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DRAFT October 14, 1996

I. Principal Macroeconomic Issues and Constraints
A. Constraints in the External Sector
B. Constraints that Affect the Competitiveness of Guyana's Exports
C. Constraints which Inhibits Capital Formation
D. Constraints that Affect the Efficiency of the Economy
E. Constraints which Weaken the Functioning of Government

II. Principal Orientations of Macroeconomic Policy

III. The External Sector and Monetary Management
A. Policy Objectives
B. Trade Policies
C. Exchange Rate Policies
D. Monetary Policies

IV. Fiscal Policy and the Public Sector
A. Objectives of Fiscal Policy
B. Fiscal Policy

V. Debt Management
A. Domestic Debt
B. External Debt

VI. Banking Policy
A. Objectives
B. Policy Recommendations

VII. Growth Prospects

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I. Principal Macroeconomic Issues and Constraints

The constraints that hinder the functioning of the economy at the macro level include those occurring in the external sector, those in the policy realm that affect the competitiveness of the economy, those which inhibit capital formation, and those which limit the Government's ability to carry out its proper role in the economy.

In addition, for the past several years policy makers have been constrained by an overriding national obligation: the need to reduce inflation rates to acceptable ranges. In this regard and others, Guyana's record of macroeconomic management has been successful. Inflation has been reduced, fiscal deficits have been contained to levels that could be financed internally and externally without difficulty, the banking system has been strengthened, and a comfortable level of foreign exchange reserves has been secured. Nevertheless, this constraint on fiscal and monetary behaviour has produced some undesirable side-effects, such as extensive operations on the bond market to sterilise liquidity, with the result of higher Government indebtedness and less availability of financing for private investments and relatively high real interest rates. Fortunately, the economy shows signs of emerging successfully from this stabilisation phase and in the future policies can give greater emphasis to promoting sustainable economic growth.

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A. Constraints in the External Sector

A high level of external indebtedness continues to impede Guyana's economic recovery. The two rounds of debt relief achieved in this decade, through applications of the Naples terms to selected categories of bilateral indebtedness, supplemented by some efforts of multilateral agencies to restructure the terms of their credits, have been most helpful in reducing the outstanding obligations. However, in practice their main effect has been to bring scheduled debt payments into line with the Government's capacity to service them. As pointed out in Chapter 16, those payments still stand at a very high 33 percent of Government revenues, a circumstance that severely squeezes the funding for vital infrastructure, social services, and salaries in the public sector.

Another potentially serious constraint in the external sector is posed by the uncertain prospects for continuation of the preferential access enjoyed by sugar and rice to markets in OECD countries. The renewal of the Lomé IV Convention is now in serious doubt, in part because of the policy stances taken by the newest members of the European Union and in part because of the general fiscal situation of the EU. Failure to renew would eliminate the preferential prices received by our rice exporters, most of whom are currently unable to compete at the world market price.

For sugar, it seems likely that the special arrangements (protocols) will continue, but the price received by exporting countries under those arrangements depends on the price set in Europe's Common Agricultural Policy (CAP). European governments are increasingly concerned about ways to reduce the fiscal cost of the CAP, and that issue will become much sharper as the date of accession of Eastern European countries come closer. The most likely prospect for sugar is a reduction in the CAP support price, and hence a reduction in the real price Guyana receives in European markets, a trend which in fact has been underway for some time now.

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B. Constraints that Affect the Competitiveness of Guyana's Exports

There can be no doubt that several of Guyana's principal exports are lacking in competitiveness on non-preferential world markets. Summary results of an extensive recent study of that issue are presented in Table 6-1.

Table 6-1

Domestic Resource Costs and International

Prices for Selected Commodities

(US$ per metric ton)
Commodities World price European Union price Domestic cost
Rice 320 425 366
Sugar 284 617 410
Pineapple 465 - 487
Bauxite 133 - 181

Source: A. Angel, Analysis of the Effects on Guyana's Export Sector of Changes in International Markets, 1996.

Although the expected trends in world market prices in coming years may constitute a major constraint to our ability to continue exporting in the necessary volumes, domestic policies have a great deal to do with the competitiveness of our exports. First of all, any level of import tariffs, no matter how small, weakens the international competitiveness of exporting sectors, because it raises the costs of production.

Secondly, the difficulties that domestic firms experience in obtaining credit and (sometimes) foreign exchange, places them at a disadvantage with respect to their competitors in other countries and points up the need for continuing improvements in the domestic banking system. The very high levels of excess liquidity that the banking system has accumulated (Chapters 14 and 15) in the face of urgent needs for working capital on the part of businesses is a clear symptom that the system of financial intermediation still is deficient in some important respects. The recent commencement of a downward trend in real interest rates is a welcome sign but does not fully address the concern. Automatic approval of dollar loans, measures that oblige domestic banks to open up interbank trading in foreign exchange, and other steps to deal with these concerns are described in Chapter 14.

Thirdly, and perhaps most importantly, the appreciation of the real exchange rate experienced since 1992 puts Guyana's exporters at a signal disadvantage in world markets. As discussed in Chapter 12, the success of the East Asian "Tigers" and other rapidly growing economies has been based fundamentally on policies that have not allowed their exchange rates to become overvalued. It is only after two or three decades of extremely rapid export growth, and after per capita incomes in those countries have increased several-fold, that the balance of payments enabled the exchange rate to appreciate slightly without causing significant damage to the economy. Sometimes what is convenient in the short run (apparent stability of the exchange rate in spite of domestic inflation) is not convenient in the medium and longer run (because it creates marked disincentives to production and therefore to the creation of employment).

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C. Constraints which Inhibits Capital Formation

This is an area in which a very substantial advance has been made in recent years, with the moves toward decontrolling and opening the economy and clarifying many basic policies. Nevertheless, there remains a distance to be traveled so it is well to remind ourselves of what the still-existing constraints are in this area. Perhaps the most fundamental constraint is one that is no so easy to quantify but which is pervasive: a sense of confidence on the part of the business community that Government policies are consistent, clear and headed in a productive direction.

Above all, a clear investment code that provides comparable treatment to investors in all sectors should be issued as soon as possible, and the approval process for investments can be further simplified and made transparent. Of equal priority is reduction of the range of variation of the consumption taxes and customs duties, so that differing products and sectors are treated more equitably (Chapter 13). A number of other measures are quite important in this respect, including removing the Government from the field of timber marketing (Chapter 30), making agricultural land leases tradeable and removing regulations that restrict land rents (Chapter 29), and accelerated privatisation of State-owned enterprises (Chapter 36). The latter measure also would open the door to the participation of strategic investors in the recapitalisation of major industries, something that could not be expected from the Government in its present fiscal and foreseeable circumstances.

A reduction in the rate of issuance of Government bonds, as recommended in Chapter 12, would favour private investment as it would lower the "crowding-out" effect in financial markets that such bonds tend to have.

Thus the constraint to greater levels of capital formation can be seen to have the following dimensions: a) the psychological one of confidence, b) a financial one related to the effectiveness of domestic financial intermediaries, c) a fiscal one related to Government behaviour in the financial marketplace, d) a regulatory one in respect of investment and tax codes and investment approval processes, and e) an institutional dimension in terms of land tenure and ownership of productive assets. All these aspects of this constrain are susceptible to improvement through sound policy decisions and policy implementation.

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D. Constraints that Affect the Efficiency of the Economy

Countries that are most successful in promoting economic growth are those which establish uniform rules of the game so that industries and sectors with great potential have a fair opportunity to establish themselves and expand, and so that they are not discouraged by economic preferences granted to less efficient firms and sectors. Chile has been an outstanding example of setting a level playing field and allowing winners to emerge on the basis of their own inherent potentials. Those winners have proven to be powerful engines of employment creation and growth.

Even without consciously trying to select winners, economic policy often provides a decidedly uneven playing field, conferring considerable advantages to some firms, sectors or subsectors, to the detriment of the prospects of the others. The pervasive irony is that it is precisely the least efficient firms that often gain the greatest preferences, because their inability to compete forces them to turn to the tactic of asking for favours through the regulatory channel. To respond to such pleas seems a justifiable course of action, because of the fears that shrinking businesses will put people out of work. This is a paradox, for the end result of granting various forms of economic protection to such firms is to eventually concentrate the labour force in industries which have weak growth prospects, and therefore in which the workers have little chance of enhancing their earnings.

