Capital flight and the exchange rate

According to Dr DeLise Worrell, Governor of the Central Bank in Barbados, such economies depend on the positive difference between forex earned and that used for general imports when properly utilised to create economic development.

Indeed, such economies depend for their very survival on exporting to generate activity and growth in the onshore, non-commodity sector — the present GDP decline in our onshore is a case in point.

This characteristic shapes the value system of the population.

Consider the circumstance in which there is a fall-off in forex earned, ie, this is insufficient to support the onshore demand for imports.

Given the inability of the economy to respond quickly with new exports or import substitution, the only option left is to reduce aggregate demand onshore. If a devaluation is normally the response to such a shortage of forex (IMF/ World Bank advice), then the pre-emptive move by much of the population with liquid assets is to export these via foreign exchange into offshore banks and in so doing increase the demand for forex — capital flight.

This is done, according to the forex exporters, to maintain the value of the assets.

If a devaluation were to occur, the assets could return to the country at their original value but denominated at a higher rate in the local currency.

Liquid assets that were not exported would have “lost value” when compared with these that benefitted from capital flight.

What this tells us is that a small and open economy that imports the majority of things it needs has a “value” system, not one tied to its own currency, but related to a more stable foreign currency; in particular to the currency or a basket of currencies of countries from which it imports.

Hence, the devaluation of the local currency in a small and open economy, say, in order to match the current demand for forex with the present supply, affects also the value of the accrued wealth of the small and open economy that is held in liquid assets.

In order to retain the value of the accrued wealth it is recommended that in a current imbalance of forex earned and the demand for imports the foreign exchange rate should be kept constant and the balance achieved via fiscal means.

MARY K KING via email