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Guyana's Post-Liberalization Stagnation

Permanent Link: http://ncf.sobek.ufl.edu/NCFE004067/00001

Material Information

Title: Guyana's Post-Liberalization Stagnation Real Exchange Rate or Oligopolistic Banking?
Physical Description: Book
Language: English
Creator: Crandell, Kyle
Publisher: New College of Florida
Place of Publication: Sarasota, Fla.
Creation Date: 2009
Publication Date: 2009

Subjects

Subjects / Keywords: Financial Liberalization
Development
Exchange Rate
Genre: bibliography   ( marcgt )
theses   ( marcgt )
government publication (state, provincial, terriorial, dependent)   ( marcgt )
born-digital   ( sobekcm )
Electronic Thesis or Dissertation

Notes

Abstract: This thesis examines the effects of financial liberalization policies on a small open economy. Building off the work from past studies, the theory of foreign capital inflows and its effects on the real effective exchange rate is used to explain growth patterns in this study. Foreign capital inflows cause a real appreciation of the real exchange rate, which should lead to decreased economic growth. Additionally, a loan-deposit interest rate spread analysis is used to elucidate how an oligopolistic banking sector adversely affects future growth possibilities. Banks desire a minimum rate of interest before investing in private sector loans, which leaves them with non-remunerative excess liquidity. Many developing countries use the United States 3-month Treasury bill rate as a benchmark rate for their financial systems, and economic growth tends to fluctuate with changes in this rate. An exploration of the interaction between the Guyanese lending rate and the U.S. 3-month Treasury bill rate will determine if such a relationship exists.
Statement of Responsibility: by Kyle Crandell
Thesis: Thesis (B.A.) -- New College of Florida, 2009
Electronic Access: RESTRICTED TO NCF STUDENTS, STAFF, FACULTY, AND ON-CAMPUS USE
Bibliography: Includes bibliographical references.
Source of Description: This bibliographic record is available under the Creative Commons CC0 public domain dedication. The New College of Florida, as creator of this bibliographic record, has waived all rights to it worldwide under copyright law, including all related and neighboring rights, to the extent allowed by law.
Local: Faculty Sponsor: Khemraj, Tarron

Record Information

Source Institution: New College of Florida
Holding Location: New College of Florida
Rights Management: Applicable rights reserved.
Classification: local - S.T. 2009 C89
System ID: NCFE004067:00001

Permanent Link: http://ncf.sobek.ufl.edu/NCFE004067/00001

Material Information

Title: Guyana's Post-Liberalization Stagnation Real Exchange Rate or Oligopolistic Banking?
Physical Description: Book
Language: English
Creator: Crandell, Kyle
Publisher: New College of Florida
Place of Publication: Sarasota, Fla.
Creation Date: 2009
Publication Date: 2009

Subjects

Subjects / Keywords: Financial Liberalization
Development
Exchange Rate
Genre: bibliography   ( marcgt )
theses   ( marcgt )
government publication (state, provincial, terriorial, dependent)   ( marcgt )
born-digital   ( sobekcm )
Electronic Thesis or Dissertation

Notes

Abstract: This thesis examines the effects of financial liberalization policies on a small open economy. Building off the work from past studies, the theory of foreign capital inflows and its effects on the real effective exchange rate is used to explain growth patterns in this study. Foreign capital inflows cause a real appreciation of the real exchange rate, which should lead to decreased economic growth. Additionally, a loan-deposit interest rate spread analysis is used to elucidate how an oligopolistic banking sector adversely affects future growth possibilities. Banks desire a minimum rate of interest before investing in private sector loans, which leaves them with non-remunerative excess liquidity. Many developing countries use the United States 3-month Treasury bill rate as a benchmark rate for their financial systems, and economic growth tends to fluctuate with changes in this rate. An exploration of the interaction between the Guyanese lending rate and the U.S. 3-month Treasury bill rate will determine if such a relationship exists.
Statement of Responsibility: by Kyle Crandell
Thesis: Thesis (B.A.) -- New College of Florida, 2009
Electronic Access: RESTRICTED TO NCF STUDENTS, STAFF, FACULTY, AND ON-CAMPUS USE
Bibliography: Includes bibliographical references.
Source of Description: This bibliographic record is available under the Creative Commons CC0 public domain dedication. The New College of Florida, as creator of this bibliographic record, has waived all rights to it worldwide under copyright law, including all related and neighboring rights, to the extent allowed by law.
Local: Faculty Sponsor: Khemraj, Tarron

Record Information

Source Institution: New College of Florida
Holding Location: New College of Florida
Rights Management: Applicable rights reserved.
Classification: local - S.T. 2009 C89
System ID: NCFE004067:00001


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GUYANA'S POST LIBERALIZATION STAGNATION: REAL EXCHANGE RATE OR OLIGOPOLISTIC BANKING? BY KYLE CRANDELL A THESIS Submitted to the Division of Social Sciences New College of Florida in partial fulfillment of the requirements for the degree Bachel or of Arts in Economics Under the Sponsorship of Dr. Tarron Khemraj Sarasota, Florida May, 2009

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! "" Acknowledgements I want to thank my parents for giving me the opportunity to attend a school that prides itself on the undergraduate thesis process. I kn ow it has been expensive, but I am grateful for their support. This work would not have been possible without the support and encouragement of Dr. Tarron Khemraj, whose interest in Caribbean development led me to choose this thesis topic. I would also lik e to thank Annie Frazier, who has supported me throughout this long process and helped me with editing my thesis.

