(2022-11) Leçons des développements récents du taux de change d'Haïti

Lessons from Haiti’s Recent Exchange Rate Developments Rina Bhattacharya and Neil Shenai WP/22/225 IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. 2022 NOV © 2022 International Monetary Fund WP/22/225 IMF Working Paper Western Hemisphere Department Lessons from Haiti’s Recent Exchange Rate Developments Rina Bhattacharya and Neil Shenai* Authorized for distribution by Nicole Laframboise November 2022 IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. ABSTRACT: From August to October 2020, the Haitian authorities were successful at bringing about a sharp appreciation in the gourde/U.S. dollar exchange rate. This paper analyzes the factors behind this appreciation and its spillovers on the economy. It finds that foreign exchange surrender requirements had a statistically significant effect on the nominal exchange rate, while foreign exchange intervention by the central bank did not. Surrender requirements were also found to have raised trading costs and volatility in the foreign exchange market and contributed to the development of a wider parallel nominal exchange rate premium. This appreciation contributed to a decline in headline inflation during the episode while delivering some fuel subsidy related savings to the government. Remittance-dependent households and exporters saw a drop in their purchasing power, and Haiti’s net external buffers were adversely affected. Following from these findings, the paper offers recommendations on ways to facilitate foreign exchange management and boost external sustainaibility while contributing to the central bank’s overall policy objectives. RECOMMENDED CITATION: Bhattacharya, Rina and Neil Shenai (2022), “Lessons from Haiti’s Recent Exchange Rate Developments.” IMF Working Paper 22/225. JEL Classification Numbers: E50, F40, F41 Haiti foreign exchange rate; fragile state monetary policy; foreign Keywords: exchange surrender requirements; foreign exchange intervention in fragile states; reserve money programming in fragile states Author’s E-Mail Address: rbhattacharya@imf.org, nshenai@imf.org * The authors thank Nicole Laframboise, Carolina Osorio Buitron, Patrick LeClerc, and Noah Ndela, for their constructive comments, as well as the country authorities and private sector representatives for their close engagement. They also thank Paola Aliperti F. Domingues (IMF Western Hemisphere Department) and Paolo Galang (IMF Strategy, Policy & Review Department) for their helpful research assistance. WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments Prepared by Rina Bhattacharya and Neil Shenai IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments Contents Glossary............................................................................................................................................................... 3 Introduction ......................................................................................................................................................... 4 Review of the Literature ..................................................................................................................................... 5 An Overview of Haiti’s Foreign Exchange Market ........................................................................................... 7 Understanding the 2020-2021 Episode ........................................................................................................... 11 Drivers of the 2020-2021 Exchange Rate Developments ............................................................................ 12 Implications of Exchange Rate Developments............................................................................................. 14 Policy Considerations ...................................................................................................................................... 18 Conclusion......................................................................................................................................................... 19 Annex I. Estimation of an Exchange Rate Model Calibrated for Haiti.......................................................... 21 Model Details................................................................................................................................................ 21 A VECM of Haiti’s Nominal Exchange Rate .......................................................................................... 21 Results................................................................................................................................................... 22 Short-Run Dynamics ............................................................................................................................. 23 Annex II. Modeling the Volatility of Haiti’s Nominal Exchange Rate............................................................ 25 Model Details................................................................................................................................................ 25 A GARCH(1,1) Model of Haiti’s Nominal Exchange Rate ..................................................................... 25 Results................................................................................................................................................... 26 Discussion ............................................................................................................................................. 26 Annex III. Estimating Exchange Rate Pass-Through to Inflation in Haiti and Regional Peers .................. 30 Model Details................................................................................................................................................ 30 Model 1: the Auto Regressive Distributed Lag (ARDL) Model of Exchange Rate Pass-through .......... 30 Model 2: A VECM Estimation of Exchange Rate Pass-through ............................................................ 