Recent trends in the foreign exchange rate: could politics muck it up?

20140101watchThe Guyana dollar to US$ exchange rate depreciated slightly from $204.5 in 2012 to $206.1 by the end of 2013. Since January 2014 the rate remained fixed at $206.5 to one US$ until the end of January 2016, the last period for which the data set is publicly available. This rate is the mid-point rate between the buying and selling rates. The unchanged rate implies Guyana appears to have transitioned to a fixed exchange rate (or fixed peg) instead of the crawling peg regime it maintained since the late 1990s. This is an appropriate foreign exchange regime for a small very open economy such as Guyana. Barbados, The Bahamas, Belize and the ECCU countries have maintained successful pegged or fixed rate regimes. Recent research coming out from Central Bank of Barbados indicates that human well-being (or prosperity) is higher in the long run for countries with fixed and managed rate regimes.

Guyana’s contemporary fixed rate regime – from January 2014 to present – is pretty new by regional standards with several Caribbean states maintaining a successful peg since 1975. These territories tend to have greater social cohesion compared with Guyana whose politics is acrimonious and is based largely on ethno-political mobilization. Maintaining a successful peg in Guyana will depend on political consensus and greater social cohesion.

Populism coupled with limited social cohesion will also make maintaining the peg difficult. While in opposition APNU+AFC made nirvana-like promises of cutting taxes, raising wages, providing free university education and other goodies. Up to this day we have not seen a simulation from APNU+AFC showing how the fiscal deficit and debt issues will be affected if VAT is reduced by 2 percentage points. Now that the PPP enters opposition it wants a loss-making Wales sugar factory to be subsidized indefinitely and public servants to receive close to a 50% salary increase. Freedom House appears to be misplacing populism for vision.

The Bank of Guyana (BOG) is doing a remarkable job stabilizing the rate in light of the political conditions, crisis in the sugar industry and export shocks. No doubt the policy makers at BOG have managed optimally given certain natural conditions in the Guyanese FX market. These include an imperfect market with two to three large oligopoly traders who handle most of foreign currency flows through the market. It also includes the asset structure of the commercial banks, near banks and other institutional investors like pension funds. In addition, remittances and other capital inflows such as FDIs are not susceptible to sudden stops and reversals that can plunge the economy into an economic depression. My co-author, Mr Sukrishnalall Pasha, and I published a paper in 2012 outlining these natural conditions that possibly help in maintaining the crawling or managed rate at that time.

However, in spite of the natural conditions and the absence of forward and futures contract speculators in the local market, it will still require ample holdings of international reserves by the BOG and net foreign assets (NFAs) by the commercial banks if stability is to be maintained indefinitely. Since 2012 the central bank’s foreign exchange reserves have turned south, moving from US$825.2 million in 2012 to US$621.1 million in January 2016. The latter number, however, represents a modest improvement from the trough of US$584.8 million in November 2015.

The level of NFAs of commercial banks in 2012 was at US$257.5 million. It increased to US$296.4 million by December 2014, but declined modestly to US$283.4 million in January 2016. As the central bank’s official reserves declined from 2012 we observe an increase in the NFA of commercial banks, possibly signalling higher capital flight as confidence in the political class wanes. A rich Guyanese with accumulated wealth will likely include a risk premium for the mutual tit-for-tat strategy of sabotage that goes back to the mid-1970s. We thought 1992 would have been the end of tit-for-tat, but the new PPP government faced a barrage of sabotage efforts by the Hoyte-led opposition. Mr Jagdeo has signalled clearly after losing the May 2015 election there will be no rapprochement. Hence, if I’m a rich person I would have to include a higher risk premium as I discount my future cash flows while making an investment decision inside Guyana. Of course, if the “investor” receives the seed capital from the underhand proceeds of the white and shiny gilded stuff, he is less inclined to worry about risk premium and discount rates. But that raises another kind of malaise.

Although Guyana faced export price pressures since 2012, the collapse of oil price helped to ease the demand pressure in the local FX market, thus helping along the stable exchange rate. There has been a significant decline in the import value of fuel and lubricants from US$638 million in 2012 to US$573 million in 2014. Brent crude oil was priced at US$111.8/barrel in June 2014 but collapsed to US$38/barrel by December 2015.

The decline from 2012 however is not only attributable to the falling oil price, but also the general slowdown in the economy after the 2011 General Election, as is evidenced by the noticeable decrease in capital goods imports from US$460 million to US$388 million over the said period. Capital goods go into the production process; if the economy is slowing down we would expect less import of these production-based items. Data are only available for the first three quarters of 2015, but there appears to be an even greater decline in the imports of fuel and lubricants (F&L) in 2015, a situation that will ease the pressure in the market in the short term. In the first three quarters of 2014 Guyana imported US$446 million in F&L compared with US$273 million over the first three quarters of 2015.

There has been a similar pattern in total exports which peaked at US$1.4 billion in 2012 but declined to US$1.2 billion in 2014. Again, we have public data for exports over the first three quarters of 2015, so we should compare with the first three quarters of 2014. For this period of 2014, total export was US$837 million versus US$813 million for the January-September period in 2015. The decline in total imports was offset by a relatively larger decline in total exports, causing the visible trade deficit to widen substantially from US$581 million in 2012 to US$624 million in 2014, no doubt partly explaining the decline in BOG’s international reserves over that period. Monetary policy can only buy time until the production sectors and the politics work things out.



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