BOJ Could Undertake Reforms to Improve Country’s Competitiveness

To address the issue of competitiveness, the Bank of Jamaica (BoJ) says it may be necessary to undertake “reforms to improve the business environment that will enhance productivity and allocate resources to more dynamic sectors.”
The recommendation is contained in a special feature entitled, ‘Exchange Rates and External Price Competitiveness’, in the recently released Quarterly Monetary Policy Report (QMPR) by the Bank of Jamaica.
The feature highlights the performance of the exchange rate in the June 2010 quarter, showed that the value of the Jamaican dollar appreciated by 4.1 per cent, representing the largest quarterly increase since the June 1996 quarter. This followed a 10.2 per cent depreciation in 2009, most of which occurred in the first quarter of that year.
Appreciation of the exchange rate has raised questions about the country’s external competitiveness and in response, the special feature of the Report highlights the factors underlying the recent appreciation of the dollar and assesses the impact of changes in the exchange rate on external competitiveness in the economy. The article explains that the recent trends in the exchange rate were influenced by economic developments both locally and abroad and that with the improving economic outlook, the holdings of some institutions declined to US$180.0 million by end-June 2010, from US$331.0 million at end-March 2010.
“The success of the recent Jamaica Debt Exchange (JDX) and the achievement of the March 2010 targets under the IMF-Stand-by Agreement led to a strengthening of investor confidence. These developments resulted in increased inflows into the foreign exchange market, as well as relatively low demand. The increased inflows largely emanated from an unwinding of long positions by authorised dealers. This was in a context where some institutions had built up balances during the period of uncertainty in 2008 and 2009 due to the effects of the global crisis,” the article notes.
In addition, the BoJ feature states that the appreciation was influenced by relatively attractive yields on domestic instruments because global interest rates were at historic lows. It also reflected some correction to the sharp depreciation which occurred in the 2008/09 financial year.
The Central Bank regards the behaviour of the exchange rate as understandable and attributes it to the behaviour of the market following the sharp change in expectations. The Bank’s assessment of whether there has been a gain or loss in competitiveness is based on the real effective exchange rate (REER), which is the most frequently used indicator of external competitiveness.
With respect to the recent episode of appreciation in the exchange rate and concerns about Jamaica’s external competitiveness, the BoJ notes that a depreciation in the currency would make a country’s exports relatively cheaper to foreigners and at the same time make imports more expensive.
“In a small open economy such as Jamaica’s, the productive process, including that of the export sector, is heavily reliant on imported factors of production, for example, energy. In this case, an exporting entity which faces a depreciation and wants to increase production will be faced with higher cost of inputs,” the bank adds.
In general, the depreciation in the exchange rate would result in an increase in inflation, which is inimical to competitiveness. Such a situation could become untenable as the economy is caught in a depreciation and inflation spiral resulting in price instability, the article cautions. This in turn could adversely affect investor confidence, business planning, economic welfare and fiscal performance.
According to the BoJ feature, the recent appreciation in the exchange rate is consistent with the positive developments within the economy since February 2010. These occurrences led to improved confidence and a reversal of the sharp depreciation which occurred in 2008/09.
However, the Central Bank believes that any “extreme price movements, in either direction, can adversely affect the economy and competitiveness. In this regard, the Bank will continue to foster orderly movement in the exchange rate, which is in keeping with its aim of price stability”.

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