30 Discussion ............................................................................................................................................. 31 Annex IV. Assessing the Sensitivity of Exports and Remittances to Exchange Rate Movements........... 35 Model Details................................................................................................................................................ 35 Model 1: Exports and the REER............................................................................................................ 36 Model 2: Imports and the REER............................................................................................................ 37 Model 3: Remittances and the REER.................................................................................................... 39 References......................................................................................................................................................... 41 INTERNATIONAL MONETARY FUND 2 IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments Glossary ARA-CC – Assessing Reserves Adequacy for Credit Constrained economies ARDL – Auto regressive distributed lag ARIMA – Auto regressive integrated moving average BRH – Bank of the Republic of Haiti FCS – Fragile and conflict-affected states FMOLS – Fully modified ordinary least squares GARCH – Generalized autoregressive conditional heteroskedasticity GEE – Global Economic Environment INS – Information Notice System IPF – Integrated Policy Framework MEF – Ministry of Economy and Finance NEER – Nominal effective exchange rate NOP – Net open positions OLS – Ordinary least squares REER – Real effective exchange rate RM – Reserve money programming SEATS – signal extraction in ARIMA time series TRAMO – Time series regression with ARIMA noise, missing observations, and outliers VECM – Vector Error Correction Model WEO – World Economic Outlook INTERNATIONAL MONETARY FUND 3 IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments Introduction 1. Haiti is a small, open, fragile, and shock-prone economy. It is also highly dependent on remittances and is undergoing considerable social, political, and economic stress. A protracted political crisis that started in 2015 and included the assassination of the President in 2021 has been a key driver of instability, fragility, and conflict. Related to these exogenous shocks, the country has experienced civil unrest with repeated country lockdowns (known as peyi-lok), increasing gang violence and control, COVID-19-related lockdowns, a hurricane, and an earthquake. These shocks hit an economy with considerable pre-existing vulnerabilities, including high rates of informality and poverty, exposure to climate-related natural disasters and earthquakes, dependence on volatile and declining foreign financial assistance, and governance challenges. 2. In mid-2020, the authorities adopted measures that were very successful at halting the slide in 130 the gourde and delivering a sharp exchange rate appreciation. From August – October 2020, the 120 gourde/U.S. dollar rate appreciated by 50 percent in 110 nominal terms from about 124 gourdes to 62 gourdes per 100 U.S. dollar (chart). This appreciation coincided with several 90 policy actions taken by Haiti’s central bank, the Bank of the 80 70 Republic of Haiti (BRH), including the introduction of 60 foreign exchange (henceforth “forex”) regulations on banks 50 and currency traders, forex sales, dollar liability issuances 40 to commercial banks, and enhanced communications, 30 Haiti's Foreign Exchange Rate (HTG/US$, average) 2010 Earthquake BRH's Policy Actions 20 including moral suasion of financial institutions. This period Jul-09 Jul-10 Jul-11 Jul-12 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jul-21 Jul-22 Jul-13 Jul-20 of exchange rate appreciation also coincided with a surge in remittances from the U.S. and reduced imports related to the ongoing domestic crisis (Table 1 and Figure 3). Source: BRH and IMF staff calculations. 3. This study explores the policy measures taken to bring about this appreciation and its economic consequences. It examines the quantitative developments and impact of these measures on the economy and financial system and offers policy recommendations drawing on this analysis. The study focuses primarily on policy actions and related developments from August 2020 through mid-2021, and the empirical work uses data available through mid-2021. 4. The rapid nominal exchange rate appreciation in the second half of 2020 had important ramifications on the economy and on Haitians. First, remittance-dependent households, savers, and financial institutions were adversely affected, while the government and large importers with access to credit and the forex market generally benefitted. Indeed, the empirical work in this study indicates that Haiti’s net remittance flows, unlike exports and imports of goods, are highly sensitive to movements in the real effective exchange rate (REER), both in the short- and long-run, implying that periods of real exchange rate appreciation would adversely affect remittance-dependent households. Second, forex regulations in the form of surrender requirements led to a decline in forex liquidity and increased volatility in the forex market, impeding the efficient functioning of the market and price discovery while making it more difficult to determine the equilibrium value of the nominal exchange rate. Third, surrender requirements were found to have had a statistically significant impact on the nominal exchange rate in the long run, whereas forex intervention did not, even in the short run. Fourth, the estimated inflation pass-through to the exchange rate suggests that exchange rate volatility contributes to price level volatility, which may have complicated monetary policy implementation. INTERNATIONAL MONETARY FUND 4 IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments 5. The rest of this paper