Mr. Chairman
Fellow Panelists
Distinguished Guests
Ladies and Gentlemen
Introduction
Making an effective contribution to a panel discussion could be tricky proposition in that the audience could be quite bored with repetition, unless the presenters had previous consultation and reached an agreement among themselves on the allocation of different aspects of the subject matter.
In addition, the financial crisis has been unfolding and intensifying over the past several months and a lot has been written by journalists and experts on the origin of the crisis and the mode of its international transmission from the USA and thence to Europe, Asia and emerging market economies in Latin America, to become to date a US$ 3.2 trillion bailout cum privatization of financial institutions, in addition to various guarantees and support measures, and consolidations and mergers among the institutions themselves.
In fact, I have contributed to this avalanche of commentary via a presentation to CARICOM staff just over a month ago, Part 1 of which was reproduced in the Stabroek News newspaper on 3rd October and Part 2 on 10 October. Nevertheless, based on the composition of the Panel, I suspect that a great deal will be said by my fellow panelists on the central banking policy dilemma and commercial banking management strategies, backed by copious statistics on performance in the financial and real sectors.
Within the time allotted, I shall therefore restrict myself to making brief remarks on the following areas:
1. Implications of the Vulnerability and Volatility of Guyana-Type Economies;
2. Impact on the Financial Sector and Financial Sector Policy;
3. Impact on the Non Financial Sector ie the Real Sector; and
4. Broad Policy Implications for Guyana and CARICOM, as a whole.
Vulnerability and Volatility Implications
Guyana is usually characterized as a small vulnerable economy which is susceptible to a high degree of income volatility. The vulnerability stems primarily from the very open nature of the economy as reflected in the fact that exports are equivalent to approximately as much as 75% of GDP. The trade vulnerability is compounded by a considerable degree of structural dependence in that a few commodities (sugar, rice, bauxite, seafood, gold and diamonds and wood products) account for the bulk of the export earnings. Moreover the sales of the commodities are concentrated on a few traditional markets in Europe and North America (although the Caribbean is not an unimportant market for rice and shrimp). The Guyana goods sector is therefore likely to be adversely impacted by the external shock occasioned by the current financial crisis, especially if it leads to a full blown recession.
Guyana is also a very significant exporter of labour and in 2007 is said to have received in remittances as much as US$424m., which represented as much as 43% of GNP. Since remittances are primarily out of income earned, the severe global downturn, centering around the USA, the main destination of the Diaspora, will have an almost immediate impact and is likely to persist beyond the period of the recession, until asset items foregone are acquired by the metropolitan based remitters.
Vulnerability also exists with respect to foreign investment flows (averaging nearly US$100m in the last three years) since these constitute a rather high percentage of private sector capital formation. Large projects involving a considerable capital outlay are likely to the ones most affected although ongoing projects would tend to be continued until the completion stage. Thus the Marriott hotel project may be pushed backwards.
Impact on Financial Sector
The financial sector is said to be made up of commercial banks and near banks, insurance companies and other institutional investors, and the securities sector. Commercial banks in a country like Guyana are fairly insulated from the global financial crisis because they are not holders of the toxic mortgage backed securities which have depreciated in value. Also the banking system does not have branches, or even stand-alone subsidiaries, of the worse hit foreign banks and correspondent banking relationships for facilitating day-to-day trading transactions are mostly intact.
However, there is a danger that the local banks may become even more risk averse than they are today and will gravitate towards holding more liquid assets and fixed income government securities, and away from start-up ventures and the more risky activities that lack assured outcomes or adequate collateral. In any event, in a worse case scenario, the Government should be prepared to perform its role of ‘lender of last resort’.
The current global financial crisis should also cause the Government to revisit the issue of introducing depositors’ insurance, moral hazard notwithstanding. Similar consideration could be given to savings in credit unions since there could be substitution between the two outlets, depending on depositors’ perceived levels of relative safety. With respect to the insurance sector, a lack of sufficient disclosure and transparency makes it difficult to determine whether any toxic mortgage backed securities are being held locally. However, it is possible that some of the major industrial, commercial and public utilities assets are insured by the distressed giant, American International Group (AIG) as is the case in Jamaica and Trinidad and Tobago, via a cross-border supply process operated by agents who have been termed “suitcase traders”. In any event, reinsurance costs are likely to increase for all local insurance companies as a result of uncertainty in the global economy
One unexpected benefit of the global financial crisis could be that institutional investors like insurance companies, pension funds, investment banks and mutual funds (that experience a fall in income on foreign held assets) might want to hold a greater proportion of local or regional assets, with spin off benefits for local capital market development. Up to now, the statutory portfolio requirement that institutional investors should, for prudential reasons, adhere to a certain minimum local assets ratio, has been honoured more in the breach.
The Guyana securities sector, therefore, may paradoxically benefit from the stress and volatility in the global financial markets, with both a larger proportion of funds being retained locally and, also, a reduced tendency for individual savers to hold asset balances abroad, and a reduced tendency of commercial enterprises to engage in capital flight.