This lesson may seem obvious, but the trap is often fallen into. It appears when, for example, tax rates and customs duties are markedly uneven across firms and industries, so that effective protection rates differ significantly. It occurs when some categories of production have preferred access to loans from State-owned banks, or differential access to plots of State-owned land for factory sites. It occurs when the rates for infrastructure services vary across firms, and in many others ways. Without putting too fine a point on the issue, it is essential to make economic policy as uniform as possible in these respects, in order to ensure that labour, land and capital are continuously allocated to the productive activities which have the strongest economic prospects. Over a period of time as short as a few years, the results can be dramatic in terms of overall economic growth rates, to the benefit of workers, farmers and their families as well as entrepreneurs.

Guyana has progressed well in this area, mainly through compression of the range of custom duties, but there yet remains room for further achievements, especially in the realm of taxation and customs duties.

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E. Constraints which Weaken the Functioning of Government

A major constraint to Government's playing its role effectively is the fact that its staff in general does not have the requisite levels of skills, as has been amply recognised by many commentators. This constraint in turn is related to the very low levels of remuneration that characterise public service, as well as to many factors related to staff recruitment, deployment, training and management (Chapter 13).

The remuneration constraint leads directly to another one: the fact that the Government's revenue base is still unduly narrow. Too many individuals and firms escape the taxman's net altogether, and consequently those who are in it tend to pay more than they ought to over the longer run. This is another area in which considerable advances have been made recently, but it is essential to push ahead further. In recognition of the key nature of this constraint, Chapter 13 and some of the sectoral chapters make well-founded recommendations for widening the tax base and reaping additional Government revenues through other channels as well.

Profound reforms in public service and budgeting procedures (Chapter 1) also are vital to bringing about a more effective performance on the part of Government. These measures, in addition to those related to revenue collection, could lead to vastly strengthened Government. In contrast, retention of the ownership f means of production weakens Government and saps its credibility, for it puts Government into areas where it does not have the institutional modalities required for effective performance. It also obviates opportunities for the private sector to utilise those same assets with more beneficial results in terms of creating employment and generating foreign exchange and income, including revenues for the Government. In this respect it can be seen that the fundamental conception of the role of Government can be a major constraint on the performance of the economy. A role that concentrates on guidance through policies offers the best chance of improving the economy's growth prospects.

Finally, it bears repeating that the high level of indebtedness that the Government has been saddled with has severely limited is scope for action and has aggravated the other problems mentioned above. The solution undoubtedly consists of a combination of three approaches: continued lobbying in international fora for additional debt relief, in light of the exceptional debt burden of Guyana; encouragement of debt swaps and promulgation of other debt-reduction policies as discussed in Chapter 14; and achieving a diminution of the relative magnitude of the problem through rapid economic growth, without incurring in a proportionate new increase in indebtedness.

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II. Principal Orientations of Macroeconomic Policy

In the broadest sense, macroeconomic policy is directly concerned with the aims of growth, distribution and sustainability that have been recognised as overriding national objectives in Chapter 2 of the Strategy. Specifically, the objectives of macroeconomic policy for the next ten years may be summarised as follows:

In order to satisfy these objectives, it will be necessary to meet a number of subsidiary objectives, or more specifically macroeconomic criteria. The principal criteria of this nature would include:

Fulfillment of these subsidiary macroeconomic objectives will not only promote achievement of the broad objectives but also will strongly facilitate implementation of the strategic orientations of this development programme that are described in Chapter 5.

At the most aggregate level, macroeconomic policy consists of the triad of monetary, fiscal and exchange rate policy. New directions in any one of these areas have to be conceived and carried out in full coordination with the other two areas. Without question this circumstance imposes some constraints on the flexibility of macroeconomic policy, but nevertheless in today's economic environment there is room in a sound macroeconomic policy for fully addressing concerns for both stability and growth, and also for fostering growth with equity.

In light of these policy interrelationships, and to fulfill the objectives established above, the following principal orientations will govern the continuing process of formulating and refining macroeconomic policy so that it continues to serve the needs of contemporary Guyana:

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III. The External Sector and Monetary Management

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A. Policy Objectives

The principal objectives for policies in this area are to promote growth of output and employment and to keep inflation at low levels. Policies should promote competition among domestic agents, encourage them to be innovative, provide consumers with a wider selection of goods, and allow firms to exploit comparative advantage and economies of scale fully, in the interest of becoming and remaining competitive on world markets.

More immediate goals to facilitate achievement of these objectives include elimination of antitrade biases from existing policies; maintenance of low, non-discriminating and transparent protection levels; improved financial intermediation to enhance savings mobilisation and capital market development; and further reforms in the operations of the Bank of Guyana.

Above all, policies in the interrelated areas of monetary management, the exchange rate and fiscal management need to be defined in a way that is consistent with broad and diversified growth throughout the economy, and also so that price stability can be attained in a lasting way, that is, through a sustainable combination of policies.

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B. Trade Policies

Three elements have been crucial to the successful recovery of exports in the last five years: a decisive impulse toward opening the economy, the depreciated real exchange rate of the early 1990s, and the internal price decontrol (which was especially important in the case of rice). These measures allowed exporters to begin to receive an appropriate return for their activities, thereby fostering investment and employment creation. To consolidate these policies further, it is necessary to continue to open the economy by focusing on effective protection, as opposed to nominal protection, and making it as uniform as possible over sectors and categories of goods.

International trade is a core activity of the economy and therefore the steps that are required to support its further development are far-reaching and diverse. The principal measures needed are the following:

Continue the progress toward narrowing the range of the nominal tariffs, adopting as a goal a range of 5 to 15 percent. Agricultural tariffs that correspond to CARICOM's ceiling should be reduced from their currently high level of 40 percent.

As part of the move toward narrow the range of tariff variation, eliminate exemptions and move the minimum rate initially to 3 percent and eventually to 5 percent. This measure, plus improved efficiency of customs collections, should offset the loss of tariff revenues that will arise out of reductions in the top range of tariffs.

Eliminate tax holidays of other kinds and apply standard tax regimes (Chapter 13), in order to further move toward relatively uniform rates of effective protection over different classes of producers. The non-uniformity discriminates against sectors that may have large potential for growth and also engenders a lack of confidence in Government's ability to manage the economy impartially.

Eliminate the remaining quantitative import restrictions such as licencing on specific goods such as fuel.

Remove export taxes, as recommended in Chapter 13, because they are counterproductive to the goal of export promotion, they tend to encourage evasion, and in any case they are relatively small in terms of fiscal revenues generated. In the case of the fishing industry, the lost revenues can be recouped through more realistic licencing fees for fishing vessels (Chapter 31).

Adopt policies that guarantee maintenance of an exchange rate that is propitious for exports and also for import substitution (see below).

Improve the system of agricultural research in order to give sectors such as rice the maximal opportunity to enhance their technologies of production sufficiently to become competitive in world markets, in anticipation of a diminution of the prices in the quota markets. (See Chapters 26 and 28.)

Eliminate the Government's marketing interventions for timber, as recommended in Chapter 30.

Carry out the suggested restructuring and participatory privatisation of the sugar industry, as described in Chapter 33, in order to give that sector the best possible opportunity to survive and continue exporting at current levels under the increasingly less favourable international market conditions that are expected to emerge after the year 2000.

Encourage international enterprises that are involved in the marketing of non-traditional agricultural products to investigate Guyana's potential and to make recommendations on how that potential can be realised.

Since substantial foreign investments will be required in trade-oriented sectors, restructure GO-INVEST along the lines suggested in Chapter 36, so that the investment promotion activity is separated from the investment approval function, and make the latter truly a one-stop experience.

Since the tradable sectors also demand ever larger quantities of skilled labour, adopt the recommendations of Chapter 35 in respect of the creation of a tripartite council for TVET and the use of a payroll tax for funding such training activities, under the supervision of the new council.

In addition to these measures, it will be vital to carefully review the possibilities for instituting an export processing zone. Such zones can become a source of dynamism for the entire economy in terms of efficient production, economic diversification, expansion of employment, provision of much needed foreign exchange, investment and technological transfer. They have made an outstanding contribution to the development of several developing countries (such as Mauritius, the Dominican Republic and Honduras).

