Chapter 12: THE EXTERNAL SECTOR AND MONETARY MANAGEMENT⁽¹⁾

DRAFT August 7, 1996

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I. Basic Characteristics and Policies of the Sector

During the past five years Guyana has undertaken important steps toward stabilising its economy and initiating major reforms in foreign trade, the role of the public sector, and the establishment of a market economy. Reforms not only have opened the economy to international competition but also have promoted the necessary realignment of key prices (real exchange rates, interest rates and wages). Despite the usual costs associated with a liberalisation process the response of exports, and production in general, has been remarkable.

It is clear, however, that the current situation concerning foreign trade is still far from being the required one for long-term development. Nominal tariff levels still provide protection to many import-competing goods and raise costs to exports; likewise, uneven rates of effective protection through administrative measures (including tax holidays, tariff exemptions, etc.) further distort incentives in the tradable sector.

The presence of market distortions, coupled with a very fragile fiscal stance at both the domestic and the external front, raises concerns on the part of private investors on the solvency of the Government and, in the end, of the entire economy. In turn, this translates in investors demanding a high return to cover projects from country risk and reducing investment levels.

Thus a key element to overcome the investment limitations consists in reducing Guyana's country risk, a difficult task when considering the size of the foreign and domestic debt overhang, and the expected weakening of some key export prices in coming years. Nevertheless, rapid export growth surely would be one of the main components of a solution to these concerns.

The four most important determinants of foreign trade in Guyana are world market conditions, domestic production capacity, Guyana's structure of protection, and its preferential access to protected areas, such as sugar and rice markets in the European Union, the United States and the economies that conform the Caribbean Community (CARICOM). Exports have grown rapidly in recent years, mostly because of changes in internal economic policies, but in the future their growth will depend also on conditions in world markets. Large differentials in prices implicit in the quota arrangements currently allow Guyana to capture an important economic rent, that is, profits that are well above the normal return to export activities. Although the immediate effect of these rents is beneficial to the country since it amounts to a transfer from richer economies to Guyana, the extent to which these rents are captured by local producers or by the Government largely determines the current and future efficiency of the production of these goods. If most of the rent is passed to the producer, then the incentives to produce goods efficiently are greatly diminished as the rents go to pay for inefficiency, possibly jeopardising long-term production and export performance. Therefore, the distribution of these rents is an important policy issue, along with the decisions on the levels of economic protection and other policies that affect trade.

This Chapter examines the basic conditions in world markets and Guyana's policies in the inter-linked areas of economic protection, including the exchange rate, and monetary policy.

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A. Evolution of Foreign Trade

Guyana experienced grave balance of payments' difficulties from the late 1970s to the early 1990s. Current account deficits increased from 3 percent of GDP in 1974-75 to 33 percent in 1981-83; during the 1984-88 period, deficits declined moderately to an average 26 percent of GDP mainly as a result of compressed imports (see Table 12-1). Exports fell because of depressed prices in commodity markets and reduced production capacity resulting from mismanagement and increasing shortage of spare parts, equipment and other imported inputs. Bauxite exports fell from $188 million in 1980 to an estimated $76 million in 1989, mostly due to Guyana's inability to compete with the People's Republic of China, while sugar exports, which suffered from adverse world prices and frequent work stoppages and equipment breakdowns, fell from $121 million in 1980 to merely $66 million in 1985. Other exports recorded a dismal performance reflecting the rapid appreciation of the real effective exchange rate. In addition, throughout the 1980s the Government resorted to restrictive trade policies in response to the continuous decline in exports; imports fell from US$431 million in 1981 to US$216 million in 1988. The most important adverse impact of import compression was the steady erosion of production capacity, since Guyana depends heavily on imported inputs: fuel shortages contributed to long power outages and the disruption of transportation services.

With the economy in disarray, the Government embarked on the Economic Recovery Programme (ERP) in 1989, aiming at reducing price distortions, restoring export competitiveness through a large exchange rate devaluation, and reducing fiscal and external imbalances. Following the unification of exchange markets, several non-tariff restrictions to foreign trade were removed in October 1990. The response of the tradable sector to the new set of incentives was immediate and significant. From 1989 to 1992, exports increased from US$224 million to US$364 million. Imports also grew rapidly in response to new capital inflows and the beginnings of economic recovery.

In the 1992-1995 period exports again increased significantly, largely due to the recovery in world prices and the significant expansion of sugar and rice output, which more than counterbalanced the decline of bauxite exports. This continuing export expansion was accompanied by a further important increase in imports, in particular of capital goods and fuel, reflecting the rapid pace of output growth. Nevertheless, trade imbalances remained a manageable levels. The merchandise trade account improved in 1994 as a result of an increase in exports and a slower increase in imports. A combination of greater volumes and higher average prices for certain key commodities moved exports to US$ 496 million by 1995. On the other hand tighter customs procedures and a slight reduction in capital imports contained the increase in imports to a rate of 4 percent bringing it to US$ 504.0 in 1994 from US$483.8 million in 1993. These factors gave rise to a merchandise trade deficit of US$ 41 million in both 1994 and 1995, as compared to a deficit of US$ 70 million in 1993.

Since the late 1980s the largest proportionate increases in export earnings have been registered by gold and rice. Guyana's potential in gold had previously gone virtually unexploited, and its upward trend is expected to continue. Rice production and exports both responded with alacrity to the decontrol of prices and the devaluation of the exchange rate. Both the area planted and yields have increased very considerably (see Chapter 26). However, the competitiveness of Guyana's rice outside of the quota markets is doubtful, and over the next few years the real prices in the quotas are likely to fall, so the prognosis for this important sub-sector is uncertain unless additional, very large gains in productivity can be made. Exchange rate policy may provide the key to the prosperity of the rice sub-sector in the future, and the same observation may be made about sugar and some classes of wood products.

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B. Regional Trade Agreements and Trade Preference Arrangements

The recent trend toward bilateralism and regionalism in trade is evidenced by the sheer number of agreements which have been signed or strengthened throughout the world since 1985. Formal notification of thirty-three regional trade agreements has been sent to the General Agreements on Tariffs and Trade, or GATT, in the last five years (Blandford). Some examples of trade agreements in the Western Hemisphere include Mercosur, the Andean Pact, the Central American Common Market, the G-3 of Mexico, Columbia and Venezuela, the North American Free Trade Agreement, or NAFTA, the Caribbean Community, or CARICOM, and the Association of Caribbean States, or ACS. Guyana's future trade patterns will be shaped in part by these agreements.

Another area important to Guyana's trade is that of preferential or non-reciprocal trade arrangements. These agreements, such as the CBI or Lomé Convention, demonstrated a fundamental shift in the perception on the part of developed countries as to how they could best help developing countries promote economic growth and political stability. These arrangements to a certain extent began replacing direct aid, hence the phrase "Trade, not aid." In the 1990s and on to the year 2000, however, the new tendency on the part of these countries is to seek more reciprocity in place of one-way preferences (Basombrío Zender, Weintraub). In other words, some trade preferences will be extended, but the developed countries may require some sort of trade preference in return.

Table 12-1

Foreign Trade Developments

(millions of current US$)

e = estimate

Notes: Exports do not include re-exports. Exports are f.o.b. and imports, c.i.f.

Sources: Bank of Guyana, Statistical Bulletin, June, 1995 (for 1980-92 data); Government of Guyana, Estimates of the Public Sector, Current and Capital Revenue and Expenditure, 1996 (for 1993-95).

Some of the alternative trade arrangements for Guyana's exports that may emerge include future negotiations of the Lomé Convention, the CBI, and the Americas 2005 initiative; changes in CARICOM; and advances in the ACS.

1. Programmes of the European Union

a) Lomé Convention

The Lomé Convention provides for free access to the European Union, or EU, without reciprocity for all exports of African, Caribbean, and Pacific States, or ACP states, except for those products subject to the rules of the EU Common Agricultural Policy, or CAP, which are granted conditions more favorable than Most-Favoured-Nation, or MFN, status. The convention's membership grew from 45 African Caribbean and Pacific States in Lomé I to 69 in Lomé IV. Its newest members are Haiti, the Dominican Republic, Namibia, and South Africa. Guyana is an original member of Lomé I of 1975.

Under the terms of the convention, all fishery products are exempt from customs duties. For rice, the convention provides for a reduction of the third-country levy per 100 kg for paddy rice and husked rice by 50 percent plus ECU0.36; for milled rice, 50 percent and ECU0.54; and for broken rice, 50 percent and ECU0.30. However, if a quantity of total imports of 125,000 tons (husked rice equivalent) of rice and 20,000 tons of broken rice is exceeded, third-country treatment will apply for rice imports from that country for the rest of the year.

In addition to trade preferences, Lomé includes agreements for cooperation with special financing to promote food security, development of fisheries, mining, industry, energy, enterprises, services, and cultural and social activities, programmes for stabilisation of export earnings and agreements concerning the philosophy for structural adjustment in the ACP countries.

Two other programmes of the convention, Stabilisation of Export Earnings from Agricultural Commodities, or STABEX, and the Mining Products Special Financing Facility, or SYSMIN, are designed to help stabilize export earnings in ACP countries for many products, including agriculture and mining. STABEX provides for stabilisation of earnings on commodities on which these economies are dependent and which are affected by fluctuations in price and/or quantity. It requires that the funds be devoted to producers, to diversification or to agricultural product processing. Eligible products important to Guyana include wood in the rough and squared wood, sawn wood, shrimps and prawns. To qualify, the country must show a significant reduction in exports of a particular product compared to a specified reference level and these exports must be at least 5 percent of total exports.

SYSMIN is designed provide special funds to safeguard mining production and related export sectors and to encourage ACP countries to diversify their industry if they are heavily dependent on one mineral. To qualify, 15 percent or more of total exports must come from one of a list of products such as bauxite, or, alternatively, 20 percent or more of total exports must come from a combination of mining products, including bauxite and gold. Guyana qualifies for SYSMIN given the importance of bauxite exports alone. The Government of Guyana has recently used SYSMIN funding for agricultural development in Region 10 and infrastructural and industrial development in Linden.

Lomé IV, completed in 1989 and implemented in 1991, reinforced the principles of non-reciprocity and free access in previous agreements. It contains improved access in agriculture for over 40 products versus Lomé III, including rice and citrus fruit. Guyana's benefits from Lomé IV include projects in infrastructure rehabilitation, mainly restoration of sea defenses, rehabilitation of the Demerara River bridge, the completion of the New Amsterdam water supply system, microcredit programmes, programmes with counterpart funds for hospital and school rehabilitation, and a soft loan of ECU 5 million to aid Guyana's bauxite industry (Baum).

Despite its substantial benefits to ACP countries, the future of the benefits of the convention is severely threatened. It seems that, to a certain extent, "The Lomé Convention...is out of fashion" ("European Aid" reference in The Economist). In an agreement signed November 4 of 1995, the EU agreed to continue trade privileges and other aid until the year 2000, after which the ACP countries will have to fight for these privileges and financial resources with the rest of the developing world. The EU is suffering from a shortage of cash, donor fatigue, and competing priorities. Aid to the former Soviet Union and Eastern Europe has become more important in Western European eyes, and fears of Islamic fundamentalism have boosted aid to Northern Africa. All of these factors left fewer funds for the direct aid of the Lomé Convention.

It is likely that the omnibus Lomé Convention will be replaced by smaller regional agreements due to the differing needs of the various ACP regions. It is expected that the more dramatic changes will occur in aid programmes rather than in trade concessions; however, new agreements mean an increased risk for losing some of the trade preferences most important to Guyana.

b) Sugar Protocol

The sugar protocol of the EU was created in 1975 for an indefinite period to allow EU countries to purchase and import, at guaranteed prices, specific quantities of cane sugar, raw or white, originating in ACP States capable of production and export. The guaranteed price is set yearly for unpacked sugar cif European ports with standard quality, and it is similar to that received by EU producers. If an ACP state cannot deliver its quota amount during a given year, it can request an extension or that the shortfall be reallocated among other ACP countries. If an ACP country does not deliver its quota amount for reasons other than force majeure, its quantity eligible for the programme shall be reduced by that quantity for all following years and the shortfall may be reallocated.

The quotas total approximately 1.4 million tons, and participating ACP countries are allowed to import sugar for domestic use if their surplus would not fulfill the quota. Guyana can send 157,700 mt of white sugar per year (July 1 - June 30) or its raw sugar equivalent, the third largest allotment after Mauritius and Fiji. Additional access on preferential terms was granted from 1 July 1995 for a six-year period for imports from all eligible countries of a total of 325,000 tons into Portugal, an increase of 23 percent in the preferential import total. At Lomé IV, the Dominican Republic served notice that it did not and does not intend to accede to the protocol, apparently to speed its acceptance as a new ACP country.

Benefits from the protocol have fallen in recent years. Although EU sugar prices are still well above the world market price, they have been virtually frozen in nominal terms for three consecutive years. Nonetheless, these benefits, although reduced in real terms are still significant, with EU prices more than twice world prices and approximately 45 percent higher than U.S. prices. Also, because it is an independent agreement, the sugar protocol can continue even if Lomé ceases to exist.

In contrast to the Lomé Convention, it is unlikely that the sugar protocol will be discontinued. More likely is a significant reduction of the EU's guaranteed prices as CAP support for beet sugar is reduced during the next ten years due to budgetary pressures (Gersovitz and Paxson). The reduction of internal European prices would greatly diminish the benefits from exporting to the EU, as rents to the quota fall.

2. Programmes of the United States of America

a) Generalised System of Preferences

As a result of the United Nations' Council on Trade and Development Conferences in 1964 and 1968, several developed countries created generalised systems of preferences, or GSP, which lower the rates of duty charged on imports from the developing nations, while continuing most-favoured-nation treatment for goods from developed countries. The rationale for the systems was to encourage reallocation of resources within developing economies to boost manufactured goods exports and spur economic growth. In most developed countries that began GSPs, only a small number of agricultural commodities were included, and 60 percent of developing countries' exports, mostly non-competing primary products, already received duty-free treatment (Dyett). The benefits of the GSP, therefore, were somewhat limited.

The U.S. GSP began in 1975. In it, about 5,000 items are eligible for duty-free entry into the U.S. market, including fish, shrimp, and fruits and vegetables, which are or could be important exports for Guyana. The future of the GSP programme itself is not threatened, but the periodic extension to each recipient country is a political process which could be threatened if, in the view of the United States, the recipient country does not make sufficient progress in such areas as human rights or workers' rights. After some discussions and evaluations, in almost all cases, if not all, however, the GSP is again extended to the recipient country. There are no reasons to expect that Guyana's GSP status will be altered.

b) Caribbean Basin Initiative

Begun in 1984, the Caribbean Basin Initiative, or CBI, is a non-reciprocal preferential trade arrangement which the United States extends to 24 countries of the Caribbean and Central America, with the notable exception of Cuba. The CBI allows eligible countries to export products to the United States free of import duties. The purpose of the initiative is to promote economic development through private sector initiatives. Guyana is a beneficiary of the CBI.

The CBI, however, has some limitations. Several commodities which would compete with U.S. production do not receive preferential treatment, including tuna, sugar, textiles and apparel, leather footwear, luggage, and handbags. The presence of these exceptions severely limits the possible impact the CBI could have in truly enhancing the region's exports to the United States.

