WITH Government presiding over a mounting balance of payments deficit, former Premier Sir John Swan this week warned that devaluation of the Bermuda dollar - currently on a par with the US dollar - could be the inevitable result of a continuing economic decline.

Expanding on statements he made during a Bermuda Broadcasting Company television interview last month, the long-time former Premier said devaluation of the Bermuda dollar may end up being an attractive short-term proposition to a Government faced with dwindling foreign reserves - but warned the long-term consequences of such a move could be catastrophic for the island.

"In my interview on ZBM TV on Tuesday, August 20 my remarks on devaluation were prompted by a statement the Minister of Finance made to the House of Assembly indicating that we had a two-quarter deficit on our balance of payments," he said.

"I observed or commented that these deficits on our balance of payments cannot be allowed to continue because we put undue strain on our foreign currency reserves which could eventually result in our currency being devalued.

"We are in a period of general economic decline which is affecting our balance of payments and our Gross Domestic Product. We must, therefore, do everything in our power to stop this serious economic slide.

"We have got to make a number of thoughtful decisions that are motivated not by political gamesmanship, but what is for the overall good of the country, because our way of life and the lives of future generations is at stake."

Sir John said devaluation of the Bermuda dollar would involve Government orchestrating a deliberate, downward adjustment in the official exchange rate to reduce the currency's value.

"For example," he said, "if the economic circumstances force Bermuda to devalue its currency by 50 per cent, a Bermuda dollar would be worth 50 cents against the US dollar."

Sir John said the intent of devaluation is to help remedy a current account deficit, which occurs when a country is not earning enough foreign exchange. A persistent current account deficit is of concern to governments because it can slow economic growth and lead to widespread unemployment and business closures by diverting funds from domestic investment to pay for foreign goods; it can also cause countries to rely heavily on foreign borrowing.

"There are three obvious implications of devaluation," he said. "First, reducing the country's credit rating makes borrowing more expensive. Second, devaluation makes the country's goods and services relatively less expensive for foreigners. Third, the devaluation makes foreign products relatively more expensive for domestic consumers.

"A key effect, therefore, of devaluation is that it makes domestic currency cheaper relative to other countries."

A psychological risk of devaluation is that it is usually viewed as a sign of economic weakness; as such it may dampen investor confidence in the devaluing of a country's economy and hurt the country's ability to secure foreign investment. This tends to exacerbate economic difficulties which could result in social instability.

"In order for Bermuda to sustain a fixed exchange rate we must have sufficient US dollar reserves, and be willing to spend them to purchase goods and services from other countries," he said "When a country is unable or unwilling to do so, then it must devalue its currency to a level that it is able and willing to support its currency with its reserves.

"Our ability to earn foreign currency from tourism continues to decline resulting in deficits on our balance of payments.

Sir John pointed out that Bermuda's balance of payments is also being affected negatively by some substantial real estate sales. This activity has tended to be more inflationary than other aspects of our economy.

"Psychologically, this brings a sense of insecurity and some middle-aged people, in particular, who have homes are inspired to downsize and/or diversify," he said. "They buy condominiums or a smaller residence and sell or rent their larger homes. The surplus cash that they get from these transactions, in some cases it could be substantial, is invested overseas.

"For example, look at Bermudians who invested, say, $500,000 in a property a number of years ago and over time paid the mortgage off. Let's say they are now in a position to sell the property for $1.5 million," he said. "If they do not buy a smaller property which they could mortgage, they have $1.5 million Bermuda dollars cash that can be converted into US dollars and sent overseas.

"The money is, therefore, not available to the Bermuda economy. If enough of these transactions take place, they could put our balance of payments in further jeopardy. It eventually eats all the savings held in US dollars and the country would not have enough foreign exchange to pay for all necessary goods and services including overseas trips and overseas education."

Sir John added that the steady erosion of tourist arrivals by air is putting the major carriers that serve Bermuda at risk.

"They could cut back their flights dramatically or one or two carriers could stop coming all together," he said. "The lack of the availability of airline seats could have a negative impact on our international business.

"If, as a consequence of limited seat availability, a hostile political environment in the US against off-shore business and adverse economic conditions, the contribution that international business makes to foreign currency earnings is not likely to grow. It could even diminish.

In order to minimise the effects of balance of payments deficit, countries usually raise interest rates in order to attract foreign capital but at the cost of slower economic growth, an option that is clearly not feasible for Bermuda, according to Sir John.

"There are a number of other options open to countries that find themselves in straitened circumstances with regard to its balance of payments," he said. "Governments, for instance, can significantly cut spending but this usually results in widespread unemployment.

"They can also borrow foreign currency to run day-to-day government affairs. But the lender often puts stringent conditions on the loan which will in some instances dictate political policy and may in the short run exacerbate social, political and economic difficulties."

Sir John said Bermuda could also attempt to reintroduce exchange controls to address the problem but such a retrograde move would be unacceptable to the Organisation for Economic Co-operation & Development.

"The only other two options are to freeze foreign exchange transactions as has been done in other countries in deep economic trouble, he said, "or, as I mentioned at the outset, to devalue the currency."

Sir John said Bermuda could stabilise its economic system only when every citizen consciously recognised the importance of tourism and international business and behaved like our survival depended on our "continuous spirit of co-operation" between the island and its domestic and international partners.

"We might also consider converting to the US dollar and abolishing the Bermuda dollar altogether," he said. "This would avoid any devaluation and bring about the realisation and the importance of the need to earn US dollars.

"And we might also study removing the 60/40 Bermuda ownership restrictions - but on businesses, not necessarily on real estate. This would inject increased foreign currency into the economy as well as raise the quality of goods, services and management of commercial activities.

"Our policy with regard to the free flow of money is rather contradictory. We have removed exchange controls permitting any amount of Bermuda dollars to be converted to US dollars with no restrictions as to how it is invested. At the same time, the method of earning US dollars remains basically the same. Any amount of uncertainty or just the desire to diversify opportunities abroad will, therefore, put a strain on the US dollars that are available.

"A further contradiction is how we still restrict Bermuda businesses from free capital flow and at the same time observe the success of international business because of a lack of restrictions."

He also appealed to Government to give incentives for Hamilton to become even more the centre of life in Bermuda rather than just a place to work. The objective would be to turn the City of Hamilton into a dynamic "living city" and environment where people could work and live.

In an interview with the Mid-Ocean News on March 30, 2001, he outlined some suggestions on how to make the city more vibrant.

"Quality not quantity of tourists should be our objective and we should develop first-class amenities to complement this objective," he said. "Our birth rate is falling and it will be impossible for us to fulfil more jobs that are created by the tourist industry, therefore, quality not quantity is needed."