Exchange rate not reflective of local economic conditions

THE recent strengthening of the local dollar against the US dollar – opening trade yesterday at 6,56 against the greenback – does not necessarily reflect the local economic conditions, but global trends which have seen the US dollar depreciating.

The Namibian dollar is pegged to the South African rand, which means that the movements of the Namibia dollar versus the US dollar reflects the movements of the rand against the US dollar. And for long term prosperity, a country would be better off to rely on its total factor productivity levels than to respond to exchange rate movements when formulating monetary policy.This the view of the Bank of Namibia (BoN) Governor, Tom Alweendo who said this as part of his presentation on the current exchange rate at a Namibia Economics Society meeting in Windhoek yesterday.Alweendo, however, added that exchange rate movements were indeed vital, but whether the central bank should respond to these flactuations when formulating policy was another issue.”An important issue is therefore whether policymakers should respond to exchange rate movements when they formulate monetary policy.There is ample evidence that suggest that for central banks to respond to either an appreciation or depreciation will transmit unnecessary volatility into inflation and therefore the real economy.”In my view, we should recognise the fact that the exchange rate is not mechanically related to the interest rate.The exchange rate shocks and these are an indication that the exchange rate conveys information in its own right,” said Alweendo.The issue has become topical as the strong dollar continues to negatively affect the export industry, and there have been calls from some sectors for the central bank to intervene and depreciate the local currency.The central bank Governor said, however, the two methods being suggested; of reducing interest rates and buying foreign currency; both had negative effects if not handled properly.”The last thing you want to do is to reduce interest rate without reference to the inflation, and to be forced to hike interest rates soon afterwards…Clearly, cutting interest rates is not in itself an effective way to move the exchange rate.”You are probably aware of experiences where central banks wasted huge amounts of financial resources trying to defend a desired exchange rate…It is therefore not a cost-free exercise to say that the central bank must buy US dollars,” said Alweendo.The governor also noted that BoN was well aware of the danger of inflation adding that to rely on a weaker exchange rate for price competitiveness might be beneficial for the short term.And for long term prosperity, a country would be better off to rely on its total factor productivity levels than to respond to exchange rate movements when formulating monetary policy.This the view of the Bank of Namibia (BoN) Governor, Tom Alweendo who said this as part of his presentation on the current exchange rate at a Namibia Economics Society meeting in Windhoek yesterday.Alweendo, however, added that exchange rate movements were indeed vital, but whether the central bank should respond to these flactuations when formulating policy was another issue.”An important issue is therefore whether policymakers should respond to exchange rate movements when they formulate monetary policy.There is ample evidence that suggest that for central banks to respond to either an appreciation or depreciation will transmit unnecessary volatility into inflation and therefore the real economy.”In my view, we should recognise the fact that the exchange rate is not mechanically related to the interest rate.The exchange rate shocks and these are an indication that the exchange rate conveys information in its own right,” said Alweendo.The issue has become topical as the strong dollar continues to negatively affect the export industry, and there have been calls from some sectors for the central bank to intervene and depreciate the local currency.The central bank Governor said, however, the two methods being suggested; of reducing interest rates and buying foreign currency; both had negative effects if not handled properly.”The last thing you want to do is to reduce interest rate without reference to the inflation, and to be forced to hike interest rates soon afterwards…Clearly, cutting interest rates is not in itself an effective way to move the exchange rate.”You are probably aware of experiences where central banks wasted huge amounts of financial resources trying to defend a desired exchange rate…It is therefore not a cost-free exercise to say that the central bank must buy US dollars,” said Alweendo.The governor also noted that BoN was well aware of the danger of inflation adding that to rely on a weaker exchange rate for price competitiveness might be beneficial for the short term.