IN his Wednesday afternoon quarterly press briefing on monetary policy, Bank of Jamaica (BOJ) Governor Brian Wynter argued the Jamaica dollar exchange rate was at or close to equilibrium. While he did not go into detail on the calculation, he noted that the BOJ’s projection for the current account deficit for the 2015/2016 fiscal year was that it would fall further from an estimated 5.9 per cent of GDP in 2014/2015 by a similar amount to last fiscal year.

The current account deficit was 8.4 per cent in 2013/2014, so a similar fall would reduce it by roughly 2.5 per cent of GDP, or to about 3.4 per cent GDP. This would be easily financeable by current anticipated flows of foreign direct investment, which he said are running in the 5.0 to 6.0 per cent range.

The Governor noted that in the December 2014 Statin inflation expectations survey, business expectations for annual inflation one year ahead were 10 per cent while annual inflation at the time of the survey was between 6.0 and 7.0 per cent. He observed: “People were forming their expectations of future inflation by looking back in time, perhaps a year or more.”

The Governor argued that inflation expectations are a powerful force that pushes both wage inflation and cost inflation, and unless they are lowered, Jamaica will not be able to transition to a low-inflation environment. He revealed that in the recent survey conducted for Bank of Jamaica by STATIN in April, of more than 250 businesses across 9 sectors, business expectations for inflation 12 months ahead have fallen to 5.1 per cent, the lowest in the history of the survey, and much lower than the 7.7 per cent recorded in the February survey and the 10.0 per cent at the time of the December 2014 survey. “They are also lower than our forecast for inflation for the same period.

“He argued that this suggests that “the business community is sensing that we are in a new economic environment and that fundamental economic changes are taking place in Jamaica. With perceptions now catching up with reality, it promises to make monetary policy easier, which is good news for everyone.”

Lowest inflation rate

in 48 years

Inflation was lower than the BOJ had expected at their last press conference, and at 4.0 per cent for fiscal year 2014/15, was the lowest in 48 years. The increase in the CPI for the month of April was only 0.2 per cent, broadly in line with forecast, which brought the annual 12-month inflation rate at April 2015 to 4.4 per cent.

Looking ahead, the Governor advised the BOJ was “forecasting that 12-month inflation will fall to below 3.0 per cent by September before rising moderately in the second half to end the fiscal year between 5.5 and 7.5 per cent. With a long-term target for inflation of between 2.0 and 4.0 per cent, in line with our main trading partners, we have by no means arrived at our destination — but we are encouraged by the strides we have made towards our goal.”

Risks to the inflation forecast

The Governor advised that the BOJ’s monetary policy stance is based on their outlook for inflation, and that changes in the signal rate (the rate we pay on the 30-day certificate of deposit), are also influenced by their view of the risks to the forecast.

In addition to external factors — such as weather-related shocks or sharp increases in international commodity prices — the other two major areas of risk which the Bank monitors closely are the pace of exchange rate depreciation and the emergence of excess demand conditions in the economy. Closely connected with the latter is the risk that fiscal balance objectives in the near- and medium-term will not be achieved.

2.5% growth

Turning to the risk of excess demand emerging, he observed that the BOJ does not see future excess demand conditions as a risk to inflation. Growth in FY2015/16 is forecast in the range of 1.5 to 2.5 per cent, which is a moderate pace when compared with the capacity of the economy. The government continues to demonstrate its commitment to continued fiscal restraint. If fiscal policy remains tight, inflation will remain constrained, which produces the additional benefit of lower interest rates. Conversely, if fiscal policy is loosened, it is likely that inflation expectations will rise, which would require a reaction from BOJ to tighten monetary policy by increasing interest rates.

He observed that the firm stance of fiscal policy so far, along with the recent trend for inflation to fall and for inflation expectations to fall, has facilitated the first easing of monetary policy since February 2013 with a reduction in the Bank’s signal rate to 5.50 per cent on 17 April 2015.

“Further adjustments to some of our interest rates in the enhanced liquidity management framework may also be warranted as conditions continue to improve, and these should cause lending rates to go down.”

In the question and answer session, the Governor advised that he was not giving forward guidance on interest rates, unlike some of the other international Central Banks that are “already at the zero or lower bound”, referring to the near zero rates of the world’s major Central Banks in the US, Europe, Japan and the UK. The enhanced liquidity enhancement framework he was referring to included not just the 30-day “policy rate”, but the overnight rate, both for borrowing and lending by the Central Bank, the 14-day “repo rate” and others, all designed to increase the number of tools available to the BOJ.

No impact yet from drought

He added that the BOJ ” is not yet seeing the impact of drought on prices” and therefore — unlike last year — is not yet “factoring anything special” into the inflation figures from drought. Inflation is currently coming in below the BOJ’s target ranges, which are themselves falling, and even if one reversed the recent decline in oil prices, inflation would be at the bottom of the BOJ’s projected range. He advised, however, that the oil “hedge” was not yet in place.

Turning to the impact of tight fiscal policy on monetary policy, the Governor observed he was referring not to the now famous primary balance, meaning the central government balance excluding interest costs (which the government largely controls), but the overall fiscal balance, which also includes the balance of the wider public sector (meaning the deficits of state enterprises).

Tackling a question from News Talk 93 on a suggestion by some university professors to reduce the primary surplus target to 5.0 per cent from 7.5 per cent through negotiation with the IMF to allow an increase in spending on infrastructure (and presumably wages), the Governor argued that the only way out of a debt problem was “sustainable” growth.

Expanding on the latter point, it was observed that the problem is that no one with money will lend it to Jamaica if we don’t meet the IMF programme tests (the lack of other lenders is why we are in an IMF programme). Interest costs are still high at 7.0 to 8.0 per cent of GDP and need to be reduced further — but if we go that route “we will need to have a different discussion on monetary policy” implying rising rates, and that we know how to spend more money than we have “as we have been doing that for the last 40 years”.

All of this suggests, to this observer at least, that the stage is being set for further cuts in local interest rates as long as progress continues on the overall macroeconomic front — particularly if we see another contraction in GDP growth for the second quarter, as the PIOJ is currently projecting.