Today’s column wraps up my reflections on the fierce controversies over the price deflator, CPI that is applied to calculate the country’s real effective exchange rate, REER. Guyana’s CPI has been widely criticized for being constructed on 1] an urban location [Georgetown] rather than the whole country 2] the outdated nine components chosen to compute the relative weights within the index, and 3] the exclusive control of its design and execution processes by a partisan administration in the controversies,, has given cause for concern.
Empirics
Reliance on an accurate inflation measure is founded on the formulation arrived at last week, which defines the REER as the weighted average of the Guyana dollar in relation to a basket of other currencies of its major trading partners. Therefore, an appreciating REER means exports are becoming less competitive relative to imports from those trading partners. And, two likely reasons for an appreciating REER are higher inflation in Guyana and/or depreciation of the nominal exchange rate of one or more major trading partners.
Indeed, recent published IMF data suggest Guyana’s REER appreciated by 3.1 percent, over the years 2019 to 2023; largely on account of higher inflation in Guyana. Many persons who joined the controversies claim this rate of appreciation would be higher, if the inflation rate was not underestimated
On the horns of a trilemma
The vast majority of citizens I talk with seem to have little to zero confidence in the statistics on inflation put out by the authorities. I hope that this arises from their confusing inflation with high prices. But, I gather even those not prone to this confusion will concede the published rates of inflation are too low in Guyana to be credible. Deliberately applying statistics that no one has confidence in is fraudulent. At the same time lacking the capability to construct the REER fatally condemns rigorous analysis of Guyana’s exchange rate regime and Exchange Rate Policy.
Analysts at the IMF have ventured exploratory studies on Guyana as a potentially booming Petrostate. Thus, the IMF posits recent oil and gas finds, promise to transform Guyana’s agricultural and mining economy into an oil powerhouse while hopefully helping to diversify the non-oil economy… a momentous opportunity to boost inclusive growth and diversify the economy by providing resources to address human development needs and infrastructure gaps.
At the same time, it presents important policy challenges. In particular, the high volatility of oil prices makes it especially challenging to maintain macroeconomic stability in the face of external and terms-of-trade shocks. Monetary and exchange rate policies can have a key role to play in terms of providing (i) a nominal anchor for controlling inflationary pressures and expectations, and (ii) an effective tool for adjusting to external shocks and balance-of-payments pressures. [Source Bhagwandin]
Indeed the author asserts the choice of an appropriate monetary policy framework and exchange rate regime for Guyana should be constructed so as to achieve the twin policy objectives of 1] output stabilization /absorption of external shocks, and 2] inflation (price stability).
The prevailing view of the Guyana Authorities is that the monetary policy framework, focuses on exchange rate stability as they do presently. This seems to be the most suitable option for the country. The exchange rate, in turn, serves as a nominal anchor for price stability. Additionally, with some flexibility the effectiveness of the exchange rate can be expanded to serve as an instrument for absorbing shocks.
For terms of trade shocks, this is likely to be muted since Guyana is mostly a price-taker in the international markets for its main exports—including oil. Moreover, most of Guyana’s exports are priced in U.S. dollars.
At the same time, the empirical evidence indicates Guyana’s non-oil exports are somewhat sensitive to movements in relative prices, both short term and long-run. In addition, reported cross country data seem to suggest that the competitiveness yielded by exchange rate depreciation tends to gain traction over the longer term, making the nominal exchange rate a more effective shock absorber.
Clearly all this support calls for more sustained research, diagnostic and policy-oriented studies to guide the Authorities on the type of framework optimally suited to Guyana’s future needs.
I readily concede that; Guyana’s widely projected rapid expansion of oil production and exports should comfortably provide adequate amounts of domestic [fiscal] and external [reserves] buffers to sustain a fixed exchange rate or an exchange rate peg for the foreseeable future. This is especially likely to occur if the planned public investment expansion is done at a pace that does not generate macroeconomic imbalances and is accompanied by a strengthening of the medium-term fiscal framework. [ibid]
Conclusion
However, as Guyana becomes a major oil producer over the medium- to long-term, there is a strong case for incorporating the elimination of persistent poverty, pauperizing wages and their socio-economic perversities as explicit targeting for the monetary policy and exchange rate framework since a gradual shift towards greater exchange rate flexibility will allow the economy to better withstand shocks and maintain competitiveness.
This will require creating the necessary infrastructure, and establishing effective regulatory and supervisory frameworks, for the effective functioning of the interbank, domestic debt, and foreign exchange (FX) markets.
In general, most analysts seem to support moving towards a more flexible de facto exchange rate regime. They urge proceeding however, in lockstep with the development and deepening of markets in domestic finance and foreign exchange as this makes the transmission of monetary policy more effective; particularly in light of the fact that, the necessary infrastructure to support a flexible exchange rate regime takes time.