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! """ Table of Contents Acknowledgments ii Figures iv Abstract v Introduction Scope and purpose of the investigation 1 Plan of study 3 Chapter I : Literature Review: Financial Repression and Financial Liberalization 1. Financial Repression 5 2. Financial Liberalization (i) Types of Finance 9 (ii) Functions of the Financial System 10 (iii ) McKinnon (1973) and Shaw (1973) 13 (iv) Prerequisites for Financial Liberalization 18 Chapter II: Post Financial Liberalization 1. Complications 20 2. Background of the Guyanese Banking System and Financial Reforms 22 3. C apital Inflows 27 4. Real Exchange Rate Values and Growth 30 Chapter III: Guyanese Growth Stagnation 1. Real Effective Exchange Rate 32 (i) Reasons for Using the Real Effective Exchange Rate 32 (ii) Real Effective Exchange Rat e Analysis 34 2. Loan deposit Interest Rate Spread 49 (i) Loan deposit Interest Rate Spread Analysis 49 3. Guyana Lending Rate U.S. 3 month Treasury Bill Rate 58 (i) Guyana Lending Rate U.S. 3 month Treasury Bill Rate Analysis 59 Summary and Concluding Remarks 69 References 74

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! "# Figures Figure 1 15 Figure 2 30 Figure 3 34 Figure 4 36 Figure 5 36 Figure 6 37 Figure 7 38 Figure 8 39 F igure 9 39 Figure 10 41 Figure 11 42 Figure 12 43 Figure 13 44 Figure 14 45 Figure 15 46 Figure 16 50 Figure 17 51 Figure 18 52 Figure 19 53 Figure 20 55 Figure 21 56 Figure 22 57 Figure 23 59 Figure 24 60 Figure 25 61 Figure 26 62 Figure 27 63 Figure 28 64 Figure 29 65 Figure 30 66 Figure 31 67

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! # GUYANA'S POST LIBERALIZATION STAGNATION: REAL EXCHANGE RATE OR OLIGOPOLISTIC BANKING? Kyle Crandell New College of Florida, 2009 ABSTRACT This thesis examines the effects of financial liberalization policies on a small open economy. Bui lding off the work from past studies, the theory of foreign capital inflows and its effects on the real effective exchange rate is used to explain growth patterns in this study. Foreign capital inflows cause a real appreciation of the real exchange rate, which should lead to decreased economic growth. Additionally, a loan deposit interest rate spread analysis is used to elucidate how an oligopolistic banking sector adversely affects future growth possibilities. Banks desire a minimum rate of interest bef ore investing in private sector loans, which leaves them with non remunerative excess liquidity. Many developing countries use the United States 3 month Treasury bill rate as a benchmark rate for their financial systems, and economic growth tends to fluct uate with changes in this rate. An exploration of the interaction between the Guyanese lending rate and the U.S. 3 month Treasury bill rate will determine if such a relationship exists. Dr. Tarron Khemraj Division of Social Sciences

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! $ Introduction Sc ope and Purpose of the Investigation The purpose of this thesis is to analyze the effects of financial liberalization policies on a small open economy using a narrative approach and descriptive statistics. The analyses used measure the effects of foreign capital inflows using the real effective exchange rate, the Guyanese loan deposit interest rate spread, and the Guyanese lending rate using the United States 3 month Treasury bill rate as the benchmark rate. The analysis of the loan deposit interest rate will reinforce the notion of an oligopolistic banking sector as discussed by Khemraj (2006a, 2007a, 2007b, 2008a, 2008b). Financial repression, through the form of government intervention, is characterized by high reserve requirements for banks, the unde rdevelopment of private bond and equity markets, and interest rate ceilings. High reserve requirements and interest rate ceilings force banks to hold excess liq uidity instead of making growth augmenting loans. On the other hand, financial liberaliz ation is characterized by free floating interest rates, and a reduction in quantitative controls to allow financial intermediaries greater control in the financial system. In theory, market determined interest rates and less government intervention will lead to increased savings and investment, which will act as a catalyst for economic growth. The real effective exchange rate is used as a means to determine the effect of foreign capital inflows on economic growth. Following financial liberalization, an econom y becomes open to foreign capital and a real appreciation of the exchange rate follows. When viewing long term growth possibilities, it is important to study the effects of exchange rate levels because of their influence on aggregate investment. An appreci ation of the exchange rate leads to artificially inflated incomes which fuel

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! % consumption led growth instead of investment led growth, thus producing a savings displacement. While financial liberalization policies are designed to increase economic growth, in a small economy such as Guyana, an oligopolistic banking sector exercises a great deal of power. A focus of this thesis is the excess liquidity phenomenon which is the result of the oligopolistic power of the commercial banking system in the loan and Treasury bill markets. A bank requires a minimum loan rate that will compensate for marginal cost s which include s any risks, and the rate of return on a safe foreign asset before making a loan to a borrower. If the borrower is unwilling or unable to pa y the minimum rate, the bank accumulates non remunerative excess reserves or excess liquidity. This phenomenon has created a liquidity preference curve that is flat at a very high interest rate. This curve shows that non remunerative excess reserves and loans become perfect substitutes at very high interest rates. Changes to the financial system that were made in the late 1980s and early 1990 s lead to earlier examination of the effects of financial liberalization policies. Under the International Monetar y Fund stabilization program, loan, deposit, and Treasury bill rates are no longer controlled by the government, but by the private sector. Credit rationing programs and directed credit to priority sectors has been discontinued. Once nationalized banks h ave become privatized and foreign banks are allowed to interact in the domestic economy. The government has also dismantled exchange rate control mechanisms and the currency has been allowed to fluctuate. Special emphasis is placed on the commercial ban king sector here because it is the main source of financing in Guyana as well as other small developing countries.

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! & Bond and stock markets are underdeveloped and account for a very small percentage of business finance, thus exacerbating commercial banks' effects of monetary policy on the real economy. Plan of Study Chapter I will review the elements of financial repression and develop an understanding of financial liberalization theory. Different types of finance will be discussed, as well as the functi ons of the financial system. The McKinnnon Shaw Hypothesis is the basis of these financial liberalization analyses where it is assumed that an increase in domestic savings will lead to an increase in domestic investment. Before financial liberalization p olicies should proceed, several prerequisites that should be met will be discussed. Chapter II will build from the financial liberalization literature review in Chapter I and discuss issues arising after liberalization policies are adopted. There are t hree assumptions to financial liberalization literature that may or may not be met: perfect information, profit maximizing competitive behavior by commercial banks, and institution free analysis. A background of the Guyanese financial system provides the framework within which the data analyses lie The effects of capital inflows on liberalized financial markets and the effects of real exchange rates on growth will form the basis for the analysis of the effects of the real effective exchange rate. Chap ter III will use the theories discussed in the previous two chapters to provide an analysis of the effects of financial liberalization policies. The analysis of the real effective exchange rate will seek to determine the effects of foreign capital inflows on economic growth. The Guyanese loan deposit interest spread analysis will reinforce the

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! notion of an oligopolistic banking sector that wields an exorbitant amount of power and influence. By using the U.S. 3 month Treasury bill rate as the benchmark ra te, it can be determined if differences in interest rates abroad affect economic growth. The higher interest rates are in the United States, the lower the volume of capital inflows into developing countries.

