The Jamaica Bankers Association

The Bank of Jamaica yesterday pulled up interest rates by over 10 percentage points to 30 per cent, by introducing to the market, a special five-month instrument that it said would help to stabilise the foreign exchange market.

But in an immediate reaction, bankers expressed concern that the move would disrupt the financial market, while running the risk of not addressing the real underlying problem of the gaping fiscal deficit.

"While we recognise that this is intended to be a temporary measure, we believe that it will have a disruptive impact on the financial markets," said Raymond Campbell, the president of the Jamaica Bankers Association and head of First Caribbean International Bank in Jamaica.

Though BOJ said that the interest rate on all other open market instruments would be unchanged, bankers and financial analysts said the higher rate would force the banks to re-price upwards, the rates paid to maintain the deposits and investments of their customers.

The new instrument, a major increase from the 19 per cent that up to now has been the highest rate offered in months, is, according to the BOJ, against the background of the recent devaluation of the Jamaican currency.

"This instrument is being introduced in a context of significant Jamaica dollar liquidity and protracted instability in the foreign exchange market," said the central bank. "It is intended to be a temporary measure which will be removed as soon as the corrective fiscal action being developed by the government takes effect."

Yesterday, on the announcement of the measure, the Jamaican dollar strengthened against its US dollar counterpart, selling on average for J$53.19/US$1 compared with J$53.78 on Friday. The local currency has devalued by 5 per cent since the beginning of the year, nearly as much as all of last year's slippage.

Campbell in his statement, stressed that a return to normalcy would depend on government' s success at its fiscal programme.

"The root cause of the exchange rate depreciation is the fiscal deficit," he said. "We trust that the long term corrective actions being considered by government will include measures to address the imbalance that exists in revenue collection so that tax collection from the informal economy will be effective."

Yesterday's interest rate increase was one of several measures including a special five per cent special cash reserve for banks that the BOJ has put in place in an effort to halt the slippage of the currency. The BOJ has over the past few months, effectively reversed what had become a medium term downward trend in interest rates - in an effort to protect the exchange rate.

But financial analyst John Jackson told the Observer that the fact that the administration was forced to take such an extreme measure in the middle of the winter tourism season "is a commentary on the state of management of the economy".

Jackson argued that it would be difficult for the government to keep the exchange rate below J$55/US$1 for the first half of the year, as a major factor driving the demand for hard currency was the 70 per cent explosion in bank credit last year.

"It will be hard to keep the rate below J$60/US$1 by yearend, barring draconian measures," said Jackson. "There is no wiggle room because of the impact of the interest rate on the fiscal deficit."

Two bankers who asked not to be identified also said the high rate would drag Jamaica deeper into its financial mess, and would haunt the fiscal deficit during the next fiscal year.

Jackson believes that the ultimate impact of the special instrument on the broad interest rate would depend on how long the instrument remains in the market and how much liquidity it absorbs.

Significant Jamaica dollar liquidity and protracted instability in the foreign exchange market," said the Central Bank. "It is intended to be a temporary measure which will be removed as soon as the corrective fiscal action being developed by the government takes effect."

Yesterday, on the announcement of the measure, the Jamaican dollar strengthened against its US dollar counterpart, selling on average for J$53.19/US$1 compared with J$53.78 on Friday. The local currency has devalued by five per cent since the beginning of the year, nearly as much as all of last year's slippage.

Campbell in his statement, stressed that a return to normalcy would depend on government' s success at its fiscal programme.

"The root cause of the exchange rate depreciation is the fiscal deficit," he said. "We trust that the long term corrective actions being considered by government will include measures to address the imbalance that exists in revenue collection so that tax collection from the informal economy will be effective."

Yesterday's interest rate increase was one of several measures including a special five per cent special cash reserve for banks that the BOJ has put in place in an effort to halt the slippage of the currency. The BOJ has over the past few months, effectively reversed what had become a medium term downward trend in interest rates - in an effort to protect the exchange rate.

But financial analyst John Jackson told the Observer that the fact that the administration was forced to take such an extreme measure in the middle of the winter tourism season "is a commentary on the state of management of the economy".

Jackson argued that it would be difficult for the government to keep the exchange rate below J$55/US$1 for the first half of the year, as a major factor driving the demand for hard currency was the 70 per cent explosion in bank credit last year.

"It will be hard to keep the rate below J$60/US$1 by yearend, barring draconian measures," said Jackson. "There is no wiggle room because of the impact of the interest rate on the fiscal deficit."

Two bankers who asked not to be identified also said the high rate would drag Jamaica deeper into its financial mess, and would haunt the fiscal deficit during the next fiscal year.

Jackson believes that the ultimate impact of the special instrument on the broad interest rate would depend on how long the instrument remains in the market and how much liquidity it absorbs.