October 20, 2006

IS DEVALUATION ON THE CARDS?

Part of the Minister of Finance, Mr Danny Faure’s statement to the National Assembly was to tell us that Mr Chang Leng, the Central Bank Governor, would announce new ways to calculate the exchange rate of the rupee in terms of the other international currencies. The same evening Mr Chang Leng was seen on SBC television telling us that the relative movement of the exchange rate of the rupee will from now on be influenced by only 3 currencies instead of 6 as previously. As is common with all such “new initiatives” it is intended to change nothing. And Mr Chang Leng told us as much.

In practice the nominal exchange rates of the various currencies will more or less stay the same at the banks. The banks will still be unable to sell you foreign currencies for rupees on demand because demand outstrips supply at this price and the banks cannot match the supply.  Outside the banks, however, there is no basket of currencies to contend with. There each currency has a price regulated by the supply and demand. Generally, the supply equates demand at a particular price which, according to the IMF, was estimated to be between 8 and 12 rupees to the dollar in 2005 compared to the official rate of SR 5.50 at the banks.

Mr Faure also said that importers will no longer need to deposit rupees with the Central Bank when they apply to their banks for foreign exchange to pay their invoices. This is the third time that an official pipeline has been dismantled since the currency crisis emerged in the early 90s. Instead importers who want to pay foreign suppliers must now apply to the banks for an LC.

Faure, however, did not give any indication as to how long it will take for an LC to be honoured. Banks will call and let you know when some foreign currencies have become available to cover all or part of your LC and then you will have to fork out the rupees. Under this arrangement, importers will not know the real rupee costs of imports until the LC has been fully financed in foreign currency.

Some banks with good connections overseas may borrow from their parent and fund 100% of the LC as a foreign exchange term loan to the importer. But this is available only to (international) credit worthy clients. There again the full costs of the transaction cannot be recovered through the profit margin allowed by law. Meanwhile, imports will still be restricted to 30% profit margins when the goods arrive. GST will continue to be imposed on the price after the official maximum mark-up has been applied. President Michel’s promise to the Seychelles Chamber of Commerce before the election that he will abolish price controls after the election is still to materialise.

Faure told the National Assembly that part of the proceeds of the bond sale would be left as foreign exchange reserves, which according to the Central Bank was some US$ 70 million at 31st September 2006, though only US$6.1 million was available to us for use freely – which is less than 10% of the value of the currency in circulation, the most liquid of all the money in the economy.

Theoretically, we could use the unallocated US$82.5 of the proceeds to raise our gross foreign currency reserves to US$ 152.5 million, sufficient to cover 72% of the value of the “high powered” money or base money, at current official exchange rate. Base money is the combine of currency in circulation and statutory reserves commercial banks have to keep with the Central Bank.  If the currency is then devalued to say, SR10 to the dollar, this level of reserves in dollars would be more than sufficient to guarantee the full convertibility of at least this portion of the money supply at that rate of exchange.  Such an exercise, however, will only work on a sustainable basis if the monetary system is radically changed from what it is at present. 

But Mr Chang Leng has instead re-jigged the way the exchange rates are calculated, which is the financial equivalent of a game of musical chairs. In the real world, among traders and those who need urgent medical treatments abroad, one can get dollars outside the banks on demand at SR 10 or more. There, there is no such thing as a currency basket. Why can’t Chang Leng learn that lesson of the real life in exchange rate transactions?

Copyright 2006: Seychelles Weekly, Victoria, Mahe, Seychelles