In future years, the benefits from the CBI may be dampened somewhat because the tariff preferences in the U.S. market enjoyed by CBI countries will decrease and disappear after ten years as tariffs toward Mexico are eliminated through NAFTA (Weintraub). Because the CBI is renewed periodically, the tides of politics could turn, preventing its renewal. Also, its future is threatened by the initiative to extend free trade throughout the hemisphere.

3. The Americas 2005 Initiative for Hemispheric Free Trade

At the December 1994 Summit of the Americas, the United States and 33 other countries endorsed the goal of hemispheric free trade by the year 2005, the Americas 2005 Initiative. The economic potential for a Western Hemisphere Free Trade Agreement, or WHFTA, is substantial. Latin American exports to other Latin American destinations increased 135 percent between 1986 and 1992. For Guyana, it is important to note that the sugar industry could benefit from special access into the United States, such as the treatment given to Mexico under NAFTA.

As to how the WHFTA may proceed, NAFTA members and Chile have begun talks to extend the agreement to the first country in South America. Significant interest exists in other countries of the region as well. The possible elimination of the CBI would necessitate a prompt negotiation of access to or parity with NAFTA for CBI countries (Serbín). In 1994, one initiative in the U.S. Congress to extend virtual parity, the Crane Initiative, was presented but not acted upon.

The possible WHFTA faces significant problems. First, any integration scheme must confront the fear of loss of sovereignty which may be sufficient to rouse the anxieties of Governments of smaller countries. Second, some experts feel that no strong economic logic exists for a hemispheric free trade agreement for most countries based on existing trade and economic linkages (Gestrin and Rugman).

Some procedural impediments to WHFTA exist, and the process is likely to be very long and complex. An additional concern for the region concerns consequence of gaining access to one trade scheme which could affect another trade scheme. Under the provisions of the Lomé Convention, ACP countries cannot give to another developed country better treatment than that which it extends to the EU, nor can they discriminate among EU countries. The WHFTA could jeopardize these Caribbean countries' trade preferences and would need to be dealt with in negotiations with the EU.

Overall, a WHFTA would be of net benefit to the region, particularly those economies with stronger macroeconomic environments, sufficient infrastructures, and entrepreneurial dynamism, but the inherent and procedural impediments to attaining an acceptable agreement are very likely to delay it well beyond the year 2005. Some individual countries may become add-on members of NAFTA before then, but the dream of hemispheric trade is still far on the horizon.

4. CARICOM and the Association of Caribbean States

After nearly four years of negotiation between the member states of the Caribbean Community, or CARICOM, the Common External Tariff, or CET, was agreed to in July 1990, implemented 1 January 1991, and revised October 1992, transforming CARICOM from a free-trade area into a customs union. The CET included the lowering of member states' tariff rates within a five-year phase-in period and has aided in the simplification of trade in the region, as well as making trade regulations more transparent. The CET was a dramatic step towards regional integration, because previously it had been difficult to find sufficient political will to proceed with internal trade liberalisation and to reduce external protection.

The schedule is divided into final goods and inputs used in the production of other products, such as primary, intermediate, and capital goods, with further distinctions made in both categories between goods which would compete with regional production and those which are non-competing (Table 12-2). CARICOM members are scheduled to reduce the CET ceiling from 45 percent to 20 percent in 1998.

Due to the high level of subsidies used by other countries in agricultural production and exports, a special rate of 40 percent was assigned to primary agricultural products, which could be changed based on developments in the Uruguay Round (CARICOM, 1993). Raw sugar, most refined sugar, citrus and citrus fruit juices are all subject to 40 percent tariffs. In an important exception, rice duties were 30 percent during 1993 and then reduced to 25 percent, with possible future reductions upon further review. Also, under certain circumstances, agricultural imports can be subject to additional duties, such as Jamaican stamp duties.

Despite the advances toward a unified external trade policy, the CARICOM still faces important challenges. The liberalisation of agricultural trade is unresolved as of yet, and there are still some restrictions on the movement of factors of production, which supposedly has been liberalised. In compliance with guidelines of the WTO, most countries need to advance on liberalisation of trade in services and intellectual property protection. Another problem for these countries, especially the small island states, is the requirement that notifications of trade policy changes to the WTO must be made by each individual member state, and cannot be made by a streamlined, regional-level secretariat, such as the CARICOM Secretariat. Rather than expend precious resources in Geneva, few of the CARICOM countries have permanent representatives at the WTO, and most countries probably do not make the required notifications.

CARICOM also has participated in agreements with other countries in the region. A one-way agreement with Venezuela permits some Caribbean products to be imported duty-free into Venezuela, while the tariffs on other commodities are being eliminated gradually. Also, a proposal has been made by the Government of Colombia to allow duty-free access for a range of imports from CARICOM.

Table 12-2

Common External Tariff Rate Structure in CARICOM

Notes: LDCs may apply rates between 0 and 5 percent for non-competing inputs.

Source: Caribbean Community Secretariat, 1993

The Association of Caribbean States, was inaugurated on July 24, 1994, in Cartagena, Colombia, with 37 member countries. The ACS has a population of 200 million people with a combined GDP of over US$500 billion. By 2005, a wider arrangement is expected to be in place with specific, timed reductions in tariffs. The association hopes to optimise economic and political advantages of geographic proximity with increased cooperation to offset the region's marginalisation in the world economy.

The concept of ACS arose in response to changes in trade relationships in the region. Member states were dependent upon extra-regional economic ties and are losing privileges formerly granted to them by these countries. Most notable is the withdrawal of European actors from the region, with at least the appearance of their redirecting priorities toward Russia and Eastern Europe. Another concern was the possible diversion of U.S. imports originating in the CBI to Mexico because of the NAFTA agreement (Serbín).

Although CARICOM and other regional agreements are considered successful, the ACS offers even more promise in expanding Caribbean trade (Ford and Josling). Additional gains could come from specialisation of economic activities and economies of scale. Perhaps more importantly, the ACS may be the vehicle to unite the region's countries in other trade negotiations, especially those with the United States, significantly increasing their technical capabilities and negotiating power. The participation of Cuba in the ACS, however, will likely prevent the group from negotiating directly with the United States, and might impede overall progress in the Americas 2005 Initiative.

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C. Multilateral Trade Reform and its Effects on Trade Competitiveness

The Uruguay Round agreement of the General Agreements on Tariffs and Trade, or GATT, signed in 1994, ended seven long years of negotiation, years often filled with periods of stalemate. The agreement contains several significant achievements, including improved market access, the integration of agriculture and textiles into the multilateral forum, the coverage of new topics such as services, intellectual property rights, investment, and trade and the environment, improved dispute settlement mechanisms, and the creation of the World Trade Organisation, or WTO, designed to not only replace but also having a more solid legal base than its predecessor, the GATT.

1. Summary of Uruguay Round Reforms

In the area of market access for non-agricultural products (including fisheries and forestry products), almost all tariffs will be bound not to exceed certain levels. These binding levels will vary by product and by country. The commitments represent a 40 percent reduction in the average tariff on industrial product imports in developed countries, and an increase from 20 percent to 44 percent in the number of import goods whose duties are bound at 0 percent, indicating that approximately 44 percent of traded products will be subject to zero duty in most developed countries (Blackhurst, et al.). The Uruguay Round also includes provisions for the gradual dismantling of the Multifiber Agreements, which currently severely limit the textile and garment exports of many developing countries, and the entrance of these products into WTO jurisdiction.

The main areas which the Agriculture Agreement covers are market access, export subsidies, internal support measures, and sanitary and phytosanitary rules. In the area of market access, almost all non-tariff import barriers should be converted into tariffs through a process called tariffication, where the difference between the domestic price level and international price level for the 1986-1988 period is calculated on a percentage basis to arrive at an equivalent ad valorem tariff. These new tariffs, as well as other pre-existing tariffs, will be reduced by a minimum of 15 percent and an overall average of 36 percent in six years in each developed country, with a 10 percent minimum and 24 percent average over ten years for each developing country. Furthermore, minimum market access levels are established to insure that the tariffication process would allow the entrance of a minimum quantity of imports at the lower tariff level.

Subsidised exports must be reduced 21 percent in volume and 36 percent in value of the subsidy over six years in relation to 1986-1990 levels in developed countries, 14 percent in volume and 24 percent in value over ten years in developing countries. Export products that were not subsidised by a country during the same period are ineligible to receive export subsidies in the future. Marketing and transport subsidies are permitted in developing countries.

The Agriculture Agreement will require the reduction of internal support measures such as price controls and subsidies. Policy measures which are considered trade-distorting must be reduced 20 percent over six years in relation to the 1986-88 level of support in each developed country, and 13.3 percent over ten years in each developing country. Another important component of the Agriculture Agreement is the so-called "Peace Clause." Under this clause, countervailing duty, or anti-dumping, proceedings cannot be brought in response to certain policies which are permitted within the agreement, greatly limiting the scope of these actions. Also, special safeguards to protect a country from a sudden increase in imports which have injured or could injure domestic producers of a particular good are now more difficult to apply due to more specific and stringent requirements.

Finally, the agreement is designed to ensure that sanitary and phytosanitary measures be scientifically based and that information on these measures be more accessible. Individual countries can have standards that are more strict than international standards. Subregional determinations of disease-free or pest-free zones within a country are also allowed.

The Uruguay Round extends special treatment towards developing countries in general and least developed countries in particular. Generally, developing countries are required to make reductions equal to two-thirds of the corresponding commitment for the developed countries, and these changes can be implemented over ten years, whereas least developed countries, whose per capita income levels are below US$1000 per year, are exempt from reduction commitments. A special section of the agreement calls for developed countries to assure that an adequate level of food aid is provided to least developed countries and net-food importer developing countries which may experience temporary food shortages during the adjustment period of GATT.

2. Guyana's Uruguay Round Commitments

Each member country of the WTO has made commitments to certain minimal tariff reductions, including the elimination of non-tariff barriers and/or the conversion of these barriers to tariff equivalents. For agricultural products, Guyana's commitments for tariffs are a 100 percent tariff ceiling, promising that it will not apply a tariff to agricultural products higher than 100 percent. In addition, Guyana has agreed not to apply other duties and charges to imports, such as special import fees, customs charges, etc., in excess of 40 percent for agricultural products, except for wine and undenatured ethyl, which have a 50 percent maximum rate for other duties and charges, and cigars cheroots and some manufactured tobaccos, which have an 85 percent rate for other duties and charges.

For non-agricultural products, the tariff ceiling is bound at 50 percent, except for jewelry, which has a 70 percent tariff ceiling. The maximum rate for other duties and charges applied to imports is limited to 30 percent, except for petroleum oils, which has a 50 percent maximum rate for other duties and charges. Previous non-tariff barriers, such as import licenses and quotas, which must be eliminated within two years, were not subjected to the tariffication process, which means that Guyana lost the opportunity to possibly secure higher tariff ceilings for some products.

Because the GATT tariff ceiling commitments generally reflect levels from the late 1980s, the tariff ceilings to which Guyana has promised to adhere are much higher than actual tariff levels under the CET. Therefore, Guyana does have some flexibility in raising protection levels within the limits of the tariff ceilings should it be deemed necessary.

3. Expected Effects of the Uruguay Round Agreement

Although the Uruguay Round will improve market access and lower the levels of protection in trade, the required reductions in agricultural protection and subsidies are based on 1986-1988 levels (or 1986-1990 levels in the case of export subsidies). In recent years, many countries have already been in the process of reduction of these levels of protection and subsidies. In fact, countries are given credit for any reductions in internal support made since 1986. Also, to ensure acceptance of the Uruguay Round agreement, some internal policies which are actually very trade-distorting, such as U.S. deficiency payments to farmers and EU compensatory payments, were exempted from the reduction requirement. Therefore, the final of reductions required by the Uruguay Round are lessened, and no further changes in tariffs or policy are required for many commodities on the part of major market players.

Despite this shortcoming, the agreement locks in important gains for developing countries, reinforces progress made through unilateral liberalisation by many developing countries, and lays the groundwork for future rounds of liberalisation. An important concern for many developing countries is the possible erosion of the benefits of preferential trading arrangements, such as the Lomé Convention or the U.S. GSP. However, the majority of these countries' exports, primary products, already had enjoyed low tariff levels before the Uruguay Round. So the relative loss in competitiveness of ACP and CBI countries after lowering tariffs toward non-ACP or non-CBI countries is small (Blackhurst, et al.).

The most important measure of the benefits of the Uruguay Round, aside from increases in total world trade, is the impact of these increases on incomes. World income has been projected to increase by as much as $5 trillion dollars over ten years solely due to the Uruguay Round agreement. As to the more general effects on world prices, reductions in tariffs will directly lower the price of imports, but if producers' support or protection levels are lowered sufficiently, they will reduce production, diminishing the global supply and increasing the price in world markets. Studies generally agree that the world price of most agricultural goods will increase.

4. Possible Effects on Guyana's Exports

As for Guyana's rice exports to the Caribbean, it is important to note that although the reduction in the CET was programmed before the conclusion of the Uruguay Round and not directly in response to the GATT, these exports to the Caribbean will face stiffer competition from rice originating outside CARICOM as the CET is reduced. The projected strengthening of the world market, with increasing demand for long-grain rice and slightly increasing prices, should be beneficial to Guyana's rice sector, but changes in rice policy in the EU, Guyana's most important market for rice, could reduce EU prices and would dampen these gains. Most of the direct price effect will occur by the year 2000 as developed countries adjust their policies to comply with GATT within the six-year limit.

The increase in world price for sugar will benefit Guyana's sugar exports, but the most significant impacts will arise from policy changes in the EU and the United States which could lower prices in those tremendously important markets for Guyana. Whether export revenues rise or fall will depend on whether the projected rise in sugar demand can keep up with the fall in quota-related prices.

For fisheries products, the United States is the major destination for Guyana's shrimp exports, which enter duty-free under the CBI. Therefore, any reduction in U.S. tariffs on shrimp from non-CBI countries would indirectly make Guyana's exports less competitive. However, the income effect increased world trade would also cause shrimp demand to increase slightly, which could compensate for some of this reduction in competitiveness. The final effect will depend greatly on the availability of supply, both in Guyana and in the rest of the world.

In the area of wood products, reductions in tariffs will not improve Guyana's competitiveness vis-a-vis the exports of other countries because all exporters will receive the same benefits of the reduction. However, with improved incomes comes increasing demand for wood for housing and furniture, which could stimulate Guyana's forestry exports.

Similarly, the reductions in tariffs for mineral products such as bauxite will not improve Guyana's competitiveness because Brazil and China will both receive the same reductions under Most-Favoured-Nation, or MFN, treatment. For bauxite, the most important impact of GATT may be the manner in which greater incomes will cause the demand for steel and aluminum to rise because of increased construction and increased demand for durable goods. These changes would directly affect the demand for RASC and metallurgical grade bauxite, respectively.

Finally, rising incomes will increase the demand for income-sensitive, luxury goods world-wide, such as tropical fruits. Non-traditional crops, such as pineapple, citrus, West Indian cherry, passion fruit and carambola, could provide tremendous export growth in Guyana if they can be grown competitively. Improved marketing channels and cooperative promotion efforts with other Caribbean countries would be important in accelerating this export growth.