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! ( Chapter 1 Literature Review: Financial Repres sion and Financial Liberalization 1. Financial Repression Economic growth in developing countries has been an integral part of the economics profession over the p ast several decades. Several theories have been formulated to explain the causes of economi c growth stagnation, while others have sought to offer solutions. Many economists and policy makers believe that financial liberalization is the key to economic growth and prosperity. The results of financial liberalization have been mixed; som e countrie s experience growth, while others experience financial crises. To understand the theory behind financial liberalization, it is important to comprehend the reasons governments promote financial repression and the consequences it has on th e economy. The pu rpose of this literature review is to develop the background and theory of financial liberalization. Ronald McKinnon said, "When governments tax and otherwise distort their domestic capital markets, the economy is said to be financially repressed'" (McKi nnon 1973, p. 29). Rangan Gupta (2004) describes financial repression as a lack of financial intermediation in financial markets in developing countries (Gupta 2004, p. 2). Financial repression consists of three elements. The first element is the demand that banks hold government bonds and money through high reserve requirements established by the government. Banks are also forced to have a high liquidity ratio, which allows the government to finance budget deficits at little or no cost. The second ele ment of financial repression is the underdevelopment of private bond and equity markets because of the difficulty in removing government revenue. The third element of financial repression is the interest rate ceilings established by the government, which p revent competition

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! ) between the public and private sector and encourage low cost investment. Controls on the deposit and lending rates of interest in a repressive financial system are below the market clearing equilibrium rate. If inflation is high, real interest rates can become extremely negative, stunting growth. Financially repressive systems are usually classified as having interest rate ceilings, credit allocation, and high reserve requirements (Gupta 2004, p. 2). Most economists believe that a l iberalized financial system will grow faster than a repressed financial system, but Joseph Stiglitz believes that the state has an important role in financial markets. Stiglitz states, "It is necessary to appreciate the limits as well as the strengths of government intervention" (Stiglitz 1992, p. 20). According to Stiglitz, financial repressi on can improve the efficiency with which capital is allocated. In a financially repressed system, interest rate ceilings prevent competition between the private and the public sector, but higher interest rates 1 under a liberalized system do no t necessarily attract the best borrowers. Stiglitz also states that financial repression increases firm equity because it lowers the cost of capital (1992, pp. 40 41). Stigli tz and Weiss (1981) address the issue of adverse selection through credit rationing in markets with imperfect information. 2 Adverse selection comes from the fact that different borrowers have different credit histories and different probabilities of repay ing loans (Stiglitz and Weiss 1981, p. 393). Banks and other financial institutions use screening processes to distinguish "good" borrowers from "bad" borrowers. One of the tools these institutions use for screening applicants is the interest rate. As t he interest !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 1 A distinction must be made between deposit rates of interest and loan rates of interest. The deposit rate of interest is the rate a depositor earns on a deposit. The loan rate of interest is the rate banks charge to those who wish to borrow money. 2 Se e Stiglitz and Weiss (1981)

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! rate increases, the riskiness of the loan also increases. Usually those borrowing at higher interest rates are more at risk for default than those who are able to borrow at lower interest rates, which may or may not affect the banks profits (S tiglitz and Weiss 1981, p. 393). Dell'Ariccia, Friedman, and Marquez (1999) look at adverse selection and the effects that it has on entry into the banking industry. 3 They use a two bank model where both serve a particular credit market. In a case of perfect competition, banks will compete to attract customers by lowering interest rates or with symmetric information, thus causing each bank's profits to be equal to zero. No new banks will enter the market because of the sunk costs that must be incurre d. In the case of asymmetric information (or imperfect credit markets), banks profits are decided by the information that each possesses. In this case the limited entry conclusion still holds, even when sunk costs are considered (Dell'Ariccia, Friedman, and Marquez 1999, p. 517). Many cross country samples of developing countries have been conducted over the past several decades. Joseph H. Haslag and Jahyeong Koo (1999) conducted a cross country analysis using the data used by King and Levine (1993). O ne of the goals of their experiment was to determine any relationships between the reserve rate requirement and the rate of inflation. In their data analysis, inflation is seen as an important part of financial repression. When the inflation rate is at a socially accepted level, that is, when fiat money offers the socially desirable rate of return, financial repression is not necessary (Haslag and Koo 1999, p. 4). In most developing countries however, inflation is a main cause of concern and is often ver y high. !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 3 The case of oligopolistic banking systems will be discussed in more detail in the next chapter.

