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DEVALUATION: pros and cons The Fiji Times. 1988

29/03/2012

[At the beginning of 1987, some public discussion (initiated possibly by one company) took place over whether the Fiji dollar should be devalued. This article was written for the Fiji Times  to clarify some of the issues. It was consequently revealed that the Reserve Bank had been quietly devaluing by small amounts over the period of this debate].

The Immediate Disadvantages of Devaluation

Most writers in the media have so far argued against devaluation. Some of the arguments are probably correct: it is true that the cost of most imports in Fiji dollars will go up by as much; that our foreign exchange receipts from sugar and tourism will probably not increase by much; that the real wages and living standards of urban workers will decline.

It is also true that any possible benefits of devaluation to one group will have to be paid for by other groups in our economy, and the biggest sufferers will normally be the weakest groups whose incomes are not able to keep pace with inflation: disorganised workers with no bargaining strength against powerful employers; unions successfully suppressed by government; rural producers of market crops selling in an over-supply situation; people with money savings which immediately lose part of their value; and people dependent on imports for their living, and who cannot pass on their increased costs to the consumers.  

Some Policy Questions 

But there are other aspects of a devaluation which must be considered if one thinks of the nation first, before one’s own personal interests:

why should any country devalue its currency?

has the Fiji dollar already been devaluing and revaluing without the public debating the issue?

why has the Fiji dollar been so high and what are the effects of a high Fiji dollar, especially on unemployment?

should we accept a high Fiji dollar because it has been given to us by our colonial past?

what are the possible long-run effects of a devaluation as opposed to the obvious short-term costs; what do Governments normally do in such situations?

under what conditions should Fiji devalue?

and should Fiji devalue now?

Who Gains Immediately

Obviously, exporters of sugar, copra, gold, cocoa, textiles, procesed agricultural goods etc, will find their Fiji dollar incomes immediately increased by the extent of the devaluation.

On the other hand, the import component of their costs will immediately go up also. BUT, not all their costs will go up by as much, nor as quickly.

Their labour costs, their local material purchases will lag behind, resulting in increased profit margins in the export industry.

It is possible, if the local suppliers of labour and materials do not increase their prices by as much as the devaluation, the profit margins will be semi-permanently increased.

If the subsistence agricultural sector cushions the cost of living increase, real incomes of exporters will increase relatively.

Why Devalue at All

It could be argued that if the export sector of the economy, for example the sugar industry, is in severe structural long term difficulty, and the rest of the economy is vitally dependent on this sector, then devaluation may be justified if it is necessary to keep this sector alive.

This may involve a severe decline in the living standards of urban workers and others dependent on imports for a living.

But if the export sector collapses, the living standards of others must decline in any case.

This income redistribution effect is separate from the question of whether the export industry will be able to expand and sell its extra production in foreign markets, especially if they are depressed and limited by quotas.

It is independent of whether the nation as a whole will benefit from other possible effects of devaluation.

Other Possible Effects

It could also be argued that a significant devaluation may result in net long term benefits to Fiji if there are currently unutilised resources (land, labour, capital) which would be used more if only imports were dearer and exports more profitable in Fiji dollars (through a devaluation of Fiji’s currency).

But this will happen only if a number of other conditions are satisfied.

Firstly, is it only the cheapness of imports which leads Fiji’s consumers to buy imports even where local substitutes are or can become available?

How many such imports can we replace?

Most economists who discuss devaluation through elasticities usually think about small devaluations of perhaps 20%.

This will do little in Fiji’s case.

To put it differently, by how much would import prices have to increase before our people completely stop consuming imports which have local substitutes, even if the quality is poor, and the price may be higher?

Think of the imported necessities of life: food items, clothing, housing components, which we all buy.

Secondly, the significant benefits of a devaluation can only come about if exporters can increase their sales abroad as a result of increased local margins. By how much do prices of exports have to increase before our farmers and “industrialists” find it profitable to export? Are the markets there? Here there is some hope.  

The Fiji Dollar has Already Devalued and Revalued

It is odd that while the debate has been about the Fiji dollar devaluing in the future¬, it has already devalued against the US dollar and the yen. More significantly, it has been doing the opposite over the last twelve years by appreciating against sterling (reducing our Fiji earnings from sugar), the Australian dollar (by 30%), and massively, against the New Zealand dollar (by 77%).

While one could not claim that the current trade patterns are a result of these exchange rate changes, one can certainly state that, from Fiji’s point of view, our exports to our nearest and likeliest two markets, Australia and New Zealand, have not been helped by the rise in the value of our currency against theirs.

The opposite, a devaluation against their currencies, may have been more useful.

The trade gap with Australia is massive, at around $100 millions, and has not changed significantly over the last five years.

There is now some potential for increased exports through Sparteca, and these would be helped if our currency devalued against the Australian dollar.

The trade gap with New Zealand is also massive, and has increased over the last five years, both because our exports to New Zealand have declined and our imports increased.

There must be room here to pressure NZ to open up its markets totally to our export or face diversion of our imports to probably cheaper sources like US or Asian countries.

It is strange that economies like Australia, New Zealand and Japan see the economic sense in having a devalued currency relative to their trading partners and competitors.

Japan has long resisted pressures by US to revalue her currency. In Fiji, however, many are proud of our “high” dollar, and refuse to see any connection with our equally high unemployment rate.

People might be reminded that in the 1930’s there were plans to link Fiji’s currency with Australia and New Zealand. For a brief period, the Fiji pound was made identical to the New Zealand pound. It is ironic that the Fiji dollar is now almost twice the New Zealand dollar whereas if we had been linked, we would already have had roughly a 50% devaluation.