The main advantages of an EPZ can be synthesised as follows:

The international evidence suggests that, although the expansion in employment can be remarkable, the process may be slow in getting momentum and, hence, that there must be clear and consistent policies supporting the establishment and development of an EPZ from the outset. Over time and as the economy develops, labour advantages tend to disappear so EPZs must be able to base their advantages increasingly on efficient production and marketing.

The export performance of an EPZ can be very important in supplying the economy with much needed foreign exchange. Dominican Republic figures are impressive in this regard; in 1975, exports from EPZs were in the range of US$ 50 million, while exports from the rest of the economy amounted to US$ 1.4 billion. By 1980, EPZ exports had reached US$130 million, by 1985 US$270 MN, and by 1993, US$1,600 million (all figures in US$ of 1980). At the same time, exports from the rest of the economy (mostly sugar and mining products) had fallen to US$ 0.4 billion.

A second aspect of investment in EPZs refers to human capital accumulation. A successful firm in an EPZ requires qualified personnel in production and, probably most important, marketing activities. Labour force training, as well as developing managerial capacities, are key to the success of an EPZ. These factors in turn have important spillover effects to the rest of the economy.

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C. Exchange Rate Policies

1. Issues

Although the real exchange rate has been quite stable in the last year and a half, this does not necessarily imply that it is in equilibrium. The importance here of the real exchange rate is that it can act as a good proxy index of competitiveness(4) --that is, as the price of traded goods in foreign countries, adjusted for the nominal exchange rate, relative to their prices in the domestic economy. Although it is quite cumbersome to determine whether the RER is misaligned or not, classical symptoms of the problem appear as large current account deficits, wide black market premia, excessive international reserves accumulation and a booming non-trade sector. In Guyana's case, the large foreign debt overhang and tight control over the external sector by the authorities, coupled with the conditionalities (targets) of the IFIs, make it hard to assess whether the evolution of the RER is towards "market equilibrium" or away from it. Observation of the current account deficit is misleading as the country has been in arrears to several lenders(5), while black market premia tend to be non-informative in this case because a narrow market allows some control of the nominal exchange rate by the Government (dirty float) and an oligopolistic behaviour of financial intermediaries(6). The existence of queuing for foreign exchange does suggest a degree of short-term disequilibrium, in the direction of overvaluation. Another indication in the same direction is the accumulation of gross foreign exchange reserves, which rose from the equivalent of 1.3 months of imports in 1990 to 9.1 months of imports in 1994 (IMF data).

The recent appreciation of the real exchange rate is worrisome as it may harm the competitiveness of exports and encourage excessive indebtedness. If appreciation arises from a transitory inflow of capital or a sudden shock of the terms of trade, the effects can be devastating on the export sectors as profitable exporting industries might be dismantled and resources switched towards transitorily profitable non-tradable activities(7) (as may be reflected in Guyana by the recent boom in non-tradable service activities). Transitory relief from speculative capital inflows can be obtained by an adequate reserve requirement, but large fluctuations in terms of trade are more difficult to control. In Guyana's case, given that most exports are concentrated in markets with support prices (EEC and US) set well above competitive world prices, it is possible that a hidden Dutch disease phenomenon might be hampering expansion of other export sectors. The price premium in sugar and rice is considerable and, although beneficial for the country's finances, may be reducing incentives in other export industries that, due to the availability of foreign currency face an appreciated exchange rate and a low return on production. In essence, this premium is sustaining the exchange rate at an inflated level.

Exchange rate policy brings into play some of the most basic factors in any economy. Experiences throughout the world have shown conclusively that the real exchange rate is one of the most important determinants, if not the most, of the rate of growth of the productive sectors -agriculture, manufacturing and extractive industries. In part the real exchange rate has this effect because it effectively determines relative prices in the domestic economy between the productive sectors (or goods-producing sectors) and the service sectors of an economy. Accordingly, it also has a preponderant influence on relative income levels between those groups of sectors. An overvalued exchange rate leads, in domestic currency, to relatively higher prices of services and relatively depressed prices of manufactures and agricultural goods, and an undervalued exchange rate has the opposite effect.

A classical dilemma for policy is that if the exchange rate is in an overvalued state, pursuit of an equilibrium level for it means a degree of devaluation, thereby raising prices for imported goods in the short run. This result can affect adversely the costs of production for many industries, but if they are export-oriented or compete directly with imports, then the concomitant increase in their output prices will more than compensate for the higher input costs, in terms of the effect on net earnings. In sectors like agriculture, where output materialises several months after an investment in inputs is made, a short-run cash-flow squeeze can arise from a devaluation in the sense that producers have to pay the higher input prices before receiving compensation in the form of higher output prices. Nevertheless, over the span of a year, they will be made better off by a move to a less overvalued exchange rate if they are exporters or they compete with imported products. In overall terms, such a move constitutes the most powerful policy stimulus possible for the trade-oriented sectors.

Appropriate levels of the real exchange rate have been a vital component of the successful, export-oriented economies of the East Asian Tigers, Mauritius, Chile and other countries. In the 1960s and 1970s South Korea, for example, gave the highest priority to preventing the exchange rate from becoming overvalued. It is only in very recent years that the country's development level and its improved trade balance have permitted the real exchange rate to appreciate to a degree, for the previous twenty-five years appreciation of the exchange rate was anathema to Korean policy makers. The same has been true of other East Asian economies in their decades of most rapid growth.

More pertinent to Guyana's case is the above-mentioned fact that the surplus earnings that arise out of international quota arrangements in trade can support the exchange rate at a level which proves to be unsustainable when the value of the quotas diminishes. When this phenomenon occurs, the level of the exchange rate is such as to effectively penalise other export products, and import-competing products too, thus prejudicing the country's growth prospects outside the products that benefit from the quotas. Gold is sufficiently competitive to be able to overcome this handicap, but that is not necessarily the case for many other products.

Seen in this light, the question of exchange rate management is one of ensuring that sectors and products with growth potential for the future are not unduly held back by the present windfall gains that occur under the quotas. In this regard, the quantitative measure to monitor is the real exchange rate,(8) and the fact that in 1995 and 1996 it is below its corresponding level in 1990 (i.e., it had appreciated) gives rise to concern. The exchange rate can be said to be "overvalued with respect to its level of 1990," and it is recognised that that earlier level was not favourable to export development. As noted, the devaluations of 1991 and other special factors accounted for the export boom in rice, sugar and gold, but future progress along those lines will be more difficult to attain. National experts in the sugar and rice industries already recognise the difficulties their sectors face because of the prevailing value of the exchange rate. Eventually the country may have to face a choice between paring back the scale of those sectors' output (and employment) or raising the cost of imported consumer goods through a devaluation.

The choice of an appropriate exchange rate for Guyana presents some difficulties, but there is ample evidence of the devastating effects of policies aimed at controlling the value of the currency. Likewise, ample evidence supports an independent floating currency. For productive and export activities, it is the real exchange rate that has real influence on incentives and profitability and sustained development. In fact, misaligned real exchange rates have been at the heart of all balance of payments crisis in developing countries and, until recently, in Guyana as well. Likewise, appropriate RER levels have been crucial in all successful export-oriented development strategies. Obviously the choice of an exchange regime depends upon, among other things, the structural strength of the economy and Government commitment at pursuing consistent, appropriate macro-policies.

2. Policy Orientations

It is clear from the analysis in Chapter 12 that in the coming years Guyana will require adjustments of the nominal exchange rate in order to maintain the momentum of export expansion, and also to provide appropriate opportunities for some import-substituting industries to develop and thrive. Policy must devise ways to determine: 1) What is the appropriate speed of adjustment of the exchange rate? 2) How can consumers be shielded in part from the effects of exchange rate movement? and 3) What kinds of policy instruments can be utilised to make the exchange rate move in the desired direction and at the desired pace? In addition, clearly the policy must be implemented in a way that keeps inflation within acceptable bounds. These issues figure among the very most delicate of policy concerns, but they go right to the heart of macroeconomic policy and its role in promoting economic development.