Impact on Non-Financial Sector/Real Sector
The depth of the global financial crisis and the extent of the credit crunch and loss of business confidence is likely to determine the depth of the recession and this, in turn, will determine the extent of the impact on Guyana’s real sector development. Indices on the international commodity stock exchanges are already showing a significant downturn for most products. Sugar industry woes will come on top of the revenue lost from the EU’s renouncing of the sugar protocol and rice exports will be adversely affected by both global and regional demand. In the case of bauxite and wood products, the slowdown by Russia, China and S.E. Asia may cause a significant reduction of demand. Similarly, the export of seafood will decline, as a result of depressed global demand and a serious shortfall in tourist arrivals in the Caribbean, and our fledgling eco-tourism industry will take a while longer to take-off.
The exception are gold exports, whose price tends to rise significantly when there is uncertainty in the global economy and fluctuation in financial and currency markets. Also, the fall in petroleum prices from the high of US$147 a barrel to the current level of less than US$70 per barrel is important from the point of view of cost efficiency of non producers like Guyana. In addition, the price of imported building materials and household equipment may fall as a result of the collapse of the house building industry in the USA.
Of course, the Government sector is also likely to feel the pinch since the downturn in private sector activity and incomes means less tax revenue generation. This will result in a cutback in government physical and social infrastructure. There may even be a fall in the exchange rate if remittances plummet and proceeds from the illicit drug trade decline significantly. The overall growth rate, already very modest, is therefore expected to be even lower in both 2008 and 2009 given the length of time most experts predict it will take for the world to fully recover from the present financial crisis. If both the private and public sector in Guyana have to cut back on employment creation, social tensions, and even the crime rate might be exacerbated.
Broad Policy Implications
The financial sector is the Achilles Heel of the global economic system. Three genuine financial crises have occurred in the USA in the last 25 years and during the same period financial crises have devastated about ten or so emerging market (semi-developed) countries as a result of flight of previous short-term inflows (portfolio investment). But this is the most severe post-war financial crisis, fuelled by globalization and the international transmission mechanism of re-packaging and sale of securities across national borders. The crisis may not have occurred if there was more effective regulation, transparency and disclosure, rather than an ideology of de-regulation and market supremacy. This gave rise to the practice of financial innovation being equated with the risk taking practice of issuing complex and exotic financial instruments (eg hedge funds, mortgage backed securities, credit default swaps, and other types of derivatives) that even the regulators did not fully understand.
Now what are the policy implications for the Guyana type economy? There is an excessive amount of liquidity in Guyana and other Caribbean financial systems, even though some commentators feel that many creditworthy entrepreneurs are thereby being denied access. However, the meltdown of the Jamaican financial system shows that it is wise to err on the side of caution, although one of the problems in Jamaica was the plethora of both bank and weakly regulated non-bank financial intermediaries. The current atmosphere is inevitably one of need for careful monitoring of non-performing assets in financial portfolios.
Thus Jamaica decided to introduce deposit insurance after its experience in the 1990s. It may be wise for Guyana to do the same. Since financial crises invariably infect the real sector, the Government should also consider increasing its level of foreign exchange reserves above the current level of about three (3) months import cover; certain Caribbean Governments have deliberately opted for over five (5) months import cover.
A larger amount of foreign exchange reserves and a vastly improved fiscal balance situation would have allowed the Government of Guyana to engage in countercyclical expenditure policy to maintain the current level of economic activity when the current global financial crisis begins to really bite. It is interesting to note that Trinidad and Tobago has a US$9 billion strong Heritage and Stabilization Fund, in addition to its normal reserves of US$2.5 billion. Some of these funds are managed by firms in the USA that have been bailed out but we are told that, as in the case of pensioned funds managed abroad, that they are “ring fenced” and therefore not endangered; this begs the question as to whether there should not be greater geographical and currency diversification of financial placements.
In Guyana Government’s case, there is going to be a particularly problem with respect to price and availability of foreign loans. The global financial crisis has brought to the fore the need for a more meaningful role of the State in market driven economies of both developed and developing countries.
At a more general level, there is need for a greater degree of production diversification and market diversification to cushion the effects of global economic crises. Guyana remains a very structurally dependent economy with a considerable amount of vulnerability. A greater degree of regional integration, with an increase of intra-Caribbean transactions, could partially compensate for this exposure to external shocks. One example could be the proposed regionalization of the mandatory local asset ratio of institutional investors.
Finally, the international financial architecture, including the role of the IMF, suffers from some serious systemic weaknesses and needs urgent fixing. Countries, especially since small vulnerable ones like Guyana, should not have to pay for the reckless financial actions of others. At the very least, they should be eligible for interest free loans from the IMF. Developing countries need to be well represented in any new Global Stability Forum.
* Paper prepared for Presentation at a Seminar organized by the Georgetown Chamber of Commerce on Monday, 20 October 2008, Georgetown, Guyana
