EDITORIAL - Why devaluation is not the answer

IN the presentation he made last Thursday evening at the Grande Salle of the Tom Adams Financial Centre, economist Dr. Patrick Honohan added his voice to the debate as to whether devaluation does work for countries which have entered relationships with the International Monetary Fund (IMF).

While not indicating what countries should or should not when it comes to this policy, and speaking broadly, the Distinguished Fellow indicated that very often subsequent devaluations follow after the first devaluation, and results in countries being right back where they started.

In other words, there are no benefits to having their exchange rate adjusted. It is one of the things that we in Barbados have seen happened to some of our neighbours who go the devaluation route, while trying to correct problems in their economy.

In Barbados and over the last two years or so, devaluation has been discussed repeatedly as a tool the present government ought to use to help the country out of the economic misfortune that it finds itself. The response by both the Government and the Central Bank of Barbados is that changing the exchange rate – which has been in place since the 1970s – will not be done since the existing rate has worked well for the country and there is no need to tamper with it.

However, the debate has intensified since the country continues to see a decline in its net international reserves. Those reserves fell from over one billion dollars to just under $700 million by the end of last year. A country, it is said, requires a comfortable stock of reserves to defend the existing exchange rate, finance foreign debt repayments, pay for imports and to meet the requirements of Barbadians travelling abroad.

It must also be added that over the years countries entering Standby Arrangements with the Fund have been influenced into using the devaluation or currency adjustment tool to make their economies more competitive. In adjusting the exchange rate, therefore, they do so with the understanding that their exports will be cheaper than the rest of the world while their imports will be more expensive.

However, the problem with this line of thinking is that domestic producers require imported inputs for their business operations. Therefore, if inputs are going to cost more since they are imported inputs, then that means the final goods will cost more to produce and therefore, defeat the decision to have the devaluation. Another point worth arguing on the subject is that small countries do not produce a wide range of goods and services which can be substituted for the higher priced imports.

Dr. Honohan said that once the policy has not worked, overspending by a government tends to resurface. To date it is known that fiscal policy has been used to curtail spending, especially on imports. To date it has worked and Barbados will have to pursue this policy in addition to others, such as stimulating the export sectors, so as to both earn and safeguard foreign exchange.

The 2017 first quarter review period for the economy has just ended and soon the country will be hearing from the Central Bank on what transpired during the period January to March. The country is anxious to hear what has happened since December last year.