Regarding the speed of adjustment, international experience has demonstrated that abrupt and large devaluations are unnecessarily disruptive of economic activity in the short term even though they may provide substantial growth stimulus in the medium term. In any case, it does not appear that Guyana requires a large devaluation to ensure the competitiveness of its export industries. Some sectors, like bauxite, are unlikely to be restored to competitiveness under any foreseeable exchange rate unless major technological breakthroughs are made at the mine site. The same may be true of the Demerara sugar estates (see Chapter 33). Nevertheless, for other sectors, including rice, more labour-intensive processed wood products and non-traditional agricultural sectors, modest movements in the exchange rate can make an enormous difference in their ability to compete on world markets and prosper, as demonstrated in the analysis presented in the section above on Guyana's international competitiveness. From this perspective, it would appear that the overall real adjustment required eventually is of the order of magnitude of 10 to at most 20 percent.

An adjustment of that size can be attained over a period of several years, without causing disruptions, by adopting a policy of successive small devaluations according to a pre-announced formula. An example would be "domestic inflation plus 3 percentage points." That example refers to annual rates of adjustment of the exchange rate, but in fact the adjustments should be implemented on a quarterly or even monthly basis, taking care to smooth observed month-to-month inflation rates before applying them to the exchange rate. Such adjustments can be carried out within the framework of moving bands the exchange rate if preferred.

It should be borne in mind that simply adjusting the nominal exchange rate by the full amount of domestic inflation each year would in fact represent a gain of 2 to 3 percentage points annually in the real effective exchange rate, because of the inflation trends in Guyana's major trading partners. Thus the formula of adding 3 percentage points to the domestic rate of inflation would in fact give a real devaluation of 5 to 6 percent per year, which is more or less the desired rate.

Exchange rate movements will of course raise the domestic inflation rate somewhat. Experience suggests that every five percent movement in the nominal exchange rate will give rise to about three additional percentage points of domestic inflation. While this additional inflation will slow somewhat the pace of attaining the stabilisation goals for the economy, it is a transitory effect and will disappear after the exchange rate adjustments are completed. In fact, over the medium term this kind of strategy would lead to a firmer basis for stabilisation of prices, and the added advantage is higher growth of real incomes and employment in the meantime.

Nevertheless, the issue of inflation does underscore one absolutely vital requirement for success in the such a policy of movement toward an equilibrium exchange rate: the fiscal deficit must be progressively reduced from year to year. If the fiscal deficit cannot be controlled in this manner, then the sequence of devaluations could lead to a ratcheting up of inflation to unacceptable levels. Thus, if the Government cannot be sure of reducing the deficit successively, then the exchange rate adjustments are best postponed until the fiscal balances are more under control, although that would be very unfortunate from viewpoints of growth, employment creation and poverty alleviation.

It must be recognised fully that a country cannot "devalue its way to growth" if the exchange rate already is in equilibrium from a viewpoint of purchasing power parity. However, what it can do, and should do, is correct a disequilibrium in the exchange rate which has arisen for any of a number of reasons, including windfall gains in foreign exchange and the existence of indirect policy controls on the exchange rate, as mentioned earlier. Once the correction is made, the devaluation actions are then terminated, or the exchange rate is then left to fully to (liberalised) market forces. Costa Rica in the early 1980s is an example within the region of a country that successfully readjusted its exchange rate in this sense, and Chile has done so as well.

In the context of the discussion of the implicit "exchange rate tax" that falls on trade-oriented sectors from an overvalued exchange rate, the objective of the devaluation policy in this regard would be to replace that "tax" with additional amounts of explicit fiscal revenues. By raising the import valuations in domestic currency, the devaluations themselves would contribute modestly to greater amounts of tariff collections, but other fiscal reforms would be needed as well (see Chapter 13).

Consumers can be partially shielded from the effects of the devaluations by concomitant actions to reduce the highest range of consumption taxes and import tariffs, including the high tariffs on agricultural imports. As mentioned, elimination of exemptions for tariffs and taxes can compensate the treasury for the revenues sacrificed in this way. Reductions of the high-end tariffs and taxes also will help reduce the temporary spike of inflation that arises from the devaluations.

This kind of policy would restore the proper structural relationship between the exchange rate and inflation: that the former is a result of the latter, and not vice-versa. In the end, inflation must be controlled, and can only be controlled, through elimination of the fiscal deficit. Use of other means to control it simply postpones the day of reckoning. In any event, the progressive, small devaluations will not add much to inflation; they simply will shift the full attainment of stabilisation goals forward in time, while inflation is still coming down.

Policy instruments that can be deployed to ensure an appropriate level of the exchange rate are discussed in Chapter 12.

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D. Monetary Policies

It is recommended that measures and strategies in the area of monetary policy be focused on the following:

Right now, there is no secondary market for security trading. However, with a view to foster work in this area, the authorities modified its rediscounting policy. They have raised the penal rate to a level much higher than the representative rate (i.e., a 91-day treasury bill rate) to encourage more active interbank lending and for secondary market operations in treasury bills between banks and others. To strengthen this process, the Bank of Guyana discontinued the remunerated Special Deposits Facility in December 1994, and established a money-market division in January 1995. In addition, a book-entry system was introduced in November 1995 to hasten the growth of a secondary market in securities.

It is recommended that the development of financial markets in Guyana should begin at the short-term end. To the extent that institutional capacity constrains the development of these markets, the strategy should be two-pronged. First, it should focus on the strengthening of money markets and the enhancement of associated market functions and skills. Some functions and skills should then be transferred to the budding securities and capital markets. Second, it should gradually promote the establishment of institutions required for the expansion of securities and capital markets.

Institution building efforts should focus initially on establishing broker and dealer institutions and guiding them through increasingly complex operations through a proactive and evolving legal, regulatory and supervisory framework. The following is a suggested sequence for the institution-building strategy.

- The development of private placement (i.e., the sale of shares to pre-identified purchasers).

- The promotion of investment companies, that invest in a broad range of securities.

- The promotion of unit trusts that contribute to wider share ownership and are geared to liquidating holdings rapidly when the need arises.

- Promotion of flexible over-the-counter markets between existing brokers and dealers. Over-the-counter trading will ultimately lead to more formal trading mechanisms that will eventually be housed in a stock exchange.

Legal, regulatory, and prudential frameworks should be developed for purposes of governance and supervision of the above arrangements.

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IV. Fiscal Policy and the Public Sector

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A. Objectives of Fiscal Policy

In the end, the appropriateness of the fiscal policy stance is often related to the size of the budgetary deficits. Domestic borrowing to pay for the excess of spending over revenues received causes prices and interest rates to rise. Thus, an expansionary fiscal policy, although raising aggregate demand (by increasing government consumption), typically reduces the rate of private sector investment.

The fiscal policy stance should continue to focus on the limitations of excess demand or curtailing government consumption in order to improve real rates of savings and permit more appropriate modes of financing of the deficit. Reduction of the deficit should be focused on the structure of revenues and expenditure priorities; this provides for the prioritisation of expenditure and the securing of revenues that are due to the State. The main objectives of revenue policy are: a broader tax base; a more uniform rate structure within each type of tax, a reduction of the reliance on indirect taxes, greater revenues from user fees, and improved tax collection methods.

The objectives of fiscal policy regarding the financing of the deficit should be focused on preventing the effects of "crowding out" of the private sector by restricting government borrowing from the domestic banking and non-bank systems.

Expenditure policy needs to give priority to the basic social needs for health, education, and poverty alleviation, and also to social infrastructure such as potable water and sewerage systems. Subsidies and transfers need to be well targeted on social priorities. The management of expenditures should be greatly improved, in the context of a thorough-going reform of the public sector. Finally, the privatisation programme should be accelerated and a role defined for the Government which is more appropriate for the economy in the present era.

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B. Fiscal Policy

1. The Role of Government

The experience of the last few decades has demonstrated that Government cannot be effective in achieving its mandated aims when it is spread too thinly and tries to guide directly the productive spheres of the economy. In addition, such an orientation on the part of Government has the effect of discouraging private initiative and fostering a mentality in the private sector which seeks favours through edicts of public policy rather than emphasising its own productive efforts.

The policy of Government is based on the premise that the private sector must be the engine of growth, that is, of creation of employment and incomes. Government is primarily responsible for assuring the provision of the basic social services and infrastructure that the nation requires, although, in many instances, the actual mechanism of providing such goods and services will be that of contracting with the private sector. Government also will strengthen its regulatory and monitoring roles in the economy, especially in areas of natural resource development such as mining, forestry and fisheries, but also in other key sectors of the economy such as banking and insurance. Above all, it will undertake to ensure that the basic needs of the poorest groups in the population are met.