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D. Projected Trends in Prices for Exports

This section summarises alternative forecasts of trends in world markets and prices for rice, sugar, shrimp, timber, gold and pineapple. When considering future trends in prices, it is important to distinguish between real and nominal prices. Nominal prices are those expressed in current units of currency, while real prices are adjusted to account for the fact that a given price received by a producer will not buy as many inputs into the production process in one period as in those previously, due to inflation. Therefore, in comparing one point in time with another, it is more appropriate to use real prices because these will reflect changes in the underlying determinants of price and will not include the effects of inflation which would distort the comparison. Real prices used in this section are deflated using the Manufactures Unit Value, or MUV, index, which is a weighted forecast of prices for manufacturing exports from France, Germany, Japan, the United Kingdom, and the United States to developing countries.

1. Rice

The world market for rice is considered to be very thin; only 5 percent of world rice production is traded. The market is naturally volatile because of constant uncertainty due to rice's dependence on weather and the low share of production that enters world market. In addition, world rice stocks recently have fallen below the average stock level during the last ten years of 15.8 percent of consumption. Combined with short stocks in wheat and coarse grains, for which lower grade rice is a substitute in animal feed, rice stocks would be less able to offset a shortfall in the production of rice or its substitutes (World Bank, 1995).

The Uruguay Round agreement will open markets in Japan and Korea and will maintain access to Europe. The EU will convert its system of variable levies which change depending upon world prices, to fixed tariffs and reduce those by 36 percent over six years. The EU must also reduce its subsidised exports of rice. No changes are necessary in the U.S. rice programme to meet its new commitments on internal support, but the U.S. will reduce tariffs 36 percent over six years. The U.S. rice price is expected to increase 12-13 percent by the year 2000 in relation to the baseline, and 11-15 percent by the year 2005 (USDA, 1994). Some studies estimate that rice prices in world markets will increase marginally due to the Uruguay Round agreement, from 1.2 percent to 4.4 percent, with one estimate of a slight decrease of 1.9 percent (Table 12-3). It is important to note that these changes are all slight in relation to the level of distortion which exists and the reductions in tariffs and support levels which the agreement purports to achieve.

Table 12-3

Projected Percentage Changes in World Prices for Rice

and Sugar Relative to Baseline due to Uruguay Round Reforms

Note: * Source is USDA, 1994.

World trade in rice is expected to increase 5 percent above the baseline by the years 2000 and 2005 due the Uruguay Round agreement. Long-grain rice will account for one-third of the increase in world trade, and will continue to constitute the bulk of the world's trade in rice. Some shifting in trade origins and destinations is predicted. The U.S. share of the rice export market will fall from 20 percent in 1990 to 12 percent in 2005 due to stronger domestic use and smaller production gains. Increased exports should be seen from Thailand, Brazil, India, Pakistan, and China, with little or no growth in Vietnamese and Burmese exports. Rice production will not keep pace with demand increases in Central America, the Caribbean, and most of South America, except Brazil, leading to increased imports into these regions. Growth in import demand is expected in the Middle East as well.

Because of the limited production capacity for medium-grain rice, especially japonica, prices for these types of rice should rise more than those for long-grain. Growth in long-grain consumption, however, will be fueled by demand increases in South America.

Despite this growth in demand, supply is expected to respond sufficiently to prevent any surges in long-term prices. World Bank estimates for real milled rice prices are for US$236/mt in 2000 and US$233 in 2005,⁽²⁾ compared with US$237 in 1995. USDA projections for real paddy rice prices are somewhat more optimistic, rising from US$98/mt in 1995 to US$108 in 2000 and US$112 in 2005. Recently, however, rice price projections by the USDA, as yet unpublished, were lowered substantially in light of a reconsideration of the aggregate global supply response capacity, making them more consistent with World Bank projections.

High fertiliser prices are a cause for concern during the next few years, due to the heavy use of nitrogen for rice cultivation. Fertiliser shortages have been present some regions, with acute shortages in Bangladesh.

2. Sugar

The U.S. and EU import quotas amount to only about 10 percent of world sugar trade, but many other countries shield domestic producers from world price, which causes the so-called world market to be quite thin and extremely volatile (Lord). For example, in last ten years, U.S. raw sugar prices (New York Contract No. 14) have varied little, from a high of US23.29/lb. in 1990 to low of US20.46 in 1986, a difference of only US2.83, while world raw sugar price ranged from a high of US13.67 in 1990 to a short-lived low of US3.76 cents in 1985, a difference of 9.91 cents (USDA, 1995b).

A drought in Europe, substantial import needs of Russia and China, and Cuba's production problems brought high prices in January 1995, with a five-year high of US14.6/lb. fob Caribbean, Contract No. 11, New York (Buzzanell). In the near-term, however, world sugar supplies will increase, leading to lower prices. Although U.S. production is down slightly, production gains in Brazil, Thailand, and Australia will offset this and other declines elsewhere. Another pattern emerging in several countries is the diversion of sugar cane from ethanol to sugar production, augmenting the supply available. After falling for three years, the world stock-to-consumption ratio has risen to 17.61 percent in 1995 from 16.37 percent in 1994 (World Bank, 1995).

For sugar, the Uruguay Round agreement will have a somewhat limited impact. The most important effect will be increased world demand due to higher incomes. The United States employs a tariff-rate quota in its sugar import policy, where a zero or low tariff level is applied imports up to a certain amount, or quota, and a higher tariff is applied to all imports beyond this amount. The United States distributes this quota among various developing countries, including Guyana, and these imports enter duty-free. The United States will bind its tariff-rate quotas at 1.117 million tons of raw sugar and 22,000 tons of refined sugar. The U.S. tariff for over-quota sugar raw sugar imports will be reduced to US14.45 per pound by the year 2000. It is estimated that U.S. sugar prices and imports will not change. These estimates assume no further changes in U.S. sugar policy, although some changes are likely, and they could further lower prices and increase imports (USDA, 1995b). Studies have estimated world price increases between 5 percent and 10 percent by the year 2005 due to GATT.

Several other recent events may have important effects on U.S. and world sugar prices in years to come. Under the terms of the North American Free Trade Agreement, or NAFTA, Mexico will have access to the U.S. market equal to its net surplus production, up to 25,000 mt. until 1999, and 250,000 mt from 2000 until 2008. It is doubtful that Mexico would be able to achieve net surplus production for at least the next five years, if at all, severely limiting NAFTA's impact on the U.S. market during the next thirteen years. Mexico will not have unlimited access to the U.S. market until the end of the fifteen year phase-in period, the year 2008, at which time the second-tier tariff falls to zero for unlimited quantities of Mexican exports (Lord).

Another former key player in the world sugar market is Cuba. The decline in Cuban sugar production has been dramatic since the former Soviet Union and Eastern European countries discontinued their preferential trading arrangements. Sugar production in Cuba has fallen from an estimated average of 7.9 million tons in 1988/89-1990/91 to 4.0 million tons in 1993/94. Poor field practices also hurt the 1994/95 crop. Export earnings were down from $3.8 billion in 1989 and 1990 to only around $800 million in 1993 and 1994. This decline may have turned upward, however; the government is encouraging foreign capital investment in Cuba's sugar industry, at the production level, but not in mills or refineries. Cuba also boasts a new bulk sugar loading terminal. It is predicted that Cuba's sugar production could rebound to five or six million tons within three years, potentially depressing prices (Buzzanell). Tremendous concern exists on the part of holders of U.S. sugar import quotas that if the political situation in Cuba were to change, a significant portion of their quotas could be diverted to that country. Another possibility is that the United States could simply increase its quota to include Cuba without reducing those of other countries, but that action would depress U.S. sugar prices, also to the detriment of current quota holders.

In the past, U.S. sugar producers comprised a powerful lobby to maintain the sugar programme. However, today they are being opposed by corporate giants and environmentalists, and many members of the U.S. Congress expect a gradual phasing out of the programme, with time for the industry to re-engineer or diversify (Navarro). When this policy change would occur and whether it will actually occur is uncertain. Policy reform which would take effect during the next five years is unlikely, but changes after the year 2000 are much more possible.

The elimination of the U.S. domestic sugar programme would definitely lower U.S. sugar prices, but the overall effect will depend on how imports are managed and how U.S. production responds. The U.S. price could theoretically fall as low as world market price plus the tariff and transportation costs because U.S. net sugar imports are relatively insignificant, less than 5 percent of the world trade in sugar (Lord). As U.S. production falls, however, world prices could rise slightly due to increasing U.S. import demand.

Another factor expected to raise world sugar prices is policy reforms in compliance with GATT on the part of other countries, including the EU. The world price is projected to increase 8 percent by the year 2005 in real terms due to these reforms, vis-a-vis the average price in 1995.

Long-term world price projections are for increases in real terms, considering the 1995 price rise an aberration, with World Bank projecting an increase from US9.62 in 1996 to US10.98 in 2000 and a slight decline to US10.66 in 2005. USDA projections are for prices to rise from US8.71 in 1996 to US9.10 in 2000 and US9.33 in 2005. The USDA utilizes stock-to-use estimates to forecast world price, calculating that for every 1 percent change in the stocks-to-use ratio, there is a US0.36 change in raw sugar price (USDA, 1995b). These price projections obviously do not take into account the possibility for U.S. sugar policy reform or substantial changes in the European sugar protocol.

Nominal U.S. prices are projected to remain constant due to the policy of managing imports to maintain a stable but elevated price level. In real terms, however, U.S. sugar prices will consistently fall, from US18.87 in 1995 to US17.04 in 2000 and US15.27 in 2005, making the United States a much less attractive market and lowering the relative value of U.S. import quota rights, not to mention what would happen if nominal prices were to fall as a result of policy reform or the entrance of Cuba into the preferential market.

The future of preferential prices in Europe is uncertain. It seems likely that the current tendency of little or no increase in nominal prices will continue until the year 2000, implying that real prices will fall, reducing the value of holding a European quota as well. However, after 2000, a number of factors could put greater pressure on the EU's CAP, including accession of Eastern European countries thus increasing the likelihood of a reduction in the nominal price of sugar for the quota of ACP countries.

3. Shrimp

Although most shrimp is exported in an unprocessed state, some product differentiation can be found among various import markets. In Europe, the common presentation is in 2 kg. boxes of frozen shrimp with the head left on, while the U.S. market typically buys 5 lb. boxes of raw or frozen shrimp tails with the shell left on. Many countries, however, are now exporting processed products. For example, Ecuador has established a market presence selling instant-quick-frozen tails and cooked tails, greatly increasing its value-added.

Approximately 75 percent of Latin American shrimp exports are marketed in the United States, but Europe is the world's largest shrimp import market. One-half of its imports, generally those flowing into Denmark, are then re-exported to Japan and the United States following processing.

Historically, both real and nominal shrimp prices fluctuated in the early 1990s, with a downturn during 1992. In the short-term, the World Bank has projected that demand for shrimp will be strong, with low inventories and a declining supply already combining to augment prices from US$13.08/kg. in 1994 to US$13.40/kg. in 1995. However, the supply situation was expected to improve as tropical supplies from Latin America enter the market and Asian production levels improved following a recuperation from earlier weather-related problems, allowing only a slight price increase in 1996, to US$13.50/kg. (World Bank, 1995).

The general global economic recovery and multilateral trade reforms are expected to increase incomes worldwide, pushing demand for luxury goods, such as shrimp, higher, but supply growth, especially from aquaculture, is expected to be sufficient to prevent real price rises. Long term projections show a slight decline approaching the year 2000, with real price falling from US$11.44/kg. in 1995 to US$11.05 in 2000. Further declines are expected in the years approaching 2005, with real price projected to fall to US$10.51/kg.

Under the Uruguay Round, the average tariff in developed countries for fish and fish products exported from developing countries will fall by 27 percent.

4. Wood Products

Recent price trends show tropical log prices in Japan falling slightly, owing to a reduction of the number of plywood mills in that country from 114 in 1992 to 83. In contrast, timber markets in Europe are expected to strengthen in the next five years, although slowly, as economic recovery continues.

Economic recovery in many regions of the world and expected restrictions on timber harvesting in many countries are expected to cause real price projections for both logs and sawnwood to increase consistently through the year 2005. As an indicator, real prices for West African sapelli logs from Cameroon are projected to increase from the 1995 level of approximately US$222/m³ to US$247 in the year 2000 and US$287 in the year 2005. Similarly, real prices for Ghanaian sawnwood are expected to increase from US$641/m³ in 1995, to US$694 in 2000 and US$726, recovering the loss in real price which occurred in early 1995.

The Uruguay Round agreement will lead to a 63 percent decline in developed countries' tariffs placed on imports of wood and wood products from developing countries. The combination of this reform plus the expected strengthening of prices may provide significantly improved incentives to Guyana's exporters of wood products.

5. Bauxite

World trade in bauxite and aluminum is largely controlled by a number of Western-based multinational corporations. Major importers of bauxite are Western Europe, the United States and Japan. The International Bauxite Association was formed in 1974 with the aim of securing "fair and reasonable returns" for its producer members, but like most cartels, its success was threatened by emergence of non-member producers such as Australia, Brazil and Guinea, and the general global economic slump, which dampened the aluminum industry in general (Araim). The price of metallurgical grade bauxite is strongly tied to the price of aluminum, while the price of refractory grade bauxite to a large extent reflects changes in steel production, and hence the demand for refractories.

a) Aluminum and Metallurgical Grade Bauxite

Aluminum prices rose in early 1995 on strong demand and drawdowns of stocks. World consumption of aluminum was 6.4 percent higher in February 1995 than in February 1994, and consumption grew 8.9 percent in 1994, much faster than the 1.6 percent increase in 1993. World supply was down 1.2 percent in February 1995, and supply declined overall by 2.6 percent in 1994, which reflects the memorandum of understanding of February 1994 by major aluminum producers to limit production in response to an apparent surplus. Exports from former Eastern bloc countries had risen 36.4 percent in 1993 and 12.3 percent in 1994, depressing aluminum prices in the early 1990s.

These gains in price may be short-lived. There are indications that the memorandum of understanding is slowly unraveling, and the market is starting to prepare for its ending. Some excess production capacity exists and will be reactivated as the expiration of the memorandum of understanding nears later this year. With production increasing faster than demand, the aluminum price is projected to fall in nominal terms in 1996 and 1997 compared to current levels.

The long-term forecast for aluminum prices, however, indicates an upward trend because weak prices in the early 1990s deterred investment in new production capacity. In addition, approximately 80 percent of aluminum's cost is energy used in its production. Only a few countries have sufficiently low-cost electricity to make new smelters cost efficient, and many others currently do not have an attractive investment climate to permit such large ventures. On a global level, not much idle capacity is left to be reactivated.

Longer-term demand growth is expected to remain high due to continuous economic recovery in industrial countries and increases in aluminum demand in the developing world (World Bank, 1995). One forecast for metallurgical grade bauxite demand is for its production to increase from 90.5 million tons in 1993 to 115.6 million tons in 2003, enough to yield 22.2 million tons of aluminum (CRU). Also, given the increasing use of aluminum in place of steel, especially in automobiles, there will be increasing emphasis on the trend toward specialty aluminum products, with greater value-added. However, given the importance of electricity in the production process, only countries with sufficiently low energy costs will be able to capitalise on this market.

b) Steel and Refractory Grade Bauxite

In 1995, the steel industry in Western Europe and Japan recovered somewhat from the sluggish demand in 1994. Prices rose in Asia as steel demand increased strongly in China, and steel exports from the former Soviet Union to Asia decreased due to higher material and freight costs. Due to a slowdown of demand for steel in the automobile industry, prices have declined in the United States (World Bank, 1995). Real steel prices are forecast to increase moderately during the next five years due to rising demand, particularly in Asia and other developing regions, including Latin America. World steel production is forecast to increase from 512.04 million mt in 1995 to 536.23 million in 2000 (CRU) but it is not clear whether that trend can be sustained beyond 2000.

