Part 1
Introduction
Some time ago Mr Mike Persaud suggested on the Stabroek News blog (SN, Sep 2, 2009) that I write a column on the Guyana foreign exchange (FX) market. I would have to probably do three columns to get over my perspective on the nature of the FX market in Guyana. This market is fundamental to the well-being of the country, as it is here where the rate of exchange between the Guyana dollar and the US dollar is determined. The other rates – for instance the Guyana dollar/euro and the Guyana dollar/Canadian dollar – are also determined in this market.
Many people understand that the exchange rate is important as it affects domestic prices, given that the country imports a significant percentage of consumer goods and almost all capital goods. Thus the cost of living could be adversely affected if the rate depreciates rapidly. A steep depreciation also breeds uncertainty and rapid flight from Guyanese assets to foreign assets.
On the other hand, an appreciation of the rate could be detrimental to a nascent export sector. Thus the central bank is always anxious over the movement of the rate. The Bank of Guyana’s monetary policy focuses on stabilizing this rate. Indeed, the rate has demonstrated a remarkable degree of stability over recent years versus the early years of the cambio market system.
This column and the next two will address three primary tasks. Firstly, this column will examine the institutional structure of the market. Secondly, column 2 will examine the reasons for the recent stability of the rate. Thirdly, column 3 will analyze the developmental implications of the nexus between bank foreign currency trading and financial intermediation.
Some historical notes
The present conceptualization of the FX or cambio market is the result of the financial sector reforms that started under the Economic Recovery Programme (ERP). The primary motive was to make the unregulated parallel (or street) market the official one and thus allow for the exchange rate to be determined by the supply and demand of foreign currencies. Therefore, in November 1989 several bank and non-bank traders were licensed to buy and sell foreign currencies at freely determined rates. By March 1990 the cambio system was implemented. Over the period 1989 to 1995 Guyana witnessed a volatile exchange rate situation as the rate depreciated considerably.
The reform of the FX market was one aspect of a wider agenda of financial liberalization in which Guyanese interest rates (primarily the lending and deposit rates) would be deregulated. The “reform” agenda also involved privatizing state-owned banks, removal of credit controls to specific sectors, and the dismantling of the state development bank. Another aspect of the reforms was the adoption of a different type of monetary policy in which the Bank of Guyana would use a market or auction mechanism to sell Treasury bills thus determining the interest rate by supply and demand.
Of course, the philosophical tenet driving the reforms was to create various market systems to set prices rather than have the government determining and controlling interest rates, the exchange rate and other financial asset prices. The basic idea holds that with these markets in existence the society’s financial savings would be better channelled to investors with the best ideas and returns, thus enhancing the growth of the economy. The channelling of savings to investors – also known as financial intermediation – would be enhanced as there is financial innovation in which new financial instruments are engineered and offered to the public.
Institutional details
Currently the market is made up of twenty-one licensed FX traders. There are six commercial bank traders and fifteen non-bank traders or cambios. Table 1 below presents a summary of the volume of purchases by the two categories of traders. It is clear that the volume of foreign currencies purchased by the traders has increased since 2000. The numbers for 2009 only reflect Jan-Sep data – thus the lower numbers in 2009 do not indicate lower trades. The table shows that commercial banks have dominated the trades. The percentage of non-bank purchases has declined since 2000.
Data available up to Sep 2009
Data source: Bank of Guyana Annual Reports
The main currencies traded in the market are the US dollar, Canadian dollar and the euro. The US dollar dominates in total trades accounting, persistently, for approximately 90 per cent of all foreign currency trades. The Canadian dollar or euro often switches places for the second spot.
An interesting feature of this data is the volume of purchases has increased in spite of the lukewarm export performance of the official economy. Unravelling the source of the build-up of available foreign currencies in the system in spite of a tepid official economy would be insightful and very interesting. The total quantity of hard currencies available for purchase by banks and non-banks at any point in time comes from various sources such as export revenues, remittances, foreign borrowing, capital inflows (foreign long-term investments or FDIs), foreign aid to the government, the underground economic activities, and various other sources.
There is no central market for foreign currency trading; thus trades occur over-the-counter as anyone can walk into a bank or non-bank cambio and exchange a hard currency for a specified amount of Guyana dollar. There is no trading of forward exchange rate contracts in Guyana, thus the exchange rate is a spot rate.
Spread
The bank and non-bank traders in this market make their money by charging a spread – the selling rate minus the buying rate. Utilizing publicly available data from the Bank of Guyana’s Statistical Bulletins, figure 1 shows that the spread has tended to increase since 1990. This is interesting as the increased volume in trades (see Table 1) has not given the traders the kind of favourable scale effects one would expect. It could also mean that the marginal cost of doing financial type business has increased over the period, thus justifying the increased spread given that the exchange rate volatility (a proxy for calculable uncertainty) has declined (more on the latter in part 2 of column) in recent years. These financial (marginal) costs could reflect economy-wide inefficiencies and also trader market power.
Figure 1. Foreign exchange market spread for bank and non-bank traders (G$)
It is an empirical question as to whether trader market power is an important determinant of the spread between selling and buying rates. A tentative confirmation of this thesis would be to compare the spread for the non-bank cambios versus the commercial banks (unlike the overall case given in figure 1). If the spread for commercial banks is higher it would be consistent with the thesis that market power (or concentration) is allowing one or two commercial banks to charge a higher mark-up between the buying and selling rates. If the latter is correct then these banks would become price leaders determining the exchange rate. Unfortunately, the data are not available publicly on the central bank’s website. Perhaps a researcher at the University of Guyana could test this thesis.
Please send comments and critiques to: tkhemraj@ncf.edu