An important implication of this policy stance is that Government does not require ownership of the means of production in order to carry out its role. On the contrary, ownership of factors of production by the private sector improves the incentives for investment. Accordingly, the privatisation programme will be accelerated and greater reliance will be placed on the mechanism of concessions for development of transport facilities and other forms of infrastructure, beginning with the proposed export processing zone. In the same spirit, the tenure status of agricultural land will evolve over time so that there is a predominance of the forms of freehold and tradeable leases.

This policy orientation will improve the Government's revenue base, thus enabling it to provide better support to essential social programmes, and it will allow Government to play its role of oversight and regulation more effectively by concentrating its effort and emphasising staff training for those purposes.

With regard to the public sector accounts, beyond question Government plans to continue to pursue its course of reducing the fiscal deficit. As long as the deficit is present to a significant degree, it not only threatens to spark a revival of inflation but it also affects interest rates, and therefore the volumes of private investment. Furthermore, its financing adds to the Government's stock of indebtedness at the very time when that stock needs additional reductions. Another deleterious effect of the deficit is that it inhibits portfolio diversification into productive investments on the part of financial institutions. For all these reasons, strengthening the revenue base and continuing to reduce expenditures are actions that will continue to command priority attention from Government in the coming years.

2. Revenue Collection

The following policies will improve the government revenue collection:

a. Capital Revenues

The pace of the privatisation programme will be enhanced. The government will focus on divesting some of its financial and non-financial holdings so as to improve the growth of proceeds from divestment; this will provide a significant source of capital revenues at least in the short to medium term, perhaps of the order of G$1 billion per year. As regards external capital funding, Government will continue its policy of reducing the interest rates on outstanding obligations wherever possible, through substitutions of new soft loans for existing loans.

b. Institutional Aspects of Revenue Collection

It is essential to implement the Revenue Authority as planned and support its activities with the necessary funding, staffing, and infrastructure. The incorporation of IRD and Customs into one body should reduce administrative inefficiency, informational gaps, and confusion of responsibilities.

It is also important to implement the proposed Unique Tax Identification Number framework, as a replacement to the faulty record-keeping systems of IRD and Customs. A computerised system will be provided to facilitate duties. This would update the information on taxable resources and allow for easier and more comprehensive collection of taxes by the Revenue Authority.

Training of staff is vital to Government's ability to collect revenues and will be pursued. This includes not only technical training, but management training as well. There is a great need for adequate personnel and training in adequate systems.

The problem of staff vacancy in revenue collecting bodies is a serious one, especially at the level of the more skilled positions and data-entry clerks. According to the Ministry of Finance, Customs & Excise had a vacancy ratio of 36 percent at the end of 1995, and 54 percent in the Ministry of Finance. This issue ties in with the greater problems of poor public sector wages. The issue of wages must be tackled before any other reforms can be properly implemented. It would be preferable to consolidate some of the vacancies into more highly-skilled positions, because a well-trained person with a good computer system at his or her disposal can make great progress in enhancing revenue collections.

c. The Structure of the Tax Regime

The tax code has been improved in recent years, but it needs further rationalisation in the interests of fairness, efficiency and ease of collection. Some of the principal options to be reviewed in this regard are the following:

One of the advantages of a VAT is that it has a larger component of self-enforcement of other tax systems and it permits easy cross-checking, since both purchaser and seller of intermediate goods and services file their receipts with the tax authorities. Therefore a VAT should reduce tax evasion.

At the other end of the scale, tariffs that are too high simply encourage evasion, so consideration will be given to reducing somewhat the top rates for "luxury" goods.

Property taxes are gaining increasing favour throughout the developing world as a revenue source. However, plans to launch them oftentimes run aground on the shoal represented by lack of up-to-date cadastral information. This obstacle can be circumvented by the expedient of establishing uniform tax rates per acre for agricultural land, and not per unit of value of the land. It is important not to establish too many categories of land for tax purposes, because that can introduce a large element of subjectivity into the taxation process. It is preferable to define at most three or four categories, such as coastland and hinterland, with and without irrigation, and establish a uniform rate per acre within each of these categories. In addition to generating revenue from a lightly-taxed sector, such a land tax has the significant benefit of encouraging more productive use of the land. A landowner can hardly leave the land idle, or underutilised, if he or she is required to pay a tax on it.

These changes in the structure of the national taxation system should result in a system that generates significantly more revenues and at the same time is fairer and more conducive to economic growth.

3. Expenditure Management

The following proposals are recommended to improve government's expenditure management:

a. Capital Expenditures

There should be a clear distinction between capital and current expenditures to estimate effectively the levels of expenditures needed to ensure that capital works are efficiently undertaken consistently with national objectives. This will reduce expenditure overlapping that is a result of substituting one category of expenditure for another, for example, substituting rehabilitation works for maintenance.

Technical management needs to be improved. Most capital works are stymied by the lack of technical competence to undertake required works and results in over-expenditure and inadequate quality. Also lack of technical competence severely affects the implementation of larger projects, resulting in delays in the completion of projects and reducing the estimated returns on the project.

Local systems should be put in place to guide project preparation and execution. Major investment projects in the past were not designed locally but rather outside the country and the Government had little say in their design. This allowed for projects to be alien to local technicians and resulted in many bottlenecks that slowed the execution of the project. More often than not, delays in the projects funded from external sources necessitate penalty fees that add further strain to the budget.

b. Current Expenditures

Policy on fiscal expenditures over the period of this Strategy is governed by three priorities:

Increasing real expenditure on basic social services, especially health, education and poverty alleviation.

Increasing real expenditure on productive infrastructure, especially transport and energy.

Increasing real salary levels in the Public Service by a significant amount, especially in the upper ranks.

Although fiscal revenues undoubtedly will have to increase so that these expenditure priorities can be met, a number of measures can be taken to ease the required net growth in revenues. They have been mentioned elsewhere in this Strategy; they may be summarised as follows:

Implementing a policy of partial cost recovery in the fields of health and education.

Improving administrative efficiency in both these fields, as discussed in Chapters 19 and 20.

Utilising the mechanism of concessions to the private sector for the construction and operation of productive infrastructure, including roads, bridges, ferry services, and water and sewerage systems.

Proceeding with the privatisation of GEC and evaluating the possibilities of eventually corporatising water and sewerage systems and harbours, as is being done in a number of countries in the region.

Pursuing gradual approaches to reducing the size of Public Service, especially in the lower ranks, including natural attrition, acceleration of retirement, prevention of moonlighting, enforcement of the retirement age, and so forth.

In share of total Central Government expenditure devoted to health and education, Guyana still falls well below international norms, as may be seen from the following data on those shares for developing countries in different regions of the world during the period 1989-92:(9)

Education Health

Africa 15.7% 6.0%

Asia 14.0% 5.5%

Middle East 14.3% 5.5%

Western Hemisphere 13.9% 10.2%

Global average 13.0% 6.4%

Memo: Guyana, 1994 6.3% 6.7%

The shortfall in Guyana is most pronounced in education. In health, we appear to be closer to the international norm except when compared with the average for our Hemisphere. However, it must be borne in mind that in most countries in Asia and Latin America the private health care systems are relatively more developed, and therefore our total share of public expenditure represents relatively less coverage of health needs than appears at first glance.

In order to meet the pressing needs in these sectors and restore them to their former preeminent state, goals for shares of public expenditure for these vital sectors in Guyana are as follows:

Education Health

Year 2001 10% 8%

Year 2006 14% 10%

To the extent that private services in both sectors grow over time, these goals could be moderated somewhat, but the fundamental point is that more expenditure is urgently needed in both fields, as well as improvements in the efficiency with which expenditures are administered.

Another basic budgetary reform that can assist significantly in helping meet basic social needs is to ensure that subsidies are well targeted on the lower-income groups. This means, among other things, charging large farmers for agricultural extension services, and requiring that better-off families pay fees for selected medical services and also that they pay basic fees to cover part of schooling expenses.

There is a linkage between the capital and recurrent budgets that requires more attention, viz., O&M costs. For new projects addressed during the planning process, the O&M costs should be built directly into the budget. Implications for the recurrent budgets should be worked out early, rather than capitalizing those accumulated costs into new investments. Only with sufficient provision for O&M are investments sustainable in the long run.

