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Consumers of alcohol, tobacco, energy hit hard by dollar slide – BOJ report

The all-out effort by the Bank of Jamaica, BOJ, to steady and even strengthen the local currency as part of its policy response to high inflation, is being supported by ongoing research by the central bank. During periods of heavy currency movements and large depreciation of the Jamaican dollar, consumers of cigarettes, alcohol and electricity take a disproportionately big hit from high prices, BOJ research measuring exchange rate pass-through, ERPT, and published in August, has shown.

“The monopolistic structure of the alcohol and tobacco industries in Jamaica, coupled with the highly inelastic demand for these products, support a stronger-than- proportional ERPT for this subcomponent of the consumer price index,” a working paper prepared by BOJ staffers Cappriece Clarke and Carey-Anne Williams said.

Working papers are not official BOJ policy declarations and reflect ongoing internal study, the central bank has pointed out. The paper, titled ‘Is Exchange Rate Pass-Through to Prices in Jamaica Nonlinear?’, is issued by the BOJ’s sector analysis department and examined the impact of currency movements on Jamaica’s consumer price index between 1996 and 2020.

Nonlinear phenomena speak generally to changing variables and situations in which output results are not proportional to input changes over time.

“Alcoholic beverages and tobacco (ABT) and electricity, gas and other fuels (EGOF) recorded a higher pass-through for periods of high depreciation than periods of low depreciation,” the paper said.

Lower pass-through

It explained that these industries have a lower pass-through to inflation during periods of low currency depreciation, but a higher pass-through during periods of higher depreciation. The economists observed a 1.40 percentage point pass-through for ABT in high depreciation environments and 0.9 per cent for EGOF. The paper determined low annual depreciation as being under 1.0 per cent, and high annual depreciation at above 7.0 per cent.

“The results indicate that pass-through differ depending on whether the economy is facing an environment of ‘low’ depreciation or ‘high’ depreciation. When the economy is facing an environment of high depreciation, the pass-through of a one per cent shock to the exchange rate raises core and headline inflation by 0.30 and 0.70 percentage point, respectively, 12 months after the shock,” the paper concluded.

It added that there is evidence of nonlinearities in the ERPT to consumer prices, estimating that the ERPT to core and headline inflation is incomplete over the 12- to 24-month horizons in the low-depreciation regime. In the high-depreciation regime, the time for pass-through to prices ranges from five quarters to four years, for headline and core inflation, respectively,” according to the study.

Illustrating that correctly understanding how exchange rate changes affect inflation is important for policymakers, particularly in emerging markets with flexible exchange rates, the researchers noted that the results of the study can be used to improve the central bank’s inflation forecasting models, as well as its understanding of the transmission mechanism of monetary policy.

Raised concern

At the bank’s most recent quarterly briefing on August 19, central bankers raised the concern that with a growing trend towards larger amounts of the assets of deposit-taking institutions, DTIs, in Jamaica being held in US dollars, BOJ’s monetary policy aimed at reducing inflation and steadying the exchange rate would influence a smaller pool of resources, leading to reduced impact. The bank’s policy of ongoing rate adjustments and increased foreign exchange market interventions are therefore also aimed at encouraging Jamaican dollar-denominated investments and discouraging US dollar holdings, thus easing pressure on the value of local currency.

The BOJ has been raising its benchmark policy rate since September last year and, in the process, sending borrowing rates higher. Last month it implemented its eighth straight rate increase, bringing the policy rate on overnight deposits by DTIs to 6.0 per cent.

Jamaica’s currency strengthened by some 2.6 per cent against the US dollar year-to-date, and closed at $151.60 to the USD on Wednesday, from $155.64 on January 3. The inflation rate, however, hit its highest levels in a decade, running at 10.2 per cent over 12 months to July, well above the target range of 4.0-6.0 per cent.

In a response to the BOJ findings, tobacco distributor Carreras says the company recognises the price pressures facing consumers of its products.

“We have sought every means possible, from as far back as 2017, to seek to ensure we can stave off any pricing pass-through/increases. Being as efficient as possible, operating with zero based budgeting, removing all non-essential costs from our operations and ensuring we leverage our global scale to bring as much efficiencies as possible, have allowed us to absorb increased cost,” Raoul Glynn, Carreras’ managing director, said in an email response to the Financial Gleaner.

Comments were not forthcoming from alcoholic beverage purveyors or monopoly power distributor Jamaica Public Service.

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