaican Dollar and the US Dollar was 100.77 and 111.56 respectively. This means if a barrel of oil on the international market was being  sold for US$1.00, Jamaican would have  required JA$100.77 at the end of 2013 compare to JA$111.56 in less than six months later to buy the same barrel of oil.

Over the past twenty three years, the performance of the Jamaican economy has been constrained by severe shortage of foreign exchange on the market, which resulted in persistent depreciation of the local currency.

Jamaica’s Foreign Exchange Market was fully liberalized in September 1991 following a period of rapid depreciation in the Jamaican dollar, which started in late 1989.  A fully liberalized exchange market means that the exchange rates between Jamaican dollar and the currencies of its major trading partners mainly the United States, the United Kingdom, China and Canada, are determined by the demand and supply of the respective currencies. Once the demand for foreign currency exceeds that of its supply, the local currency depreciates (weaken) against the foreign currency.

Despite the implementation of a high interest rate policy and several other public as well as private sectors initiatives to stem the slide, the Jamaican Dollar continued to depreciate, relative to the US dollar, from 7.18 in 1990 to 111.56 in June 16, 2014 (see figure 1).  This represents a depreciation of approximately one thousand four hundred and fifty two per cent (1451.54%).  Such massive decline in a country’s currency within a quarter century will no doubt destabilize any economy and Jamaica is no exception.

Since the 1990s Jamaica’s economy has been plagued with:

1) double digit or high single digit inflation rates which significantly eroded the purchasing power of  Jamaicans in particular the middle class

2) double digit interest rates which retarded private investments and ultimately exports.

3) high unemployment and increased levels of crime and violence due to low private investments.

4) low labor productivity  which increased the country’s level of un- competitiveness. It is little wonder that over the last ten years, this country has spent almost US$40 billion more on imports than the US$18 billion it has earned from exports.

5) high national debt, which  is currently  J$1.68 trillion or approximately 140 per cent of the monetary values of everything this country produces in a year {GDP}. Jamaica’s 140 per cent debt to GDP is way above the international bench mark of 90%d. 

For too long Jamaica has been under the illusion that depreciation of the local currency is the answer to our problem of low productivity. We have long been under the illusion that achieving a competitive currency must be the first objective. The first objective should be the achievement of a competitive economy by prioritizing the correction of the various macroeconomics variables. There is a real probability that this country will experience an economic depression at its worst or an anemic growth at its best for the next twenty five years if stability within the economy is not achieved.  Stabilizing the exchange rate for at least the next five years is the first step in achieving economic stability. The government must undertake serious dialogue with members of the productive sectors in which such initiative is clearly outlined (the objectives, time frame to achieve objectives and the part the productive sectors must play in order for objectives to be achieved).  

This monetary policy will:

eliminate currency depreciation. Depreciation of the local currency increase the cost of imported raw materials such as oil, which Jamaican firms depend on heavily.   The prices of finished goods also increased hence, reduced profitability to the firms.  An examination of the average annual change in the value of the local currency with the annual change in Jamaican value of imported oil between 2000 and 2013 shows a very strong positive correlation (r = 0.945).  This also indicates that the depreciation in the Jamaican dollar is responsible for approximately eighty nine cents (r2 = 0.8932) of every one dollar increase in the imported cost of oil.

encourage investment. The elimination of exchange rate fluctuations can increase the incentive for firms to invest in export capacity which will ultimately result in increased foreign exchange inflows. Recently a number of CEOs from several Japanese firms expressed the view that the UK’s reluctance to join the Euro and provide a stable exchange rate makes the UK a less desirable place to invest.  By maintaining a fixed rate, both buyers and sellers of goods on the international market can agree on a price and not be subjected to the risk of later changes in the exchange rate before contracts are settled. The greater certainty should help encourage investment.

eliminate speculation, which is a destabilizing economic factor.  A fixed exchange rate is usually used to stabilize the value of a currency against the currency to which it is pegged. This makes trade and investments between the two countries easier and more   predictable and is especially useful for small economies like Jamaica in which external trade forms a large part of their GDP.

stem the increase in the country’s national debt.  Jamaica’s debt to GDP is one of the highest in the world. A one per cent depreciation of local currency increases the national debt by approximately 0.5 per cent.  The dollar depreciated by approximately twenty five per cent under the current government, which is   responsible for a twelve and half per cent increase in the national debt. It also means that any gain achieved due to the inflows from the IMF agreement and the success of the NDX is countered by the persistent depreciation in the dollar.

Stabilizing the exchange rate would make it possible for local firms to undertake more effective planning and forecasting with the aim of reducing their unit costs. Currently many of these firms are faced with energy costs upwards of twenty per cent of their total operating costs and this will increase if the local currency continues to depreciate.
 

Kirkland Anderson is associate professor of economics and management and acting chairman of the College of Business and Hospitality Management, Northern Caribbean University, Jamaica.    

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