4. Resource Utilisation

In the area of resource utilisation, the aim should be to implement an efficient national budgeting system, which would require tackling the problems identified in the legal framework, the organisational arrangements and the budget process. This should be done for the following reasons:

It creates the linkages with Government's overall development strategies and priorities;

It provides the key tool to enforce the spending disciplines which help to ensure macro-economic stability;

It establishes the best use of scarce resources;

It evokes public confidence in the Government's financial management;

It creates accountability in sector ministries;

It facilitates decision making and implementation of decentralisation policies;

It points out policy overlaps and gaps; and,

It brings policy coherence questions into the open.

In addition, it is essential that the important links between resource utilisation and the National Development Strategy are realised. For instance, the budget process is a principal way in which the NDS will actually get implemented.

The subject of resource utilisation is developed more fully in Chapter 13.

5. Public Service

Despite the reforms already implemented much remains to be done to improve public service performance: the size of the public sector needs to be reviewed; there is a need for a pay policy, and incentive structure; job evaluations; setting and maintaining staff establishments which reflect the real needs of the Public Service; developing systems for the generation, storage and dissemination of operating and management information; and improvements in accountability.

It should be noted that this reform process must include dialogue with interested parties, and participation from the highest levels in the sector ministries and agencies if the reforms are to be lasting and sustainable. The process must also be sensitive to the political and economic realities of Guyana.

There should also be consideration of how staff in the civil service can be retrained, either to fill vacancies at higher levels, or to take advantage of alternative employment opportunities in the public sector.

Additional specific measures that are needed include the following:

The standardisation of recruitment and evaluation procedures. There also needs to be a clear framework for disciplinary procedures. One possibility would be to devolve some of the responsibility for disciplinary action to Disciplinary Committees established within sector ministries under the guidance of Permanent Secretaries. In general, managers should be given greater control over staffing issues. The idea of the public sector as a source guaranteed lifetime employment may need to be reassessed, though only in the context of higher wages to compensate for the greater risk of redundancy.

The introduction of a clear and complete system of information regarding vacancies.

The introduction of transparent procedures for the evaluation of performance and for the linking of incentives to performance. The issue of a merit based appraisal system should be considered, and a promotion scheme, in which there would be incentives for increased performance through increments to salaries and/or promotion.

The development of a transparent pay policy.

A review of the actual needs of the civil service as they relate to establishment levels to fulfil Government policies and priorities. There needs to be a comprehensive project to look at what establishments are and whether they are needed. For a start, we need to determine whether all people on the payroll actually exist.

Initiating programmes to retrain lower level staff as the recruitment of high level staff progresses.

Develop a comprehensive recruitment policy, so as to attract technical and professional staff. This issue was addressed to some extent under the World Bank-supported Public Administration Programme, but remuneration levels were not set at a sufficiently high level to attract the numbers of staff the policy had envisaged.

Given the fundamental nature of many of changes being considered, managers need to be trained to manage the change effectively.

6. Semi-Autonomous Agencies

The basic policy thrusts required to deal with the issues concerning SAAs are the following:

Clarification and standardisation of procedures for setting up SAAs, with an emphasis on the transparency of the process.

Clarification and standardisation of administrative and policy powers of SAAs, giving them the authority to make policy decisions in their respective domains.

Streamlining the mandates of SAAs to eliminate overlap and to allow the agencies to focus their activities on fulfilling those mandates.

Rationalisation and institutional strengthening of existing SAAs to enable them to operate more efficiently and where applicable in a financially sustainable manner.

Rationalisation of SAA wage and employment policies so that they conform to a standard structure rather than the dictates of high-level officials.

Institution of a system of monitoring the SAAs to ensure they are operating efficiently and effectively and in consonance with their mandates.

Specific measures to put these policy thrusts into practice include:

An extensive review of existing SAAs with the aim of disbanding or restructuring those which have outlived their mandates.

Establishment of guidelines and a standard legal framework for the creation of SAAs, relating to, for example, organisational structure, linkages with the civil service, staffing regulations, salaries, and revenue generation and subventions.

Standardisation of the definition of the different types of SAA and development of corresponding operating procedures for each type.

Verification of their mandates, and determination of options for how the agencies can better fulfil their mandates.

An institutional analysis of the relations between SAAs and Central Government. Ways to provide SAAs increased autonomy and decision-making power should be formulated under this study.

A financial analysis of the agencies. Issues to be addressed include a clarification of the funds each SAA may retain if it is a revenue generating body and a standard and transparent procedure for Government subventions. The financial sustainability of all SAAs must also be examined, including ways in which the agency can generate revenue through and for its activities.

Greater autonomy and decision-making power should be vested in the Boards of Directors of SAAs to allow them to fulfil their mandates without undue political interference.

Development and implementation of monitoring system for SAAs to promote their more efficient provision of goods and services

7. Public Corporations and Privatisation

The Government's privatisation strategy is now being clarified and the process is moving forward with greater dispatch. To complement this momentum, it is important to carry out the following additional measures:

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V. Debt Management

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A. Domestic Debt

Even with declining interest payments on domestic debt over the last few years, those payments are still very high. Already, the increasing share of interest payments in the recurrent budget has crowded out other important public sector programmes, almost all of which require purchase of materials and supplies and expenditures on personal emoluments. The Government has maintained a fairly stable level of foreign exchange reserves over the last six months, and in the medium term would have to maintain an import cover of about six months. The need for this measure arises because of the vulnerability of the economy to uncertainties in Guyana's export arrangements. Also with the scheduled elimination of foreign exchange surrender requirements next year, the Bank of Guyana may have to buy foreign exchange to meet its foreign exchange targets. By maintaining a modest import cover, pressure on the exchange rate would be reduced at the outset of the new policy, thereby avoiding a crisis of confidence in the market. But the key to reducing debt service is (i) better forecasting of excess liquidity in the system and the appropriate levels of treasury bills necessary to mop up this excess liquidity; (ii) prudent fiscal and monetary policies to lower inflation; and (iii) reduction of the domestic debt itself.

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B. External Debt

The objective of seeking further debt relief is to reduce the debt burden, maintain debt sustainability in the long run, and release budgetary resources for other priority activities. The elements of the strategy will include the following measures:

(i) maintain sound policies to generate rapid growth so as to further reduce the debt burden. The elements of these policies will include providing an improved policy framework for supporting exports and policies to promote competitiveness;

(ii) as part of the May 1996 agreement, Guyana committed itself to securing comparability of treatment for the debts owed to other external public or private creditors. The comparability of treatment would be assessed on the basis of reductions in the face value of debt and/or the terms of repayment on debts not cancelled in net present value terms. The application of Naples Terms to the debts owed by Guyana to the main non-Paris Club creditors would result in additional write offs worth an estimated US$145 million. The Government has already approached a number of these bilateral creditor countries to seek equivalent debt relief.

(iii) although the stock of debt operation under Naples Terms was meant to represent a permanent exit from rescheduling, Guyana can still make a case that debt service represents an undue stress on its resources and apply for a second stage operation. In this respect, Guyana will need to have maintained a good track record of macroeconomic performance and be prepared to approach the Paris Club in the event that the decision is taken to offer severely indebted low-income countries additional write-offs, which are believed to be of up to 90 percent.

It is in this context that the outcome of the present discussions on the sale of some IMF gold reserves is of major interest to Guyana. Nevertheless, concrete decisions on such a facility and the definition of instruments are not expected soon, in part because the nature of commitments to ease the burden of debt and how the roles of various creditors and donors would have to determined. Even so, a 100 percent write-off of the debt owed to the Paris Club would not significantly reduce the debt burden. We need relief from multilateral agencies. The only reason the May 1996 Paris Club agreement proved possible was that Trinidad and Tobago joined on an exceptional basis. However, it unlikely that Trinidad and Tobago could generate the political will to bilaterally reduce the debt obligations of Guyana for a second time.

For Trinidad and Tobago to participate in a second debt reduction facility for Guyana, it may have to be offered a triangulation deal, whereby it could repay its own debts to the Paris Club with debt owed to it by Guyana. At that point, the Paris Club donors could apply a second stage Naples Term operation to the new debt owed to it by Guyana.