is organized as follows. Section II surveys the literature on monetary policy frameworks and exchange rate regimes in fragile and conflict-affected states (FCS). Section III provides an overview of Haiti’s forex market, with an emphasis on the market and legal infrastructure for forex, the main market participants and their forex needs, how the official exchange rate is determined, and stylized facts on forex market liquidity. Section IV evaluates the 2020-2021 exchange rate appreciation and deprecation episode, elaborating on the key measures taken and analyzing their macroeconomic impacts. Section V summarizes the findings and discusses policy implications. Annexes I-IV present the empirical analysis supporting the paper’s findings with the aim of providing insight into: the factors driving the sharp appreciation of the nominal exchange rate in the latter half of 2020 (Annex I); the impact of forex regulations on underlying forex market volatility (Annex II); the pass-through of exchange rate movements to CPI inflation (Annex III); and the sensitivity of exports, imports, and net remittance flows to exchange rate movements (Annex IV). Review of the Literature 6. The choice of appropriate monetary policy framework and exchange rate regime continues to be highly debated, particularly in low-income countries and FCS. A desirable monetary policy and exchange rate framework is one that “keeps inflation expectations well anchored and minimizes unnecessary fluctuations of economic activity around its trend path in response to shocks” (Minella, Powell, Rebucci, & Souza-Sobrinho, 2009, p. 4). While pegging the exchange rate provides a useful commitment device for the central bank to anchor expectations by disciplining policies, it also limits a country’s ability to respond to macroeconomic shocks. Forex regimes that are more rigid help countries anchor inflation expectations, sustain output growth, and foster deeper economic integration. But, as highlighted by Ghosh and Ostry (2009), they also constrain the use of macroeconomic policies, increase vulnerability to crises, and can impede external adjustment given prevailing rigidities (Ghosh & Ostry, 2009). Pegged exchange rate regimes are often associated with the best inflation performance, but growth performance is best enhanced under intermediate exchange rate regimes—i.e., those that maintain relatively rigid exchange rates but do not formally peg to a single anchor currency (Ghosh, Ostry, & Tsangarides, 2010). 7. Caribbean countries have adopted a range of exchange rate regimes. The Caribbean’s small, open economies are especially vulnerable to external shocks, including terms of trade and financing shocks, and frequent natural disasters. At the same time, there is considerable heterogeneity across the region, with many countries dependent on tourism, a few major commodity exporters, and a wide range of per capita income levels. Exchange rate regimes thus range from a hard peg to the U.S. dollar (e.g., Bahamas and Barbados) to a soft peg with periodic step adjustments (e.g., Suriname and Trinidad and Tobago) to a managed float with no predetermined level or path for the exchange rate (Jamaica). The classification of Haiti’s exchange rate regime was recently changed by the International Monetary Fund from a ‘crawl-like’ arrangement to ‘other managed’ arrangement.1 8. Identifying an appropriate monetary policy framework and exchange rate regime is challenging for FCS such as Haiti where state capacity is limited and political legitimacy is contested. Many fragile states are jurisdictions where the rule of law has limited traction, the normal functioning of the state can no longer be presumed, and economic, social, and political anarchy prevails. 1 See (International Monetary Fund, 2020b) background on this classification methodology. INTERNATIONAL MONETARY FUND 5 IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments 9. State fragility alters the macroeconomic stabilization challenges faced by FCS in three main ways: i. The composition and magnitude of shocks differ from non-FCS. In addition to terms-of-trade and/or climate related shocks, fragile states are more likely to have shocks that emanate from, and interact with, the risks and consequences of civil or cross-border conflict compared to non-FCS. This factor is particularly relevant in Haiti, where gangs and other organized criminal organizations overwhelm the state and challenge the government’s legitimacy.2 ii. The capacity for countercyclical action is often severely compromised since automatic fiscal stabilizers are absent. To a large extent this is because access to international private capital markets is generally limited and capital flows to and from fragile states are procyclical, while bilateral official flows have also become more procyclical in recent decades as concerns about corruption and transparency have increased together with aid fatigue, and domestic debt markets tend to be extremely thin. In Haiti’s case, official support started to decline around 2012 after the surge following the 2010 earthquake and in the wake of domestic political instability and governance problems. Haiti has weak and declining domestic revenue mobilization, and fiscal policy space remains severely limited as well. Furthermore, Haiti does not have access to international private capital markets, and the IMF has provided by far the largest share of external financing in recent years.3 iii. Fragility shortens horizons for policymakers and undermines their incentives to balance current against future outcomes. This dynamic gives rise to temptations to increase borrowing on unattractive terms and to pursue macroeconomic stabilization through short-term political expediency. 