AS FIJI'S ECONOMY CONTINUES TO NOSE-DIVE, IS

C O N F I D E N T I A L SECTION 01 OF 03 SUVA 000378 SIPDIS SIPDIS E.O. 12958: DECL: 07/31/2017 TAGS: ECON EINV ETRD PGOV FJ SUBJECT: AS FIJI'S ECONOMY CONTINUES TO NOSE-DIVE, IS DEVALUATION OF THE FIJI DOLLAR INEVITABLE? REF: SUVA 127 Classified By: DCM Ted Mann, per 1.4 (B,D) Summary -------------- ¶1. (SBU) Lack of export competitiveness and a drop in tourism earnings since the December 2006 military coup have led to a difficult balance of payments situation for Fiji and a serious foreign reserve shortage. While a number of economists have suggested that a devaluation of the Fiji dollar is the best way to cope with Fiji's balance of payments problems, the interim government (IG) and the Reserve Bank of Fiji (RBF) are adamant that no devaluation will take place, apparently based on concern that the price hikes resulting from such an action would spur a strong public backlash against the IG. Instead of devaluing the currency, the RBF has greatly tightened credit and instituted new, stringent requirements for foreign investors. So far, that strategy seems to be working, but at a potentially great loss in terms of investment and long-term economic growth. End summary. Trends in Fiji Macroeconomics -------------- ¶2. (SBU) Over the past few years, Fiji has faced a dramatically increased trade deficit and a decrease in the inflow of capital, with a resulting strong negative impact on the country's foreign reserves. From 1998, exports have remained virtually flat while imports have increased 11% annually, on average. Earnings from tourism, Fiji's top foreign exchange earner, have dropped substantially in 2007 due to the late December military coup. As a result, Fiji's foreign reserves have fallen from enough to cover 8 months of imports in 2000 to about 3.4 months of import coverage at present. Even that figure, as low as it is, is subject to debate. Fiji's reserve level is buttressed from proceeds of a USD 150 million bond offering the Qarase government floated in Singapore last year. In addition, in 2005 the IMF agreed to include offshore assets of Fiji's social security system in Fiji's reserves (see reftel). If those two elements were deducted, Fiji's "core" level of reserves would be less than two months of imports. Given Fiji's low reserve level, the drop in tourism earnings and a very low level of new foreign investment in the wake of the coup, the Reserve Bank of Fiji has been forced to take strong actions to forestall a reserves crisis. These include higher interest rates, credit ceilings, and new overseas borrowing requirements for non-resident investment in Fiji. Some of the steps taken by the RBF have been criticized, as has ONE action not taken - devaluation of Fiji's currency. Arguments for a Devaluation -------------- ¶3. (SBU) At a late-June international economic conference in Suva, Professor Satish Chand from Australia National University asserted that the Fiji dollar is overvalued by at least 12%. Chand believes this is a direct result of RBF policy which, he said, intentionally maintains an overvaluation, a policy which goes well beyond the bank's statutory functions. The appreciation of the currency, said Chand, has discouraged exports and encouraged imports. Chand believes the RBF should be addressing the value of the currency to ensure a healthy external balance. The longer the RBF maintains its policy practices, Chand concluded, the harder the ultimate devaluation shock will be. ¶4. (C) Anqian Huang, Fijian country economist for the ADB, told Emboffs he agrees with Chand's main point - a devaluation is needed to correct Fiji,s balance of payments problems. Tourism, said Huang, is Fiji's main economic driver, but tourists find Fiji more expensive than other comparative locations. A devaluation would have an immediate positive impact on the industry, he said. Similarly, devaluation would benefit farmers and the agriculture industry, as a more suitable environment for an increase in exports would be created. ¶5. (C) Huang and others we spoke with acknowledge that a weakening of the Fijian dollar would reduce the purchasing power of the average Fiji citizen immediately. Combined with the recent increase in costs of consumer goods and fuel (inflation is now running at about an annual rate of 7% and rising),this would be a substantial shock. Current life style and consumption patterns in Fiji, said Huang, have been SUVA 00000378 002 OF 003 artificially created through government financial policy, and a devaluation would bring a much needed reality check. A devaluation is a long-term solution, said Huang, with inevitable short-term pain. Interim Government Position -------------- ¶6. (SBU) The IG has staunchly maintained policies that attempt to address Fiji's precarious financial situation without a devaluation. In a press statement on March 2, interim Finance Minister Chaudhry stated that "we have to at any cost avoid devaluation." This policy has been supported by interim PM Bainimarama who stressed to reporters on July 6 that a devaluation would definitely not take place. ¶7. (SBU) The IG appears to have staked its reputation on being able to improve Fiji's economy and reduce the level of poverty. In his acceptance speech upon assuming the position of interim Prime Minister on January 4, Bainimarama dedicated his administration to, among other goals, reducing poverty and levels of destitution in Fiji. Another goal is to "steady the economy through sustained economic growth." Upon announcing the revised 2007 budget in March and in several subsequent statements, Chaudhry has insisted that the IG will be able to stabilize the economy and significantly reduce poverty after what he calls 6 years of poor economic performance and management under Qarase. ¶8. (SBU) Politically, a devaluation could exacerbate the IG's already precarious position in public opinion, even among some coup supporters. With urban drift, rising unemployment and inflation, poverty in Fiji is growing. A devaluation could slide segments of the population into overnight poverty and undermine the stated objectives of regime. Chaudhry appears especially sensitive to how the regime's economic policies play in the public arena and has continuously tried to put the best face on Fiji's economic situation. On July 