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! + Haslag and Koo (1999) present two sets of findings. The first set observes the relationship between financial repression measures and growth indicators. The results reported are: (i) i nflation and the required reserve ratio have different purp oses for growth, meaning that inflation is not a sufficient statistic for a financia l system to be repressed; (ii) o n average, countries with higher required reserve ratios grow slower than those with lower reserve ratios. On average, there is a weak corr elation that countries with high inflation rates grow slower than countries w ith low inflation rates; (iii) i t is unlikely that a financial development measure and the required reserve ratio are jointly significant in growth (Haslag and Koo, 1999, p. 4). The second set of results focuses on the relationship between financial repression measures and the level of financial development. The results reported are: (iv) o n average, countries with higher required reserve ratios have less developed financial syst ems than countri es with low reserve ratios; (v) t here is a non linear relationship between the level of inflation and financial development. Generally speaking, countries with high inflation rates tend to have less developed financial markets, but the rel ationship is non existent after a threshold rate (Haslag and Koo, 1999, p. 5). While many believe that financial repression causes growth to slow in developing countries, Korea has managed to incorporate a small part of financial repression alongside its liberalization policies (See Chang, Park, and Yoo 1998). While many countries in Latin America were focusing on import substitution, Korea slowly began to liberalize its financial system while focusing on export oriented credit (Stiglitz 1992, p. 44). Ko rea, along with most of the East Asian countries, realized that export markets were more competitive and more efficient, and that consumption would come at the expense of

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! foreigners. By directing credit 4 and through other government policies, Korea has e xperienced steady economic growth. As stated earlier, financially repressed systems usually consist of interest rate ceilings, high reserve requirements, and directed credit, but all need not be used simultaneously. Financial repression has also been sho wn to lead to curb markets (also referred to as black markets). These types of markets are usually regional and are not subject to regulation by the government. Deposits become less attractive than real assets such as gold, so when interest rates are low on deposits, it is more cost effective to place wealth in assets. Perhaps the biggest flaw, according to McKinnon and Shaw, is that financial repression leads to reduced savings, which ultimately leads to reduced investment and growth (Gibson and Tsakalo tos 1994, pp. 584 585). However, as will be shown in the following sections financial liberalization does not necessarily lead to increased savings. 2. Financial Liberalization (i) Types of Finance When discussing financial liberalization, it is impo rtant to ask whether financial development leads to economic growth, or economic growth leads to financial development. Walter Bagehot (1873) and John Hicks (1969) say that the development of the financial system in England ignited the industrial revoluti on. Joseph Schumpeter (1912) said that good banks spur innovation through the loan application process. From this point of view, a developed, well functioning financial system is the key to economic growth. Others, such as Joan Robinson (1952) say finan cial development is a function of economic growth. Debates over w hich comes first have been gone on for decades, with !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 4 Controlling the quantity of credit is better than trying to control the interest rate.

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! $! each side presenting reasons for one scenario and against the other. Although there are disagreements, it has become clear that the fina ncial system plays a very important role in development. There are three main types of finance within the financial system that require explanation : self finance, direct finance, and indirect finance. Self finance is consumption based on income and inv estment financed from internal savings. Direct finance involves borrowing by deficit spending units 5 from surplus spending units. 6 7 Indirect finance is the situation in which financial intermediaries issue their own debt by soliciting loanable funds from surplus spending units and allocate those funds to deficit spending units, thereby absorbing the direct debt (Gurley and Shaw 1955, pp. 518 519). Since financial intermediaries pool together loanable funds from surplus spending units, total debt (which i ncludes the direct debt that financial intermediaries buy and the indirect debt they issue) rises faster than income. Gurley and Shaw state that, "Institutionalization of saving and investment quickens the growth rate of debt relative to the growth rates of income and wealth" (1955, p. 519). (ii) Functions of the financial system In modern economies, indirect finance is the most common form of finance, although self finance and direct finance still exist on smaller scales and in black markets. Financial markets have one primary function: to facilitate the allocation of resources in an !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 5 Consumers in an economy. Consumption is greater than total income. 6 Savers in an economy. Consumption is less than total income. 7 An ex ample of direct finance: instead of going to a bank or other financial intermediary for a loan, an entrepreneur would have to go door to door asking for a loan until he received the amount needed for the investment.

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! $$ uncertain environment. There are several subsections of this function which include: (i) the facilitation of trading, hedging, diversifying, and pooling of risk; (ii) the a llocation of resources; (iii) the monitoring of managers and the exertion of corporate control; (iv) the mobilization of savings; (v) and the facilitation of the exchange of goods and services (Levine 1997, p. 691). Liquidity risk is the uncertainty of converting assets into a medium of exchange. Where capital markets are liquid, it is inexpensive to trade financial instruments. John Hicks (1969) says that it was the development of liquid capital markets in England that helped spark the industrial revo lution, not technology. The technology used during the revolution had been present, but lacked the long term financial capital to function properly. Secondary markets measure liquidity. Therefore, a higher liquidity rate means longer gestation, high ret urn technologies. The development of stock markets also helps reduce liquidity risk by allowing trading of financial instruments that do not affect firms' access to capital. The most common risk reducing agent is the banking system. Banks help reduce li quidity risk by spreading it over many clients and can also invest in low and high return investments (Levine 1997, pp. 692 693). Financial intermediaries improve resource allocation by economizing and pooling together loans. By economizing, intermediari es reduce transaction costs and improve efficiency. The ability (or inability) of intermediaries to screen loan applicants is an important part of the growth process. Being able to diversify risk by pooling together loans does not necessarily lead to gro wth. 8 Schumpeter (1912) states that, "The banker, !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 8 In this case, a microeconomic study is needed to determine whether or not the loan application process for financial intermediaries is sufficient to spur growth.

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! $% therefore, is not so much primarily a middleman, [] He authorizes people, in the name of society as it were, [] [to innovate] ( Schumpeter 1912, p. 74). However, Stiglitz (1985) argues that very liquid s tock markets create few incentives to spend private resources for public information. Financial intermediaries can also monitor and exert corporate control over clients to whom they issue loans. When outside creditors finance a firm's activities, this ac ts as an incentive for managers to act in the best interest of the creditor. 9 As relationships build over time, monitoring and enforcement costs decrease allowing for more efficient investments (Levine 1997, p. 696). Perhaps the most important function of a financial intermediary is to mobilize savings. Banks borrow loanable funds from surplus units, and issue indirect securities. They then transmit the borrowed funds to deficit spenders and receive direct securities. Each type of financial intermedi ary provides a financial package as a service for spending units to accumulate 10 (Gurle y and Shaw 1955, p. 520). Pooling together savers and convincing them to relinquish control of their savings is costly and time consuming. Therefore, better savings mob ilization leads to more efficient resource allocation. As transaction costs decrease, financial development increases and leads to specialization (Levine 1997, p. 700). Developed financial systems are characterized by a diverse group of financial int erme diaries, through which competition can lead to increased specialization and greater economic growth. !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 9 In this case, minimize risk of default and be able to repay the loan. 10 This is a substitution for direct debt and money.

