US embassy cable - 05KINGSTON2497

UNCLAS SECTION 01 OF 02 KINGSTON 002497 
 
SIPDIS 
 
STATE FOR WHA/CAR (WBENT), WHA/EPSC (JSLATTERY) 
 
SANTO DOMINGO FOR FCS AND FAS 
 
TREASURY FOR L LAMONICA 
 
E.O. 12958:  NA 
TAGS: ECON, EFIN, JM 
SUBJECT: JAMAICAN CURRENCY UNDER PRESSURE 
 
 
1.  (U) Summary:  The Jamaican dollar is facing its 
biggest test following a prolonged period of stability 
dating back to early 2003.  Foreign exchange market 
instability emerged during September 2005, prompting the 
Bank of Jamaica (BOJ) to institute new measures aimed at 
identifying and blacklisting speculators.  However, the 
measures have drawn the wrath of some foreign exchange 
dealers who are of the opinion that the depreciation is 
being driven by demand pressures for U.S. dollars to buy 
GOJ bonds.  Inflationary pressures, increased Jamaican 
dollar liquidity and seasonal demand for foreign exchange 
have also provided additional impetus for the 
depreciation.  The declining supply of foreign exchange 
reflects flat tourism earnings and lower goods exports 
have also impacted the market.  The instability could be 
halted in upcoming weeks as supply increases on the back 
of higher bauxite/alumina exports and increasing FDI.  The 
BOJ also has the alternative of hiking interest rates, but 
this option could have an adverse effect on fiscal policy. 
End summary. 
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Bank of Jamaica stabilization efforts 
------------------------------------- 
 
2.  (U) The Jamaican dollar has depreciated by four 
percent since June 2005, after trading at around USD 1 to 
JMD 61 for the last two years, the longest period of 
stability in a decade.  Signs of instability emerged in 
the foreign exchange market during September 2005, 
prompting the Bank of Jamaica (BOJ) to convene a meeting 
with foreign exchange dealers to discuss strategies to 
stabilize the currency.  Despite the use of moral suasion 
and the selling of funds from the Net International 
Reserves (NIR) to temper the demand pressures, the 
currency continued to depreciate, trading as high as USD 1 
to JMD 64.5 in October.  This forced the BOJ to convene a 
second meeting on October 19 to institute measures aimed 
at identifying pure speculators to segregate them from the 
real users of foreign exchange.  One foreign exchange 
dealer at local firm Mayberry Investments told emboff that 
based on the new rules only buyers who could prove they 
were carrying out legitimate business would qualify for 
funds sold to the market by the BOJ.  As a consequence, 
prospective buyers considered to be speculators by the BOJ 
would be denied supply-side intervention funds, creating a 
de facto blacklist. 
 
3.  (SBU) However, this latest BOJ measure has drawn the 
ire of foreign exchange dealers.  Former President of the 
Securities Dealers Association and CEO of Alliance 
Investment Management, P.D. Chin, told emboff that the BOJ 
must be realistic as the depreciation reflects market 
sentiment rather than speculation.  "If I am in the market 
I am going to take a position in U.S. dollars and you can 
call it speculation if you want to," Chin stated.  "We are 
badly overvalued and the market must correct itself.  In 
addition, people have been coming out of Jamaican dollars 
to buy the USD bonds issued recently," Chin continued. 
The evidence appears to support Chin's assertion, as the 
GOJ has issued two bonds worth over USD 300 million in 
less than two months.  While USD 250 million of this 
amount was raised on the international capital market 
(primary market), Jamaicans have purchased over 60 percent 
of these issues on the secondary market.  The redemption 
of a U.S. dollar indexed bond (USD 46.7 million) on 
October 4 provided additional demand pressures as 
investors converted their Jamaican dollars to U.S. 
dollars. 
 
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External Factors 
---------------- 
 
4.  (SBU) The build up in inflationary pressures has also 
provided some impetus for the slide in the currency. 
Inflation of 2.6 percent in September has brought overall 
price increases for the April to September period to 11.8 
percent or 2.8 percentage points above the target for the 
full fiscal year.  Investors who are receiving real 
negative returns on their local investment are therefore 
realigning their portfolios by switching to U.S. dollars. 
Increased liquidity in the money market due to maturing 
debt instruments has also provided substantial resources 
to build up demand pressures for U.S. dollars. In 
addition, some investors are anticipating an upward 
adjustment in interest rates to reflect the surging 
inflation, but Director of Research and Publications at 
the BOJ, Louise Brown, told emboff that the bank would 
resist this move as it has not worked in the past. 
Additional pressures have also stemmed from the seasonal 
demand of industrial and commercial users to purchase 
goods for the Christmas season. 
 
5.  (SBU) While most of the recent pressure on the local 
currency has been demand driven, there has also been some 
weakness on the supply side. In particular, the economy is 
going through its traditional "tamarind season" when 
foreign exchange inflows tend to be low.  The seasonal 
falloff in foreign exchange inflows, which is more 
pronounced this year due to flat tourism revenues and 
declining goods exports, has consistently led to slippages 
in the local currency.  The only aberration occurred in 
2004 when speculators were recovering from the heavy 
losses inflicted by the intervention of the BOJ during 
2003, which led to an appreciation of the local currency. 
When asked about the prospects for the foreign exchange 
market, Brown told emboff that the market was settling 
down due to the ongoing supply-side interventions, but 
speculators were still lurking around to capitalize on 
weaknesses that might appear.  Brown said that the 
inflation rate, oil prices and the weather were the bank's 
main concerns.  "We cannot wait until the hurricane season 
comes to an end," Brown concluded. 
 
6.  Comment:  The pressure on the local currency could be 
arrested in upcoming weeks, given a jump in bauxite and 
alumina export earnings as well as the expected uptick in 
remittances for the Christmas season.  The start of the 
winter tourist season, increasing FDI and external loan 
inflows will also improve supplies and bring some order to 
the foreign exchange market.  The BOJ is also in an 
improved position to make supply-side interventions given 
the record build up in the stock of NIR to over USD 2.2 
billion in October.  As a last resort, the BOJ also has 
the option to increase interest rates to remove Jamaican 
dollars from the market.  However, while this is an 
effective tool of monetary policy and might scare 
speculators away for a long time, higher interest rates 
would have serious implications for the GOJ.  In addition 
to reversing the downward trend in interest rates, it 
would lead to higher domestic debt servicing costs, which 
are already running ahead of target.  This could derail 
the country's financial program, as the GOJ would not be 
able to meet most of its targets, chief among them the 
balanced budget objective.  This may trigger a decline in 
confidence among investors in general and external 
investors in particular, leading to renewed instability in 
the foreign exchange market.  End comment. 
 
TIGHE