Business Monday: Economic Viewpoint: Case against currency devaluation continues to be argued

WHEN he met with private sector representatives earlier this month, the Minister of Finance and Economic Affairs, Christopher Sinckler highlighted that there will be no adjustment to the country’s fixed exchange rate. That rate which has been in place since the 1970s. 

 

This subject of an exchange rate adjustment and that as to whether Barbados should enter an arrangement with the International Monetary Fund (IMF) have been part of the continuing discussion on the options for Barbados to improve its economic situation.

 

The IMF has somehow been able to evoke comments on economic policymaking and there was no exception especially when it came to the subject of an exchange rate adjustment the Fund believes would help Barbados’ export sectors.

 

The Minister told the Barbados Chamber of Commerce and Industry (BCCI) that the rating agencies – Standard and Poor’s and Moody’s would somehow prefer if the island enters a Standby Arrangement with the Fund. He reckoned that a Fund agreement without the exchange rate adjustment would most likely clear the frontline staff of the IMF. However, he is not sure whether it would get past the Directors.

 

Small Caribbean countries including Barbados have repeatedly argued that devaluation is not an option for small countries looking to improve their economies. This is unlike the other territories – Jamaica, Guyana and Trinidad and Tobago which have done currency adjustments.

The theory is it that when a country considers a currency devaluation to correct balance of payments deficit and to improve the performance of its export sectors. It is said that the devaluation allows a country to sell more goods and services to the rest of the world. In doing so, economic theory and the IMF maintained that while technically exports could become cheaper imports are expected to become more costly to consumers in the country undertaking the devaluation. 

 

With the devaluation presenting an opportunity for countries to export more they should embrace it, according to the thinking within the Washington D.C. based financial institution.

 

However, the issue of elasticity which is the responsiveness of demand/supply to price changes occasioned by the devaluation , holds the key to whether the goals of the devaluation will be achieved. The concept indicates that when demand or supply is elastic the amount supplied will be related to the adjustment in price. Inelastic suggests no response in demand to price changes.  

 

It is widely accepted that a devaluation will present challenges to small counties similar to Barbados and the others in the Caribbean, unlike the bigger industrialised countries.

 

Due to their large size and large productive capacity, the latter countries can switch production from the more expensive imported goods (following a devaluation) to domestic substitutes, thereby shielding their consumers from the higher priced imports.

 

Small countries, according to Dr. Delisle Worell, the Governor of the Central Bank  of Barbados, have no such luxury. Their manufacturing base is small and that allows them to produce only a small fraction of substitutes. So they have to carry on importing the more expensive imports following the devaluation, for which the demand is still demand.

 

 It is also recognised that in addition, the manufacturing sector in the small countries tend to use significant foreign inputs in their production processes. As such a devaluation makes these inputs more expensive, thereby resulting in the manufacturers becoming more uncompetitive since their products will not be cheaper and they lose export market share.

 

With all of these factors in mind, Sinckler would have assessed them and come to the conclusion that Barbados will not be going the route of a currency adjustment.

 

He said that the island has enough foreign exchange to defend the existing rate of the Barbados dollar. The option therefore is to use fiscal policy to manage the foreign exchange flows and outflows since the country’s high debt profile does not allow it to go to the capital markets to conclude loans which could be costly.

 

What would also make for that position are the repeated downgrades Barbados continues to be subjected to by Moody’s and Standard and Poor’s.  

 

A readjustment of the exchange rate would also give rise to a loss of confidence in the country, in that it could lead to capital flight, lower the level of credit foreign suppliers make to domestic importers, and possibly pave the way for other devaluations.

 

Currently Barbados has a fiscal deficit running at over five per cent of GDP, a national debt of over 100 per cent of GDP, foreign reserves of just under $900 million (as at June this year), and economic growth of about 1.3 per cent, also up to June this year.

 

The rating agencies view is that based on those statistics the outlook is negative.

 

 In Asia, Africa, Latin America and the Caribbean, the story is the same, whatever the economic crisis: devaluation, expenditure trimming, the removal of subsidies and other support to producers/exporters, unreasonable and tight conditionalities, perfor-mance tests and a whole host of other measures that at the end of the day seem to do more harm than good in most cases. Since there will be no IMF and no devaluation then it will be good news for those expecting the worst.