Devaluation may be necessary, but not so simple

It is likely in the coming months, availability of foreign exchange will become a hot news item again as citizens begin to complain about those elusive greenbacks doled out with decreasing frequency by banks and financial institutions.

Some, to beat the rush, have been stockpiling small amounts of US for months, while others may find themselves resorting to more unofficial channels to have their demands met for the season.

At the heart of the matter is the competition for scarce resources, in this case the US dollar, less available now because of the significant reduction in price of our major export. There have been escalating calls since late last year to devalue the currency, along with rumours of devaluation in the pipelines, all of which government has denied.

Those calling for the devaluation argue that an adjustment to a rate of TT$9/$10 to US$1 will reduce demand from those less able to pay for US at that rate, freeing up the supply. They also say manufacturing will be helped as the devaluation will make their goods more competitive on a global market. The finance minister has already signalled what may be an official policy shift by government having said several weeks ago that he could not see the justification for continuing to give importers the same level of access to foreign exchange as local manufacturers.

But there are other factors to consider.

Marla Dukharan, Group Economist, Caribbean Operations, said that both the IMF and ECLAC have weighed in on the value of the TT dollar last year and, both concluded that it was overvalued, ECLAC estimating that it might be so by 40 to 50 percent.

The Ministry of Finance and the Central Bank, said Dukharan, had the final responsibility in determining whether to devalue and to what rate of exchange, but as she noted, they appeared to have particular policy stances.

“Our Central Bank governor has stated that his focus is maintaining a level of inflation that is deemed to be stable and desirable. He has made that his focus. If that is your focus, you would construct your policies around maintaining inflation at a level that you think is appropriate,” said Dukharan.

“If they are saying that their policy goal is to maintain inflation that is acceptable and stable, though I am not sure what that rate is, then there are other policy tools to achieve that goal. They will keep interest rates at a level that is not too expansionary. They are going to keep the money supply at a rate that will not stimulate inflation. They are going to keep the exchange rate at a level that will not stimulate inflation.” According to the Central Bank website, as of January, headline inflation was 3.6 percent, core inflation 2.6 percent and food inflation was 7.6 percent.

Dukharan also told Business Day that a devaluation may not necessarily support efforts to boost local manufacturing.

“When you have to decide whether a devaluation or a depreciation of your currency would be beneficial, you have to calculate something called the Marshall Lerner condition.

What that does is measure the elasticity of your imports and the elasticity of your exports relative to your exchange rate,” Dukharan explained.

The result of the calculation will show whether devaluation will augment the current account balance on the balance of payments or worsen it.

Dukharan said without knowing whether the Marshall Lerner condition is satisfied, we may just be assuming that a devaluation will help local manufacturers.

The RBC group economist used a hypothetical rate of 9:1 to demonstrate.

“Our goods will become more price attractive to the person importing our exports. Their price competitiveness will improve.

That is what you were assuming.

We are not sure of that. You have to remember that everything that we produce in Trinidad has a high import component.

We produce soft drinks, juices, cereals. Anything that people use, we import a significant portion of the raw material. It is not always straightforward to assume that if we have a devaluation in the currency that the locally produced goods will be more price competitive.” A devaluation also may not stem black market activity.

Dukharan said in unofficial markets, price is not the only determinant as to whether US will be available, but supply is also a factor.

If the government were to move the exchange rate to 9/10:1 and the black market was also trading at that, essentially what would happen is that both markets would be aligned, but it would not eliminate the unofficial one.

“You might still have black market activity for those conditions where you are not able to get a supply from the official sources,” she said.

Dukharan added that according to the monthly average selling rate data from the Central Bank, the currency appreciated slightly in January, and again in March.