10. Monetary and exchange rate policy can be a useful tool to limit the risks of potential fiscal dominance—a key problem facing many FCS, including Haiti. Adam and Wilson argue that fiscal dominance is a major policy challenge in many fragile states. Broadly speaking, fiscal dominance exists when fiscal policy considerations play an overwhelming role in monetary policy decisions, as reflected for example by the extent to which government deficits determine the growth of the money supply or the evolution of interest rates. The impetus toward fiscal dominance often stems from institutionally weak central banks that cannot resist political pressure for provisioning central bank credit to the government, a lack of domestic resource mobilization together with high public funding needs, and general short-termism, among other factors. In Haiti, central bank credit to the government and base money creation more broadly coincided with recent rises in inflation (chart on next page). Thus, adopting a monetary policy and exchange rate framework that constrains excessive central bank money creation (for example, through what Adam and Wilson describe as a reserve money targeting regime, see below) can be helpful in restoring fiscal discipline by limiting the government’s access to central bank funding (Adam & Wilson, 2021, pp. 383-384). 2 See (Abi-Habib & Paultre, 2022) and (Walsh & Gallon, 2022) for recent accounts of the increasing influence of gangs in Haiti. 3IMF financing includes an emergency loan in 2020 under the IMF’s Rapid Credit Facility and the 2021 SDR allocation (combined worth about 2.6 percent of GDP), see (International Monetary Fund, 2020a) and (International Monetary Fund, 2022a, p. 32) INTERNATIONAL MONETARY FUND 6 IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments 11. Fragile states exposed to a multitude of ‘real’ shocks (both domestic and external) may find it useful to adopt a relatively flexible exchange rate regime. Forex flexibility can help deal with such shocks when complemented by efforts to strengthen liquidity management, develop financial and forex markets, contain fiscal dominance, and continue with structural reforms to enhance competitiveness and promote expenditure-switching. A key element in any exit strategy from poverty, fragility, and conflict is to strengthen control over government finances and address the challenge of fiscal dominance while using monetary policy, such as reserve money (RM) programming, to anchor inflationary expectations. RM programming is an essentially non-discretionary, rule-based approach to monetary policy and is well-designed for anchoring inflation in flexible or managed exchange rate regimes in which government transactions play an important role in the structural generation of liquidity and where fiscal dominance is a major policy challenge. Moreover, as (Adam & Wilson, 2021) note, the RM framework functions well when financial markets are in an embryonic 35 state and are dominated by banks that rely heavily on 30 transactions with central banks for their funding and 25 liquidity. The authors further find that one of the striking themes in the economic history of sub 20 Saharan Africa is how many of the successful exits 15 from fragility have been built around money-based 10 stabilization programs, complemented with strong fiscal reforms and measures to strengthen public 5 finances on a sustainable basis. Since both conditions 0 Monetary Financing and Inflation BRH financing (cumul. terms since beg. of FY), HTG billions (RHS) Inflation, y/y, % 60 50 40 30 20 10 0 -10 Oct-21 Oct-19 Oct-20 *Jul-28-22 Jan-19 Jan-20 Jan-21 Jan-22 Apr-19 Apr-20 Apr-21 Apr-22 Jul-19 Jul-20 Jul-21 are present in Haiti—including embryonic financial markets and banks that are heavily reliant on the central bank—this suggests that more stringent controls on base money creation can be an important tool in anchoring inflation expectations and containing fiscal dominance in Haiti. Source: BRH. An Overview of Haiti’s Foreign Exchange Market 12. It is worth emphasizing that macroeconomic policy formulation and execution is exceptionally challenging in Haiti given its fragility, vulnerability to exogenous shocks, and capacity limitations. The protracted political and security crisis have had a major impact on the economy and drastically limited the authorities’ ability to respond to shocks, while the security situation deteriorated during 2021 and 2022 to an acute level, significantly affecting the circulation of people and goods and choking off economic activity, akin to the peyi-loks of 2019. This fragility has impeded FDI inflows and capital deepening while exacerbating Haiti’s acute development needs. This has led to an erosion in human capital and institutions, with the resulting weak administrative and institutional capacity hindering the ability of policymakers to implement basic policies or respond to shocks. 13. The main sources of forex revenue in Haiti are private transfers (remittances) and textiles exports. In 2021, it is estimated that Haiti received about $4.7 billion in private transfers, equivalent to about 22 (Table 1). Apparel exports, such as knit t-shirts and other clothing articles, accounted in 2021 for about $1.2 percent of GDP, of which $4.2 billion were remittances sent from abroad, mostly Haitians working in the U.S. INTERNATIONAL MONETARY FUND 7 IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments billion in export revenues (5.1 percent of 2021 GDP), in turn constituting about 94 percent of Haiti’s goods exports. 14. Haiti’s main forex outflows are for goods imports, with fossil fuels being a major component. In 2021, Haiti imported about $4.6 billion of imported goods (worth about 22 percent of Haiti’s 2021 GDP), of which about $850 million (4 percent of GDP) were fossil fuels. Net external debt payments from both the public and private sectors are not major contributors to Haiti’s balance of USD millions % 2021 GDP Table 1. Haiti: Balance of Payments, 2021 (est.) Current account $ 98 0.5% Receipts $ 6,113 29.1% o/w remittances $ 4,196 20.0% o/w goods exports $ 1,130 5.4% Expenditures $ (5,890) -28.0% o/w fossil fuel imports $ (643) -3.1% o/w food imports $ (815) -3.9% Capital and financial account (non-reserve) $ (72) -0.34% Overall balance $ (4) -0.02% Source: BRH. payments, with gross public sector and bank outflows amounting to about $200 million (1 percent of GDP). 