Treasury advice on exchange-rate float

Press, 31 August 1984, Page 4

Treasury advice on exchange-rate float

By

MICHAEL HANNAH

in Wellington

The Government followed Reserve Bank advice for a “sizeable” devaluation after the July 14 Election, but appears to be implementing Treasury advice for a smooth introduction of a floating exchange rate. This emerged from documents released yesterday by the Government in its “opening of the books” exercise.

The bank was particularly scathing of controls, protective measures, and support schemes such as export incentives and supplementary minimum prices which, it said, obscured the extent of misalignment in the exchange rate. The Reserve Bank told the incoming Government that the dollar was “substantially” overvalued, and

laid the blame on a 25-30 per cent drop in the terms of trade, which it said must be regarded as a long-term, rather than transitory, reaction to the 1970 s oil shocks. The bank said that the balance-of-payments current account had been in "persistent deficit” for 10 years, and private capital inflow had been insufficient to finance this deficit. The extent of the overvaluation of the dollar was obscured, however, by exchange controls, import controls, and other protection arrangements. But the bank reserved its harshest comment for export incentives and supplementary minimum prices. The bank considered that "they effectively imply that different sectors face different exchange rates, which makes no sense at all — it contributes to the

structural misallocation of resources.”

In spite of all the indications of a need for a real drop in the value of the dollar, the real exchange rate index had changed little since the early 19705, the bank noted.

It concluded, “In our view, both the magnitude of the present imbalance and the urgent need to make progress in redressing it leave no choice but to proceed with a significant devaluation of the nominal exchange rate in the near future, supported by firm monetary and anti-inflation-ary policies.” The bank conceded that the’ devaluation would have price effects, but advised firm monetary control to avoid the inflationary effects becoming permanent. The Treasury also advised firm monetary con-

trol but as part of an agenda for an eventual floating of the dollar. It said that other measures which should be taken before the dollar was floated should include liberalisation of the market, and communication of the implications of this to the public and particularly to the labour market.

The Treasury considered floating the most efficient way of achieving an adjustment of the exchange rate, but conceded that an immediate float would create problems. It therefore recommended a tightening of the monetary policy, a reduction in the fiscal deficit, and the freeing of interest rate controls as essential prerequisites. It said that it might be necessary to build up foreign exchange reserves before the exchange rate was floated.