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Letter: Devaluation in the plantation
Published on July 13, 2017 Email To Friend    Print Version

Dear Sir:

There is much uninformed talk by both local commentators and the agents of the multi-lateral agencies that the TT$ is overvalued, particularly so since the foreign exchange earnings of the country have dropped and cannot meet the demand of consumer driven imports. Hence the solution is seen in the devaluation of the currency; make imports more expensive in TT$s, so reducing aggregate demand for imports and foreign exchange.

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There are two problems here. The first is what is the exchange rate that will bring this equilibrium? The second will a more expensive US$ reduce the demand for it, as expected, for example, if the price of lettuce was raised.

Taking the second first. A devaluation of the TT$ would cause some economic insecurity and the players in the market will seek to capture more foreign exchange to protect their wealth/income situation, so increasing the demand for foreign exchange- some refer to this as hoarding or capital flight. In fact, one of the local conglomerates referred to this as typical behaviour; buying any US$s that are available given the uncertainty of the future.

Further, in a normal market economy foreign exchange speculation is part and parcel of market behaviour where players buy and sell currencies given their perception of the uncertainty in the economies. However, in Trinidad and Tobago speculation on the value of the TT$ is discouraged.

An economist, Erika Cain, from the Scotiabank Economic Team, suggested that unless we devalue the TT$ we will continue to run down our reserves. The two are disconnected though this government may choose in part to meet the demand for foreign exchange by using its reserves, savings and even foreign borrowings- hoping for near term oil/gas prices and production increases. Instead it could allow the economy to contract because of the drop in foreign exchange income. The foreign reserves have fallen to US$8.95 billion or just under ten months import cover.

Why is a drop in foreign exchange earnings or a devaluation so much of an event in Trinidad and Tobago when, say, in Canada these fluctuation occur on a daily basis without them causing nationwide concern? According to Lloyd Best, this goes back to the origin of the society, the economy. All economic activity on the island was about export, about earning foreign exchange on foreign investment; the slaves did not earn money.

Hence, as the society, the economy, developed the main economic activity was, and still is, about earning foreign exchange, whereas on-shore economic activity uses the TT$ via the exchange rate to buy imports. Hence the exchange rate relates Trinidad and Tobago income (the ability of the consumer to obtain imports) to the US$s earned. This is why in the face of a shortage of foreign exchange, a devaluation, meant to reduce aggregate demand for US$s, can indeed increase this demand, to maintain income value.

Immediately on the drop in foreign exchange earnings average prices in the country increase without even a devaluation. The reduction of foreign exchange means that some of the privileged will get US$s, have access to imports and others will not – to the latter it is equivalent to inordinate price increases. With a devaluation, prices to all will increase and if an optimum exchange rate exists, it should balance supply and demand for foreign exchange. But experience has shown that such an optimum may be an economic mirage since a devaluation could increase foreign exchange demand.

It is noteworthy that the 1993 series of devaluations of the TT$ needed the immediate continuation of exchange controls by the Central Bank to constrain foreign exchange demand despite the devaluations! The experience of Jamaica with its virtually continuous devaluations and exchange control systems since its independence demonstrated the tight relationship between foreign exchange earnings and local income in the dynamics of a plantation economy.

If then devaluations are controversial and exchange rate is not like the typical price parameter in the supply/demand curves of a product, the question remains what does one do? Indeed, Dr Delisle Worrell, the ex-governor of the Barbados Central Bank, advises that given the important role that foreign exchange plays in wealth and the income structure of small open economies, a fall in foreign exchange income should not be accompanied by any change in the exchange rate. The supply/demand equilibrium of foreign exchange should be achieved by fiscal means and this will be accompanied by a contraction of the economy.

With a drop in foreign exchange earnings the income of the population is immediately devalued since prices of the many imports on average increase. The reaction of the population is to bid for the reduced supply of foreign exchange. The population should be discouraged from so doing; one method is to increase the local interest rates such that some are encouraged to hold on to their TT$s in the local banks and others dissuaded from borrowing to support an on-shore economy that the foreign exchange drop is forcing into contraction.

According to Dr Worrell, the only option we really have in the short term is to grin and bear it; there will be increases in unemployment, less goods and services from imports, inflation will increase. That is the model, the dynamics, of the undiversified plantation.

Mary K King
St Augustine
 
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