15. Haiti’s spot forex market participants are comprised of eight commercial banks and several non-deposit taking money transfer operators. Prior to August 2020, commercial banks quoted bid and offer prices for clients reflecting market supply and demand for forex, with transactions settled in a BRH-operated clearinghouse. Haiti did not maintain restrictions on current account transactions and residents were permitted to hold forex accounts with Haiti’s eight licensed commercial banks. Exporters and households, such as remittance receivers, could hold forex accounts as well. These accounts were credited with proceeds such as export receipts and transfers received from money transfer operators. Due in part to Haiti’s dependence on worker remittances, Haiti’s financial system remains highly dollarized, with forex deposits accounting for about two thirds of total banking sector deposits (Box 2). Moreover, there is no forex futures market in Haiti. 16. The BRH was involved in the forex market in several ways. It set forex-related macroprudential requirements, intervened in the market, and served as the fiscal agent for the Ministry of Economy and Finance (MEF) for certain transactions, including those with international financial institutions (IFIs). Bank lending in forex could not exceed 50 percent of total forex liabilities, while reserve requirements on U.S. dollar deposits are 50 percent for commercial banks and 40 percent for savings and housing banks. Net open positions (NOP) in forex were limited to 0.5 percent of equity for banks and money transfer companies, which is low by international and regional standards. The BRH periodically intervened in the forex market by buying and selling international payments via an MEF-designated account at the BRH. forex directly with licensed banks. Prior to late-2021, the government had a fuel import monopoly and made INTERNATIONAL MONETARY FUND 8 IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments 17. Since the 2020 appreciation episode, Haiti has had two exchange rates: the bank rate and the 30 informal rate. Banks and non-deposit taking money 25 changers transact at the interbank rate, while the informal rate reflects supply and demand conditions for 20 forex in the sizeable informal economy. There are two 15 informal rates: the rate as reported by the BRH (via its website) and the parallel market rate obtained from 10 informal surveys (chart). The BRH’s daily reference 5 forex rate (taux de référence) is determined by a 60 0 percent-40 percent weighted average of the bank rate and informal rate, respectively. Since the emergence of -5 Parallel Market Premium (Percent) lnformal market premium - from BRH Parallel market premium - from surveys 5/2/2014 5/2/2015 5/2/2016 5/2/2017 5/2/2018 5/2/2020 5/2/2021 5/2/2019 5/2/2022 the parallel rate in late-2020, the spread between the bank and informal rates has ranged from 5 to 25 percent (chart). 18. Forex market turnover has remained stable since 2015. Forex market turnover―the sum of forex purchases and sales by commercial banks―averaged about $400 million per month since 2015, equivalent to about 3 percent of 2020 nominal GDP. Forex liquidity in both the official and parallel markets declined in 2020, as measured by proportional bid-offer spreads, while median proportional bid-offer spreads rose from about 35 to 65 basis points in 2020 (Figures 1 and 2). Figure 1. Forex in Haiti 140 800 15 Foreign Exchange Turnover in Haiti Foreign Exchange Liquidity in Haiti (USD millions) (Proportional bid-offers spreads, basis points) 700 120 10 Bank rate 600 Informal rate 100 5 180 per. Mov. Avg. (Bank rate) 500 80 0 400 180 per. Mov. Avg. (Informal rate) 60 -5 300 40 -10 200 Foreign exchange turnover 20 Average turnover -15 100 Net selling (buying), RHS 0 0 -20 Nov-16 Nov-20 Nov-14 Nov-15 Nov-17 Nov-18 Nov-19 Nov-21 May-14 May-15 May-16 May-17 May-18 May-19 May-20 May-21 May-22 Apr-17 Apr-19 Apr-21 Apr-16 Apr-18 Apr-20 Apr-22 Oct-15 Oct-16 Oct-17 Oct-18 Oct-19 Oct-20 Oct-21 Source: BRH and IMF staff calculations. INTERNATIONAL MONETARY FUND 9 IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments Figure 2. Volatility of Trading Costs in Various Periods (Proportional bid-offer spreads, basis points) Source: BRH, Author calculations. INTERNATIONAL MONETARY FUND 10 IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments Understanding the 2020-2021 Episode 19. After an extended period of depreciation, the BRH launched a strong defense of the currency in August 2020. During 2019 and the first half of 2020, the gourde/U.S. dollar rate depreciated steadily, driven by inflationary financing of the deficit in 2019/20, supply shortages in 2019-2020 related to social unrest and gang activity that resulted in repeated peyi-loks, and to a lesser extent by COVID-19 containment measures. Starting in August 2020, the gourde/U.S. dollar rate appreciated by nearly 50 percent through October 2020. The nominal effective exchange rate (NEER) appreciated by about 50 percent over this period, while the REER appreciated by 78 percent (Figure 3). This appreciation took place against a backdrop of declining growth momentum across sectors due mostly to COVID-19 related lockdowns, an upsurge in violence and social unrest, and the continued political crisis. As a result, domestic expenditures were compressed, and total imports fell as a percentage of GDP from about 31 percent in FY2019 to 26 percent in FY2020. This decline in import demand, coupled with surging remittance inflows, helped turn the current account deficit of about 2.4 percent of GDP in 2019 into a small surplus of 0.2 percent of GDP in 2020. This improvement on net in the balance of payments contributed to the strength of the gourde in the latter half of 2020. Figure 3. Selected Economic Indicators 80 140 180 REER and NEER Exchange Rate and FX Intervention 160 130 (Index) 