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The foreign exchange question

Thursday, January 18, 2018

All sectors are complaining, either that they cannot obtain foreign exchange (forex), or in amounts required.

Minister Imbert has publicly said that the authorised dealers have been instructed to favour the manufacturing/business sector. These complaints are not new and date back to 2013; the exchange rate depreciated by seven per cent during this period. The problem has become so intractable that the Minister last week mused publicly about reintroducing exchange control.

Exchange control will not solve the problem. Exchange controls were dumped in April 1993 by the then PNM administration for many reasons. First, they did not work; created opportunities for corruption; led to a poor allocation of foreign exchange and did not encourage new supply.

Our exports have declined in volume and value, therefore likewise foreign earnings. Yet imports have not declined by the same amount so that forex demand is greater than the supply.

This situation is expected to continue as the improvement in the volume of gas exports is not expected to generate enough earnings to meet forex demand.

This is a market imbalance that cannot be solved by administrative controls. It is amply demonstrated by the differential between the price at which US dollars are bought and sold at the Cambios, versus the banks and the existence of an (unofficial) parallel market.

The IMF estimates that the exchange rate is overvalued, somewhere between 28 per cent and 49 per cent. Continuing fiscal deficits exacerbate this problem as deficits expand economic activity and imports without generating foreign exchange. And we have been in persistent deficit since 2009.

The problem is largely on the demand side: non-exporters or those who do not earn enough foreign exchange. This imbalance can only be solved through a market clearing rate, defined as the rate that balances demand and supply. That was the purpose of moving to a floating rate with the understanding that a managed rate should not vary too far from this clearing rate. Sadly, we have lost our moorings, suppressing the natural depreciation in the exchange rate because of the declining trade terms.

In short, the current policy of “muddling through” will exacerbate uncertainty and engender a lack of confidence. Further, when the inevitable decision to adjust the currency is made, it will be a very steep adjustment and invoke the law of unintended consequences.

Why then is it so difficult to allow the exchange rate to depreciate? There are political, social and economic costs. Both the Prime Minister and Finance Minister have said that they must protect society’s vulnerable as devaluation is likely to lead to high inflation, increased wage demands and job losses, resulting in social unrest. These are possible outcomes, though the evidence of 1993 does not support this. In addition, businesses are currently repricing their inventory at the margin, the unofficial rate at which additional forex is bought. This has not led to an inflationary surge.

But devaluation by itself will not solve our problems. It must be complemented by a comprehensive set of policies to improve productivity and efficiency in both the public and private sectors and realignment of our skill sets to survive in the 21st century. Petrotrin is a metaphor for this challenge. On this matter the Prime Minister has prevaricated, avoiding critical decisions.

The political costs are simple. Adjustment policies are unpopular as they involve sacrifice. Political leaders tend to lose elections when they adopt such policies. Devaluation close to an election raises the probability of defeat significantly.

The fate of the NAR in 1991 is instructive. But difficult times require tough decisions to move a country forward, or to avoid collapse.

However, like the UNC in 2014, who promised to deal with the budgetary imbalances by 2016, the Prime Minister has promised to do the same in 2021, after the election.

He would do well to remember that, ultimately, economics trumps politics. The county needs leadership not to be confused with coarse language.


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