Time for the Jamaican dollar to revalue


Friday, August 17, 2018

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The recent sharp decline in the Jamaican dollar has apparently created a surprising level of confusion, consternation, even panic, in the society.

Some with selective memories have compared the decline unfavourably to similar episodes of devaluation in the past, others have called again for fixed exchange rates, while many have demanded that the government better “manage” the currency.

Finally, the catch all bugbear of “speculators” has been invoked as one of the possible culprits. Virtually all this criticism seems to have missed the mark, although better communication and perhaps some measures to anticipate and ameliorate the likely, even obvious impact of Jamaican dollar liquidity developments might have been helpful.

The first thing to note is that the recent spike in the Jamaican dollar appears to primarily be driven by a number of large corporate transactions over the past couple of months, where several tens of billions of debt financing has been raised in Jamaican dollars, and has then — perfectly reasonably — been used to purchase US dollars to pay down existing US dollar debt.

The first round of this re-financing was in June, taking advantage of already very liquid Jamaican dollar conditions, but July 11th saw a huge new round of Jamaican dollar liquidity entering the market ($51 billion) primarily due to the repayment of National Debt Exchange restructured debt, with corporates continuing to borrow in Jamaican dollars to replace their US dollar debt.

This would also have been anticipated by local players, and was undoubtedly the principal reason for the spike in the dollar during that month.

A second reason is that the fundamentals — namely the current account deficit — have deteriorated somewhat over the last six to nine months (we only have first quarter figures for this year so far) almost entirely due to the rise in oil prices. From a situation where foreign direct investment covered our current account deficit several fold last year, we are likely to now be near balance.

Nevertheless, this is a much better situation than virtually any time over the last 55 years, and most financial market players do not appear to believe that there is a fundamental shortage of dollars — a position supported by our fairly stable net international reserves, which are of continually improving quality as the portion representing borrowed money continues to decline.

A third reason is that around the same time that this new but very welcome wave of re-financing began, the Bank of Jamaica (BOJ) entered the market in mid-June on the buy side (a decision probably made more than a month before, based on their read of market conditions at that time) under its new B-FXITT mechanism, as opposed to being only on the sell side previously.

While it is understandable that the Bank of Jamaica would have wanted to follow through for credibility reasons with this operation (particularly as the IMF physically arrived for their review just as it started), it is also likely that this had a negative signalling impact for the Jamaican dollar, despite the actual volumes being relatively small as a portion of total purchases over the period.

This is because, in the past, local players would have expected the BOJ to lean against such a depreciation and not accentuate it, despite the clear recent messaging from the Bank of Jamaica that it intends to stop doing this as it moves towards inflation and not exchange rate targeting.

Another possible reason for the decline in the dollar would have been a major shift by local institutional investors into US dollar instruments eg Eurobonds. but while there may have been some purchases at the margin, most of the recent buying and selling in our Eurobonds appears to have been done by foreign institutions, and does not appear to be driven by local institutional investors. This is because most local institutions are already, for the most part, capped in their US dollar positions for regulatory and other reasons.

Finally, there is the danger of a collapse of confidence that has underpinned Jamaican dollar collapses in the past, such as in 2003, when the Jamaican dollar fell from $50 to $70 to one US dollar in just 10 days. The backdrop to this (and other) collapse was the seeming unsustainability of our debt post the 2002 election.

Jamaica is in a quite different situation now as it runs a balanced budget with a declining debt to GDP, and has strong business confidence. The roughly just over seven per cent fall in the Jamaican dollar year to date, or the just under seven per cent fall year-on-year to mid-August, hardly qualifies as a collaps — the main issue being that most of the fall was concentrated in one month.

In summary, in line with a number of other financial sector players, I expect the dollar to begin to recoup some of its losses in the coming weeks, possibly back to the $135 to US$1 level or even stronger.

The Bank of Jamaica has now begun to sell US dollars, and I would also expect their communication to improve.

Perhaps as importantly, the financial system should now be sitting on excess US dollar deposits from the repayment of the US dollar debt of its clients (most of the impact of the recent Jamaican dollar liquidity shock should therefore have already passed through the system). Some of those US dollars will probably need to be sold to meet regulatory and other requirements, particularly if the Jamaican currency now looks likely to revalue.

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