By Keith Collister, ContributorCAN SINGLE digit interest rates be achieved without precipitating a currency crisis in the light of the recent higher inflation numbers?
The recent failure of the foreign exchange market to respond
to last week's central bank
intervention has been attributed to some of the recent increased
liquidity being converted into U.S. dollars by domestic investors, particularly to buy undervalued GoJ global bonds and the attractively priced GoJ Euro 200 million Bond that was recently issued. Expectations are for the pressure on the exchange rate to continue until dealer demand for GoJ Global and Euro bonds are satisfied.
There is a view that as long
as the Government continues to issue debt instruments in U.S. or Euro currency with double digit yields, it will be impossible for Jamaican interest rates to fall much lower, particularly with the recent monthly inflation numbers. The view is that investors require a
premium interest rate to beat
inflation and devaluation, making it near impossible for interest rates to fall to single digit levels.
DOMESTIC INTEREST RATES
This, however, is not comparing like with like as in this scenario we are comparing, say, a seven to 10-year U.S. dollar Eurobond yield as the floor on interest rates compared with our short term Jamaican "policy rate," e.g., the 30-day repo at 14.2 per cent. What would be true to say, comparing with, say, Brazil's experience, is that Jamaica can never have comparable maturity domestic interest rates lower than US$ rates while it is operating with an open capital account and local investors are demanding a premium for the risk of devaluation.
The Brazil experience also suggests practically that, like Jamaica, the policy rate has a lot of trouble falling through the long term (7-10 year) dollar bond rate, mainly due to large fiscal challenges and currency risk, so that while in principle it would certainly be possible for J$ short term policy rates to be at or lower than long term US$ bond rates, in practice US$ rates have often been a de facto floor. In the past, the main emphasis has been on reducing the supply of J$ through open market operations, thus increasing interest rates, and increasing the supply of U.S. by foreign intervention when that doesn't work.
Trinidad has shown, however, that single digit interest rates are not an impossible scenario as long term rates in TT$ are at or below longterm rates in US$ because there is a chance the TT$ could appreciate. In Jamaica's case, to achieve single digit interest rates we would require that one simultaneously lowers expectations of devaluation (and other risk factors) and creates an environment in which higher returns are expected from real assets.
INCREASE THE DEMAND
We should therefore be increasing the demand for Jamaican dollars, e.g., to pay for privatised assets or to make new investments, and reducing the domestic demand for U.S. (for precautionary reasons) or capital flight. A significantly expanded privatisation programme, even beyond what is currently envisaged, would be helpful in this regard. Thus, high cost debt could be reduced by the sale of these assets and government could expect to see growth in its revenue base resulting from higher economic growth, reducing fiscal concerns, thus creating a virtuous circle. Local investor confidence is of crucial importance in allowing this to happen. As evidence of this, we can point to the fact that despite extremely high domestic liquidity, the dollar was extremely stable during the recent stock market boom. We therefore believe that Jamaica can achieve single digit interest rates, but that this will require a fall in the expectation
of devaluation (perhaps driven by the expected large inflows on the capital account) and country risk (likely if we exceed this year's deficit target and the market believes we will eliminate our deficit in the following fiscal year).
