Last week, I contended that though there is evidence pointing to a decline in net inflow of the US currency, the aggregate foreign currency holdings by the banking system remained relatively unchanged. However, a substantial shift in the composition of commercial banks’ foreign holdings, wherein a larger portion was utilised for foreign investments, was evident.
I argued that this was largely attributed to the distortion of the exchange rate in the domestic foreign exchange market, causing the Guyana dollar to depreciate.
To this end, the findings stemming from my analysis on this matter are thus far in sharp contrast with the contentions put forward by central government officials (the central bank governor and the minister of finance) when they met with the bankers’ association on March 24, 2017. Arising from that meeting, in a press release on March 25, 2017, it was stated that exporters are hoarding foreign currency in their retention accounts, and are sourcing foreign currency in the domestic market instead; which reduced the supply of foreign currency as demand increased, leading to the depreciation and instability of the rate.
Further, the proposed solution of a possible ‘moral suasion’ cited by the finance minister was such that, if the situation persists, closure of retention accounts held by exporters could be exercised with the aim of correcting and stabilising the exchange rate.
I, on the other hand, would respectfully like to strongly disagree with this proposed course of action. Closure of exporters’ retention accounts might do more harm to the economy than good. The reason is simple, and has potential catastrophic consequences to the economy if pursued. Guyana’s financial market is still highly underdeveloped in comparison to the more advanced economies like obtain in the U.S, U.K etc., in respect to innovative financial instruments.
Students of finance and accounting, finance professionals and all business executives would know that firms operate within an environment which can also be described as THE economic environment, and they do not operate in isolation of the external environment. Thus, within this framework, companies are exposed to a number of inherent risk factors, such as political risks, economic risks, market risks, social risks, technological risks. In the context of this article, they are also exposed to exchange rate risks or foreign currency risks, and of course there are many other risks. In light of this, companies and businesses therefore need to engage in prudent risk management practices by using various risk management tools. In regard to exchange rate risks, there are various financial instruments that can be used to hedge exchange rate risks (exchange rate risk is simply the fluctuation of the exchange rate against another foreign currency with which a country engages in international trade).
These instruments referred to are known as derivatives. Derivatives are normally traded within a submarket, by itself called a ‘derivatives market’, which include forwards, futures, swaps and options contracts. Unfortunately, space precludes me from explaining each one of these in detail; but, generally, they are used as risk management tools by investors by either hedging a portfolio against risk and/or arbitrage or speculation over specific profit opportunities. Hedging ensures counterbalancing of cash flows, which reduces dispersion of possible outcomes and therefore reduces the risk. Note that derivatives instruments are popularly used for hedging interest rate risks and exchange rate risks.
With that said, Guyana does not have a derivatives market or any derivatives instruments, and as such, the only financial instrument available to participants (firms and businesses) within the domestic economy to hedge or manage foreign exchange risks are those very ‘retention accounts’. By operating the exporters retention accounts, businesses can conduct transactions directly in the foreign currency market without having to worry about exchange rates, as any adverse fluctuation in the exchange rate could pose serious cash flow problems for companies and businesses, and could lead to substantial losses on the part of companies.
I conclude here for now, and will continue this discussion again next week. The nature of this topic in particular is very complex and far-reaching, and therefore it is imperative that I dedicate a series of articles in dealing with some of the major components of the subject. Just to give you a quick hint though, next week I will touch on some revised reserve management practices and foreign exchange policies that were developed by the International Monetary Fund (IMF), forming the basis of my discussion relative to a likely urgent solution to the problem at hand. These policies and practices ought to be examined by the country’s policy makers and other relevant authorities.