60 Net central bank FX sales, US$ million BRH reference rate (RHS) 140 120 Parallel EXR (RHS) 40 120 Interbank market EXR (RHS) 110 20 100 100 80 0 90 60 -20 80 40 NEER REER -40 70 20 0 -60 60 May-20 Nov-17 Aug-16 Aug-21 Mar-16 Mar-21 Jun-22 Jun-17 Jan-17 Apr-18 Dec-19 Jan-22 Jul-19 Oct-15 Oct-20 Sep-18 Feb-19 May-21 May-22 Aug-21 Nov-20 Nov-21 Aug-20 Mar-21 Mar-22 Jun-21 Jun-20 Jun-22 Jul-20 Dec-20 Dec-21 Jan-21 Jan-22 Apr-21 Apr-22 Jul-21 Jul-22 Oct-20 Sep-20 Sep-21 Oct-21 Feb-21 Feb-22 5 20 Contribution to GDP Growth Exports and Imports (Supply-side GDP, percent) (Percent of GDP) 4 10 3 2 0 1 -10 0 -1 -20 Agriculture Manufacturing -2 Construction -30 Exports of goods Imports of goods Services -3 Other Trade balance CA balance -4 -40 2015 2016 2017 2018 2019 2020 2021 2015 2016 2017 2018 2019 2020 2021 Sources: BRH, IHSI and IMF staff calculations. INTERNATIONAL MONETARY FUND 11 IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments 20. Between its October 2020 peak and end-April 2022, the gourde depreciated steadily. This was reflected in the NEER and REER, which depreciated about 20 percent and 33 percent respectively from their October 2020 highs. Some of this depreciation may have been due to equilibrating market forces: as of November 2020, IMF staff assessed that Haiti’s REER was overvalued by about 40 percent based on the 2020 External Balance Assessment (EBA)-Lite REER model-based results. A subsequent review conducted in April 2022 found that this gap had narrowed to about 5 percent.4 Drivers of the 2020-2021 Exchange Rate Developments 21. The BRH was able to exercise its considerable market power to deliver a large nominal exchange rate appreciation. Key steps taken include: • Forex regulations: The BRH introduced new regulations governing international money transfers (Box 1), which had the effect of requiring financial institutions to surrender forex to the BRH. Transfer receiving financial institutions, including money transfer operators and banks, were required to surrender 30 percent of their forex receipts to the BRH in exchange for gourdes as settled at the daily BRH reference rate, which was lower than the prevailing parallel market rate for sellers of U.S. dollars. (Some of these rules were relaxed via circular 114-3 on September 5, 2022. The announcement of circular 114-3 coincided with circular 118-1, which increased the reporting requirements related to international transfers and forex transactions (Box 1). At time of publication of this study, it is too soon to assess the impact circulars 114-3 and 118-1 would have on the forex market.) • Forex sales and balance of payments developments: In August 2020, the authorities announced plans to intervene in the forex market by up to $150 million to defend the value of the gourde against the U.S. dollar. From August 2020 through end-December 2021, the authorities sold about $100 million in forex. This took place at a time when balance of payments receipts, namely from remittances, had risen considerably, as witnessed across the region and following the deployment of public pandemic support and recovery spending by the U.S. government, the main source country of remittances to Haiti. The authorities sold dollars directly to corporate clients in competition with commercial banks in what the authorities described as an already-thin forex market. • Enhanced communication and possible moral suasion: Also in August 2020, the authorities announced that they would levy sanctions on two commercial banks of about $14 million in total because of violations in forex market regulations. Feedback from banks indicated that one of the sanctioned banks allegedly had to unwind a long U.S. dollar position, which could have contributed to the strengthening of the gourde against the U.S. dollar. Reportedly banks were also encouraged to provide dollars to clients only for essential reasons, such as necessary imports or debt service payments. The BRH’s announcements of its intervention plans may have also anchored expectations of the future path of the nominal exchange rate among market participants. 4 For more on the IMF’s EBA methodology, see (International Monetary Fund, 2016) and (International Monetary Fund, 2019). For Haiti’s most recently completed External Sector Assessment, see (International Monetary Fund, 2022a, pp. 57-61). INTERNATIONAL MONETARY FUND 12 IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments The analysis that follows finds that the following factors also affected the outcome: • A rise in GDP in the U.S. relative to that in Haiti is found to have had the impact of depreciating the Haitian gourde over the long run, while a rise in money supply in the U.S. relative to that in Haiti had the opposite effect. • A rise in interest rates in the U.S. relative to those in Haiti led to an appreciation, rather than depreciation, of the Haitian gourde relative to the U.S. dollar, both in the long-run and in the short-run, and the effects of interest rate differentials are statistically significant. One potential explanation of this counterintuitive result could relate to the shallow nature of the financial system, which impedes the intermediation of funds and the efficient functioning of market forces, including those which would help achieve (uncovered) interest rate parity, thereby weakening the monetary policy transmission mechanism. • Short-run analysis of relative growth rates of real GDP and money supplies for the second half of 2020 do not suggest that GDP growth and money supply growth differentials played a significant role in driving the sharp appreciation of the gourde. • The forex regulations that came into effect in the fourth quarter of 2020 are found to have led to a statistically significant and relatively long-lasting appreciation of the gourde. • Central bank intervention in the forex market does not seem to have affected the exchange rate significantly over the sample period, even in the short run. A potential driver of this result could be a negative reaction to the signaling effect of forex sales and/or the announcement of forex sales, whereby the loss or expected loss of external buffers (reserves) and concomitant loss of policy space hindered the effectiveness of intervention by raising expectations of further depreciation (chart on GIR and NIR). 