Why is our Dollar So High in Value?

It might seem puzzling that a basically weak economy like Fiji should have a currency whose value is so high relative to currencies of much stronger economies.

A large part of the explanation for this phenomenon may be derived through Fiji’s colonial history and an analysis of who benefits from a high exchange rate now.

In the colonial days, a high Fiji dollar ensured that we were good markets for imports from Britain, Australia and New Zealand rather than goods made in Fiji.

The major companies then, MH’s and BP, depended for profits on imports rather than local production, and so also preferred an overvalued currency.

Generally, foreign investors needed to earn fewer Fiji dollars in order to obtain a given amount in foreign exchange (usually Australian and New Zealand dollars). They also preferred to maintain a high exchange rate.

In the process, the high exchange rate also ensured that local incomes when spent, employed foreign labour rather than Fiji’s labour.

At that time, the unemployment was not visible.

Half the population was kept out of the labour force and in the villages.

The other half were well controlled in the cane fields.

This is no longer so.

Similar forces are still at work in Fiji today.

Some foreign and local firms who remit profits from Fiji, have Fiji incomes which will be reduced in foreign exchange terms by a devaluation.

There are many firms whose profits are extremely dependent on the import trade, hence on maintaining a high value for the Fiji dollar, which cheapens imports and encourages the consumption of imports.

Through an overvalued exchange rate, the nation is still saying that we prefer to employ foreign makers of furniture, foods, clothing, and other necessities and luxuries of life, which we “have” to import, rather than consuming our own.

We are also saying that we are happy to keep alive false local industries making toothpaste, paints, plastic products etc whose inputs are all imported, whose only local content is the finger turning the machine on and off, and the fingers counting the high profits resulting from massive effective tariff protection and licensing.

We are also saying that the living standards of people who currently earn incomes and profits, are more important to us than unemployed people in our economy.

One statement may be made with certainty: if following a devaluation,  all employers, businessmen, workers and farmers were able to maintain their real incomes, then the devaluation would produce very little lasting net benefit for the nation.

The key question is, who will sacrifice in the short run, for the nation’s good in the long run?

What do Governments Usually Do With Exchange Rates?

Governments the world over are notorious for refusing to devalue when they should. In many cases, devaluations have been followed by a change in government, because of general public unpopularity over the resulting inflation and immediately declining real incomes of the powerful in the electorates.

In other cases, the vested interests behind political power, especially powerful foreign investors or local capitalists dependent on imports for profits, prevail over the national interest.

Technocrats usually find that the safest advice (for their own careers) is to recommend no action. In the case of Fiji, one must distinguish between two kinds of businessmen: those who see their future in expanding production for both local and overseas markets, and who would therefore gain from devaluation.

Then there are others who are producing for a protected domestic market only, and who are in the process of realising and repatriating the profits on their past investments: they are klikely to lose through a devaluation.

There is one special case of businessmen, who might be intending to bring large funds into the Fiji economy, entailing significant purchases of local labour and materials or even local businesses.

If a large devaluation occurs before they bring in their capital, and if they think they can keep down their domestic purchase prices of labour, materials or businesses, these potential investors stand to make a windfall increase in their profit margin by some proportion up to the value of the devaluation.

Is there anyone in Fiji currently arguing for a devaluation, in this category?

How Might an Exchange Rate Affect Government Revenues?

It should also be noted that if the dollar has quietly been appreciating relative to the countries from which we import (like Australia and New Zealand), as in the case of Fiji, then government revenues are also boosted since existing import duties very quietly do their dirty work on easier and larger imports.

One should also note that a high exchange rate also means lower import prices and lower costs of living if a large part of people’s consumption are imports.

Governments therefore also find it easier to resist wage demands if costs of living are artificially kept down by higher exchange rates.

In the process, the prices of luxury goods, usually consumed by the elites, are also kept down. On the other hand, if the country was finding it difficult to import (for instance if Fiji devalued massively), then Governments, raise the same revenue, would have to become more unpopular by imposing export and other new taxes.

When Should We Devalue if at All?

There is a big difference in final outcome between countries which are forced to devalue (whether by IMF loan conditions, international bankruptcy, internal pressures, or otherwise) and those which devalue from positions of strength (strong reserves and strong economy), of their own choice, and in their own time.

Open, import dependent economies like Fiji will have great difficulty in keeping the benefits of devaluation.

They must expect a worsening of the balance of payments immediately after a devaluation.

This can only be cushioned if foreign reserves are healthy, and if the devaluation is carried out when the business community least expects it.

Most importantly, the Government must be able to cushion the impact of the inflation on the lowest income people  through other measures such as specific tax reductions, lowered duties on essential imports etc.

In the current climate, this would seem a difficult option to the current government.

We should not devalue now

Whatever the arguments mentioned above, the Fiji dollar should NOT BE DEVALUED NOW, since the business world is aware of the possibility and has probably prepared for it.

As the government rightly says, public discussion of a devaluation before the devaluation, is totally irresponsible.

The Fiji public, in addition to other costs, would have to pay for the ill-gotten gains of successful speculators.

Nasty decisions such as large devaluations are probably unlikely to be made.

What may be more practical, is the gradual floating down of the Fiji dollar slowly enough to prevent significant gains to speculators.

After all, over the last twelve years, the Fiji dollar has quietly revalued (upwards) against the Australian dollar by 30% and against the NZ dollar by 77%.

Devaluing by 20%, the subject of the recent hooh hah would not even take us back to 1974 relativities with Australia and NZ.

 

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