Inflation, exchange rate and excess liquidity
EDITORIAL
Stabroek News
April 30, 2004
Too much money chasing too few goods! This is the nuts and bolts definition of what inflation really is. The effect of inflation is that it erodes the purchasing power of a currency.
But is it the case in Guyana of too much money circulating with limited supplies of goods or is it the other way around? Everyone is complaining that business is bad so it must mean that the purchasing power is not there.
If it is the case of impoverished workers being unable to buy goods and services because of limited incomes, then how do we explain the inflationary effect of excess liquidity in the financial system? People already do not have money to spend on essential goods and services so how do we explain that the excess liquidity will translate into purchases for them? Companies are not generating sufficient profits to park these in the banking system and spending by businesses would drive economic growth. However, commercial banks have been very cautious in lending so there is no big boom in private investments. In the case of banks and insurance companies they are already sending funds abroad to be invested while many companies are complaining about the lack of long-term financing to allow them to be efficient.
So what is the source of this excess liquidity, especially as businesses are struggling to make a dollar?
This brings into play a larger question - the government's monetary policy. Why is the government spending billions each year mopping up this questionable liquidity? What could happen to this liquidity if it just sat in the banking system? Most likely, it would push commercial banks to seek returns elsewhere which may take the form of foreign investments. Of course this would put some pressure on the Guyana dollar, which in turn would have an inflationary effect as a depreciated dollar makes imports more expensive.
However, former IMF resident representative in Guyana, Ebrima Faal estimates that the informal sector, which includes money laundering, is as large as 30% of the formal sector. This sector contributes to the supply of foreign currency in the local market so the net effect of the export of foreign currency would not be as large if the informal sector was absent. The proceeds from this illegal sector and from the illicit drugs trade cannot be hoarded under mattresses and has to be deposited somewhere. It is natural that it would be in the banking system. So this brings us back to the point, why are we mopping up money generated illegally?
Capital flight is taking place everyday. Persons and companies looking for a decent return on their funds would not leave these in the local banking system where the net returns are negative. The mopping up exercise has not been able to curb capital flight, which is an issue of confidence in an economy. And once there is no confidence, flight will take place. Hence spending money to stop pressure on the currency is a futile exercise if exports are not bolstered to strengthen the foreign currency position of the country.
According to the Bank of Guyana statistics, Guyana's domestic debt has reached $61.9 billion (US309M) at the end of 2003 from $10.4 billion (US$266M) in 1990, a nominal increase of 495% while the exchange rate has deteriorated from G$39/US$1 to today G$200/US$1 - a depreciation of 412%. The long-term solution to stabilising the currency cannot just be mopping up excess liquidity, which has resulted in the domestic debt spiraling out of control and the currency being massively devalued. It has to be coupled with a serious programme to support and sustain export growth to increase foreign exchange earnings. A currency depreciates because of foreign currency supply constraints.
Inflation, on the other hand, would have been kept low by virtue of the low wages and salaries rather than the spending of billions each year to mop up this questionable liquidity. The depreciation of the dollar would have had a larger effect on inflation than increased wages and salaries.
It is high time that the government call in economists with the relevant skills and experience from this region to take a hard look at the numbers, the structure of the economy and the effect of the underground economy and to determine how best it should treat the excess liquidity in the banking system. The domestic debt is troubling and it is hoped that debt workshop concluding this week would come up with a workable solution to this problem.
Funds spent mopping up excess liquidity in a lopsided programme can be spent elsewhere gainfully.