21. Based on empirical estimates, several variables highlighted in the theoretical literature turn out to be important determinants of the nominal exchange rate in Haiti (Annex I). These results draw on a monetary model of the exchange rate approach, as explained by, inter-alia, (Genberg, 1981) and (Suss E. , 1980). The spot exchange rate was modeled using a standard vector error correction model (VECM). Key explanatory variables in the model include: (i) the differential between growth in broad money in the U.S. and Haiti; (ii) the differential in real GDP growth in the two countries; (iii) the differential in short-term interest rates; (iv) the level of remittances received by Haiti as a percentage of GDP; and (v) the level of forex intervention by the BRH. The model also included a dummy variable to capture the impact of new forex regulations noted above that came into effect in October 2020. Long- and short-run specifications were considered. 22. The results suggest that, indeed, forex regulations, enhanced communications and moral suasion helped drive the rapid nominal appreciation in the second half of 2020. Actual forex intervention seems to have been relatively less important in determining short- and long-run exchange rate movements when compared with the introduction of the forex regulations. That said, these results should be interpreted with caution as the authorities announced their intervention strategy prior to intervening. Thus, it is possible that market participants incorporated these planned forex sales into their price expectations prior to the actual interventions. Ultimately, data availability prohibited a more granular assessment of the impact of the announcement and actual forex intervention on the nominal exchange rate. INTERNATIONAL MONETARY FUND 13 IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments Implications of Exchange Rate Developments 23. The findings show that liquidity declined following the introduction of forex regulations and forex sales, while surrender requirements may have led to higher exchange rate volatility. Data on proportional bid-ask spreads (Figures 1 and 2) show that liquidity in the forex market declined after the introduction of forex surrender requirements, forex sales, and central bank communications, although the analysis does not permit definitive identification of which of these factors was decisive in reducing liquidity and increasing volatility. Reduced liquidity could have resulted from the inability of market participants to hold stocks of forex on their balance sheet due to the forex regulations and limits on NOPs, in turn reducing their ability to make two-way markets. 24. The results of a generalized autoregressive conditional heteroskedasticity (GARCH) model of exchange rate volatility show how forex regulations increased nominal exchange rate volatility. In the GARCH model, the return on the nominal daily average exchange rate is determined by an auto-regressive equation. This equation makes it possible to estimate the conditional variance of the nominal exchange rate, which itself is a weighted average function of the squared residual from the mean equation from the prior period and the long-term variance. A dummy variable was included for days when the surrender requirements were made effective (Annex II). The results show that the sign on the dummy variable is positive and statistically significant, indicating that the surrender requirements increased the volatility of the nominal exchange rate. These results are paradoxical insofar as the surrender requirements were reportedly adopted, in part, to smooth excess volatility in the nominal exchange rate. 25. These policy actions also appear to have contributed to a widening of the parallel forex market premium. The actions noted above coincided with a widening of the parallel market premium to an estimated 25 percent in March 2021 before falling to about 10 percent by June 2022 (Figure 3). The sharp rise in the parallel premium implies a supply-demand imbalance and mispricing of the official exchange rate for the gourde that would have cleared the market. 26. The nominal exchange rate appreciation in 2020 helps explain the decline in headline inflation in 2020-2021 (chart). The dynamics between the nominal rate and headline inflation is reflected in the relatively high estimates of exchange rate pass-through to CPI inflation in Haiti. The pass-through of forex changes to CPI inflation was estimated by a bivariate auto regressive distributed lag (ARDL) model and a more model based vector error correction model (VECM), both using monthly data. In the ARDL model, a bivariate model is estimated by regressing month-on-month CPI inflation on month-on-month movements in the NEER and twelve lags of both variables. For the VECM, in addition to the NEER and the CPI index, the interest rate (3-month treasury bill rate) and the money supply (broad money) were included in an attempt to incorporate a monetary policy reaction function and the monetary policy transmission mechanism. The key empirical finding in both models is that movements in the NEER have a higher pass through to prices in Haiti compared to other Caribbean and Central American countries (Annex INTERNATIONAL MONETARY FUND 14 IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments III). This high level of pass-through also illustrates that higher exchange rate volatility can feed through to higher volatility of inflation, making it more difficult to anchor inflation expectations and achieve monetary policy objectives. 