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! $& (iii) McKinnon (1973) and Shaw (1973) When considering financial liberalization, it is important to take into consideration the benefits of some governme nt intervention in fina ncial markets. During the 1960 s 11 countries began to liberalize their domestic markets because it was becoming too difficult to control them on an international level. To liberalize financial m arkets, countries generally use a two step program. First, interest rates must be allowed to float freely. The market will decide the appropriate interest rate for deposits and loans. Second, the government must reduce quantitative controls to allow financial intermediaries greater control in the system (Gibson and Tsakalotos 1994, p. 579). Ronald McKinnon (1973) and Edward Shaw (1973) were the first to provide an original theoretical analysis for financial liberalization as a means to promote financial development and growth (Gibson and T sakalotos 1994, p. 585). They say that financial repression reduces the "real rate of growth and the real size of the financial system relative to nonfinancial magnitudes. In all cases this strategy has stopped or gravely retarded the development proces s" (Shaw, 1973, pp. 3 4). The McKinnon Shaw hypothesis 12 originally focused on interest rates in developing countries, but later expanded to high reserve ratios and government directed credit programs (Gemech and Struthers 2003, p. 2). According to Fry (199 7), the McKinnon Shaw hypotheses have four common elements: (i) a savings function that responds positively to the real rate of interest on deposits and the real rate of growth in output; (ii) an investment function that responds negatively to the effe ctive real loan rate !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 11 This was a time of massive liberalization. Most analytical surveys begin during this time period. 12 McKinnon's hypothesis is known as the "Complementary hypot hesis," and Shaw's hypothesis is known as the "Debt intermediation hypothesis."

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! $' of interest and positively to the growth rate; (iii) a government fixed nominal interest rate which holds the real interest rate below its equilibrium level; (iv) and inefficient non price rationing on loanable funds (755). The idea behind the McKinnon Shaw hypothesis is that financial liberalization will act as a catalyst for higher savings, which will lead to a higher level of investment and greater economic growth. Fixed nominal interest rates (artificial ceilings) reduce savings and capital accumulation, which stunts economic growth. At an artificial interest rate, other market clearing devices take the place of equilibrium interest rates such as credit rationing and queuing. At artificially low interest rates (on deposits and loans), the quantity of savings is low, but investment activity is a lso poor. When the market can not clear, the quantity and quality of savings and investment will be l ow and each will play off of the other 13 (Gemech and Struthers, 2003, pp. 2 3). Unde r the McKinnon Shaw model, banks allocate resources based on risk of default and transaction costs, not on the productivity of the loan. As the rate of interest (for loans) decreases, projects with lower returns become profitable. Investments that could not enter the market at a higher interest rate can now enter based on the artificial interest rates. In the case of higher interest rates, adverse selection occurs producing disequilibrium in credit rationing. 14 Repressed interest rates also have a negati ve social impact on future consumption (Fry, 1997, p. 755). Low interest rates discourage saving and investment and encourage current consumption, which has negative impacts on future !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 13 This is a result of the Feast and Famine consequences of government intervention in credit and financial markets 14 See Stiglitz and Weiss. (1981).

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! $( growth prospects. In the McKinnon Shaw model, the solution to increase d savings and investment is to decrease government intervention in financial markets and to allow the market to determine interest rates. The McKinnon Shaw hypothesis is classical in nature, where the level of savings determines the level of investment in an economy. In this model, investment (I) is a negative function of the interest rate (r): (1) I= I(r): I r < 0 Savings (S) are influenced by the rate of interest and also the rate of growth of national income (g): (2) S=S (r,g): S r > 0 ; S g > 0 Figure 1 Source: Gibson, Heather D. and Tsakalotos, Euclid (1994); The Scope and Limits of Financial Liberalization in Developing Countries: A Critical Survey, p. 585 Figure 1 represents the impact of an in terest rate ceiling on savings and investment. In this model, savings functions are drawn and it is assumed that g 1 < g 2 < g 3 In the case ./!0 1 2304056!% 2304056!$ 1 & 17 1 % 1 $ .89 $ :! .89 % :! .89 & : 0 % 07 ; 2 3 < = 0 0 $

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! $) where there are no interest rate ceilings, the equilibrium level is marked at E, with an equilibrium rate of intere st at r* and an equilibrium rate of investment at I*. If the government were to impose an interest rate ceiling (CEILING 1) on nominal deposit interest rates, and the growth rate is at g 1 the interest rate that banks and other financial intermediaries wo uld charge would be r 3 The profit made from such high margins will most likely be used for non price competition (Gibson and Tsakalotos, 1994, p. 586). Now assume that the interest rate ceiling (CEILING 1) applies to both nominal deposit interest rate s and loan rates (and assuming growth at g 1 ). In this case, only investment at I 1 can be financed, leaving the total investment given by the line AB unfinanced. Banks must ration credit at such a low interest rate. Investment projects that are deemed to be "risky" will most likely not be financed and there will be a trend to finance projects with rates of return just above the interest rate ceiling (Gibson and Tsakalotos, 1994, p. 586). In the case of partial financial liberalization (CEILING 2), the in crease in the interest rate will lead to more efficient investments, and cause the savings function S(g 1 ) to shift to the right to S(g 2 ). As the interest rate increases from r 1 to r 2 savings increase, which causes the savings function to shift. Now that savings have increased, there are more loanable funds in the financial system, which will shift the investment level to I 2 at the new rate of interest r 2 (Gibson and Tsakalotos, 1994, p. 586). There is still credit rationing present under partial financi al liberalization, but this decreases and is represented by the line CD. Under full financial liberalization, equilibrium will be reached at point E, with an investment rate of I*, and an interest rate of r*. At this point growth will be maximized.

