As indicated at the outset of the present series of columns, outlined in my October 27 2024 column, starting today I engage the third of the five topics listed therein; namely, Guyana’s macroeconomy and the policies needed to promote, ensure, as well as sustain both internal and external balance. In regard to internal balance, I cited inflation, fiscal deficits and domestic debt creation. And in relation to external balance the balance of payments, foreign exchange rate, foreign reserves and foreign debt were cited.
I am afraid that, on later reflection, I may have seriously underestimated the task that I have set myself, particularly in light of the fact that this series on the oil and gas sector has not dwelt at any length or indeed in any serious depth with debt, exchange rate regimes, monetary policy, macroeconomic policy and so on.
To cope with this limitation, I shall therefore narrow my focus to foreign exchange rate management and its related monetary and fiscal policies promoting macroeconomic balance. This requires me to introduce beforehand the concepts of the real effective exchange rate, REER; and the exchange rate regime in the sections to follow.
Nominal and Real Exchange Rate
Simply put, the nominal exchange rate is the prevailing rate at which one currency can be exchanged for another. In effect this means it is the price of one currency in terms of another currency. Thus, it is usually expressed as the number of units of one currency that can be exchanged for one unit of another currency. The 2024 mid-year Report of the Ministry of Finance noted that the official nominal exchange rate for the Guyana dollar to its equivalent in the US dollar held steady also over the review period; that is, it was unchanged at $208.5. At the same time the ruling nominal market mid-rate for the Guyana dollar to the US dollar ended the first half of the year at $215.1 This is of course, the nominal exchange rate.
Real Effective Exchange Rate [REER]
While I anticipate most readers are likely to be familiar with the concept of the nominal exchange rate through their personal transactions in foreign currency, whether direct or indirect, the real effective exchange rate (REER) is far less likely to be the case.
Based on my experiences in providing this Sunday column series, I have found that, in practice an excellent glossary for popular and accurate presentation of technical business/economic terms is Investopedia. There the REER is presented as the weighted average of a country’s currency in relation to an index or basket of other major currencies.
In particular, it further notes that the weights are determined by comparing the relative trade balance of a country’s currency against that of each country in the index.
Consequently, an increase in a nation’s REER is an indication that its exports are becoming more expensive and its imports are becoming cheaper, reducing its trade competitiveness. Investopedia identifies several key takeaways from this concept. These are:
Notion of trading partners.
• It is an indicator of the international competitiveness of a
nation in comparison with its trade partners.
• The formula is weighted to consider the relative importance
of each trading partner to the home country.
• An increasing REER indicates that a country is losing its
competitive edge.
• A nation’s nominal effective exchange rate (NEER), adjusted for inflation in the home country, equals its real effective exchange rate (REER).
A nation’s currency may be considered undervalued, overvalued, or in equilibrium with those of other nations with which it trades. A state of equilibrium means that demand and supply are equally balanced and prices will remain stable.
A country’s REER measures how well that equilibrium is being held.
REER is determined by taking the average of the bilateral exchange rates between one nation and its trading partners and then weighting it to consider the trade allocation of each partner.
For information purposes the Bank for International Settlements website provides updated effective exchange rate indices on a daily and monthly basis.
I familiarize readers in the next Section with the concept of the exchange rate regime
Exchange Rate Regime
As was noted above, exchange rates can be viewed as the price of one currency in terms of another such currency. This requires that, similar to other goods and services, readers must take into consideration the determination of that price.
This is complicated because government can, and does influence the exchange rate; even indeed fixing it.
Exchange rate regimes or systems are in reality the frame within which that price is determined. Such regimes in practice range from a purely floating exchange rate, to a central bank determined fixed exchange rate. This difference reveals the basics of each of these regimes.
Rate regimes range from Strong Independence [flexible managed floats to Low Independence [Monetary Union]]
An exchange rate regime is the system that a country’s monetary authority – generally the central bank – adopts to establish the exchange rate of its own currency against other currencies. Each country is free to adopt the exchange-rate regime that it considers optimal. The key distinction amongst exchange rates regimes is generally between fixed and flexible exchange rate regimes, but we find there are many other different regimes, between these extreme cases: Examples are,
–Monetary Union with a shared currency, such as the Eurozone; Currency Board as in Guyana when a colony, Target zone, where the exchange rate is allowed to fluctuate within certain bands; Crawling Peg, with a periodically adjusted exchange rate; and Managed [dirty] float, a flexible exchange rate regime with some government intervention.
Conclusion
All exchange rate regimes have their particularities; strengths and weaknesses. These clearly intermingle thereby making arrival at the most appropriate exchange-rate regime for Guyana a particularly difficult task Much is at stake for Guyana as it fixes its exchange rate regime in a period when it is held to be the Americas fastest growing Petrostate.