27. Oil importers, including the central government, benefitted from the nominal exchange rate appreciation initially. Driven partly by the impact of appreciation on fuel subsidy costs, the overall deficit (after grants) fell from 3.2 percent of GDP in FY2020 to 2.4 percent of GDP in FY2021 (ending September 30), with transfers to the state electricity company EDH and direct fuel subsidies to oil companies declining from 1.4 percent to 1.1 percent of GDP. Thus, the appreciation in the nominal exchange rate contributed to near-term fuel subsidy savings worth about 0.3 percent of GDP. However, fuel subsidy costs subsequently rose again by an estimated 0.5 percent of GDP in FY2022 due to higher world prices and the steady but gradual depreciation of the nominal exchange rate, indicating that any fiscal savings associated with the exchange rate appreciation may have been temporary. Exchange rate appreciation in FY2021 also helped to lower debt service costs, with external amortization costs falling by 0.2 percentage points of GDP compared to FY2020. Haiti’s debt-to-GDP ratio also decreased from about 26 percent in FY2019 to about 21 percent in FY2020, partly reflecting the appreciation of the nominal exchange rate (in addition to a GDP rebasing in October 2020). 28. By contrast, remittance-dependent households and exporters saw their purchasing power in gourdes fall. Although both net private transfers and exports of goods increased in nominal U.S. dollar terms, as a share of U.S. dollar GDP, the former declined from 20.0 percent to 16.7 percent from FY2020 to FY2021 and the latter from 6.1 percent to 5.4 percent over the same period. Equations of exports, imports, and net remittance inflows were estimated using the Engle-Granger approach with annual data over the period 1996 to 2020 (Annex IV). The analysis shows that exports of goods are mostly affected by output growth in key trading partner countries but are not sensitive to movements in the REER, either in the short or long run. Hence, the decline in exports in FY2021 is likely explained mostly by the impact of the global recession following the COVID-19 pandemic. Moreover, the empirical results show that Haiti’s imports of goods are not sensitive to movements in the REER. Like exports of goods, net remittance inflows are also shown to be strongly and positively correlated with economic activity in partner trading countries. However, in contrast to exports and imports, they are highly sensitive to movements in the REER; specifically, and counterintuitively, a depreciation of the REER is associated with an increase in net remittance inflows, both in the short run and in the long run. INTERNATIONAL MONETARY FUND 15 IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments Box 1. Haiti’s Forex Regulations The authorities introduced new regulations in mid-2020 governing international money transfers and instituted several forex regulations targeted at banks and money transfer agencies engaged in international transfers. The most binding regulation was circular 114-2, announced in September 2020. This circular mandated that banks and money transfer companies exchange dollar remittances into gourdes for persons not holding U.S. dollar bank accounts; convert all dollar remittances into gourdes at the BRH reference rate, which was less favorable than the parallel exchange rate for dollars; and required banks and money transfer companies to sell 30 percent of the forex received from remittance inflows to the BRH at the reference rate and 40 percent to banks (which themselves are not allowed to keep a net open forex position above 0.5 percent of equity). The table below summarizes the key directives introduced by the BRH that had implications on Haiti’s forex market. As noted above, several of the measures introduced in 2020 were reversed in the latter half of 2022, though the impact of the relaxation of these measures on the forex market is beyond the scope of this paper. Summary table of Haiti’s forex regulations Regulation Reference Regulated entity Announcement Effectiveness circular 114 - standards for 10-Jul-19 26-Aug-19 international unrequited funds transfers Guidelines for law 28 September money laundering 27-Aug-20 at announcement Stockbrokers 2016 and financing of terrorism circular 114-2 decree 5 June 2010 standards for 18-Sep-20 1-Oct-20 international unrequited funds transfers circular 114-3 circular 114-2 Additional 23-Aug-22 5-Sep-22 standards for international unrequited funds transfers circular 118 circular 114-2 Submission of 11-May-21 19-May-21 reports relating to intermediate transfer and forex transactions circular Additional circular 114-2 Daily sale of 30% of 8-Oct-21 at announcement Note 118 transfers received by transfer houses circular 118-1 circular 118 Banks and money 23-Aug-22 5-Sep-22 transfer companies circular 119 decree of 25 Exchange 11-May-21 1-Jun-21 November 2020 on intermediaries forex intermediation Source: Authors’ presentation and the authorities. INTERNATIONAL MONETARY FUND 16 IMF WORKING PAPERS Lessons from Haiti’s Recent Exchange Rate Developments Box 2. Schematic of the Forex Market in Haiti Source: Authors’ presentation. 29. Forex regulations also had an impact on the functioning of the domestic financial system while increasing its exposure to sovereign risks. Limits on banks’ NOPs in forex at 0.5 percent meant that banks would carry a low inventory of dollars on the balance sheet and that would in turn make it difficult to meet the forex needs of customers. This could have also hampered the development of the interbank forex market, as the lack of space for dollar-related balance sheet expansion could have limited the preference of banks to absorb liquidity shocks from counterparties. Additionally, the increase in commercial bank forex deposits at the central bank, brought about by Circular 114-2 and related measures, may have posed an operational risk to commercial banks if they faced restrictions on dollar redemptions from the BRH. Finally, the interest rate offered by the BRH on banks’ deposits was lower than the risk-adjusted return available to banks in the open market