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! $* Unde r the McKinnon Shaw model, it is assumed that all households have direct access to credit markets. It should be noted however, that not all households have liquidity or access to credit (See Campbell and Mankiw, 1990). In poor developing countries, curre nt consumption is based on current income, but when credit is added there is a boom in consumption and a subsequent drop in aggregate savings. It is also worth noting the role of subsistence consumption in developing countries. Poor countries generally c onsume on subsistence levels and will not respond well to changes in the interest rate (s ee Ostry and Reinhart, 1992). Therefore, the degree to whi ch savings increase based on higher real interest rates will depend on income. Along with financial liber alization, countries must also be willing to implement macroeconomic stabilization policies, which will help offset some of the ill effects of liberalizing financial markets. Basant Kapur (1976) offered one of the first models to examine the effect of fin ancial liberalization and simultaneous stabilization. 15 16 After financial liberalization, a developing country will experience capital inflows which can cause the exc hange rate to appreciate, inflation to increa se within the domestic economy, or both. Kapu r states that stabilization programs usually result in a decline in real output when prices are sticky and there are adaptive expectations. Real output declines because a reduction in the nominal money supply by the government leads to a reduction in the real money supply, which causes a reduction in the quantity of bank credit available to firms. As the quantity of bank credit decreases, the quantity of working capital available to firms !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 15 It is important to note that the framework for Kapur's model is based on a closed economy setting. 16 Stabilization programs in this case are designed to combat inflation after financial liberalization.

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! $+ decreases and real output decreases. 17 To combat inflation and incr ease output, financial intermediaries can raise interest rates on deposits. The inflow of funds into the financial intermediaries offsets the inflation caused by the increase in the money supply (from capital inflows). Financial intermediaries can then t ake these deposits and make loans, causing real output to increase. (iv) Prerequisites for financial liberalization Fry (1997) offers several prerequisites to a country's consideration of financial liberalization: (i) adequate regulation and supervisi on of commercial banks; (ii) reasonable degree of price stability; (iii) fiscal discipline by sustainable government borrowing. The government should avoid inflationary expansion of reserve money by the central bank; (iv) competitive commercial banks 18 ; (v ) and a tax system that does not discriminate against the financial system (Fry 1997, p. 759). While Fry's prerequisites for financial liberalization are accurate, it should be noted that he ignored the issue of oligopolistic interest rates in post liberal ized financial systems. Once these prerequisites are met, a country should liberalize its financial system, but there is an optimal order in which sectors sh ould be liberalized if the changes are to be successful (s ee chart in Gibson and Tsakalotos 1994, p. 591 592). Most economists believe that domestic financial liberalization should occur after domestic real sector liberalization. If a country liberalizes its financial system before its domestic real sector, it is highly likely that credit will flow t o sectors in the economy that are the most !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 17 This is a supply side effect. Normally it is a demand side effect when pri ces are sticky. 18 Post liberalized banks in small economies are not competitive but oligopolistic. This will be disc ussed in more detail in the following chapters

PAGE 24

! $, profitable. It is not agreed upon whether a country should liberalize its financial system before its external real sector or vice versa. If a country liberalizes its financial sector before its external real se ctor, credit will most likely flow to the sectors that are the most profitable. If the financial sector is liberalized after the external real sector, credit may not flow to a certain tradable sector, limiting their competitiveness in the international ma rket. If external liberalization occurs before domestic financial liberalization, there will be high levels of capital flight to countries with higher interest rates. Domestic banks will not be able to compete with foreign banks, which will offer higher interest rates.

PAGE 25

! %! Chapter II Post financial Liberalization 1. Complications Arestis and Demetriades (1999) claim that the ideas behind financial liberalization theory contain three assumptions that may or may not be met in reality: perfect information, profit maximizing competitive behavior by commercial banks, and institution free analysis (Arestis and Demetriades 1999, p. 443). Imperfect information may lead to adverse selection and moral hazard. When interest rates are relatively high (or rising), this leaves a larger proportion of high risk borrowers in the pool for loans. 19 The term "m oral hazard is used to describe situations in which borrowers act in a way that is not in the best interest of the lender. This may cause the rate of interest to i ncrease even further, causing "normal" borrowers to take on riskier projects to borrow at the higher interest rates. Banks and other financial intermediaries may engage in adverse selection or moral hazard during this type of situation Without proper ba nking regulation, banks may take on e xcessive risks, putting depositors at a higher risk. In countries with sound financial systems, deposit insurance will protect depositors from these types of situations, but it also puts banks in the position to do as they please. Deposits are guaranteed by the government, so if the bank makes quality loans, the bank profits, and if the bank makes bad loans, the government insures deposits and the bank does not necessarily lose (Arestis and Demetriades 1999, p. 444). Under the McKinnon Shaw hypothesis and other contemporary models it is assumed that perfect competition exists in the banking sectors of developing countries. In !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 19 Borrowers who are willing to take loans at lower interest rates are usually not going to except the higher interest rate because it usually implies a greater risk.

PAGE 26

! %$ reality, small developing countries tend to have oligopolistic banking sectors where a fe w firms control the industry. 20 If this is the case, financial liberalization may lead to larger spreads between lending and deposit rates (Demetriades and Luintel, 1996). The institutional framework surrounding a financial system should not be dismisse d when evaluating the theory of financial liberalization. The state provides the legal framework that helps support the financial system, and helps promote the confidence in the currency that is vital to economic development (Arestis and Demetriades, 1999 pp. 445 446). After attempts of financial liberalization in Latin America and Asia, it has become imperative to examine the institutions of countries and determine their soundness before proceeding with any sort of financial liberalization agenda (World Bank, 1989). It is not only important to strengthen institutional supports to financial growth, but also to develop and maintain other agents that can help regulate and promote stable economic growth. Traditional financial liberalization theory has al so failed to recognize the role that stock markets play in economic development. Stock markets become very important in the development process following financial liberalization for three reasons: (i) higher interest rates post financial liberalization e ncourage firms to issue equity; (ii) stock markets provide an easy way for international investors to gain access to emerging markets; (iii) they are usually part of a financial libera lization package, whether implicitly or explicitly (Arestis and Demetria des, 1999, p. 446). Stock markets may increase economic growth by increasing the resources available for inv estment from foreign and domestic capital inflows To function properly, the institutional framework surrounding !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 20 See the next section for a more in depth explanation of oligopolistic banking sectors.

