(Part 3)
Introduction
In my previous column I noted that GDP grew at an average rate of 1.95% over the Jagdeo years. This was a quite tepid pace of growth. At this rate it will take Guyana about thirty-six years to double the size of GDP. This is a very long time for the people to wait. Had Jagdeo achieved an average of 7% growth, GDP would have doubled during his time as President (actually in 10 years). The economy remained structurally dependent on a few primary products like gold extraction, unprocessed price, bulk sugar and wood (mainly logs). Very little was achieved in terms of manufacturing development. Indeed, nine ethanol investors expressed interest in Guyana but the Jagdeo Administration never followed up. This was reported three years ago by Stabroek News.
However, the economy witnessed heightened housing construction and a proliferation of mini businesses. There was no large-scale manufacturing business created in nineteen years. The retail sector continued to flourish importing foreign manufactured goods and selling in the Guyana market. In spite of the limited structural transformation of production and low average growth rate, the Guyana exchange rate and inflation rate remained relatively stable under the Jagdeo Administration. This is perhaps the President’s main economic accomplishment. The cost of living of ordinary Guyanese is tied in a significant way to the stability of exchange rate and inflation. Hence, it is important that we understand the factors behind the stabilization.
Before I proceed I think it is in order for me to comment on Minister Robert Persaud’s silly pronouncement that Guyana grew fifteen times since 1992. In fact Guyana grew nineteen times since the government was in power for nineteen years. This growth was positive, negative or zero. It is the average that matters. I will not repeat here since I wrote several pieces in the past outlining the historical growth rate.
Credit to Jagdeo
From around 2004 the exchange rate showed a remarkable degree of stability compared with earlier years. Prior to 2004 the G$/US$ depreciated substantially. Since 2004 the rate stabilized at around G$204 to one US$. It appears like there has been a change in the foreign exchange rate regime that was unannounced. Indeed, the IMF is now classifying Guyana as having a de facto pegged exchange rate. One benefit of this outcome would have been less pressure on the cost of living compared with the periods of steep depreciation. Although most economists tend to support a flexible rate, I am sympathetic towards a fixed rate because of the favourable outcome for cost of living. I also do not believe we have a very elastic response of exports to take advantage of a depreciating or weak currency. A stable exchange rate also reduces price inflation since Guyana imports fuels and consumer goods.
The Jagdeo Administration never announced this shift. Therefore, it is not clear what exactly they did to achieve the sudden shift in the foreign exchange regime. I have written in a more academic setting that moral suasion was utilized. Moral suasion implies talking directly to the main foreign exchange dealers, which are the commercial banks. It is easier to control the rate if the policy makers can persuade the price leaders to maintain a stable exchange rate. Indeed, it is in the interest of commercial banks – which trade on average 90% of foreign currencies in Guyana – to have a stable exchange rate because it maintains stable inflation. Inflation would adversely affect the Guyana dollar loan portfolios of the banks. Loan positions are larger than holdings of foreign assets. Therefore, a foreign exchange rate depreciation that passes through to price inflation will adversely affect the banks. The key point to note is inflation penalizes lenders and benefits borrowers. Hence, it is not surprising the banks might cooperate in any exercise of moral suasion. I believe this is a good thing for Guyana.
Other Factors
The stabilization of the exchange rate was made easier because of several structural features of the Guyana economy. The first could be the focus on non-tradable production sectors like housing and mom and pop businesses. These types of businesses are less susceptible to foreign adverse shocks compared with sectors that directly export and import. Since it is clear President Jagdeo consciously focused on housing and mini enterprises, I score this as another stability factor in favour of the President. However, as I have noted in past columns this type of production has to be complemented by large enterprises so that we are not stuck at a subsistence level. Sufficient large-scale businesses just did not materialize during the Jagdeo years. Also, in the long-term non-tradable sectors cannot earn foreign exchange. They are non-tradable because their focus is internal.
Second, there is a high degree of asset concentration in the commercial banking sector. In addition, commercial banks are the main traders of foreign currencies. There are six commercial banks and the top two hold around 85% of the total assets of the banking system. The asset concentration increased substantially in late 2003 after the merger of the state-owned commercial bank (Guyana National Cooperative Bank) with the private bank (National Bank of Industry and Commerce now Republic Bank). The high degree of asset concentration implies the existence of one or two price leaders. In economics we call this an oligopoly market structure where the seller has the market power to fix the price and the buyer accepts it. The trick in policy would be for policy makers to convince the price leaders about the social good of a stable exchange rate.
Third, money and capital inflows into Guyana are stable and do not result in sudden reversal as in Asia in 1997 that caused the Asian Financial Crisis. Guyana’s inflows are mainly remittances, foreign direct investments and grants. These are long-term inflows as opposed to short-term portfolio inflows (such as bank deposits, bonds, stocks and derivatives). We know the underground economy is very large as it has been quantified by Professor Clive Thomas and two co-authors. However, we do not know the breakdown of the underground economy to determine the percentage share of narco-trafficking, smuggling and non-declared gold production. We do know however that as a percentage of GDP Guyana is one of the world’s top two recipients of remittances, which are as high as 40% of GDP annually. Remittance inflows do not reverse overnight and destabilize the banking sector. Guyanese remittances are altruistic in nature – this means even when there is an economic downturn families abroad still remit to Guyana. However, I should caution that remittances are the other side of the erosion of human talents and skills as Guyanese must first leave before sending money back home.
Foreign direct investments, although small relative to remittances, also cannot leave overnight. A foreign investor cannot liquidate a mine or factory and leave immediately when there is a panic. On the other hand, they can liquidate and leave immediately when foreign investments are in the form of Guyanese bank deposits, bonds, stocks and derivatives. The latter are examples of portfolio or hot money inflows. In the Guyana context there is no market for derivatives (options, swaps and futures), the bond market is virtually non-existent and the stock market is moribund. There are relatively small foreign investments in Guyanese bank deposits. Therefore, the limited portfolio investments meant there was nothing to suddenly leave when the subprime crisis broke in Aug 2007. Meanwhile, Guyanese abroad continued to send money home and the underground economy persisted. The one firm, CLICO, exposed to the Florida subprime market failed. Therefore, Guyana was saved by its underdeveloped financial structure. The crucial question from a long-term perspective is how to modernize the financial system while preserving stability. I believe it can be done.
In the next column, I will examine the opportunity costs of the Skeldon sugar factory, Fip’s Amaila access road and the One Laptop Per Family (OLPF).
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