Growing concern at falling kina

 PAPUA New Guineans are becoming increasingly worried about the weakening kina, despite an assurance by the Bank of PNG that there is little to fear,

The central bank maintains that the situation is manageable and that the kina remain a floating currency that uses a floating exchange rate or fluctuating exchange rate.

A floating currency is contrasted with a fixed currency.

In the modern world, the majority of the world’s currencies are floating. 

Central banks often participate in the markets to attempt to influence exchange rates. Such currencies include the most widely traded currencies: the United States dollar, the Japanese yen, the British pound, the Swiss franc and the Australian dollar.

There are economists who think that in most circumstances, floating exchange rates are preferable to fixed exchange rates. As floating exchange rates automatically adjust, they enable a country to dampen the impact of shocks and foreign business cycles, and to pre-empt the possibility of having a balance of payments crisis. 

However, they engender unpredictability as the result of their dynamism.

In certain situations, fixed exchange rates may be preferable for their greater stability and certainty. 

Another option worth considering is “pegging” the kina to the US or Australian dollar.

The advantages of pegging the kina are that speculators are unable to influence or manipulate the currency level.

The financial authorities are able to bring down the interest rate or boost public spending through deficit financing, without being constrained by how the currency markets will react.   

Another benefit is that business people are able to import and export products at prices fixed either in the US/Australian dollar or the kina, with certainty as to how much these prices will be worth in terms of the other currency.

It is very hard to accurately predict what the relative exchange rates between the major currencies will be like even in the near future.

Another pertinent question: Would a devaluation of the kina help the PNG economy?  

There are plus and minus factors.  

Exporters would gain, as they may receive more revenue in kina terms.

Thus, oil revenues would go up, and the incomes of coffee and oil palm smallholders may increase.

However, it is unlikely that a kina devaluation would have such a major effect in increasing the demand and volume of exports overall.  

This is because the demand for many of our major export items –petroleum, palm oil, coffee, copra and cocoa –is not dependent on the kina prices.  

The demand for commodities depends more on the state of economic growth in the major countries.

There are, on the other hand, some disadvantages arising from a devaluation of the kina.  There will be pressures for higher inflation.  

Consumers will find that imported consumer goods such as food items will cost more.  Producers will find their cost of production rising because of the increased cost of imported inputs and parts. A large portion of the intermediate goods that are used for production in this country are imported.  

The producers will pass on their increased cost and will jack up the prices of their final products, adding to consumer-price inflation.

A devaluation would cause the level of foreign debt to go up. While the level of the debt will remain the same when counted in the foreign currencies in which they were contracted, it would increase in terms of the kina.

A devaluation would thus make it more difficult for both the public and private sectors to service their foreign loans, and the steeper the depreciation, the more serious the difficulty.  

Companies with foreign-exchange loans would be in trouble, and a larger share of the government’s expenses would have to be allocated to servicing its foreign debt.

Having a strong local currency helps in paying off the foreign debt easier while  devaluation works in the opposite direction.

Thus, there are pros and cons to devaluing the kina, just as there are advantages and disadvantages to retaining a fixed exchange rate system.