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! %% the stock market must promote eff icient operation. Recent studies have shown that most developing countries lack the necessary institutions to efficiently regulate and maintain stock market operations (Singh, 1997). In the following sections, the imperfections of financial liberalizati on theory will be discussed as they apply to Guyana. 2. Background of the Guyanese Banking System and Financial Reforms McKinnon and Shaw (1973) claimed that financial repression leads to decreased savings and investments, a lower quality of investments, and credit rationing to priority industries. According to t he theory of f inancial liberalization, by liberalizing financial markets, investment and savings will increase, which will boost domestic growth. Financial intermediaries are more efficient at a llocating funds because they are able to diversify risk, reap economies of scale, etc. Bencivenga and Smith (1991) add that competitive intermediaries eliminate self finance 21 and the holding of cash or other liquid assets. However, in many developing cou ntries, such as Guyana, the theory of financial liberalization is flawed for several reasons. Through data analyses it has been shown that many developing countries, including Guyana, experience interest rate mark ups in domestic loan markets after financ ial liberalization. The reasons for these interest rate mark ups can be traced back to the uncompetitive nature of the oligopolistic banking sector. Interest rate mark ups due to oligopolistic tendencies have been one of the reasons for growth stagnation in Guyana as well as other developing countries. To understand the reasons for an oligopolistic banking sector, it is critical to examine the history of the financial system and political reforms that have led to the current uncompetitive system. !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 21 See Gurley and Shaw (1955)

PAGE 28

! %& Guyana is a small country in South America that borders Venezuela, Suriname, and Brazil. It was a Dutch colony in the 17 th century, but in 1815 it became a British possession. When slavery was abolished, former slaves settled in urban areas and indentured serv ants from India were brought in to work the sugar plantations. This has led to a racial divide that still exists today, making the political system fallible (Central Intelligence Agency 2008). Guyana received its independence from the United Kingdom in 1966. Tarron Khemraj (2007) describes three important periods since Guyana received independence from the United Kingdom in 1966. The first period began in 1966 and ended in 1975. During this time, real GDP increased at an average annual rate of 3.9 per cent. There are several key events that took place during this time period such as (i) the start of the shift in economic policy towards Socialist planning by the nationalization of major production industries such as bauxite and sugar in 1970 (ii) the first oil shock in 1973, (iii) and a major increase in world oil prices in 1974 and 1975 (Khemraj 2007a, p. 9). The second period Khemraj describes occured between 1976 and 1988. D uring this time period, there was a decrease in the growth of real GDP b y an average rate of 2.1 percent. Again, there are several key events during this time period such as (i) the nationalization of foreign owned banks, (ii) the adoption of a foreign exchange control scheme to ration foreign exchange, and (iii) price con trols (Khemraj 2007a, p. 9 10). In 198 8, the Guyanese government, with the help of the IMF set in motion the Economic Recovery Programme (ERP) to address the declining growth in gross domestic product. The IMF realized that the Guyanese government had taken on a serious burden by supporting state owned enterprises during its socialist movement following

PAGE 29

! %' independence. The government was forced by the IMF to cut public spending for state owned enterprises, except the Guyana Electricity Corporation (Ishma el 2007). By 1 989, the government pursued liberalization policies in accordance with IMF guidelines to help boost the slumping economy. From 1989 to 2005 the economy experienced an average growth rate of 2.5 percent. When viewed in subsections, from 199 1 to 1997 the economy experienced growth rates of 7.1 percent, while from 1997 to 2005, the economy grew at an average rate of 0.1 percent (Khemraj 2007a, p. 10 11). The years following the adoption of the ERP helped shape the current financial system. The poli cy reforms during the late 1980s and early 1990 s can be divided into three categories: (i) policies that help improv e the efficiency and competitiveness of the financial sector 22 ; (ii) policies that help strengthen the economic framework and bank su pervision; (iii) policies that help modernize and deepen financial markets (Ganga 1998). To improve efficiency and competition within the financial sector, the government enacted several reforms such as dismantling interest rate controls on deposits and loans and abandoning the notion of directed credit to priority sectors of the economy. The government also encouraged the privatization of state owned financial institutions to help boost the economy, as well as allowing the entry of foreign banks. The black market had become ext remely powerful during the 1970 s because of strict government regulations and may or may not have been a cause of the downturn in GDP. To compensate for this large portion of the economy, the Guyanese government adopted a flexib le exchange rate regime by merging the black market exchange rate and the official rate (Khemraj 2007a, p. 11). !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 22 For the purposes of this thesis we will be focusing on the ba nking system of Guyana.

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! %( The government also adopted the use of indirect instruments for monetary policy. Prior to 1991, monetary policy focused primarily on direct i nstruments such as interest rate controls, a credit ceiling, and direct lending to the government and select private entities (Khemraj 2007b, p. 103). The Bank of Guyana (Central Bank) used reserve and liquid asset requirements to control excess bank liqu idity. In 1991, the government set up a competitive bidding system for short term treasury bills on a monthly basis, then bi weekly in 1994, and weekly in 1996 (Das and Ganga 1997). With this in mind, the rate of interest on 91 day Treasury bills became the anchor rate of the banking system. 23 However, Khemraj (2006a) states that the current monetary policy framework can lead to several problems, one of which is the "potential crowding out of private investments as commercial banks hold excess reserves an d treasury bills instead of making growth augmenting loans to private businesses." 24 Since the banking system of Guyana is oligopolistic, commercial banks are able to influence the Guyanese Treasury bill rate. In 1990, commercial banks and non bank deale rs were authorized to trade foreign currencies in the cambios market (exchange market). By 1995, the Exchange Control Act was abolished, removing the limit on the inflow of foreign currencies. To further enhance the competitive nature of the banking syst em, the government sold shares in the two largest commercial banks, and sold the biggest state owned bank in 2003 (Khemraj 2007a, p. 12). To help strengthen the economic framework and bank supervision, the government passed the Financial Institutions Act (FIA) in 1995. This act allowed the !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 23 This determines the bank rate and the prime lending rate. 24 This will be discussed in greater detail later.

