macroeconomic instability, shocks and unsustainable current account deficits
The most recent Bank of Guyana Quarterly Statistical Abstract that is available for 2019 is for the third quarter which ended September 2019. The report revealed an unsurprisingly affirmative position articulated in previous writings by this columnist with regards to the trade balance position and the potential implications on macroeconomic stability.
To this end, particular attention is focused on the balance of payments where the overall balance recorded a lower deficit of US$50.8 million compared to US$168.3 million deficit for the same period last year. This was due to a higher capital account surplus attributed to increased foreign direct investments in the oil and gas sector.
Conversely, the current account deficit expanded to US$1386.3 million from US$992.5 million for the same period in 2018. This resulted from a larger merchandise trade deficit of US$880.5 million from US$652.4 million recorded for the corresponding period in 2018, thereby reflecting a 22% growth in imports to reach US$2039.1 million.
The Bank of Guyana international reserves amounted to US$528.3 million which was equivalent to 1.5 months import cover at the end of the third quarter of 2019.
High and rising current account deficits pose a serious threat to an economy. They reflect domestic imbalances which ultimately will have to be restored. This would require an appropriate domestic adjustment. The adjustment may take place automatically in the market place. Alternatively, the adjustment may require changes in government policies. The risk of large current account deficits is that they may become “excessive” as investors lose confidence and demand repayment or re-financing of loans and/or as countries lose foreign currency reserves. In brief, some current account imbalances are sustainable, others are not.
The distinction between persistent and transitory current account deficits primarily arises from the difference between permanent and transitory shocks. The question has been raised as to whether this distinction has implications for the way in which current account balances change. It is possible to argue, for example, that a persistent decline in terms of trade (due to, for example, a collapse of commodity prices) will widen the current account deficit because people are more likely to increase savings and, hence, reduce consumption as a short-term phenomenon rather than on a persistent basis. On the other hand, as argued by Obstfeld and Rogoff (1995a), transitory productivity shocks may move the current account into surplus but may not be accompanied by a growth in investment reflecting responses of investors to new opportunities generated by the growth of productivity.
The nature of shocks – ie whether they are persistent or transitory – affects both the “investment” side of the macroeconomic balance as well as “savings”. As the study of Obstfeld and Rogoff (1995a) indicates, the shocks of productivity changes – as an example – may affect investment decisions. The critical question for policymakers is whether these shocks lead to a permanent change in savings behaviour or not. A transitory increase in productivity will not be translated into a permanent improvement of the current account balance while a permanent increase in productivity will have that result (World Trade Report, 2004).
The nature of shocks will affect the way in which economic agents respond to these shocks and decide whether the current account deficit can be financed by running down reserves or by borrowing, or whether an adjustment is necessary to restore external balance. The academic “wisdom” would suggest that temporary imbalances should be financed by borrowing or lending depending on the nature of the imbalance. Permanent imbalances should be addressed by adjustment through policy changes. Thus, the challenge for policymakers is to manage shocks with the appropriate balance between discretion and recourse to policy rules. Part of this challenge, for all economies, is to avoid overreacting when correcting macroeconomic imbalances (World Trade Report, 2004).
In previous articles, it was argued by this author that with oil and gas-related activities, and now that oil production has commenced in December last, import will grow rather exponentially and will, in turn, expand the trade deficit thus placing undue pressure on the Bank of Guyana Reserves and exchange rates. These have inherent implications on macroeconomic stability. Already, as is evidenced by the report, the BoG international reserves are well below the standard minimum benchmark of three months import cover to 1.5 months import cover. Over the last ten years, the BoG reserves were well above 4 months import cover in some cases, and as high as six months at one time. When the foreign companies start to repatriate their profits, the net foreign assets in the banking system will be depleted thus, inducing exchange rate pressures, if not sharp depreciation, and rising inflation rates.