In addition, the Government will (i) continue to borrow at concessional terms and retire some non-concessional debt with concessional borrowing; (ii) avoid the accumulation of arrears so as to maintain Guyana's creditworthiness and reduce its country risk in the international financial community; (iii) seek to reduce the cost of debt servicing through schemes such as redemption price, debt for nature swap, debt for aid, debt for equity swaps, and other local currency debt swaps; (iv) link the ongoing privatisation programme with the domestic and/or external debt reduction through swaps and other mechanisms. The justification for using privatisation revenues for the repurchase of debts is that the public companies themselves contributed to the accumulation of these debts in the past.

The Government will also consider options in swapping foreign debt for domestic assets and for concessions for the exploitation of natural resources. Considering the narrow domestic financial market and the need to inject new technologies into the production process, direct foreign investment will be crucial in generating sustained growth. A divestiture programme will provide one of the vehicles for this. Further, like Costa Rica, Bolivia and Surinam, Guyana will continue to seek assistance from the international community in debt reduction operations which swap existing debts for a commitment to preserve unexploited selected areas with high environmental value. Under such agreements, environmental groups buy, usually at a large discount, part of the outstanding stock of debt and exchange it at a lower discount for Government bonds paying an agreed-upon interest rate. The proceeds of the payments are used to finance monitoring and management of the protected areas. (In this regard, see also the proposal for an endowment to finance non-timber concessions, developed in Chapter 18.)

Finally, with respect to the use of debt relief and privatisation revenues, the Government will review and rank debts by their term structure. For instance, the Government will need to know whether the highest economic rate of return derives from the rapid repayment of external or internal debt. While it accrues at a lower rate of interest, the external debt is dollar-denominated and carries an exchange risk. That is, the domestic debt, although currently accruing at higher nominal rates of interest, must be weighed against the foreign interest rate plus the expected rate of exchange depreciation in the medium to long term. In the simplest of cases, the Government, for example, may choose to sterilise privatisation revenues with the repurchase of external or domestic debt.

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VI. Banking Policy

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A. Objectives

As for the commercial banking sector, the major objective is to promote the viability of the banking system while preserving competitiveness and sound financial environment. The seminal work of Gurley and Shaw (1956) shows that financial intermediaries in general, and commercial banks in particular, have an important economic role to play simply because financial markets are imperfect. Among the imperfections that produce a need for financial intermediaries are the varied nature and terms of financial claims, the corresponding transaction costs of search, acquisition, and the diversified nature of lenders and borrowers. Financial intermediaries exhibit economies of scale with respect to such costs. By exploiting market imperfections financial intermediaries do alter the yield relationship between lenders and borrowers, thus providing higher returns to the former (at a given level of risk) and lower costs to the latter than would be possible with direct finance.

A major goal is to enhance the mobilisation of financial savings in a way consistent with the stability of the financial system. Stability in this context refers to the ability of the financial system to withstand disturbances, including those that may arise internally. Economic problems in a financial enterprise have been frequently cited as potential sources of disturbances. In view of this, banks and other financial institutions need regulation and supervision aimed at limiting their exposure to risk, while ensuring that they maintain an adequate margin to deal with economic strain. Regarding the criterion of "soundness," the thrust of policy will be the establishment of financial legislation with the purpose of protecting consumers (borrowers) and suppliers of resources (depositors). This implies that legislation should be put in place to ensure that suppliers of resources have access to their money on the terms agreed upon and that they are knowledgeable about these terms and that deposits are adequately insured. Soundness in this context will therefore afford consumers the opportunity of making intelligent portfolio decisions based on their assessment of the level of services, interest rates, risk, maturity of investment, and so on.

Like soundness, the criterion of "efficiency" is sometimes difficult to define or interpret. In a general sense, efficiency indicates that the financial intermediation process is carried out in a way that contributes to an optimal distribution and use of savings and other resources. In other words, the idea of "efficiency" would ensure that economic agents cannot earn abnormal profits by trading in the market at prevailing prices. In practice, competition is viewed as the best instrument for promoting efficiency. This is so because it encourages the development of new and better techniques, institutional solutions, and management strategies.

Another aspect of the efficiency of the financial system is its ability to meet the term structure of demand for financial instruments, and in this area Guyana's financial system is notably deficient to date. The mobilisation of the level of long-term financing required to sustain the long-term growth path in Guyana, would require the establishment of securities and capital markets. These markets are essential to development since they provide long-term debt and equity finance for the corporate sector and the Government. By making long-term investment liquid, securities and capital markets mediate between different maturities and maturity preferences of lenders and borrowers. Moreover, these markets facilitate the spread of ownership and the reallocation of financial resources between corporations and industries. They also permit financial institutions to hedge against risk over term structures.

Among the prerequisites for the establishment of such markets are: (1) a demand by businesses for long-term funds; (2) an adequate level of savings of both individuals and institutional investors; (3) a good regulatory structure; (4) a strong judicial system; (5) leadership by the Government in establishing long-term instruments; and (6) a monetary policy environment in which the issuance of short-term debt instruments by the Government does not play such a dominant role. Prerequisites (1) and (2) appear to be satisfied, but policy makers need to work on (3) through (6).

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B. Policy Recommendations

1. Improving Accounting and Disclosure Standards

Reporting and accounting standards and practices vary across banks in Guyana. An improvement and some harmonisation of accounting and disclosure practice are highly recommended since it would enhance transparency in financial markets. Although some measures have been taken to address this issue, much more need to be done. Under section 22, subsection (1) of the FIA, every licensed financial institution will appoint annually an auditor.

At present, the local operation of a foreign-based bank does not publish independent accounts, but rather these are amalgamated in a consolidated statement. A statutory requirement needs to be issued to the effect that separate financial statements for local operations should be published, to permit the necessary supervisory scrutiny and to guarantee transparency and facilitate assessment of these local operations.

2. Credit Concentration

Legal amendments to reduce credit risks are essential to maintain the stability of the financial system. Of the various risks faced by banks, credit risk appears to be the one of greatest concern. Three main factors have influenced the heightened concern over credit risk in Guyana:

a. The recent trend towards deterioration of the loan portfolio of some banks.

b. Enhanced awareness of credit risk following the introduction of the capital accord.

c. Difficulty in assessing credit standing of borrowers as well as credit exposure in view of a changing financial environment and the paucity of relevant statistical data.

In dealing with this issue, the regulatory authorities have placed limits on loan concentration. The provisions under Section 14(1) of the FIA seek to limit the exposure of a licensee to a single person/borrower group in the case the person/group fails to repay the credit. The relevant provisions state:

"A licensed financial institution shall not grant to any person, or borrower group, any loan, advance, financial guarantee, or other extension of credit, or incur any other liability on behalf of such person or borrower group, so that the total value of the loans, advances, financial guarantees or other extensions of credit, and other liabilities is at any time, in respect to such person, more than twenty-five percent of its capital base, or in respect of such borrower group, more than forty percent of its capital base, and where any portion of the total value of loans, advances, financial guarantees or other extensions of credit or other liabilities is unsecured, that portion shall not exceed ten percent of its capital base in the case of a person or twenty percent of its capital base in case of a borrower group."

While the limits imposed on credit concentration are commendable, additional measures are required. The imposition of limits on an individual borrower or borrower group is necessary but not sufficient. A bank lending four individual borrowers an equal amount equivalent to 24 percent of its capital base would be acting in conformity with the letter of the law. However, in such over-concentration of credit a bank would evidently be excessively exposed. Thus, while the single borrower's limit is useful, supplementary regulations are needed to prevent excessive credit concentration among a few borrowers and within a specific sector.

3. Resolving Legal Uncertainties

Informal discussions with financial market participants in Guyana reveal that there is both a great deal of ignorance of and uncertainties about the various financial laws. A recommended measure to deal with this issue is the establishment of a Legal Review Committee formed by legal practitioners. Such a committee should be charged with the responsibility of identifying areas of obscurity and uncertainty in the laws affecting financial markets. The Committee should also be responsible for proposing possible solutions to promote greater legal certainty. More important, the Committee should formulate recommendations for improvements in the judicial system that would promote tighter enforcement of contracts.

4. Provisioning Requirements Relating to the Quality of Loans

As stipulated under the FIA, supplementary regulations dealing with provisioning for bad debts have been drafted. According to the proposed regulations, all depository institutions will conduct, at least, annual reviews of their credit portfolio and submit the results to the Bank of Guyana. The proposed regulations provided a common minimum standard to be applied in the classification and provisioning of credit assets. This minimum criteria and standards are intended to provide a yardstick against which one can assess the quality of loan portfolios and the adequacy of reserves. The provisioning in the supplementary regulations to the FIA is likely to erode the capital base of some deposit-taking institutions but nonetheless is essential to guarantee the stability of the financial system.