The most popular use for refractory grade bauxite is in teeming ladles for the steel industry, but European countries are increasingly using basic refractories, such as Dolomite, which are available in Europe and have a lower price. Refractory grade bauxite has seen increasing competition in Japan from synthetic alumina materials, andalusite, and synthetic bauxite, and in the United States from materials prepared from bauxite clays for refractory uses. However, the move away from bauxite use in ladle refining is less advanced in the United States than in Japan and Europe.

Specific consumption of all refractories in the steel industry is projected to fall 2.0 percent annually from 1992 to 2000, but bauxite-based refractories consumption should fall even more quickly, 1.5 percent per year until 2000. Its use in the aluminum industry, although limited, will rise approximately 1.1 percent in the same period (CRU).

The refractory grade bauxite found in Guyana, known as RASC, commands a higher price on the world market than that of its competitors from Brazil and China due to its higher quality, although it has lost significant market share in the previous two decades. A recent study estimated that 84 percent of the RASC market is secure and will not switch to alternative bauxites. In the base case of the study, with improvements in customer service, RASC is projected to increase its market share from 22.2 percent in 1993 to 26.3 percent in 2000, and RASC sales would rise to 276,900 mt. However, if Guyana's operations can retain vulnerable customers, win back other business, and expand production without incurring losses, this share could increase to 31.9 percent of the market and 374,600 mt (CRU).

Very few deposits of refractory grade bauxite are being exploited in the world. Brazilian bauxite production is threatened because unless the country amends its constitution and permits foreign ownership of mining operations, perhaps two or three of the five major companies may decide to withdraw from production in Brazil, threatening the immediate survival of the industry there. China's State-owned mining company is reportedly losing money, and is perhaps dumping its refractory grade bauxite on the market. With the new era of economic policy in China, such unprofitable enterprises are being closed or are being forced to become competitive; in the case of the bauxite operation, the two possible outcomes are a closure of the operation or sharp increases in prices. These events in Brazil and China point to the fragility of a market with few suppliers; a contraction in production in either country would seriously affect world supply and would raise prices sharply for RASC. However, due to the possibility of substitution of other refractories for RASC in many of its uses, the probability of increased prices is limited.

Even if world supply remains stable and refractory demand for the steel industry declines, there are some alternative uses of refractory grade bauxite, such as in roadstone and as a flux constituent in submerged arc welding. Of the high quality refractory grade bauxite which Guyana produces, 90 percent is used for refractories (60 percent in the steel industry, with the rest for aluminum and cement manufacturing), and 9 percent is used in roadstone, mostly in the United Kingdom. Significant growth is possible in roadstone use, possibly increasing to ten times current levels within the next ten years. This growth would be due to mainly to new users in other European countries, and RASC matches the specifications for roadstone use perfectly. These alternative uses ensure to a certain extent the sustainability of RASC prices.

6. Gold

Prices of gold on world markets have been somewhat depressed and are below the profitable level for most gold producers of US$400/oz. Although there was a short-term rally in prices in early 1995 due to the weak dollar, inflation has not increased enough in major markets to offset investors' concerns and lead them to invest more in gold. It is expected that nominal prices will stay in the US$380 to US$400 range in the short-term.

Gold is typically used as a store of wealth, especially in China and India, and because of the region's economic growth, demand for gold in the longer term should continue to be strong, supporting prices (World Bank, 1995). Because of its high conductivity, gold demand will rise in the electronics industry. Its real price is expected to rise by 10 percent from 1995 to the year 2000. However, demand is expected to stabilise after the year 2000, leading to a slight decline in real gold prices subsequently.

7. Pineapple

Because the pineapple market is very differentiated, with differing varieties commanding different prices, and because processed products hold an important share of overall trade, no specific price projections for Guyana's export product are available. However, a summary of market trends in pineapple can provide some information concerning the outlook for prices.

For fresh pineapple, wholesale prices in the United States are low, ranging from US$0.40 to US$0.60/kg., when compared to those in Europe, which range from US$0.80 to US$1.50/kg. The main exporters of fresh pineapple are the Philippines, Hawaii and the Ivory Coast. U.S. imports of fresh pineapple, approximately 120,000 tons, originate mostly in Central America and the Caribbean. Japan imports approximately 140,000 tons, mostly from the Philippines. EU imports are approximately 220,000 tons, with the Ivory Coast the main supplier, but other countries are emerging as important exporters. Shipment is mostly by sea and is not containerised; due to higher freight charges, airshipped pineapple commands a much higher price.

Concerning the canned pineapple market, the United States is the world's largest importer, with imports ranging from 250,000 to 350,000 tons a year. EU imports increased to more than 300,000 tons in 1991. Other important importers are Japan and Canada. Demand for pineapple juice has also risen in recent years, but production growth has outpaced demand, prohibiting significant price strengthening. Because juice production is a complement to canning, its supply potential is strongly linked to the supply of canned pineapple. In the world market, again the United States is the major importer, and Japan imports small quantities, while in Europe, the United Kingdom and France are major juice consumers.

In terms of long-term market outlook, export demand for pineapple should continue to increase, particularly due to the income effects of GATT and the general global economic recovery. The outlook for prices is less clear and will greatly depend on the ability of exporters to respond to this elevated demand. If too many countries increase exports beyond levels demanded, prices will stagnate and fall due to the surplus, but if exporters do not respond sufficiently to increasing demand, shortages will occur, driving prices upward. Overall, however, in the long-term, demand expansion should outpace that of supply, and real prices for pineapple are expected to rise.

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E. Forms and Levels of Protection

Guyana adopted the Common External Tariff (CET) of CARICOM in early 1991. The CET is a highly differentiated tariff regime with low rates for inputs and basic commodities that do not compete with CARICOM exports (5 to 10 percent), medium rates for commodities competing with CARICOM products (20-30 percent), medium rates for final goods not competing with CARICOM products (30 percent) and high rates for goods competing with CARICOM products (45 percent). In 1992, it was agreed to lower rates to the 0-20 percent range by 1997. Nevertheless, agricultural goods, which comprise an important portion of trade in the region, were exempted of the reduction and a 40 percent rate remained in place, allegedly to counterbalance the large subsidies given to exporters in most trading partners.

Although most non-tariff restrictions were removed and a move towards narrowing the tariff structure was implemented in January 1994 (when maximum tariffs were reduced to 30 percent), licensing requirements for fuel and another twenty products remain in place. When considering the favorable current state of the economy, these requirements may now be an unnecessary policy. In the end, they raise the cost of those imports to the Guyanese consumer or industrial user.

A major form of implicit protection arises from the fact that the main exports -with the exception of gold and bauxite- are destined to protected markets in the EU or the US. Since prices in protected markets are considerably higher than world prices, local production can be inefficient (for world standards) and use part of the extra return to cover the cost of inefficiency. Calculations for Guyana reveal that sugar production is extremely inefficient (in particular in the Demerara region), while rice production probably could not compete in the international market at present, as costs surpass current world prices (Angel, 1995; see below).

Another form of indirect protection that also has an important effect in public finances is the transfers given to public enterprises to cover current or capital expenditures. This is especially the case of the bauxite industries that have received substantial funds from the Government to cover operation costs. It is estimated that subsidies given to LINMINE amounted to more than US$ 6,000 per worker only in 1994. Although direct transfers are certainly the most obvious way of protection -and for that reason the easiest to control- public enterprises frequently receive support also in the form of the service and repayment of loans used for acquiring or rehabilitating capital goods. As such, these costs should appear as part of the production cost, thus reducing profits; if the Government assumes these costs, a subsidy is implicitly given to producers. However, these transfers have been reduced very significantly in recent years.

Yet another form of protection is the practice of allowing tax holidays as a way to attract foreign investment (e.g., gold mining at OMAI). Tariff exemptions and tax holidays, being administrative measures, have led to a highly differentiated structure of effective protection among goods and, inclusively, among firms. In turn, this promotes rent-seeking activities, as producers sometimes find it more profitable to engage in activities devoted to maintain or obtain preferential treatment from the authorities than to improve efficiency levels. Furthermore, a system of administrative exemptions becomes rapidly cumbersome to manage, thus reducing the efficiency of revenue collection, and makes it unnecessarily expensive to monitor and control customs' personnel.

In 1990, 80 percent of imports were exempt from duty, resulting in an average collection rate of less than 5 percent, compared to an average nominal protection rate of 20 percent. About half of all duty-free imports, however, result from international agreements or from multilateral and bilateral aid programmes. Crittle (1991) estimated that the nominal structure of protection combined with exemptions, some subsidies and tax holidays, yields an effective protection rate for manufactures of 55 percent.

Finally, one of the most basic ways in which economic protection can be conferred is through an overvalued exchange rate. Such a policy cheapens imports, thereby conferring an advantage on foreign producers at the expense of domestic producers, and squeezes the profit margins of our exporters. As a result, production suffers, as happened in Guyana in the 1970s and 1980s. It should be borne in mind that all forms of protection reduce the competitiveness of trade-oriented sectors, and those effects can reduce the living standards for most of the population in a small, trade-based economy like Guyana's.

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F. Nominal Exchange Rate Developments

During the 1970s and 1980s the currency became very much overvalued, with highly deleterious effects for export-oriented sectors such as bauxite, sugar, rice and timber. The real appreciation of the currency was reflected in the rising premium for foreign exchange in the parallel market. In 1984, the authorities devalued the currency⁽³⁾ by 28 percent and in early 1987 by a further 56 percent. However, the exchange rate adjustments failed to shift resources towards the traded goods sector adequately as required by the high domestic inflation rate and the increasing debt burden. Prices and tariffs were changed to reflect the devaluation but increases in petroleum prices, public transportation fares and electricity were delayed to protect consumers. The continuing overvaluation of the exchange rate resulted in the export volume index falling from 100 in 1980 to 69.8 in 1987.

With the introduction of the ERP, the Government made progress towards correcting the overvaluation of the Guyana dollar in the official market and the unification of the exchange rate system.⁽⁴⁾ In March of 1990, the Government legalised the parallel market in foreign currencies and established a new market (Cambio market) for foreign currency transactions, licensed banks and other non-bank dealers to trade in foreign currencies in this market at freely determined rates. Transactions relating to non-traditional exports and non essential imports were transferred from the official to the Cambio market. Following a 27 percent devaluation in June 1990 (to G$45:US$1), the Cambio rate applied to most trade except sugar exports, fuel imports and official debt service. Full unification of the exchange rate occurred only in February 1991, when the official rate was adjusted to match the Cambio rate, and was depreciated from G$45 to G$102. The official market was abolished completely in October 1991 and the bank of Guyana set its own official rate as an average quotation of the three largest Cambio dealers.

The nominal exchange rate in the open market depreciated in the early weeks after unification reaching a peak of about G$135 in March 1991, but subsequently appreciated to a rate of about G$123 by the end of the year (see Table 12-4). In the following three years, the nominal exchange rate depreciated slowly, although at a zigzagging pace, to reach G$132 at ending 1993, while it remained relatively stable during 1994, especially when account is taken of price differentials vis-a-vis Guyana's major trading partners. By December 1994, it reached G$142 with a cumulative annual depreciation of 9 percent compared with 4 percent in 1993. It appreciated again in 1995 and early 1996.

A complete liberalisation of the exchange market has not accompanied the unification of nominal exchange rates, although significant strides have been made toward it. Rather, a dual system reflecting what may be termed a "dirty" float --in which exporters of gold and sugar required to surrender part of their foreign exchange earnings to the Bank of Guyana at the Cambio rate-- has developed. The Cambio market operates as a free market for foreign currency.

In real terms, the exchange rate movements in the 1990-95 period represented a substantial depreciation, followed by a slightly larger appreciation. Following a significant depreciation of 35 percent in 1991, the real effective exchange rate, which has a strong influence on incentives, profitability and sustained development, appreciated steadily reflecting increase capital flow to Guyana and improved macro-economic conditions.⁽⁵⁾ Nevertheless, the appreciation has also been the result of relatively high interest rates and domestic wages settlements greater than productivity gains. The subsequent reduction in export profitability raises concerns regarding the long-run sustainability of current exchange rate policies.

Table 12-4

Guyana: Nominal and Real Exchange Rate and Inflation

Sources: IDB, IMF, Bank of Guyana.

Notes: RER calculations extracted from study by R. Soto, consultant.

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G. Financial Services and Capital Flows

The financial side of the external accounts of Guyana has been shadowed by an external debt burden that increased very rapidly in the 1970s and 1980s, almost all of it incurred by the public sector. In 1970 the external public debt stood at US$93.6 million; by 1980, it was US$639 million and in 1990 it reached US$1,820 million. As a result, it proved unserviceable and significant arrearage accumulated. The lion's share of this debt is owed to bilateral and multilateral official development agencies. An important step towards the reduction in debt service undertaken at the outset of the ERP was the clearing of arrears with the international financial institutions. A second key development was debt renegotiations.

After launching the ERP, Guyana received substantial debt relief to finance its external arrears. It benefited from rescheduling operations from the Paris Club under the Toronto Terms. Rescheduling arrangements were also concluded with various non-Paris Club creditors. In particular, Guyana's debt to Trinidad and Tobago was rescheduled, and negotiation or further relief has been initiated. Some bilateral creditors have canceled the debt owed to them unilaterally, including the United States (US$112 million) and Canada (US$9 million). In 1993, the Government was able to buy back its total public debt owed to commercial banks, amounting to US$93 million, with a US$11 million grant provided by Inter-American Development Association (IDA). On the whole, debt relief amounted to US$418 million in 1990, US$51 million in 1991, US$155 million in 1992, US$41 million in 1993 and US$56 million in 1994. A much larger debt reduction of about US$500 million was achieved in 1996. In addition, the composition of Guyana's debt has changed in favour of long-term concessional loans at low interest rates. The service account of the external current account have improved from a net deficit position of US$102 million in 1990 to a deficit of US$60 million in 1994, mainly due to significant reduction in interest obligations.

The capital accounts improved significantly over the period 1990-93 from a deficit position to surplus but registered a small deficit in 1994. In 1990 the capital accounts recorded a deficit of US$47 and in 1993 a surplus of US$78 million that fell to a surplus of US$23 million in 1994, owing to slower disbursements from the Multilateral Financial Institutions, higher scheduled amortisation payments and much lower net private capital inflows.⁽⁶⁾

According to the IMF, the non-financial public sector recorded a net capital inflow of negative US$36 million in 1994 compared with US$15 in 1993. Disbursements amounted to US$22 million in 1994, almost 44 percent of the previous year while amortisation payments amounted to US$58 million compared with US$41 million one year earlier. Disbursements to the public sector, originating mainly from multilateral sources, were made on loans contracted in previous years and only one disbursement was made on a 1994 agreement. This affected negatively not only the balance of payments (BOP) but also the implementation and completion of the Public Sector Investment Programme (PSIP).

In 1994, Central Government received inflows of US$10 million from the sale of assets compared with a sum of US$4 million in 1993. Like the non-financial public sector, the private sector had a slight reduction in flows originating from direct and other investments recording US$24 million as against US$25 million in the year prior. Some investments were made in the manufacturing, financial and commercial sectors but, unlike the previous three years, there was no direct investment for forestry and the extractive industries that by their very nature attract more sizable investment.