17 Chaudhry asserted that "as a direct result of the interim Government's fiscal policies and prudent management of State finances and the economy, interest rates have come down, imports are falling while exports have risen - easing the critical balance of payments situation that prevailed under the Qarase-led government." ¶9. (SBU) Comment: These remarks by Chaudhry were made in response to Australian Foreign Minister Downer's widely published July 15 statement "...the outlook for the Fiji economy is bleak with employment, construction activity, and tourism trending downwards, and foreign currency reserves at a record low." While Downer's statement about foreign reserves might be arguable, Chaudhry's comments are flat out misleading. While it is true that imports are currently trending downward, exports are also falling. According to the June 2007 RBF financial update, exports have fallen 5.6% in the first 5 months of 2007 compared to the same period last year. Exports did, indeed grow in the months of January and February (the numbers Chaudhry chose to quote) but as the RBF pointed out at the time, the numbers were strong "mainly due to the volatile nature of the monthly data," and did not reflect a positive trend. ONE RBF staffer told us Chaudhry made his statement after having been informed by the Bank that export numbers in March and April had dropped precipitously. On July 29, Chaudhry again proclaimed that Fiji's economy was recovering, despite RBF data issued July 27 indicating the economy would decline by 3.1% in 2007, down from the 2.5% drop earlier predicted. RBF Position -------------- ¶10. (C) Ever since the coup, the Reserve Bank of Fiji has never wavered from its anti-devaluation stance. Most recently on July 6, RBF Governor Narube told reporters that "devaluation is not the solution to Fiji's economic woes and the RBF will not devalue the Fijian dollar." In a meeting with Emboffs in mid-July, Jitendra Singh and Frazine Dutta of the RBF Economics Department disputed allegations that the Fiji currency is overvalued. They asserted the recent relative strength of the Fiji currency against the U.S. dollar is due almost entirely to the weakening of the U.S. dollar in global markets. (Note: The Fiji dollar is tied to a basket of currencies, with the Australian and New Zealand dollars accorded the most weight. When those two currencies appreciate against the U.S. dollar, as has happened recently in global markets, the Fiji dollar necessarily appreciates against the U.S. dollar. End note.) SUVA 00000378 003 OF 003 ¶11. (C) Singh and Dutta maintain that a devaluation would not curb imports significantly and would not necessarily help grow exports. Imports, they told us, are made up of roughly 1/3 consumer goods, 1/3 investment goods, and 1/3 intermediates. The intermediates, which include fuel and other items, have shown big price increases recently and are not particularly susceptible to the economic pressures a devaluation would bring about. Imports of consumer goods would be reduced if the value of Fiji's currency dropped, but not enough to counteract the increased price of intermediate goods, they said. Singh and Dutta also believe a devaluation would not necessarily make Fiji a cheaper destination for tourists. Most tourist consumables in Fiji are imported, they noted, and the lower cost of lodging would be balanced by higher food and fuel costs. Fiji's US $150 Million Albatross -------------- ¶12. (C) As Singh and Dutta's comments indicate, concern about import price hikes appears to be the main driver of RBF policies. At a media forum on July 10, the Permanent Secretary to the Finance Ministry Peceli Vocea said that a SIPDIS devaluation could increase inflation by 10% over the current 7% rate. It is therefore not a realistic option, he concluded. The ADB's Huang told us the "cheap" US$150 bond offering from last September may also be a key factor in the Bank's decision-making process. A devaluation would drive up the cost of repaying that 5-year loan by up to US$30 million. Effectively, he said, the bond is a financial obligation that must be repaid before the possible long-term financial benefits of a devaluation occur. If Devaluation Isn't the Answer, What Is? -------------- ¶13. (U) In numerous press releases and speeches, the RBF has asserted that it has the wherewithal to stabilize foreign reserves without devaluing the Fiji currency. The RBF has significantly tightened exchange controls, raised interest rates and imposed credit ceilings on banks (no borrowing over 2006 levels). The Bank has announced that, beginning next year, foreign investors will have to source all capital expenditures from offshore. Working capital may continue to be funded through local borrowing. The Bank has also told foreign investors that they will have to refinance 50% of domestic debt for capital expenditure offshore by the end of ¶2008. ¶14. (C) Several bankers and investors have told us these new investment rules will have a strong negative impact on foreign investment. An RBF staffer told us she thinks the rules "will kill foreign investment in Fiji." At the international economic conference noted in paragraph 3 above, Prof. Satish Chand cited the planned borrowing restrictions as an example of how, in their desire to avoid devaluation, the RBF was instituting policies which could have powerful negative long-term impacts on the Fiji economy. The RBF's Singh and Dutta recently told us, however, that the Bank is reevaluating some of the planned borrowing restrictions, especially the 50% refinancing requirement noted above. Comment -------------- ¶15. (C) The interim government has been forced to address Fiji's economic problems without a public mandate and with little external resources at its disposal. This spells trouble for Fiji's economy in both the short- and long-term. Short-term fixes that could potentially damage hopes for an influx of much needed foreign investment appear to be the most expedient and politically viable options. Most parties agree that the only way out of Fiji's economic mess is growth in the export and tourism sectors. Unfortunately, an overvalued Fiji dollar is hurting exports and, without a clear horizon for any political breakthroughs in Fiji, prospects for growth in tourism remain anemic, at best. DINGER