Governor S Quarterly Press Briefing
News Release
19 February 2003
Bank of Jamaica Quarterly Press Briefing
Remarks by Derick Latibeaudiere
Governor, Bank of Jamaica
19 February 2003
In November when I released the Bank’s Quarterly Monetary Policy Report, I outlined the challenges that were emerging in the December quarter 2002. I also explained the initial policy action that was taken by the Central Bank. These challenges included the need to contain the expectations of exchange rate depreciation, the necessity for contraction in public sector demand and the uncertain international outlook.
You will recall that prior to the November 2002 meeting, the Bank increased interest rates on its 90-day and 120-day open market instruments. This was done in an effort to absorb the liquidity that was contributing to instability in the foreign exchange market. The intention at the time was that we would endeavour to keep monetary policy relatively unchanged so as to maintain stability in prices and in the financial markets. Unfortunately, protracted instability in the market forced the Bank to tighten monetary policy.
I will now briefly review the economic performance during the quarter and present the Bank’s short-term outlook for the economy particularly with regard to monetary policy.
Economic Performance in the December 2002 Quarter
Throughout the quarter the Bank’s focus was on reducing the excess liquidity that existed at the end of the September quarter as well as restoring stability to the foreign exchange market. Disequilibrium in the foreign exchange market prompted the Bank to increase interest rates on its 90-day and 120-day instruments by 200 and 235 basis points on the 9th of October. The rates were moved to 19.25 per cent and 19.4 per cent, respectively. Later in October the rates on these instruments were reduced by 100 basis points, as there were indications that liquidity conditions were normalizing and the prospects for foreign exchange flows were improving.
However, by November the money market again became extremely liquid after the Government used the proceeds of a World Bank loan of US$74.5 million to redeem domestic debt held by commercial banks. This liquidity fuelled an increase in the demand for foreign exchange, prompting the Bank to sell funds to augment the supply in the market.
The demand pressures were exacerbated in December when the Supplementary Estimates presented in Parliament indicated that the fiscal deficit was larger than budgeted. A few days later, Standard and Poor’s (S&P) downgraded the outlook on Jamaica’s sovereign debt from “stable” to “negative”. This further intensified the demand for foreign exchange.
In spite of the continued sale of foreign exchange in the market by the Central Bank, there was a sharp depreciation in the value of the domestic currency. For the December quarter, the weighted average selling rate depreciated by 3.3 per cent, while for the calendar year 2002 the depreciation was 7.0 per cent.
Notwithstanding the Central Bank’s activity in the market, at the end of December 2002 the net international reserves were approximately at the same level as the target of US$1.6 billion that was agreed under the Staff Monitored Programme.
For the December quarter headline inflation was 2.5 per cent. This was somewhat higher than anticipated and significantly higher than the seasonal average of 0.9 per cent for the last three years. The higher level of inflation in the quarter was largely due to the disruption in domestic agricultural supplies, caused by adverse weather conditions. Additionally, increased prices for international commodities, such as, wheat, corn and rice, fed through to domestic prices.
In spite of the higher out-turn for the quarter, inflation for the calendar year was 7.3 per cent, 1.5 percentage points below the rate for 2001.
The lower out-turn in 2002 was primarily due to the absence of administrative price adjustments. Similarly, for the fiscal year to end December headline inflation was 6.6 per cent, 0.2 percentage point below the rate for the comparable period of the prior fiscal year.
Core inflation for the review quarter was approximately 1.2 per cent, representing an increase relative to approximately 0.8 per cent registered in the September quarter. The higher level of core inflation was a consequence of the lagged effect of the stronger growth in base money in the September quarter.
Prospects for the March 2003 quarter and Fiscal Year 2002/03
Ladies and Gentlemen, we have experienced a period that has broken the pattern of previous years. Usually, by late December or early January the Central Bank would have been indicating a lowering of interest rates. This would have been in the context of relative stability in the foreign exchange market, low inflation for the December quarter and a fiscal programme that was more or less in line with the budget. Unfortunately, these macroeconomic conditions have not prevailed and the environment has not been conducive to the lowering of interest rates.
