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Friday, May 25, 2007

Will the Fiji Dollar really be devalued?

Will the Fiji Dollar really be devalued? Read an interesting analysis by an economist, Satish Chand, which is reproduced below from the Fiji Times, Friday, 25 May 2007.

"Dollar faces drop in value, Fiji Times, Friday, May 25 2007

The Reserve Bank of Fiji has come out strongly, denouncing the widespread speculation of an impending 15 per cent devaluation of the dollar.

The signals from the bank regarding its intentions have been mixed, at best.

The Governor, as late as last week, had voiced extreme concern regarding the worsening current account position in the face of dwindling export income and rising imports.

He then announced that some tough decisions would have to be taken; this could be read as a code for a devaluation, with the public being softened up before the strike.

Not so, if the bank's most recent announcement is to be believed, but again no central bank ever preannounces a devaluation.

Doing so would be akin to shouting 'fire' in a crowded theatre, with impending mayhem at the door.

A number of my academic colleagues in Fiji and the local business community have defended the decision of the bank, arguing they cannot afford a fall in the value of the currency.

This, on their part, is understandable, but the question remains as to whether the nation can afford to withstand the consequences of an over-valued currency.

Devaluation by choice would be preferred to succumbing to one because of a balance of payments crisis.

Such a change, regardless of its trigger, will produce gainers and losers.

We have noted the opposition to a devaluation from those likely to lose, but are as yet to hear from those likely to gain.

Surely exporters such as sugarcane farmers, vegetable vendors both for the domestic and export markets, and providers of tourism services are all likely to gain from a devaluation.
People remitting money home are likely to get more for their remitted funds.

Part of the import binge in Fiji can be explained by an appreciation of the Fiji dollar (against the US dollar) and an expectation of an imminent devaluation of the currency.

On the first, the value of our local currency is determined through a formula that combines the Australian, US, and New Zealand dollars, the euro, and the Japanese yen.

Each of these currencies has recently appreciated against the US dollar, and for good reasons.
The economies of Australia, New Zealand, Europe, and Japan have all outperformed the US economy recently.

Thus the demand for the US$ has fallen relative to the currencies mentioned above.

The formulaic determination of the Fiji dollar has meant an appreciation of the local currency against the US$, but few would dare suggest that the Fiji economy has outperformed the US economy, or for that matter that of Australia, New Zealand, Japan or European economies.

Certainly, the exchange rate is affected by a few other factors, but the above, for this discussion, should suffice.

There is little doubt that our economy remains in the doldrums.

Exports are down, tourist numbers are falling, foreign reserves are at record lows and falling, and workers are either being retrenched or working on reduced hours.

The RBF has eased conditions for credit while tightening further the avenues for taking money abroad.

The bank has been actively rationing foreign exchange and, before the coup, was raising interest rates in the hope of dampening demand, and has since December tightened up capital controls considerably.

The bank's cautions of the past two weeks suggest that these measures have not been sufficient to rescue the deteriorating foreign exchange position.

Could it be time to devalue the currency?

If so, then by how much?

The answer to the first, in my view, is in the affirmative.

On the second, the value of a currency as that for any asset can only be determined in a free market, but for now let me make a calculated guess.

If you had $173.76, equal to US$100, as of 12 September last year in a fixed deposit you could, at least in theory, have bought a US$100-denominated sovereign bond issued by the Fiji Government in Singapore.

If you track the value of the two options, namely that of keeping the money in the fixed deposit at home visvis the purchase of the US$-denominated bond, and ignoring any interest rate differentials between the two, your home asset by mid-April would have given you a capital gain of 12 per cent compared to the sovereign bond.

Absent capital controls, this differential would have been arbitraged out.

Furthermore, the implied overvaluation of the local currency by 12 per cent would be a conservative estimate since the supply of bonds has been kept fixed while that of local money increased since last September.

How long can the RBF wait until its hand is forced?

Hard to predict, but on the rate of decline in foreign reserves and absent a quick and strong rebound in exports and/or foreign investment, time may be running out.

The bank, if and when the devaluation eventuates, will have the defence of saying that it had good reasons not to announce a devaluation before the fact.

The backers of the currency at the Ministry of Finance, however, will not be able to use the same excuse.

Satish Chand is director of the Pacific Policy Project at the Crawford School of Economics and Government, Australian National University (College of Asia and the Pacific)."

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