There appears to be a dispute over the size of the deposit the coalition government plans to withdraw from the commercial banks to be quarantined into the Consolidated Funds. The Bankers’ Association and Private Sector Commission imply the number is G$60 billion, approximately US$290 at present exchange rate. The government may be uncomfortable with such a sizable amount after all the accusations of PPP corruption, which I have never doubted; except my position was much more nuanced (see essays “Corruption perceptions in Guyana” SN Jan 15, 2014; “Credibility and signalling in public life” SN Jan 9, 2013). One other media outlet reported the size of the withdrawal to be G$30 bill. Minister of Finance, Mr. Winston Jordan, noted that there will be a withdrawal of government deposits, but he was less specific on the exact amount.
Whatever the size of the withdrawal, it is a form of monetary sterilization as the money is quarantined from the private sector. The policy is very likely to diminish bank liquidity. It is through the liquidity channel the potential monetary and real sector implications are likely to be felt. As at June 2015, the broad money supply amounted to G$326 bill, while narrow money amounted to G$123 bill. Let us assume the amount to be withdrawn is G$30 bill. That means in a short period of time the government will contract the narrow money supply by 24%, assuming other contributions to the money supply stay the same. The broad money supply will contract by 9%, assuming other sources are constant. The proposed sterilization would be coming at a time when there is steep rise in non-performing loans from G$11 bill in 2013 to G$18 bill in 2014.
There might be several motivations for this policy. First, the government feels in the name of transparency it should deposit most funds, including those earned by quasi-government agencies, into the Consolidated Fund. This perspective is prominent among the populists. The PPP did itself no favours by failing to explain why these funds should be deposited in private banks. Its high tolerance for bad governance – and plausible examples of off-the-book kickback agreements – provided much fuel for besmirching a potentially powerful policy tool. Second, the Minister of Finance appears willing to utilize excess liquidity in the banking system to finance government spending and capital operations, such as the dredging of the Demerara River.
If the objective is to finance the government’s deficit with these funds, then there is no need to remove them from the commercial banks. After all, the government makes some money, albeit at a very low interest rate. All the government needs to do is write cheques on these accounts. If the government pays for productive services by writing cheques on the accounts the money is simply moving from one private agent’s bank account to another. Bank liquidity is not affected and the money supply will not contract.
Excess liquidity is made up of excess reserves (non-remunerated) and liquid assets like Treasury bills that pay the banks a rate of interest. Excess liquidity is in local currency units. They are meant for replacing foreign assets in the commercial banks’ asset portfolio. These liquidities, therefore, allow for a local currency profit centre instead of draining the economy of scarce foreign exchange, part of which is better held by the central bank for the purpose of meeting the country’s stabilization and developmental objectives.
Therefore, excess liquidity has a stabilizing influence. I know of one Caribbean economist – a good friend of mine – who published an empirical paper showing this to be the case. A main reason for writing my book, which was published last year, was to work out how this mechanism works at the theoretical level. I call it the compensation thesis.
There is also another idea of compensation in Post Keynesian monetary economics that is more applicable to European conditions prior to the formation to the European Monetary Union. It essentially says that foreign capital inflows can be compensated on the liability side of the central bank’s balance sheet. Therefore, capital inflows need not affect the domestic money supply as conventional wisdom has it. Observe that in the present Guyanese context this component of central bank liability is not the usual monetary base, which is also a central bank liability. The Consolidated Fund is not part of the monetary base, so in effect the government’s deposits are quarantined from the private sector.
Of course, if the government spends the entire G$30 bill on services provided by the private sector the money leaves the Consolidated Fund and enter the private agents’ bank accounts. However, it is a matter of timing and lags. How fast will the money be quarantined versus being spent on the services of private agents? Some monies will have to leave the country through the foreign exchange market as government also do business with foreigners. In addition, one government agency may make payments to another government agency, so it is unlikely all the funds quarantined in the consolidated account will return to the private sector.
It is interesting to note that while Bank of Guyana’s net foreign assets (NFA) is declining, the NFA of the commercial banks is increasing steeply. In January 2015, commercial banks held US$290 mill NFA; by June 2015 this number increased by about 18% to US$341 mill. For the same period commercial banks reduced their demand of Treasury bills from G$61 bill to G$58 bill, thus indicating a tendency for switching from the domestic currency asset, Treasury bills, to foreign currency assets, NFA. Hence, we are seeing a compensating movement away from domestic financial assets to foreign ones. Furthermore, this may reflect a loss of confidence given the numerous political gyrations coming from the full-time career politicians since 2011.
Therefore, the task of monetary policy in most developing economies, and even several high income ones, involves stabilizing the flow of foreign exchange through the FX market by constantly rebalancing the portfolio of assets commercial banks demand. The benchmark policy interest rate is most times secondary in these economies. This is unlike the Federal Reserve which has a more powerful policy rate that evolved out of the historical circumstances of the United States, which even before 1776 never had a shortage of financial dealers and traders.
Another potential tool of policy could be the central government’s and quasi-government deposits in private commercial banks. This would require new rules to allow flexibility to move funds between the Consolidated Funds and the private banks, depending on the market’s demand for liquidity. Tracking these accounts for transparency purposes is not as difficult as landing a spacecraft on a moving comet 320 million miles away.
Comments: tkhemraj@ncf.edu
