|How viable is a single Caribbean currency? - Part III
Friday, December 08, 2006
Last month, the viability of a single Caribbean currency was examined in Caribbean Business Report with commentaries from a number of regional luminaries on the subject.
Some say that the effectiveness of the Caribbean Single Market and Economy (CSME) lies with the implementation of a single Caribbean currency. Others hold the view that this is neither practical nor feasible and that the diversity that exists among the island economies is a vitiating factor. This week, Caribbean Business Report continues its series on this contentious matter.
Caricom Central Bank Governors concluded in 2001 that focus should be placed on the establishment of the CSME before pursuing the harmonisation of monetary policy in the region. Since then significant progress has been made on the creation of a single market and economy in the region. As such, there is the view that the formation of a monetary union would give added impetus to the creation of a single economy - a central objective of the CSME. Moreover, with increased regional trade and capital flows, the regional private sector has expressed interest in a common currency or any arrangement that reduces the transaction costs and currency risks associated with trans-regional business activity.
At the meeting of the Caricom Central Bank Governors held in Belize in May 2005 under the chairmanship of Governor Sydney Campbell, the conclusion was drawn that monetary union requires economic convergence among prospective members in order to avoid a concentration of resources in any member country that offers a greater return on either human or financial capital.
For the Caribbean, the assessment of economic convergence has been based on the 3-12-36-15 criteria established in 1992. This would see eligibility for joining the proposed union requiring each member country to hold external reserves equivalent to at least three months of merchandise imports for at least a year, to maintain a stable exchange rate for at least 3 years and to have external debt service obligations that amount to no more than 15 per cent of exports of goods and services. Member countries were further required to contain fiscal deficits below 3.0 per cent of GDP and maintain inflation rate, which is the median for the three countries with the lowest but positive rates of inflation in the previous year, plus or minus 1.5 per cent.
While the overall macroeconomic performance of the region has been positive since 1991 and there has been some amount of convergence since 1995, there is wide variation in the speed of convergence among countries. In particular, the number of countries with flexible exchange rate regimes has increased since 1992.
Among the flexible regime countries, the Guyanese and Trinidadian currencies have approached the stability criterion, but the Jamaican and Surinamese currencies have displayed significant volatility. At the end of 2004, most of the countries met the import cover criterion but only four met the debt criterion. Additionally, while inflation has generally been trending down in the region, fiscal deficits remain a concern as for most countries there were large swings in the deficits, with little indication of a clear declining trend.
Based on economic trends between 1991 and 2004, three convergence clubs have been identified.
. First Club - The Bahamas (The Bahamas, though eligible, is not part of the CSME and therefore has no interest in joining a Caribbean Monetary Union), Trinidad and Tobago and Barbados: These countries have been most consistent in meeting the criteria over time;
. Second Club - Belize, the ECCU, Guyana and Suriname: The degree of convergence has been less rapid.
. Third Club - Jamaica: Furthest from satisfying the convergence targets.
Caricom central bank governors are acutely aware that while economic policies in the various countries have been geared towards either achieving or maintaining macroeconomic stability and growth, the convergence criteria have not featured in their economic targets.
The relevance of the convergence programme, and hence the rate of transition towards monetary union, therefore, depends critically on the extent to which the criteria form an integral part of the planning and budgeting cycle in individual Caricom countries. The vulnerability of the countries to varied shocks implies that the performance criteria have to be based on bands instead of point targets.
There are a number of Caribbean central bankers who, while assessing the trends over the past five years and medium-term prospects for convergence based on macroeconomic projections, believe that monetary union may be feasible among Group 1 countries, (namely the Bahamas, Trinidad and Barbados) within the next three years. They maintain that concerted action towards meeting
agreed targets could bring the threshold for a wider monetary union appreciably closer.
An independent monetary authority
The Committee of Caricom Ministers of Finance has recommended that monetary union with a common currency that would replace existing national currencies should be administered by an independent regional monetary authority
- The Caribbean Monetary Authority (CMA). The CMA would report to a Council of Ministers of Finance. The Governor and Board of directors would serve for a period of seven years and five years, respectively, with one Director retiring each year.
The objective of the CMA would be narrowly defined to be the preservation of price and financial system stability. A federal institutional structure is recommended with a Governing Council responsible for setting monetary policy. Regional Governments would have to cede their monetary policy to this authority.
Peg a single currency to the US dollar
The exchange-rate regime recommended is one which is pegged to the US dollar at an agreed rate for a transitional period, following which it is allowed to float freely. A period of fixity is deemed necessary to ensure the credibility of the new monetary regime. A pool of reserves contributed by the participating countries would back the regional currency.
The legislative requirements would entail an amendment to the Revised Treaty of Chaguaramas to include a Monetary Integration Protocol.
Financing of fiscal deficits
The CMA's relation with the regional governments with respect to the financing of fiscal deficits must be clearly delineated. Given the multinational character of the proposed institution, clear rules need to be established. Ideally, the model used by the European Central Bank of no deficit financing should be emulated. However, given the vulnerability of member countries to external shocks, there needs to be some established limits on the level of financing that may be provided under exceptional circumstances.
National central banks ceding power
If monetary union is to be successful then the CMA must be given the power to conduct a uniform monetary and exchange rate policy for the Caricom region as a whole.
This would involve national central banks ceding power to the CMA, with the implementation of monetary and operational policies of individual jurisdictions being undertaken by their central banks based on the decisions taken by the Board of the regional authority.
National governments must decide if they are willing to cede this authority to a regional institution. Further, while there has been some relaxation in capital controls in some of the territories with fixed exchange regimes, the commitment to full liberalisation, even in the medium term, is still weak.
On the other hand, the countries with floating rates appear to be reluctant to enter into a regime that removes the flexibility to make policy adjustments in the face of shocks to the economy.
Monetary union cannot include Jamaica, Suriname and Belize
The formation of a monetary union at this time could not include Jamaica, Suriname and Belize. The other countries which qualify could proceed if that is agreeable. However, concerns remain about the sustainability of such a union in the face of any shock. Europe has 60 per cent of its trade among European countries which are pointed reminders of the fragility of such unions.
There is a school of thought that Jamaica is not quite ready for full membership at this point and is in no position to cede discretion over monetary and exchange rate policy in the near term.
As domestic macroeconomic stability, low inflation and sustainable fiscal and external balances become the norm, the option of cementing these by joining the Caribbean Monetary Union could be considered. However, Jamaica would be likely to support an initiation of the process by members who are currently qualified and interested with others retaining the option as circumstances permit.
An acceleration in the pace of economic convergence could bring Caricom members to a point where the option of forming a monetary union would become an issue of convenience rather than one of risk. At the current pace of convergence, only a small group of countries could be considered eligible for the next five years.
National macroeconomic assessments by some members are still pending, and receipt of these would provide the Caricom Committee for a single currency with a base on which to build a more definitive timetable that could take account of all prospective members.
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