The overall deficit in 1994 was estimated at US$64 million, a deterioration of 28 percent from the previous year, due entirely to a weaker capital account. The deficit was financed by exceptional receipts in the form of balance of payments support and debt relief. Balance of payments support came in the form of commodity assistance from the Canadian International Development Agency (CIDA), the United Kingdom, the United States Public Law 480 Agreement (PL 480), Italy and the European Economic Community (EEC), and cash assistance through United States Agency for International Development (USAID). Debt relief was mainly a result of agreements reached with the Paris Club creditors in prior years. The receipt of exceptional financing permitted an increase in the net foreign assets of the Bank of Guyana to US$18 million compared with US$38 million in 1993.

The overall deficit of the balance of payments in 1996 is expected to be somewhat larger than it was in 1994, but then it is projected to decline gradually.

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H. Evolution of Monetary Policies

Before the beginning of the Economic Recovery Programme in 1988, both banks and non-bank financial institutions were directed to lend to selected industries and sectors on subsidised terms. Interest rates were administratively fixed and kept low, generally below the rate of inflation. The credit rationing and low interest rate policy met with some success, particularly during the early stages --many rural bank branches were set up (especially by the state-owned GNCB), the fiscal deficit was financed and credit was channeled to priority sectors. Pressure was put on the financial institutions, mainly on the state-owned bank, to base some of their lending on non-economic factors. This situation, coupled with little experience and inappropriate organisational and information systems to assess credit and other market risks adequately, resulted in substantial increases in non-performing loans. The absence of proper supervision and inadequate regulatory standards further aggravated this development. The problem of non-performing loans reached alarming levels; non-performing loans were as high as 41 percent of the total loans in 1992. Thus, this policy did not contribute substantially to the development of a dynamic financial system. Moreover, in the light of negative real interest rates, much of the domestic savings was not used to increase holdings of financial assets. Some funds were sent abroad in capital flight while others were used to purchase real assets. Because of these developments, the financial system remained small in terms of assets and undiversified as to institutions.

The major goals of monetary policy after 1988 were the reduction of inflation and the stabilisation of the Guyana dollar. The other objectives of the authorities were to promote financial deepening and ease the private sector's access to bank credit. To achieve its primary objectives, the authorities intervened in the foreign exchange market through sales of foreign exchange and adopted a policy of monetary sterilisation of capital inflows to keep the growth in the monetary base broadly in line with the growth and inflation targets. To meet its secondary goals, the authorities embarked on a programme aimed at the liberalisation of the financial system. Accordingly, interest rates were freed, credit and most foreign exchange controls and restrictions were removed, and a floating exchange rate regime was introduced.

Due in part to increases in the net foreign assets of the banking system, a large buildup of liquidity emerged. Excess liquidity as a percent of required reserves rose from 81 percent at the end of 1990 to a record level of 202 percent in February 1993, before gradually declining to 57 percent at the end of June 1995. Excess liquidity, expressed as a percentage of commercial banks' total deposits, after rising to the record level of 43 percent in February 1993 from 27 percent at the end of December 1990, started to decline continuously, reaching 12 percent at the end of June 1995. Until the end of December 1994, a significant part of the balances of the commercial banks' liquid assets was in Special Deposits (SDs) held as remunerative reserves at the Bank of Guyana. From mid-1991, the Government securities (both treasury bills and debentures) were the major instruments used to accomplish the sterilisation policy. The Government agreed to eliminate SDs through a phased approach. This agreement was based on the belief that the elimination would increase the ability of the Bank of Guyana to influence short-term monetary conditions and interest rates. Moreover, it was felt that the existence of a high level of SDs would have hindered the development of an interbank market or secondary trading in treasury bills. Considering the above, the Bank of Guyana in April 1993 embarked on a strategy to convert SDs into treasury bills and to introduce treasury bills with longer maturities (six-month and one-year). To increase the effectiveness of managing monetary conditions through the treasury bill tender, the authorities from January 1994 increased the frequency of the TB tender from a monthly to a fortnightly basis. This strategy of absorbing liquidity through TB tenders, resulted in a substantial buildup in Government's net deposits at the Bank of Guyana.

From a net debtor position of G$4.1 million at the end of 1990 at the Bank of Guyana, the Government became a net depositor (G$22.2 billion at the end of June 1995). To avoid the indiscriminate use of these huge balances and the resultant risk to monetary stability, a sub-account within the Consolidated Fund was established in June 1992. This sub-account, called the Monetary Sterilisation Account has been used for the placement of proceeds arising from the sale of treasury bills with longer maturities (6-month and one-year). The balances in this account rose from G$6,873 million at the end of June 1992 to G$62,231 million by the end of June 1995.

The authorities also employed the Minimum Reserve Requirements (MRRs) to control the liquidity in the financial system. To enhance compliance, the penalty imposed on banks for failure to maintain minimum balance on required reserves was increased from 1/30 of 1 percent per day on the amount of the deficiency to five percentage points above the bank rate. Before May of 1991 the MRRs had remained unchanged for more than two decades. In May of 1991 the MRRs were increased by five percentage points to 11 percent on demand liabilities and 9 percent on time liabilities. Additional increases were made to MRRs that rose, starting April 7, 1994, by an additional five percentage points to 16 percent and 14 percent on demand and time liabilities, respectively.

Liquid assets requirements (LAR) which determined the minimum level of liquid assets holdings of commercial banks in relation to their deposit liabilities, was also used as part of the strategy to absorb banks' excess liquidity. Before March 1989, the legally required level of liquid assets to be held by the commercial banks against their deposit liabilities was calculated as the sum of 20 percent of demand liabilities and 15 percent of time liabilities. In March 1989, as a temporary measure, banks' liquid assets were frozen at the then prevailing level. The freeze was extended on two occasions and the level of the frozen assets was also raised twice to the levels prevailing, in September 1989 and July 1990. With effect from May 15, 1991, however, the basis for calculating required liquid assets was changed to 25 percent of demand liabilities and 20 percent of time liabilities.

Throughout this period significant financial deepening occurred as private sector holdings of financial assets increased. High interest rates have contributed to reversing the flight out of the Guyana dollar and consequently have contributed to the real appreciation of the exchange rate. Broad money increased from 33 percent of GDP in 1991 to 48.5 percent in 1994. The total of broad money plus private sector holdings of Government securities and claims on non-banks reached 69 percent of GDP in 1994, vs. 49 percent in 1991. See Chapter 15 for further discussion of developments in the financial sector.

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II. Issues Concerning the External Sector and Monetary Management

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A. Trade Protection

A first crucial element in a market economy is to have in place an adequate set of incentives or relative prices --for both private and public agents-- so that the production, distribution, investment and consumption of goods and services can be as socially efficient as possible. In a small economy open to world markets, incentives for firms exporting or competing with imports are key to achieve a path of sustainable development, because the expansion of the domestic demand cannot be expected to provide the basis for sustained growth. For these reasons, issues concerning the level of protection⁽⁷⁾ of domestic producers vis-a-vis the rest of the world are important. Protection levels that are too high encourage inefficiency and mismanagement of resources, while protection levels that are very low or negative might discourage social and economically profitable activities.

Although protection can be directly achieved by imposing tariffs and other taxes or subsidies on trade (nominal protection), a usually more pervasive form of protection implicitly arises from distorted exchange and interest rates, direct Government transfers to firms to cover current and/or capital expenditures, and from institutional arrangements and regulations, such as environmental and labor laws. All these issues affect significantly the profitability of firms in the economy so, when discussing long-run trade strategies, it is important to evaluate their impact on the future evolution of the economy.

Thus, in discussing the current trade structure, its contribution to the economy and its future development, it is important to bear in mind the possibilities for developing new markets for existing goods and new exportable goods. This is an area of particular importance for Guyana as it is expected that traditional exportable goods may have reached their quota limits and prices are at historical maxima. Given that Guyana is well endowed with natural resources (timber, gold and other minerals, fish and shrimp, geographical location, etc.), appropriate measures could be used to give encouragement for their exploitation along sustainable lines, as discussed in several other Chapters of this Strategy. It also is important to remember that sectors which currently are sheltered by international quota agreements (rice, sugar) probably will see the benefits of such agreements reduced in a very few years' time. Rice producers already have been feeling price pressures from their export sales, owing in part to the recent revaluation of the exchange rate. Diversification of exports is an essential goal for the medium term.

Efforts are currently on track to deepen trade liberalisation by reducing the tariff charges further. The Government has adopted the CARICOM Common External Tariff (CET) with the first phase introduced effective January 1, 1994. Under the CET, tariff rates will gradually be reduced to a range of 0-20 percent by 1997. Lower tariffs could reduce tariff revenues by as much as 28 percent by 1997. Tariff revenues can substantially be increased with the removal of exemptions; in 1991 such exemptions were estimated to have reduced tariff revenues by 60 percent. The net effect of full compliance with CET and removal of exemptions would be a revenue increase of at least 18 percent.

It is extremely important that protection levels be as nearly uniform as possible over sectors and classes of goods. Variations in protection levels usually induce resources to flow to areas of the economy that are less productive, for it is precisely those areas that seek out the protection.

The existing skewness in tariff structure, caused by the pattern of exemptions, can create especially important distortions in a trade-based economy such as that of Guyana. First, because it taxes final goods and inputs at different rates it consequently discourages efficiency in the overall economy. In particular, it plays against the development of efficient import-substitution processes that are necessary for the development of the economy. A producer of a final good will benefit from having a higher level of protection for the output than for inputs, but a local producer of capital goods or intermediate inputs will find itself in a disadvantageous position. Consequently, the substitution of efficiently produced local substitutes for imported intermediate goods would require a longer term to be achieved, thus retarding development. Moreover, since the producer of final goods finds it cheap to use imported intermediate and capital goods, then the demand for labor is subsequently reduced.

The tariff structure also has an important bias against agricultural exports, the latter being a potentially important source of foreign trade expansion for Guyana. A local producer of potentially exportable agricultural goods will find him/herself paying high prices for inputs because of the tariff structure, thus losing competitiveness vis-a-vis exporters in countries that have a lower tariff structure. In addition, the higher tariff rate in place for agricultural goods weakens incentives to improve productivity.

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B. The Competitiveness of Guyana's Principal Exports

This section reviews the competitiveness of some of Guyana's most important export products. Measures of competitiveness, termed domestic resource cost coefficients, or DRCs, are presented for Guyana's exports of sugar, rice, pineapple, and calcined bauxite, for the year 1995 and under hypothetical future scenarios.

1. Methodology

A number of factors influence the competitiveness of an industry, including physical infrastructure, transportation systems, credit availability, and marketing institutions and systems, aside from macroeconomic policy and the natural endowments and labour skills traditionally considered when analysing competitiveness. Domestic resource cost calculations are an empirical measure of competitiveness. DRCs are not a measure of profitability in its usual sense. An activity may be profitable in its private sense, but it still can cost more in terms of foreign exchange than it earns. Its lack of competitiveness would signal an "unprofitable" use of domestic resources in macroeconomic terms and that the country could gain more foreign exchange in other export activities.

In the calculation of the DRC, first the net foreign exchange earnings from exports are calculated by subtracting the costs of imported inputs from the product's value. This value is then divided by production costs to express the cost in domestic resources of earning one unit of foreign exchange (Norton, and Norton and Garcia Ugarte).

The first steps in DRC calculation involve separating tradable and non-tradable input costs. Tradable goods include both currently traded or potentially traded goods. Most agricultural inputs, machinery, and fuel are examples of tradable inputs. Land and labour are non-tradable inputs. But even tradable inputs contain a domestic content, including internal transportation costs and the importer/seller's margin. For example, it is estimated that for agricultural inputs, 25 percent of the costs are non-tradable, or domestic, costs. The rest are tradable costs and taxes.

If the value calculated for the DRC is less than the exchange rate, then the product holds a competitive advantage, indicating that the country gains foreign exchange in net terms by exporting it. The DRC is always expressed in units of Guyana dollars per U.S. dollars.

Another factor which influences competitiveness is market intervention, typically in the form of taxes, tariffs, and other Government policies. By repeating the calculations under a scenario without any Government interventions, the DRC becomes a measure of the underlying or "true" comparative advantage. Given the sensitivity of exports to variations in the exchange rate, alternative calculations are presented for a different, hypothetical level of the real exchange rate.⁽⁸⁾

2. DRC Coefficients by Product

a) Rice

Current DRCs

Rice exports are competitive according to the methodology of DRC analysis only in the cases of exports to the current EU market, which paid an the average cargo rice price of US$400 in 1995, as shown by the DRCs of 109.05 and 112.42 (for small and large farms) being greater than the exchange rate of 142. The dominant role of the EU market in Guyana's exports also influences the results when the average export price is used, which yield DRCs of 116.43 and 119.94 (Table 12-5). For other markets, even though the activity may generate a profit at the farm or mill level, it costs more in domestic resources than the country gains in foreign exchange. However, in all scenarios for exports to the EU, the cost structure using the traditional mill really is not a valid consideration because the rice produced by these mills generally is not of sufficient quality to export to the EU. This difference is also important in noting the higher cost of production, and therefore higher DRC, for the large farms using modern mills; although their costs are higher, the rice produced is of higher quality and would therefore naturally receive a higher price.

To convert current CIF world rice prices to fob Guyana, a deduction of US$75/mt was made for shipping, leaving a net world price for 1995 of US$203/mt. (This shipping cost is very high and could be reduced by about 50 percent by using a deepwater harbour.) Care must be exercised when comparing Guyanese export quality rice to the world price for rice in general because the long-grain rice from Guyana commands a naturally higher price, and the price should be adjusted for quality differences. However, in the general world rice market, and even in the nearby Jamaican market, Guyana's rice exports are woefully uncompetitive, with large farm DRCs at 321.69 in the world market and 206.54 in the Caribbean market.

Costs of production of a typical small or medium farm are approximately US$395/mt, and US$337/mt for a large farm, including a 25 percent markup for producer profits. These costs, which are lower than prices currently paid by millers to farmers, can be compared to those in the United States of between US$256/mt and US$269/mt, in Thailand of US$186/mt, and in Vietnam of US$167/mt (Stringfellow).

Potential DRCs

When subjected to projected price, yield and wage rate changes, for the years 2000 and 2005, Guyanese rice exports again are competitive in terms of the DRC measure solely in the cases of exports to the EU (Table 12-5). Given the likelihood that real prices will fall in the EU due to lower domestic support levels, this analysis signals further competitiveness problems for the rice industry even in the most preferential market available.

When searching for reasons for this lack of competitive advantage in an industry which has experienced significant growth and appears generally profitable, the reasons for high domestic costs must be considered. First, port costs are relatively high. Second, relatively low yields indicate that fixed costs per acre (labour, mechanised practices, etc.) are spread among fewer units of output than if yields were higher. Third, internal transport costs may be considered high due to poor roads. Finally, taxes, both on imports and consumption also add to the domestic cost of production, reducing competitiveness.

The calculations of comparative advantage using shadow prices and in the absence of taxes indicate that with an estimated world price of US$300 in a distortion-free world market, rice exports still do not hold a competitive advantage. Furthermore, looking at the costs of production for countries such as Thailand, whose rice growers receive few subsidies but are able to produce at a cost of US$186/mt, gives an indication that equilibrium world price would not increase to such levels if all trade distortions were removed.