As I stated previously, the demand pressure in the foreign exchange market in the December 2002 quarter did not abate in spite of the Bank of Jamaica increasing the level of supply to the market. This pressure, partly speculative and partly facilitated by high levels of Jamaica dollar liquidity, continued into the New Year.
The increasing pace of depreciation of the Jamaican currency could not have been allowed to continue. We must never forget the disastrous repercussions of exchange rate depreciation and a high inflation environment. Jamaica suffered its consequences in the early 1990s and I am sure I speak for everyone present when I say it is not an experience to be repeated.
To bring order to the market, the Bank instituted a “special deposit” requirement for commercial banks and institutions licensed under the Financial Institutions Act on January 10 this year. This requirement stipulated that each institution should place with the Central Bank, cash deposits equivalent to 5 per cent of its Jamaica dollar liabilities. These deposits would attract interest of 6 per cent per annum.
Initially, the Bank’s action had the desired effect of absorbing some of the Jamaica dollar liquidity from the system. However, the money market again became extremely liquid with the maturing of Government securities as well as some of the Bank’s instruments, and the demand pressures returned to the foreign exchange market.
In January the weighted average selling rate of the Jamaica dollar depreciated against its US$ counterpart by approximately 4 per cent.
The significant Jamaica dollar liquidity and the protracted period of instability in the foreign exchange market, forced the Bank to introduce a special five-month open market instrument on the 10th of February. This instrument will earn interest at 30 per cent per annum. Interest rates paid on all other open market instruments were left unchanged. The market responded favourably to the instrument and approximately J$7 billion was absorbed in four days. Consequently, the weighted average selling rate on the foreign exchange market appreciated sharply, by approximately 4 per cent.
The Bank indicated that these measures were temporary and would be removed as soon as stability was restored in the market. The five-month instrument was withdrawn on February 14 in response to the rapid correction in the market. In withdrawing the instrument, however, there were agreements between the Bank and the authorized dealers on the market protocols that are to be observed. With this agreement in place, the Central Bank expects to see a greater level of transparency and efficiency in the market as well as less volatility.
Ladies and Gentlemen we are almost half way through the March quarter. The policy actions I have just outlined define the Central Bank’s stance for the short-term. As we have repeatedly stated, the mandate of the central bank is price and financial system stability.
The Bank will therefore take whatever action it deems necessary to achieve that mandate and the recent measures were taken with this in mind.
Going forward, the Bank is forecasting that headline inflation for the current quarter will be in the range of 0.5 per cent to 1.1 per cent. Consequently, the inflation rate for the fiscal year is forecasted to be approximately 7.5 per cent, close to the 7.6 per cent registered for the previous fiscal year.
The heightened concern about war in the Middle East and the possible disruption to the supply of oil could result in further increases in the prices of petroleum products. Of concern also, is the continued increase in world commodity prices. Items such as corn, soy and fertilizers are base inputs of heavily weighted items in the Jamaican consumer basket.
We are expecting strong countervailing price movements from the rebound in the supply of domestic agricultural products. In fact, the inflation rate for January was negative 0.3 per cent, largely reflecting price reversals in domestic food items.
The return of normal production levels in the agriculture sector is being projected to contribute significantly to growth in real output in this quarter.
Indeed, economic activity in this quarter is expected to register marked improvement relative to March 2002. Growth is expected from both the goods producing and services sectors, with agriculture, mining, construction, basic and miscellaneous sectors being the driving forces.
Ladies and Gentlemen, price stability is necessary to facilitate resumption in the downward trend in interest rates. It is also an integral factor in the containment of wage demands in line with productivity. Stability in prices fosters an environment in which all economic agents can make reasonable plans.
Monetary policy will therefore continue to be tight until order is restored in the market.
However, the Central Bank recognizes that sustained stability requires more fundamental adjustments in the macroeconomic policy mix.
In particular, there is as we all know the clear imperative to correct the fiscal deficit.
Finally, ladies and gentlemen, the challenges of the present environment dictate that all stakeholders in the economy ... public and private… individually and collectively, have a serious obligation to behave in a responsible manner in order to ensure that we do not destroy the gains that we have made in recent years. Thank you.
1