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Saturday, February 21, 2015

Exchange controls and the Bahamian dollar!

Since the introduction of Value Added Tax (VAT) in January, 2015, there has been some turbulence. As expected, it's a new initiative, one in which it places an additional cost on goods and services, so it was expected. One can only hope that with this additional cost to Bahamians that there would be additional revenue and spending reforms placed on the government with this windfall.

The information or proof of movement towards greater fiscal responsibility has been a little dodgy, to say the very least about it. But, let's trust but verify that these reforms will be delivered as promised.

What came as a result of VAT's implementation was something very extraordinary. Something that I did not expect to be brought into the debate post-implementation. Persons began making statements pertaining to the valuation of the Bahamian dollar, claiming that the Bahamian dollar is worth 7.5% (or cents) less after VAT implementation.

Of course that's not how it works. That's not how any of that works. It didn't stop people from saying it, and most likely won't stop people from thinking or feeling that it may be the case. But, let's try to discuss the importance of the valuation of the Bahamian dollar and by extension, the fixed exchange rate's usefulness at this time.

Just coincidentally over the last week or so, discussions about the exchange rate and it's usefulness was brought up in a very heated debate in the House of Assembly during the mid-term budget debate by two back-bench parliamentarians from the governing party. On one side pro-fixed exchange rate was Ryan Pinder, MP for Elizabeth and former minister for financial services; and on the other side, Dr. Andre Rollins, MP for the Fort Charlotte constituency.

Through this I began to think, and harkened back to the notion that the Bahamian dollar would be devalued by the VAT, and at what risk will we be devalued on purpose or not, and then that almost means that a discussion on the fixed exchange rate system needs to be addressed and addressed in the proper way.

I'm more than receptive to the idea of removing the fixed exchange control. It's something that should be in serious consideration at this time in our country's development. How do we go about doing that and to the extent it happens is up for debate.

For the most part, persons in favour of keeping the fixed exchange control hinge their rationale on two main tenets:

  1. Removing the fixed exchange rate would lead to a direct devaluation of the dollar; and
  2. There really is no need to remove the fixed exchange rate.

Let's examine the first point. Removing the peg will in fact devalue the local currency against the currency it is pegged against, for example the Bahamian dollar (BSD) versus the US dollar (USD).

How does this happen? It's quite simple. The US dollar is the universal currency that is used to settle payments world wide. Aside from the Euro and to some extent the British pound, the USD is the new "gold standard".

Countries try to make payments and use the USD in international trade and exchange because the USD is strong, universally accepted and in frequent supply and demand.

However, this automatically means that all other smaller nation currencies are of lesser importance and to a significant extent of lesser value than the USD to begin with. So, before we speak about the merits of valuation and devaluation, we need to begin from that premise and understanding.

How is a nation's currency valued? Well, there are two main factors. The first of which a currency is valued is based on the macroeconomic perspective of trade and exports minus imports, or in other words the balance of trade and the differences in the current account.

When exports are higher than imports, this affects the value of a currency through the exchange rate by signalling that a country's goods and services are worth more than what they import. In The Bahamas, this is the exact opposite, or so it seems.

From the information that Trading Economics has compiled from reports from the Central Bank of The Bahamas, The Bahamas recorded a current account deficit of $533 million (USD) in the third quarter of 2014. The current account in The Bahamas averaged -$309.34 million (USD) from 2005 until 2014, reaching an all time high of -$49.20 million (USD) in the first quarter of 2010 and a record low of -$533 million (USD) in the third quarter of 2014.

The methodology of balance of payments; i.e., current account balance, is slightly outdated. Glaringly, the balance of payments neglects the impact of tourism receipts on exports. Tourism is now and should be defined as an export, as the World Centre of Excellence for Destinations (CED) in conjunction with the United Nations World Tourism Organization.

With tourism accounting for 60% of GDP in The Bahamas, which at any given year hovers around $5 billion dollars worth of value annually, with an average of $2.5 billion in actual tourism receipts since 2012, considering all of new information, The Bahamas is accounting for balance of payment surpluses year-on-year.

Be that as it may, the fundamental point for one side of a country valuating their currency is based on the balance of trade. The second fundamental determining factor for valuating a currency is with regard to capital inflows.

Capital inflows, quite directly for the Bahamian experience, almost solely, means foreign direct investment (FDI) for major projects that require land and human resources for construction and development, in addition to other receipts from sovereign bond issuances. Countries that have balance of payment deficits, but not exclusively, follow a capital inflow or a "FDI" based growth model for development, for obvious reasons.

Because of the current prevailing notion on the balance of payment deficits and as that relates to capital inflows/FDI, policy makers, most likely, feel there is no need to tinker with it if removing the exchange control carries with it the psychological damage of currency devaluation and thus the self enforcing notion of the second point with regard to persons seeing no need to tinker with exchange rate in the first place.

To further bolster the position on at least thinking along the lines of considering models and methods in which to relax the exchange control, we must take into consideration several things now:

  1. The balance of payment methodology used by the economic establishment is outdated;
  2. Rejecting, off top, for psychological reasons of currency devaluation, is meaningless considering the fact that when compared to the USA, almost all other countries currencies are meaningless because settlements are almost always denominated in USD;
  3. Not having a concerted effort with regard to bolstering foreign reserves has not worked well in the past and targeting a foreign reserve quota per quarter would be more helpful;  
  4. International payments and trade is denominated in USD, and even the Euro-Zone and the ASEAN and APEC zones, even with the prevalence of the Euro, British pound and the Chinese Yuan, still use USD predominantly and especially when they are doing business with North-American, Latin American and some European countries;
  5. The current thinking and rationale on keeping the exchange control, based on the outdated balance of payment methodology, and also based on the fact that now devaluing the currency would make production for export cheaper if we take into consideration that tourism is an export, only if in services; and
  6. While imports would be more expensive, it also means exports- including tourism- would be cheaper to produce relatively speaking and per value and that would mean more US dollars to spend with local shops and venues.

The value as determined for what we pay for imports is inconsequential because our major exports are service related and not manufacturing based and also for the fact that The Bahamas imports "inflation" and are "price takers" from the USA, primarily.

Even with regard to inflation, as The Bahamas is a price taker, increasing Bahamian dollar supply would not necessarily indicate a decrease in value once US dollars is still being brought into the country via tourism, primarily, and also by capital inflows once brought in as USD or another controvertible currency that can be held in foreign reserves as it already is the norm. An additional best case scenario would be to allow simultaneous US dollar accounts with Bahamian dollar accounts.

The operative term is "value", and not in a dollar for dollar or monetary sense, but value in terms of the quality and value of life and living in The Bahamas.

For example, while the US dollar is trading at $1 for every .88 cents in Euros, can we with certainty say that every country in Europe has a better quality of life than America? The UN's Human Development Index (HDI) states that the United States has the fifth highest HDI with Norway #1, Australia #2, Switzerland #3 and the Netherlands at #4. Conversely, for the Australian dollar, you would need $1.28 for every US dollar. Are we to say that Australia is doing more poorly qualitatively speaking in terms of their lack of equal parity with the US dollar.

As it stands now with the latter issue of imports requiring US dollars in any event, if we move away from the exchange control and it results in currency devaluation based on the old methodology for balance of payments, a devaluation that really would be normal under any circumstance when faced with the obvious fact that the USA is the dominant economy in the world would not make much difference when the quality of life is the ultimate goal and not necessarily keeping exchange controls for superficial reasons.

The considerable reliance on customs duties that have now since started along the process of being replaced by VAT would still make thinking on the possible benefits of moving away from exchange controls fruitful even at this stage.
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