Finally, taxes are removed and a hypothetical exchange rate of G$170 is assumed, and the assumption of a world market price of US$300 per ton is maintained, rice under the advanced technology demonstrates a comparative advantage, with a DRC of 159.10, compared with the new exchange rate of 170. This result suggests that over the medium term exchange rate policy will be a crucial determinant of the industry's ability to sustain its production and export levels without requiring financial assistance from the Government.

Table 12-5

DRCs for Rice

Note: * Assumes the use of silos for storage at export facilities in years 2000 and 2005, eliminating the cost of bagging for export and lowering overall export costs.

b) Sugar

Current DRCs

The calculations of DRCs for sugar from the Berbice Estates (Skeldon, Albion, Rose Hall, and Blairmont) as a group and the Demerara Estates (Enmore, LBI, Wales, and Uitvlugt) as a group are presented in Table 12-6. Exports from both groups of estates hold a competitive advantage if they are destined to the EU market, while those from the Berbice estates to the U.S. market also hold a competitive advantage. It is interesting to note the differences between the DRCs for the two groups of estates, with those from the Demerara region demonstrating a much lower level of competitiveness. In both cases, exports to the preferential CARICOM market and the world market do not demonstrate a competitive advantage, indicating that these activities cost the country more in terms of foreign exchange than it actually gains in export. Prices of US$390/ton for Berbice and US$525/ton for Demerara are needed for the DRCs for these regions to equal the exchange rate. These findings are consistent with the analysis presented in Chapter 33.

When considering the reasons for this lack of competitive advantage beyond the EU market, several factors become important: first, the high cost of employment and the lack of mechanisation in the fields; second, the outdated nature of the mills; third, the modest cane yields; and fourth, the prevailing level of the exchange rate.

Potential DRCs

As noted earlier in this Chapter, the stagnant tendency of EU nominal sugar prices, and the fall of real prices, is likely to continue during the next decade as CAP policy reform limits internal EU subsidies, and the Sugar Protocol may be phased out, along with the Lomé Convention. The industry itself realises the importance of the European market, stating that "What happens in this market makes or breaks the industry's prospects" (GUYSUCO). If real prices in the EU and other markets continue to fall as expected, these prospects are dimmed.

Table 12-6 shows that it is profitable to export Guyana's sugar to the European market, and to export sugar from the Berbice estates to the US quota market as well. Both regions are uncompetitive on world markets. Given real price projections for the U.S. and world markets, sugar exports from neither of the regions will be competitive in those markets in the years 2000 and 2005. Although no policy reforms are assumed in the DRC calculations, U.S. market prospects are further diminished by the possible dismantling of the sugar import quota system after the year 2000, which would lower U.S. prices to possibly as low as world price levels.

Table 12-6

DRCs for Sugar

Note: The current prices assumed in the first four lines of this table were revised somewhat subsequent to these calculations.

In the last set of scenarios, if the exchange rate were to float by 20 percent in real terms, the Berbice estates would demonstrate a comparative advantage, with a DRC of 157.78 (when taxes are removed and if the world price rises to US$340, equivalent to US18/lb., a common cost of production, compared to the current US$275). The Demerara estates, however, do not demonstrate this comparative advantage even under a revised exchange rate, having a DRC of 230.63. These scenarios demonstrate the dramatic effect that a distorted world market, an overvalued exchange rate, and taxes can have on competitiveness. Although the scenarios demonstrate that the sugar activities, especially in the Berbice region, are competitive for some markets, in the long run the industry must survive in the context of the world market and Guyana's macroeconomic policy environment. In this regard, the exchange rate is seen to be a critical factor for the industry's prospects for survival, and even so a restructuring of the industry would appear to be essential.

c) Bauxite

Current DRCs

The DRC in the baseline or current scenario, 285.74, demonstrates the severe lack of competitive advantage which the operations at LINMINE currently possess (Table 12-7).

Potential DRCs

One of the "solutions" suggested for the industry is to hope that prices for refractory grade bauxite will increase enough to make LINMINE a cost-efficient venture. However, as Hojman postulates, "the special characteristics of this industry--vertical integration, horizontal concentration, energy intensiveness, dependence on overall industrial growth--make most leading bauxite producer and consumer countries intermarginal: comparative advantages are far too high for realistic range change in their own price to make any difference." Using existing projections of increases in real steel prices as an equivalent projection of trends, the DRCs calculations for the years 2000 and 2005 show that it would be very difficult for a price increase to be large enough to give the operation a competitive advantage (Table 12-7). Note that real steel prices are expected to rise from 1995 to 2000, and then decline to 2005, so that the projected 1995-2005 price increase is less than the 1995-2000 price increase.

Another theory is that with an increase in efficiency, increasing output would permit the fixed costs of operation to be spread over a larger quantity of production. Again here, however, with an estimated increase of 10 percent in production, the DRC, 276.46, remains well above the exchange rate.

A recent report indicated that LINMINE's costs could be significantly reduced if ancillary services were "unbundled" (either privatised or closed down) including several of the smaller shops, security services, and recreational facilities, and in fact that route has been pursued. Potential savings were estimated at US$800,000, not including the effects of power station unbundling. Further savings of an additional US$200,000 could be achieved over time as prices fall for services bought from the unbundled units (Adam Smith Institute). When these cost reductions of US$800,000 and US$1,000,000 are included in the DRC analysis and split proportionally between tradable and nontradable costs, the mining activities continue to fail to demonstrate a competitive advantage, with DRCs of 266.70 and 262.19, respectively.

Table 12-7

DRCs for Bauxite

d) Pineapple

Overview of the Industry

The typical variety of pineapple found in Guyana, the "Montserrat," has shown to be a potentially competitive product against the more common smooth cayenne variety from other major export markets. Although more spiny and of a triangular shape, the Montserrat variety has greater sweetness and firmness of flesh.

Pineapples are grown by approximately 1500 producers in Guyana, with an area of approximately 445 ha. (Jokhu). Pineapple production in Guyana has been consistently increasing, while exports showed a downturn from 1993 to 1994. In 1994, 340 tons were exported to Barbados and 6 tons to Trinidad and Tobago. Exports to Barbados are typically fresh and for use in the tourist industry, while exports to Trinidad and Tobago are typically sliced or chunked and placed in large containers. These exports are then placed into smaller cans in Trinidad and Tobago. Exports to Barbados are threatened by competition from St. Lucia, while exports to Trinidad and Tobago are threatened by exports from the distant country of Thailand, which have a lower price and more consistent quality.

Several problems have been noted which impair Guyana's pineapple exports, first, the incidence of diseases, such as gumnosis and endogenous brown spot, which cause flesh discoloration. The high cost of labour, loss of quality in shipment due to inadequate handling and storage, difficulty in arranging sufficient quantity to warrant an export shipment, and the lack of promotional programs are other constraints to the development of this industry (Rouffiange). Also, exporters are not well connected to producers, and it is felt that growers maintain an attitude of producing for the local market, and they strategise that whatever production is "good enough" will be exported, in contrast to an attitude of production specifically for export purposes.

Current DRCs

The costs of production for pineapple used in this exercise are the average annual cost for the three- year cycle of production. Under the baseline or current situation, pineapple production at both low and improved levels of technology use comes very close to demonstrating a competitive advantage. The DRCs are not much greater than the prevailing exchange rate: 149.55 for low technology and 148.55 for improved technology.

Potential DRCs

As the calculations in Table 12-8 demonstrate, pineapple production in Guyana would hold a competitive advantage if real prices were to increase by only 5 and 10 percent in 2000 and 2005, respectively. Because pineapple prices, like those of most fruits, are determined a large part by quality, improvements in handling and marketing would be important in the drive to increase prices received.

When the hypothetical exchange rate is used, the DRCs for pineapple demonstrate a strong comparative advantage. Removing taxes and setting interest rates at a long-run level would change this conclusion very little.

It is likely that Caribbean pineapple exports, in general, will not be price competitive with exports from Central America, but niche markets could be developed for particular varieties, such as the Montserrat varieties (Antoine and Taylor). However, if Guyana wishes to create specialty market for its Montserrat varieties, it would require significant improvements in production practices, disease and pest control, and handling.

3. Summary

When comparing current DRCs between the different activities analysed, rice and sugar demonstrate a competitive advantage in the case of exports destined for preferential markets. However, these results could change dramatically if those preferences are lost. Exports to the world and Caribbean markets for these two products do not hold a competitive advantage. Bauxite production at LINMINE fails to demonstrate a competitive advantage. Pineapple production comes relatively close being competitive in a market which is not overly distorted and would be given a significant competitive improvement by a shift to an exchange rate that is not overvalued.

In terms of comparative advantage, the measures for rice and sugar are greater than the nominal exchange rate when tax, interest rate, and international price policy distortions are removed, i.e., those products lack long-run competitiveness on world markets. However, when the effects of an overvalued exchange rate are removed, rice and Berbice sugar demonstrate a definitive comparative advantage, and they come close to it, in the case of sugar from the Demerara estates. Bauxite demonstrates a comparative advantage in neither instance, while pineapple does hold a comparative advantage when the exchange rate overvaluation is removed. In this regard, pineapple could well represent the situation of all non-traditional agricultural products.

The comparison of the DRCs gives an indication as to which activities are the most efficient use the country's resources of the activities compared. Rice and sugar are an appropriate use of resources while preferential markets remain. Sugar from Berbice is a productive use of resources even without the preferential markets, provided that exchange rate is in equilibrium. Non-traditional activities, such as pineapple, are other options with tremendous potential for a net gain for the country through export. The analysis suggest that activities at LINMINE are a drain on the domestic resources of the country, and in the long run its resources would be put to better use in other activities.

Table 12-8

DRCs for Pineapple

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C. Issues in Exchange Rate Management

1. The Nominal Exchange Rate

Although levels of mandatory surrender of foreign exchange have declined in the last two years, they remain about 40 percent of export revenues. Besides having a direct impact on the exchange market, export surrender requirements signal to agents the willingness of the authorities to intervene in the market, thus introducing an element of uncertainty to agents' decisions. Moreover, in such a small financial market as that of Guyana, continuous participation of the Bank of Guyana in the foreign exchange market beyond what could be considered the normal activities of a central bank may signal commitment to protect financial intermediaries facing liquidity and solvency difficulties that arise from exchange movements. Since the Bank of Guyana is a large participant in the market and will typically lead the path, commercial banks could demand protection during hard times, claiming that previous Bank of Guyana policies had contributed to the problems.

Spreads between the buying and selling rate for bank and non-bank dealers have continued to be relatively small and stable. For banks they averaged G$3 over 1994, compared with G$1.9 for non-banks, the difference arising from the lower overheads of non-bank dealers. These relatively stable differentials suggest a reasonable degree of market competitiveness. Nevertheless, reports of queuing of import orders during 1994 and 1995 suggests that noncompetitive behaviour might be on the rise. Furthermore, the recent reaction of banks facing a small decline in nominal exchange rate where they refused to buy or sell US currency because of fears that changes in the nominal rates might induce capital losses, reflects the extent by which a noncompetitive structure still dominates the financial system.

A related concern is that there still exists a notable reluctance on the part of banks to buy and sell foreign exchange among themselves, in spite of Government's efforts to develop an interbank market. This problem and the queuing for foreign exchange will have to be solved, and the mandatory surrenders of foreign exchange eliminated, before the exchange system can be termed completely liberalised.

2. The Real Exchange Rate

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⁽⁹⁾ --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⁽¹⁰⁾, 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⁽¹¹⁾. 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⁽¹²⁾ (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 estimate, 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.

For consumers, a devaluation undoubtedly represents a net loss in the short run. However, the alternative of leaving the exchange rate in an overvalued state leads to lower growth rates and therefore less creation of employment in the coming years. Hence, in this respect there is a trade-off between the present well-being of consumers, especially middle- and upper-income consumers who purchase more imported goods, and the possibilities for creation of employment and higher incomes over the succeeding few years. Increasingly, the international consensus is that the country is better off in opting for the second choice, the higher growth path.

It may be asked how applicable these lessons are to Guyana, where two of the major exports are subject to international quotas and therefore their levels are presumably not very responsive to changes in incentives. There are three answers to this question:

1) Since the quota volumes for rice and sugar are unlikely to expand, the prospects for increasing Guyana's exports rest in part with other products (such as wood products, pineapple and other non-traditional agricultural products, aquaculture products, goldworking products, etc.), and the production levels of these items are indeed sensitive to incentives. See, for example, the analysis of section II.B.2 above concerning the effect of changes in the exchange rate on the competitiveness of Guyana's pineapple exports.

2) As earlier sections of this Chapter have demonstrated, the real export prices for rice and sugar under the quota arrangements are likely to decline in the next few years, especially after the year 2000, as indeed they already have been doing. For rice in particular, severe pressure on profit margins is likely to occur after 2000, and perhaps sooner. Hence every possible economic incentive, along with continuing and rapid technological progress, is needed for that crop, in order to avoid a situation in which massive numbers of rice farmers are obliged to countenance harsh reductions in their standards of living. In the case of sugar, it already is clear that three of the eight estates are money-losing propositions (section II.B.2 above and Chapter 33), and further erosion of real price levels could raise that number to four in a short time. Exchange rate policy could help compensate for such a price erosion.

3) Even if output levels in the rice and sugar sectors were to remain unchanged under different scenarios for the exchange rate, it is important to bear in mind the role of the exchange rate in determining intersectoral income levels. Given the predominant role of these two crops, it is evident that their real prices are the major determinants of rural income levels in Guyana, and therefore a move toward an equilibrium exchange rate would improve rural incomes. In this context, it is worth recalling the findings (Chapter 17) that the bulk of the nation's poverty still is found in rural areas.

The measurement of the extent of overvaluation of an exchange rate is not completely free of ambiguities. In the short run sense, the level of a free exchange rate is outcome of the interaction of the demand for and supply of foreign exchange. Capital movements and remittances from abroad, as well as trade volumes, determine this demand and supply. Since capital movements are sometimes volatile, a completely free exchange rate in a small, open economy can exhibit fluctuations to a degree, obscuring what may be its "equilibrium" level.

More pertinent to Guyana's case is the above-mentioned fact that the surplus earnings that arise out of 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,⁽¹³⁾ 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.

In these circumstances, the issues that policy must face include: 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? These issues are taken up in section IV below.

While no consensus exists among experts regarding the best choice of an appropriate exchange regime, many developing economies have flexible rates and are, nevertheless, open economies with convertibility and do not restrict current or, often, capital transactions. One way of viewing the difference between floating and fixed exchange rate regimes is that in the floating system, the money market clears through the float with an exogenous money supply and does not affect international reserves, while in the fixed system, the market clears through an exogenous exchange rate with a fluctuating money supply bringing into focus international reserves. Put in other terms, under a fixed-rate regime, employment and production levels must bear the brunt of adjustment, as Argentina has found with its unemployment rising from 7 percent to 17 percent.

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.

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D. Issues and Constraints in Monetary Management

1. Overarching Issues

Four major categories of issues have been identified in this area:

• Issues relating to the promotion of price stability. In this connection the liquidity overhang in the financial system is considered of critical importance. This is so because of its potential for an adverse and direct impact on prices. Besides a direct impact, a liquidity overhang can also exert an indirect impact on prices through its influence on developments in the foreign exchange market.