5. Developing Long-term Financial Instruments

The Central Bank will take the lead in developing rediscount instruments for both mortgages and medium to long-term production loans, to encourage commercial banks to diversify their portfolios in the direction of providing greater volumes of long-term finance. It will also, as a priority matter, conduct study on the issuance of long-term real return bonds, a form of indexed instruments, as well as direct U.S. dollar-denominated instruments. Widening the country's scope of financial intermediation in these ways is urgent.

6. Deposit Insurance

It must be recognised that deposit insurance is a two-edged sword, raising as it does the question of moral hazard in respect of the behaviour of financial institutions. There are several cases, including Argentina and Chile in this continent, in which the existence of implicit or explicit deposit insurance has induced high-risk strategies on the part of banks, leading to the need for massive infusions of financial resources to rescue them during crises. On the other hand, uninformed depositors, especially those with lower incomes, need protection from risks they cannot properly evaluate. Therefore the policy will be to establish insurance coverage for deposits of up to G$500,000, with that limit revised annually to keep in step with changes in the consumer price index. This policy will achieve both the goals of reducing incentives for risk-taking by financial institutions and encouraging the continuing mobilisation of resources.

7. Developing Greater Understanding of New Instruments and Activities

Evidently, market participants, including the central bank and other supervisory and regulatory bodies, must have a full understanding of what is involved in the financial deepening process and the risk faced individually and collectively by various participants in the financial markets. Cooperation between market participants and the Central Bank is needed to achieve such an understanding. It is essential that the Central Bank further develop its existing expertise with respect to market instruments and mechanisms. There is also great need for all market participants to have more comprehensive and meaningful statistical coverage of financial operations of financial intermediaries.

8. Supervision of Financial Institutions

The various reforms taking place in the financial sector in Guyana have highlighted the importance of supervision and regulation. It is widely agreed that the supervisory authority must have sufficient legal powers if it is to fulfill the purpose for which it was created. Adequate legislation to support an effective supervisory activity is required. Without it, there is potential risk that the supervisory authority will be regarded as a "toothless animal" by the entities it supervises.

Under the Financial Institutions Act of 1995 the Bank of Guyana is responsible for the supervision of licensed financial institutions. A set of supplementary regulations has been drafted and distributed to commercial banks to solicit their reactions. The proposed legislation should have three characteristics: flexibility, transparency, and fairness. The legal system should permit sufficient flexibility to give supervisors the ability to respond quickly and flexibly to changing markets and conditions. More attention should be given to the need to provide adequate transparency to enable financial market participants to understand what is required of them. Section 5 of the FIA highlights the requirements for granting a licence to conduct banking or other financial business in Guyana. However, despite satisfying all the requirements of the Act, a licence may only be issued after consultation with the Minister, raising serious concerns about the transparency of the procedure. The criterion of fairness would require the laws and regulations to be perceived as being "even-handed" thus ensuring that a subset of financial players are not placed at a competitive disadvantage. Therefore, this requirement of consultation needs to be eliminated.

The question of the autonomy of the supervisory body continues to be a source of debate. There is no conclusive agreement whether the supervision of the financial institutions should be conducted by an independent body or by the Central Bank. An independent body would certainly require funding, but direct funding from the State may not be appropriate since the supervisor may be subjected to political control. On the other hand, obtaining funding from the industry they regulate is also not considered the ideal solution. As for this, the notion of conflict of interest is likely to arise. In view of the situation, there is strong support for the supervisory body to remain part of the Bank of Guyana, and that is the policy adopted in this National Development Strategy.

The development of an effective supervision system would require a continuous focus on the following areas:

9. The Structure of the Banking Sector

Continuing the policy that was initiated in 1994 with the sale of Government shares in GBTI, the State's partial holdings in GBTI and NBIC will be disposed of in stages, as follows:

10. Home Mortgage Institutions

The New Building Society (NBS) has changed the composition of its asset portfolio over time and now the value of its T-bill holdings is approximately three times that of its mortgages. Clearly this pattern is not consistent with its mission as originally envisaged. While respecting the institution's need to have a measure of portfolio diversification, steps will be taken to reduce its T-bill holdings to no more than one-third of the total portfolio. In the one exception to the rule of on-lending of external funds at market interest rates, international funding sources will be sought for mortgage finance, at concessional rates.

An orderly closure of GCMFB will be arranged, and its remaining liabilities and performing assets will be transferred to the NBS.

Government also will explore the possibility of establishing a rediscount line in the Central Bank for mortgage finance.

11. Bank Collateral

The main concern in the area of collateral has been related to agricultural land tenure and urban land titling. The land tenure reforms proposed in Chapter 29 of this Strategy, of making leases tradeable and longer in term and accelerating the process of conversion of leasehold to freehold, will help immeasurably to reduce lending constraints related to the quality of collateral. In the same sense, it is urgent to accelerate the process of titling urban land, including for squatters who have recognised occupancy, in order to enable an expansion of mortgage lending to take place.

12. The National Insurance Scheme

There are important concerns about the long-run actuarial soundness of the National Insurance Scheme, as well as about its high administrative costs and operational problems in meeting its health insurance obligations. As mentioned in Chapter 17 of this Strategy, these issues will be addressed in a thorough going review of the NIS, its role, functions and financing. Cabinet-level recommendations will be formulated on the basis of such a review.

13. Equities Markets

The limited scope of the present call exchange and the obstacles to the launching of a stock exchange have been described in previous sections of this Chapter. Because of those considerations, the most appropriate course of action would be for Guyana to join forces with other countries of the region in an initiative to create a Regional Stock Exchange for the Eastern Caribbean. A request will be presented to CARICOM to sponsor an initial study of the concept, its prospects and the issues it raises. The paper will be circulated to governments of the region for review and comment, and if there is sufficient consensus a feasibility study will be undertaken. An interesting precedent in this regard is Central America, where steps are underway to create a regional stock exchange.

14. The Autonomy of the Central Bank

As a necessary step in improving the degree of independence of the Bank of Guyana, its net worth will gradually be restored to positive levels, thereby compensating it for the losses on foreign exchange transactions that it incurred on behalf of the Government (see Chapters 12 and 14).

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VII. Growth Prospects

Chapter 16 develops quantitative growth scenarios, taking into account all the principal macroeconomic variable. The range of real aggregate growth explored is from a little over 5 percent per year to about 7 percent per year, for the period 1996-2004, with the outcome depending on both internal policies and external factors.

The reader is referred to the details of the projections in that chapter.

1. Data on the experience with the EPZ in the Dominican Republic is striking. The direct employment in EPZs increased from 500 workers in 1970 to 165,000 in 1993. The expansion, however, was not evenly distributed in time; in 1980 there sere only 18,000 workers in EPZs; by 1985 they had increased to 35,000, and by 1990 EPZs employed over 130,000 workers.

2. Dominican Republic figures show that investment effects are sizable. In 1975 there were 35 firms operating in EPZs with accumulated net assets in the range of US$ 42 million; by 1985 the number of firms increased to 144 with combined assets of US$ 102 MN. As of 1993, over 450 EPZ firms had assets in the range of US$ 400 million.

3. Total factor productivity in EPZs increased as fast as 4.5 percent per annum in the Dominican Republic in the 1982-93 period, while in the rest of the economy it remained stagnant.

4. See note 4 in W. Max Corden "Exchange Rate Policy in Developing Countries" in Approaches to Exchange Rate Policy, IMF Institute (1994).

5. Since the country is not servicing its debt entirely, a more appreciated real exchange rate is the likely outcome. If Guyana were to service all its liabilities, a larger trade surplus would be required and, consequently a more depreciated RER.

6. Regarding the RER faced by producers, it should be recognised that the G$ to US$ relationship may be to some extent misleading as most of the transactions are undertaken within the EC and, thus, not quoted in US$.

7. This is known as the Dutch disease case.

8. The real exchange rate is usually called the real effective exchange rate when it is calculated in a way that takes into account the inflation rates in all the country's trading partners.

9. Source: World Bank, Latvia Public Expenditure Review, 1994.

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