Part 2

By Tarron Khemraj

Introduction
A State Development Bank (SDB) could be an important aspect of the financial system, which channels the society’s savings (cash and financial assets of households and government) to the private sector to invest in production activities (bio-fuels, agro-industrial processing, other manufacturing, financial services, eco-tourism, art and cultural industries, etc). Of course, a SDB is only one aspect of a menu of financial institutions and markets that are necessary to finance economic growth and production transformation of the economy. In addition, foreign investments are essential and so too are investments from the Diaspora. For instance, close to 50% of China’s FDIs are really Chinese Diaspora investments in China. Guyana is yet to realize that its people (including the Diaspora) are its most important asset and not the forests as the LCDS asserted.

Nevertheless, I would use this essay to articulate how a SDB could serve in mobilizing savings in Guyana and from the Diaspora so as to fund investments and economic growth at home. It is also important to seek alternative and innovative sources of funds given that the LCDS would realize just about US$50 million per year for five years. That sum is substantially below what is expected to propel the economic transformation and given the lukewarm rate of growth since 1998 we can expect that the government will have to use those funds to keep propping up its day-to-day operations (sometimes called capacity building) rather than finance new industries to engender fundamental changes.

I would like to emphasize that a SDB will not jeopardize the profitability of existing commercial banks. Instead, it is intended to help widen Guyana’s industrial base and thus help to deepen the pool of business opportunities for the private commercial banks. In addition, as more businesses are created it provides the opportunity for stock offerings for public purchase thus deepening trading on the struggling stock exchange.  The subtle point here is Guyana needs to focus explicitly on expanding industrial and agricultural output rather than the passive focus on financial liberalization and financial sector development. Once the production sector changes the financial sector is expected to respond. In an economy with many binding constraints to private investments, it would take a lot more than financial liberalization to propagate new production sectors.

In addition, the ERP derivative policies have also focused on price stabilization without structural production transformation (see my two Columns “Sound Macroeconomic Fundamentals Versus Structural Production Transformation” of July 15 and July 22). It is also disappointing that a PPP government has failed to realize this difference. The underlying assumption is once Guyana achieves low inflation (an important objective) and financial liberalization, private sector production initiatives will take over. Thus Guyana’s policymakers, following the economic vision of the IMF and World Bank, implemented several pieces of financial sector legislation but never an industrial expansion act (as for instance Mauritius did since 1993). Guyana has not yet looked at an export processing zone – which a small country like Mauritius implemented since 1971.  Our policy makers are yet to sit down and figure out Guyana’s immediate comparative advantages and how to ‘bend’ them with industrial policies. This essay argues that a SDB is one essential financial institution for the task of bending our comparative advantage.

Broad principles under which SDB must operate
The SDB would adhere to the following general principles. First, the CEO must be a banker who is qualified on banking issues and understands risk management. Second, the CEO must be chosen on merit and not through political party connections. Third, members of the board must be qualified in banking, understand risk management and developmental issues. Fourth, each political party in Parliament is allowed one representative on the board. However, the party must propose skilled individuals. Fifth, appointments of CEO, credit analysts and other technical staff must be based on merit and not via political connections. Sixth, any profits in excess of normal profits would be ploughed back into the bank for further lending. Seventh, lending decisions must not be made because of political pressures.  Eight, the bank must not be a burden on the treasury but must finance its own operations.   Legislation, backed by tough penalties, must enforce these requirements.
Specific lending principles
In my opinion some specific lending principles should be as follows. First, the bank must lend below market interest rates but at the same time must be able to finance its own operations. In essence, the bank aims to make normal profits (analogous to the notion of break-even in accounting) and not excess profits. Second, priorities must be given to nationally agreed industries. However, the focus should be on promoting large scale production for domestic, regional and global markets. Third, borrowers are expected to signal the viability of their projects by providing up-front capital and a sound business plan. Fourth, borrowers are required to meet performance criteria such as employment quotas and workers’ rights, successfully compete in foreign markets, and create sufficient domestic linkages. Fifth, the SDB would provide free technical advice on the viability of the investment projects (some of this can be outsourced to private commercial banks). Sixth, political connections must never determine lending decisions.

How to finance the liability of the SDB
As noted above, the SDB should play a role in mobilizing savings (cash and finance) from Guyanese at home and in the Diaspora. Below are several possibilities for raising funds so that the bank is in a position to channel these funds to profitable private investors. First, long-term government-backed bonds could be issued against excess commercial bank reserves (on which private commercial banks currently earn zero interest rate).  The intention is to optimally mobilize and channel the society’s scarce stock of financial savings into productive investments. These funds are to be channelled into investment-led expenditures and not consumption-led expenditures. Therefore, the expansion of the money supply from this process is concomitant with production and exports. Furthermore, the issues of price instability and loss of foreign exchange reserves do not arise.

It should be noted that the liability of the SDB is not included in the money supply. However, when the SDB makes loans to businesses, the new payments and incomes generated will be deposited in the commercial banking sector, thus increasing the money supply indirectly. Income and output is also increased in the process, thus maintaining the balance between money and aggregate output. Further, once low-interest credit of the SBD is tied to export performance of businesses, the concern of loss of foreign exchange reserves of the Bank of Guyana is assuaged.

Second, like other development banks around the world, the SDB could raise funds from bilateral donors and multilateral agencies. GAIBANK also did this in the old days. The Brazilian development bank I mentioned in my last column obtained several large concessional loans from the IDB.

Third, in my very first column I noted that remittances – which amount to approximately US$450 million annually or 40% of GDP – enter the economy in small separate amounts. They then circulate in the domestic foreign exchange market (financing consumption of mainly imported goods) and exit to pay for imports and other foreign services. Therefore, for remittances to have a developmental role a percentage must be lumped together. Therefore, the bank and the Guyanese government need to capitalize on the patriotism of the Diaspora. Perhaps the SDB could present an excellent and efficient website that allows Guyanese abroad to send remittance funds online via a credit or debit card. It is similar to online banking (I pay all by bills online!). Family members and friends at home are then able to redeem the Guyana dollar equivalent at the market exchange rate. Imagine if the bank could lump together US$100 million each year. Of course, this is not the only way to mobilize scattered amounts of remittances into a lumpy sum. Despite what method is agreed, in my opinion, the State needs to think about the principle of lumping remittances.

Fourth, the bank would be allowed to establish a cambio arm buying and selling foreign exchange in the domestic foreign exchange market. Therefore, as the economy develops it would be in a position to raise foreign currencies within the domestic foreign exchange market. A profit is also made on the mark-up between the buying and selling rates.

Conclusion
A SDB allows Guyana to have a defined platform from which to enhance business formation. It also presents our politicians with a common agenda from which to work towards this focus objective. It is my firm belief that Guyana needs to reactivate a SDB. This type of institution has played an important role in early economic development in places like South Korea, Taiwan and Japan.  In my previous column, I also noted the Brazilian example. I encourage others to critique, refine and improve these suggestions.

Please send comments to: tkhemraj@ncf.edu