• Issues relating to the mobilisation of financial resources consistent with the criteria of stability, soundness and efficiency.

• Issues relating to the mobilisation of an adequate level of resources for long-term financing. The development of secondary markets for trading in various financial instruments and the establishment of a capital market should be considered.

• The relation of exchange rate management to inflation control.

The existence of a liquidity overhang in the financial system is considered one of the major issues facing the financial sector. Added to the fact that the existence of a high level of excess liquidity implies less lending to support potentially high-yielding private investment, it has major implications for price and exchange rate developments. Excess liquidity, if not effectively sterilised, can result in substantial pressure being placed directly on domestic prices. It can also exert pressure in the foreign market resulting in larger-than-desirable depreciation of the domestic currency.

The nominal level of the exchange rate has an obvious bearing on the inflation rate, so much so that it frequently is a temptation to monetary authorities to enlist exchange rate policy in their constant battle to contain inflation. The principal means of doing so are policies that drive up interest rates, thereby making the net balance of short-term capital flows more favourable than it would be otherwise, and indirect controls that lead the banking system to effectively ration foreign exchange so that queuing results.

However, while this approach represents a short-term answer to the inflation, it does not constitute a long-run solution. The longer-term answer arises out of appropriate monetary and fiscal policies, above all by continuously reducing the fiscal deficit. The danger of the short-term approach is that it inverts the structural relationship between the exchange rate and domestic price levels. In the end, the nominal level of the exchange rate is determined by productivity increases and the domestic inflation rate. Accordingly, the lasting way to stabilise the exchange rate is to control inflation by reducing the fiscal deficit and augmenting productivity rapidly, thereby making export sectors and import-competing sectors more competitive on world markets.

When the exchange rate is indirectly influenced for short-term price-control purposes, resulting in an overvalued exchange rate, the country's trade balance is eventually undermined and the level of the exchange rate becomes unsustainable, and sometimes a sharp, traumatic adjustment becomes inevitable, as has happened in recent years in countries as diverse as Britain, Sweden, French Africa, Ukraine and Mexico. In the meantime, the productive sectors suffer, employment levels slide, and poverty worsens.

The nexus between the exchange rate, monetary policy and fiscal policy may be viewed through the prism of taxation, both direct and indirect. The starting point is the proposition that government requires a source of financing to carry out its functions, including development of productive and social infrastructure, alleviating poverty, and carrying out its regulatory role. To date, taxes and other revenues have not been sufficient to support these functions at the desired level, so recourse has been made to deficit finance. A consequence has been some inflationary pressure which has been repressed temporarily through the instruments of monetary sterilisation and an appreciating exchange rate. In reality, what has happened has been that the direct burden of taxation has been supplemented by indirect taxation in the form of an "exchange rate tax"⁽¹⁴⁾ on export sectors and import-competing sectors, weakening their international competitiveness; plus a "deficit finance tax" on producers and investors which has taken the form of higher interest rates caused by the crowding out effect of T-bills in the financial market.

Obviously, a persuasive argument can be made that the trade-oriented sectors, and producers and investors in general are the groups that policy should tax the least, in order to promote economic growth and its attendant employment creation. Taxes, rather, should fall mainly on consumption, although under a realistic plan incomes and wealth also have to be taxed, with exemptions for the lowest-income households. This perspective on macroeconomic policies lends more force to the recommendations in Chapter 13 for tax reform, so that these indirect forms of taxation can be eliminated.

The unsustainability of the approach that substitutes an "exchange rate tax" and a "deficit finance tax" is seen by the fact that these effects reduce the economy's growth rate over what it would be otherwise, thereby reducing the amount of fiscal revenues collected as well. This result in turn enlarges the fiscal deficit, which then compels the Government even more to resort to the policies that create the "exchange rate tax" and the "deficit finance tax." A vicious circle is spawned.

2. Constraints

Among the many constraints faced by the authorities in dealing with the liquidity overhang are:

a) The limited availability of financial instruments to manage liquidity.

Financial instruments available to the investing public consist mainly of treasury bills. Financial reforms in Guyana since mid-1988 have resulted in a shift from a system of monetary control by using interest rate ceilings, quantitative credit quotas, and reserve requirements, to one based on the use of indirect instruments, predominantly in the form of the primary sale of treasury bills.

In June 1991 the Government introduced a system of competitive bidding for treasury bills. Under this system the Government offered 91-day treasury bills at monthly auctions. The amount offered was determined by the forecast of excess liquidity in the financial system. In April 1993 the Government introduced two additional instruments by offering, via competitive bidding, 182-day and 364-day treasury bills. From January 1994 the Government increased the frequency of the treasury bill auctions by offering 91-day bills for sale twice per month instead of once a month. A special variable interest debenture was also offered in 1991. This debenture, which was rolled over in August 1994, was restricted to banks by statute. In recognition of the need to remove the restricted access of the public to such an instrument, legislative amendments were made. The Banking System Law (Amendment) 1995, passed in the Parliament on May 22, 1995, empowers the Minister of Finance or any person authorised by him to issue to the public debentures of variable interest rate and fixed date.

b. Absence of uniform tax treatment for different financial instruments.

The Government, to improve tax collection, introduced a withholding tax of 15 percent on bank deposits in March 1995. This tax rate compares with a 33-1/3 percent levied on income from treasury bills for individuals (35 percent for companies engaged in manufacturing and 45 percent for other companies). Because of the differential tax treatment, treasury bills have lost their attractiveness to most non-bank investors.

c) A paucity of timely data required for policy making.

Given the promotion of sustainable non-inflationary growth as a major goal of the Government, the Bank of Guyana, via legislative amendments in May 1995, has redefined its primary policy objective as that of fostering price stability. In executing this mandate, the Bank of Guyana has found that availability of accurate and timely data continues to be a major constraining factor.

d) Institutional weakness and limited capacity in the area of liquidity management.

The market-based environment requires a new approach to monetary management. Accordingly, new and increasing demands will continue to be placed not only on policy makers but also on market participants, especially commercial banks and other financial intermediaries. While the Bank of Guyana has already taken some initial steps for organisational restructuring and capacity building, much more is required. Concerning organisational restructuring, in January 1995 the Bank of Guyana established a Money Market Unit and the International Department. Moreover, some departmental directors' posts that were vacant for many years, were filled in 1995. Also, it expanded and strengthened its Bank Supervision Department with foreign-funded advisors, enabling it to be more responsive to the developments and needs of the banking system. As recently as late July-early August 1995, a team of technical advisors from the IMF assisted the Bank of Guyana in strengthening its liquidity management capabilities. They also helped the Bank in developing its capacity to conduct foreign exchange trading in view of steps taken to unify the foreign exchange market. For financial intermediaries in general, and commercial banks in particular, the need for organisational restructuring and capacity building is also critical.

e. Central bank losses

Great concern has been raised, especially in recent times, over the huge losses by the Bank of Guyana, since central bank losses can be an important source of liquidity creation. It is well documented in the literature that cash-flow losses in domestic currency have an expansionary effect in the monetary supply, which the central bank can only postpone temporarily by incurring debt. In the end, central bank losses will contribute to money creation (and inflation) and the loss of international reserves. It is imperative, therefore, that these losses are dealt with since they impair the central bank's effective monetary control and undermine the achievement of the Government's macroeconomic objectives.

Annual Bank of Guyana losses on an accrual basis average G$4.8 billion during the period 1991-1994, compared with a loss of G$254 million in 1990 and a break-even position in 1989. Expressed as a percent of GDP, the losses amounted to 2.8 percent in 1994. These losses originated mainly from the conduct of quasi-fiscal operations. Such operations included:

- on-lending of foreign resources to the Government without any corresponding payment by the latter of the domestic counterpart;

- provision of loan guarantees and making payments on behalf of public sector entities;

- provision of foreign exchange guarantees and foreign exchange trading at non-market clearing rates.

Operations of this nature need to be phased out as quickly as possible.

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III. Objectives for Policies for the External Sector and Monetary Management

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.

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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IV. Policy Recommendations and Their Technical Justification

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A. 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 adopt the recommendation, made in Chapters 34, 35 and 36, to institute an export processing zone. The importance of having an export processing zone (or export promoting zone) in Guyana cannot be overemphasised. 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:

Employment Effects. One of the outstanding characteristics of an EPZ is its ability to provide large amount of employment for the labour force. To the extent that goods and services produced in the EPZ are labour-intensive, which they usually are, the relatively lower wages prevailing in Guyana constitute an important advantage over other competitors in world markets. The existence of a large group of unemployed or underemployed workers with good education makes it possible to attract foreign and local firms to an EPZ.

It should be emphasised that EPZs usually provide an important income source for low-income families. Moreover, they can also provide a second income source for a family, not only improving living standards but also reducing the costs of an eventual unemployment of the head of family.⁽¹⁵⁾

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.

• Production and Exports Effects. For a small economy as that of Guyana, the EPZ can be an important source of income and exports' earnings. Though a fraction of intermediate inputs is imported, an important share of exports from an EPZ is based on domestic inputs. Non-tradable components can be very significant (electricity, construction materials, services like machinery maintenance, rental equipment, etc.). However, local producers can also supply several tradable components more efficiently if their domestic production is sufficiently competitive and international transportation costs are high.

  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.

• Investment Issues. An important aspect of EPZs is their ability to attract investment not only from abroad but also from domestic markets. Although it can be argued that there is some diversion of investment from domestic investment projects towards EPZ activities, it is also very likely that an important source of funds corresponds to a reduction in capital flight and rent-seeking activities or, at worst, a contraction in socially less profitable investment projects.⁽¹⁶⁾

  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.

• Technology Development and Transfer. One usually overlooked aspect of EPZs is their role in bringing in and transferring technology to the rest of the economy. The setting up of a firm that will compete directly in foreign markets requires a high degree of specialisation and quality control. When using domestic intermediate inputs, the requirement of quality goods delivered in a timely manner imposes a competitive discipline to the rest of the economy, which in turn can have significant effects on efficiency and overall welfare.⁽¹⁷⁾

  Key issues for the establishment of a export processing zone are the following:

  In setting up an EPZ, two considerations should guide the analysis: the fostering of comparative dynamic advantage and the requirements for private sector development.

• Comparative Advantage. Although it is customary to determine comparative advantage in view of the country's endowment of natural resources, this usually overlooks the role of dynamic comparative advantage, that is the development of industries that are not yet in production but could result from the working of the EPZ. In Guyana, although the advantages of developing forestry industries (such as sawn wood or plywood) for EPZs would be apparent in view of the country's abundant forests, it is likely that wood derivatives such as doors or furniture may represent a better long-run investment strategy. Likewise, processing of diamonds and gold could become an important source of value added. Likewise, clothing assembly plants (perhaps in combination with Brazilian clothing firms) are a possible area for investment, most of all when low transportation costs and the availability of a qualified labour force are taken into consideration.

  Certainly, a successful forecast on which sectors have a better long-run profile is very difficult to make. In this aspect, the work of sectoral groups for this Strategy is extremely helpful and should be considered for the final decision.

• Private Sector Participation. Arguably, an EPZ is a response to the lack of success in attracting foreign (and domestic) investment to the rest of the economy. The reasons for this lack of interest usually relate to a poor infrastructure, excessive Government intervention, unmanageable union problems, macroeconomic instability, political interference, etc.

  By definition, then, an EPZ must be understood from the outset as a private sector business area. The attractiveness of an EPZ for the private sector relies in allowing firms to develop in an environment that, being free of Government intervention, can guarantee investment returns and the required flexibility to adjust to world market conditions.

  Then, what is the role of the Government? Certainly, a EPZ cannot be thought of as a joint venture between the Government and the private sector. What the Government can (and should) do is:

• Define which exporting activities are to be developed in such zones.

• Set the basic regulatory framework for EPZ activities (e.g., labour regulations and protection, legal responsibilities, installment fees, etc.).

• Set locations for EPZs according mostly to private enterprise considerations (e.g., minimising transportation costs, allowing access to ports, etc.).

• Provide adequate infrastructure for the EPZs to be successful, especially including adequate deepwater harbour facilities.

• Provide the land for the EPZs very cheaply or at no cost.

• Establish criteria for selecting enterprises for EPZs, emphasising employment and net export earnings generated per unit of investment.

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  B. Exchange Rate Policies

  
  

  Section II above has described fully the major issues concerning exchange rate management. It is clear from that analysis 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. As stated in section II.C, 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. 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 earlier 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.

  With regard to the policy instruments that can be used to move the exchange rate, there are several options.

  The first approach is to give a clear signal to banks, as well as the general public, that Government intends to correct the existing distortion in the exchange rate and promote a regular series of small devaluations. This kind of announcement will enable banks to adjust their expectations accordingly and purchase foreign exchange at the progressively higher rates without fear of bring burned on the transactions. It is preferable if Government were to in fact announce the formula for mini-devaluations that will be used.

  A second step is to eliminate the phenomenon of queuing for foreign exchange. This can be done by issuing a regulation that requires all demands for foreign exchange to be satisfied by the banking system, within two working days for amounts less than US$10,000 and within five working days for larger amounts. The regulation should be accompanied by specification of penalties for lack of compliance. Among other things, such a regulation would encourage development of an interbank market in foreign exchange.

  If these steps do not prove sufficient to move the nominal exchange rate in the prescribed amounts, then the central bank can initiate a series of purchase of foreign exchange from private banks for early retirement of part of the outstanding foreign debt. The purchases can take place at two-week intervals over a period of several months or, if necessary, for a period of several years. This kind of action, by raising the demand for foreign exchange in the marketplace, will constitute a remedy for the "Dutch disease" phenomenon which arises from the exceptional export earnings conferred by the international quotas for primary products. It will also leave a legacy for future generations of a reduced debt. To avoid an undesirable impact on the fiscal budget of such operations, the central bank can restructure the domestic equivalent of the foreign debt that is been canceled, granting to the Central Government terms longer than the remaining terms on that foreign debt, for the reimbursement to the Central Bank of the domestic currency utilised in the cancellation operation.

  These three options are complementary to each other. The first two should be utilised, and the third one added if necessary. There exists yet a fourth option, which is simply to move back to a fully administered foreign exchange rate for a period of three to four years, and announce the successively higher monthly rates (or limits of the band). As long as the currency movements are reducing the degree of overvaluation, a black market in foreign exchange should not emerge. Black markets emerge when the exchange rate is overvalued, not when it is undervalued.

  Such a policy regarding the exchange rate, with the accompanying reforms in monetary, banking and fiscal policy, would constitute the principal axis of a clear definition of macroeconomic policy, removing ambiguities in that regard and making a strong statement in favour of growth as well as the attainment of stabilisation on a thoroughly solid basis.

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  C. Monetary Policies

  
  

  1. Basic Policy Orientations

  Recently, the Bank of Guyana redefined its primary policy objective as that of fostering price stability. This monetary policy objective was formalised in May 1995 when the Guyanese Parliament approved the Bank of Guyana Amendment Act that gave the central bank increased authority over the financial system and the mandate to maintain price stability. Specifically, according to Section 5 of the Bank of Guyana Act 1995, "the bank shall be guided in all its actions by the objective of fostering domestic price stability through the promotion of stable credit and exchange conditions, as well as sound financial intermediation conductive to growth of the economy of Guyana."

