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
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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
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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