  While it is generally argued that monetary policy cannot permanently influence production and employment, it can exert an impact in the short to a medium term, due to short-run rigidity in prices and wages. Therefore, potential scope exists for the monetary authorities to take advantage of monetary policy's ability to influence production and employment over the short term. In practice, however, such scope is fraught with considerable difficulties and would require careful analysis and assessment of costs and benefits. Against this background it is recommended that, in the conduct of monetary policy over the next four to five years, the growth in monetary and credit aggregates should be kept in line with the growth and inflation targets.

  The important change that should be made in this regard is to define a more realistic basis for the annual and quarterly targets for monetary aggregates. Recently they have been defined consistently on the basis of an assumption that real growth will be 4 percent p.a. In fact, that assumption has been exceeded consistently, usually by a wide margin, and the resultant targets for monetary aggregates have proven to be too tight in light of actual growth performance. This has been the central fact contributing to the high real interest rates which weaken the growth prospects of sectors such as the domestic timber industry and agriculture, which depend heavily on production credit. Therefore, the policies developed under this National Development Strategy enunciate a new growth target of 5.5 percent p.a., for purposes of establishing the operational goals for monetary aggregates.

  The rationale for using this growth figure is premised on the fact that the link between the money supply and inflation depends on the economy's real growth, i.e., on the transactions demand for money. Obviously, the central bank can influence the money supply through its control of reserve money (the monetary base).

  As an operational matter, attention is given to monitoring currency in circulation --a major component of the monetary base. The results from preliminary Ordinary Least Square (OLS) estimates of the long-run demand for different Guyanese monetary aggregates over the period 1980 to 1994, suggest that a stable relationship exists between these aggregates, real income and real interest rates. The best results were obtained when currency was regressed on real income and real interest rates on treasury bills. The signs on the income and interest rate elasticities were as one would expect (positive on real GDP and negative on the interest rate). Moreover, the calculated test statistics (distributed as ²) did not show some degree of parameter stability. These results do appear to suggest that there is potential for the Bank of Guyana to realise its mandate of price stability by controlling the growth rate of monetary aggregates, particularly of currency, in the context of the nation's real growth goals.

  In addition to these considerations, its management of interest rates, the central bank should consider several factors. This approach to monetary policy involves the use of indicators that give information on the prevailing inflationary pressure. Such variables should provide information about the following phenomena:

• demand situation

• real economic development capacity utilisation

• inflation expectations

• the degree of monetary policy restrictiveness

• fiscal and budgetary policies

  The conduct of monetary policy in the light of several different variables, without specifying targets for any of them, is usually referred to as indicator based. This approach to monetary policy is the one in vogue in industrialised countries with a flexible exchange rate. Under this option the level of interest rates should be chosen to ensure that expected inflation (derived from an evaluation of the various indicators and allowing for central bank measures) is consistent with the price stability target. In Guyana the adoption of this option is likely to be constrained by the fact that data on relevant variables such as capacity utilisation, vacancies, and unemployment, are not readily available, so it can be implemented only slowly. Moreover, changes in these variables over time are sometimes difficult to interpret.

  Two other fundamental changes in monetary and fiscal policy are required to complement the above approach. One is to ease the Central Government's debt situation by moving away from a policy of depending only on issuance of T-bills to one in which those operations are complemented by a return to management of reserve ratios for the banking system. Both approaches will have the same effect on interest rates, given the size of the fiscal deficit, but the exclusive reliance on T-bills aggravates the deficit management problem in future years by adding to the Central Government's debt burden. Obviously, market instruments of deficit finance have an important place in a modern economy, but due recognition must be accorded to the fact that Guyana is still moving out of a period of extraordinary indebtedness, one of the highest in the world in proportionate terms. In such circumstances, to fashion a policy of deficit finance solely on the basis of bond instruments ignores one of the most fundamental constraints on Guyana's development.

  The other basic policy change is to accelerate the present movement toward lengthening the term of the T-bills. Their shortness, combined with their preponderant influence on the financial system, creates risks of instability in the financial system.

  2. Policies related to monetary management

  Before the implementation of the Economic Recovery Programme, the Bank of Guyana adopted an accommodating monetary policy stance by financing the Government deficits. Some of this financing was based on external credits that were on-lent in domestic currency. The new market-based environment now requires a different approach to monetary management. There is need for the Bank of Guyana to become more proactive rather than reactive as was the practice in the past. The Central Bank has already received technical assistance from the International Monetary Fund (IMF) in the context of an Enhanced Structural Adjustment Facility (ESAF) Arrangement. In response to Guyana's request for assistance to carry out a broad-base financial reform programmeme, a team from the IMF visited the country in May 1993. According to the terms of reference, the technical assistance mission was required, among other things, to advise the authorities on measures and strategies to improve monetary management. This included advice on further improvements to the existing monetary programmeming framework, the operations of the treasury bill tenders, and monetary instruments and linkages to exchange rate management.

  Despite some success in mopping up excess liquidity through the competitive bidding for treasury bills introduced in June 1991, the liquidity overhang persisted. The strategy in April 1993 to convert SDs into treasury bills with longer maturities, coupled with the increase in the frequency of treasury bill tenders and the closure of the Special Deposit facility helped in reducing the liquidity overhang. Further refinement to Bank of Guyana's monetary programmeming and decision-making framework for conducting monetary policy is urgently needed. Such refinements must explicitly take into consideration the above-mentioned linkages with the exchange rate policy and the new projections of real growth that are used in establishing monetary targets. Against this background, it is recommended that measures and strategies be focused on the following:

• Monetary programming and decision making. Right now the Bank of Guyana adjusts its monetary policy stance twice monthly following the treasury bill tenders. The existing liquidity forecasting framework currently used needs to be further developed.

• Strategy for foreign exchange market intervention. Effective monetary management requires control from the central bank of the monetary base that comprises currency and reserves of banks. Movement in the non-currency part of the monetary base is determined mainly by net domestic credit and net foreign assets. To the extent that foreign exchange inflows/outflows can lead to large fluctuations in the liquidity of the commercial banks, the Bank of Guyana (subject to its foreign reserve target) should continue to initiate sales and purchases in the Cambio market to offset such liquidity effects.

• Strengthening the capacity to analyse policy. In addition to upgrading the financial legislation and the regulation of financial institutions, meeting the challenges of a more dynamic and competitive financial sector will require strengthening the capacity to analyse policy and to make decisions. In view of the importance of capacity building, measures focused on the Government should be initiated. Given the chronic shortage of skilled manpower in the public sector and its inability to attract and retained skilled personnel, direct efforts within the Government to create the capacity to analyze policies are not expected to make a noticeable impact, except in the long run. So, it is recommended that indirect interventions be continued in the form of external consultants and technical assistants to ministries and the central bank. Greater use should also be made of NGOs' contributions to capacity building.

  It is important for the Government to focus on factors affecting both the demand for and supply of analytical skills as part of its capacity building strategy. To stimulate the supply of policy analysis, attention should be given to strengthening the local research institutions (e.g., the Institute of Development Studies of the University of Guyana). Commercial banks have already taken the initiative in contributing toward the funding of the "Banking and Finance" diploma programmeme taught at the University of Guyana. Personnel from both the central bank and the commercial banks have benefited from this programmeme.

  The supply of policy analysis should also be encouraged by a concerted effort to recognise its usefulness in Government and other circles. It is well accepted that an environment that seeks and encourages policy advice will attract and retain better people for policy analysis. Guyana needs good analyses to support its policies and its negotiations in the international arena. Serious attention should also be given to stimulating a wider public demand for policy analysis. This can be done by making available to the academic community, the press, organised private sector groups and the public at large, relevant and timely data and policy analysis. Policy debates among various interest groups should be encouraged since they create a demand for policy analysis in the process.

• New markets. Interbank markets are virtually absent in Guyana. A well-functioning interbank market is one of the two major markets that help the move toward indirect monetary management. The two major factors that hinder the development of a viable interbank market are the lack of trust between financial institutions and the lack of market-makers. In view of the above, it is recommended that the Bank of Guyana promote a market-maker and help it to launch the interbank market on a collateralised basis. A second-best option would be for the Bank of Guyana to establish and operate the interbank market on a collateralised basis until it is well grounded. To avoid the problem of confidence a lending financial institution could request the borrowing bank to place collateral at the Bank of Guyana. However, under no circumstances should the Bank of Guyana act as guarantor for interbank transactions.

• Diversification of instruments. The principal financial instrument used in Guyana by economic agent is bank-intermediated loans. A diversification of financial instruments is needed. Such diversification implies the emergence of other short and long-term financial instruments, such as bankers' acceptance, certificates of deposits, bills, bonds, and equity. Longer maturities are associated with higher risks. To the extent that Government debt is in principle riskless, extending the maturity of its instruments should be adopted as a strategy for encouraging the extending the maturities of other financial instruments. Also, the existence of a mechanism to ensure the liquidity of these instruments and the receipt of a positive rate of return will undoubtedly stimulate the demand for these instruments. Leasing should also be encouraged since it is a good source of longer term debt instruments.

• Clearing and payment systems. Discussions with financial market participants highlight the need for improvements in the clearing and payments systems in Guyana. Weaknesses in these systems can contribute to macrofinancial instability. Every effort should be made to improve and expand the clearing system, promote a greater degree of computerisation and the use of cheques and electric transfers, and strengthening the accounting framework for the clearing process. It is well established that the existence of efficient clearing and payments systems are a prerequisite t the development of interbank and money markets and treasury bill auctions.

  3. Policies to Deal with Central Bank Losses

  The authorities have already taken some steps to eliminate central bank losses. An important measure taken was the conversion of SDs into treasury bills and the elimination of the Special Deposit facility at the Bank of Guyana in December 1994. This measure resulted in a shift of the cost of sterilising excess liquidity from the Bank of Guyana to the Government budget.

  Some broad strategies to deal with the elimination of the Bank of Guyana's losses were put forward in the August 1993 report of the Monetary and Exchange Affairs (MAE) Department of the IMF. Based on the general proposals of the MAE report, steps should be taken to effect the following:

• Transfer of foreign liabilities to the Government. In 1994 the Bank of Guyana registered total losses of G$3.8 billion, of which G$3.6 billion (95 percent) was associated with external operations and reflected, in part, he depreciation of the Guyana currency in a situation where the gross foreign liabilities were almost thrice as large as the stock of gross foreign assets. At the end of 1994 the stock of gross foreign assets amounted to US$269 million while that of gross foreign liabilities amounted to US$797 million. Of the total foreign liabilities US$404 million (51 percent) was owed to Trinidad and Tobago, US$143 million (18 percent) to the CARICOM Multilateral Clearing Facility, and US$168 million (21 percent) to the IMF. It is recommended that all of Bank of Guyana's debt obtained on behalf of the Government be transferred to the Government, as well as the full responsibility for debt servicing. This would require new contractual agreements with external creditors. For this, serious consideration should be given to MAE's recommendation that the foreign liabilities be retained on Bank of Guyana's books, but at the same time the Government should issue to the Bank of Guyana foreign currency-denominated securities in the same amount, currency denomination, interest rates, and maturities as the Bank of Guyana's external liabilities. These foreign currency-denominated securities should be used to replace Bank of Guyana's large holdings of non-interest bearing debentures. To the extent that this proposal has the same effect of an outright assumption of debt by the Government, it would not only provide the Bank of Guyana with a stream of income but also ensure that exchange rate movements do not affect its solvency.

• Recapitalisation. The impact of inflation and currency devaluations over the years has resulted in a substantial erosion of the capital base of the Bank of Guyana. Under Section 7 of the Bank of Guyana Act 1965, it is required that "the Bank shall have an authorised capital of six million (Guyana) dollars." Despite several amendments to the Bank of Guyana Act over the years, this capital requirement remained unchanged since the Bank of Guyana was established in 1965. As at September 1995 this capital requirement was equivalent to approximately US$43,000 compared with US$3 million in 1965. The actual amount of paid-up capital as at September 1995 was G$4.3 million (approximately US$30,000). The recommendation for the Government to issue Bank of Guyana foreign currency-denominated securities would constitute a partial recapitalisation of the central bank. However, much more capital injection will be required to bring the Bank of Guyana's capital in line with international standards. It is recommended that the Bank of Guyana Act be amended to give effect to a substantial increase in the authorised capital to the equivalent of between G$1 billion (US$7 million to US$11 million).

• The elimination of external payment deposits. Under the Bank of Guyana's External Payment Deposit Scheme (EPD), started in 1978, there is an estimated balance of approximately G$330 million at the Bank of Guyana as of September 1995, made by some 1,000 depositors. Between 1978 and 1990 the Government required all private importers in Guyana to deposit the remittance value of imports of goods (and services in some cases), in Guyana dollars, in the Bank of Guyana. These deposits were made with the understanding that the Bank of Guyana remit the required foreign exchange to the respective suppliers. It is agreed that honoring the terms of the EPDs is not practical due to the inability of the economy to withstand the shock that is likely to arise from the magnitude of the external payment and/or domestic monetary injection. It should be borne in mind that some of these deposits were made at a guaranteed rate of G$3 per US$1. Although these credits are in arrears they do not qualify to be treated under the Paris Club agreement since they are not classified as Government guaranteed debt. In resolving this issue either of the following options is recommended for consideration:

  - The original deposits in the EPD schemes should be returned. Support for this proposal is based on the fact that from its inception the Bank of Guyana paid interest on the original deposits. Moreover, many original liabilities have been paid or written off.

  - Negotiate a debt buy-back operation similar to the one executed in 1992 with foreign commercial banks. Preparations for such an operation will require technical assistance, which through negotiations, can be financed by bilateral donors or multilateral financial agencies.

  4. Policies Related to Secondary Trading and Capital Market Development

  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 preidentified 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.

1. Parts of this Chapter are adapted from Amy Angel, "Analysis of the Effects on Guyana's Export Sector of Changes in International Markets," report prepared for the Ministry of Finance, February, 1996.

2. Throughout this section, real prices are expressed in US$ of 1995.

3. In 1981 the G$ was pegged to a basket of currencies - British Pound Sterling, French Franc, German Mark, Japanese Yen and the Dutch Guilder, with the US$ being the intervention currency. The intention was for the G$ to float as the US$ fluctuated vis-a-vis the basket of currencies. Between 1981 and 1984 the rate remained unchanged. In 1984 with the devaluation the G$ was reduced with respect to the basket of currencies and the US$.

4. Prior to 1990, a multiple exchange rate system existed. The key rates were the official rate and the parallel market rate. For a short time commercial banks were allowed to purchase foreign currency at street rates (in 1987) which was abolished in 1989 following a devaluation. In theory the official rate was to be determined in relation to a basket of currencies with the US$ being the intervention currency but this was not followed in practice.

5. The real effective exchange rate (REER) indicates the rate at which traded goods are exchanged for foreign goods. The REER weights exchange rates by their importance in our trade and adjust these nominal rates to differentials in prices at home and abroad.

6. The source of these data on the balance of payments is the Bank of Guyana. The IMF's estimates differ somewhat.

7. Protection is used throughout the Chapter in a broad sense to include indirect measures of protection, in both positive and negative directions.

8. Full details of the methodology of the DRCs and the components of the costs of production are found in A. Angel, op.cit.

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

10. 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.

11. 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$.

12. This is known as the Dutch disease case.

13. 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.

14. By "exchange rate tax" is meant the reduction of real prices and profitability of trade-oriented sectors which is a consequence of an overvalued exchange rate.

15. 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.

16. 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.

17. 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.

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