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! %) Bank of Guyana to license and supervise all financial institutions undertaking banking businesses. In addition to this act, the Bank of Guyana Act of 1998 sought to preserve the independence of the central bank (Khemr aj 2007a, p. 12 13). Policies designed to help modernize and deepen the financial markets have been relatively ineffective. One of the first steps towards the development of financial markets is the development of the money market. The government expan ded measures to facilitate the auctioning of Treasury bills to help manage liquidity conditions and adopted a rediscounting policy to encourage trading and increase the bills' liquidity. In 2003, the Guyana Association of Securities Companies and Intermed iaries, Inc., (GASCI) was selected to operate the Guyana Stock Exchange (Khemraj 2007a, p. 13). Its members are stockbrokers who compete against each other to trade shares. Although attempts to liberalize and develop financial institutions have stagna ted, the banking system is still the most important source of financing in a small developing economy such as Guyana. Banks are required to hold a certain fraction of their deposits as reserves. If a bank has excess reserves, it will typically get rid of these funds by buying financial instruments or by making loans to the public. In Guyana, as well as other developing economies, excess liquidity is a permanent feature of the banking system (Khemraj 2007b, p. 103). To help counteract excess liquidity, t he central bank sells 91 day, 182 day, and 364 day Treasury bills consistent with targeted growth rates for broad money and reserve money. By examining banks' liquidity preferences, it is easier to understand their behavior in developing countries such a s Guyana. In these types of economies, a bank requires a minimum loan rate that will compensate for risks, marginal transaction costs,

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! %* and the rate of return on a safe foreign asset before making a loan to a borrower. If the borrower is unwilling or unab le to pay the minimum rate, the bank accumulates non remunerative excess reserves or excess liquidity. This phenomenon has created a liquidity preference curve that is flat at a very high interest rate (Khemraj 2008a). This curve shows that non remunerat ive excess reserves and loans become perfect substitutes at very high interest rates. In the following chapter, analyses will show that this behavior is consistent with an oligopolistic loan market. 3. Capital Inflows Rodrik and Subramanian (2008) say "[] there is a crucial difference between domestic and foreign finance: improvements in the former depreciate the real exchange rate, while improvements in the latter appreciate it [] for any given level of investment, the more that is financed by dome stic savings the greater the long run growth" (Rodrik and Subramanian 2008, p. 17). As domestic financial intermediation improves, it closes the gap between desired investment and saving, which is good for investment in tradable sectors and economic growt h. This causes the real exchange rate to depreciate relative to other currencies. The opposite occurs when there is improved access to foreign finance: the real exchange rate appreciates (Rodrik and Subramanian 2008, p. 9). To help stabilize real exch ange rates, the government can impose capital controls on the financial sector. Studies using microeconomics to determine whether capital controls have adverse effects on overall investment have delivered mixed results. Prasad et al. (2007) found that in developing countries where sectors were open to mixed forms of capital flows, those that were more dependent on foreign finance grew slower than those that did not depend on foreign finance.

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! %+ Rodrik and Subramanian (2008) divide economies into two sep ar ate categories: those that are investment constrained, and those that are saving constrained. In saving constrained economies, interest rates will be high and any increase in foreign capital will increase investment more than consumption. When the capita l account is liberalized, domestic interest rates are reduced and the economy opens to foreign capital flows. This increases the availability of foreign finance to help boost domestic investment. For consumers, a change in relative prices causes them to consume more and save less. Economies that are constrained by investment demand will have low interest rates, and banks will be very liquid. Any inflow of foreign capital will help increase consumption more than investment. In this case, foreign savings are a substitute for domestic savings and there will be no noticeable difference in investment or growth (Rodrik and Subramanian 2008, pp. 12 16). It is worth noting the relationship between interest rates in the United States and those in developing c ountries. The higher interest rates are in the United States, the lower the volume of capital inflows into developing countries (Rodrik and Subramanian 2008, p. 13). As stated earlier, domestic investment should respond well to capital inflows when an ec onomy is saving constrained. If this is true, domestic investment should be lower in developing countries when interest rates in the United States are high. Rodrik and Subramanian (2008) argue that capital inflows appreciate the real exchange rate, but i t is important to distinguish between short run capital flows and long run capital flows when making this statement. By liberalizing short run capital flows, it allows speculation to flourish (Arestis and Demetriades, 1999, p. 449). Increasing short run capital flows has seve ral destabilizing effects: (i) t hey put upward pressure on the

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! %, exchange rate of the receiving country, and a s the exchange rate appreciates, exports become less competitive and the current account deficit begins to increase; (i i) s hor t run capital inflows increase asset prices, which have a positive effect on wealth and import consumption, which can lead to domestic inflation (Arestis and Demetriades, 1999, pp. 449 450). Long term capital flows are not speculative and can be advantage ous to the long run growth of a country (foreign direct investment, for example ). In the new growth theory, long run capital flow s such as foreign direct investment can have long run growth effects from human capital formation and spillover effects in the economy. The importation of technology helps enhance the marginal producti vity of capital, which aides the growth process. Short run capital outflows are much more volatile than long run capital outflows because of their effect s on the immediate boom bu st cycles (Arestis and Demetriades, 1999, pp. 450 451). Producers of tradable goods are those that are most effected by the appreciation of the real exchange rate, but producers of non tradable goods benefit. In F igure 2 below the inflow of foreign savi ngs causes the real exchange rate to appreciate, which shifts the investment curve to the left from I to I 1 The new equilibrium at point C implies a decrease in investment after allowing foreign capital to flow into the country (Rodrik and Subramanian, 2 008, p. 16). With this in mind, real exchange rate appreciation reduces the profitability of these tradable goods on the international market and consequently slows economic growth. To help offset this, it is important to increase domestic savings to hel p reduce the real exchange rate (an increase in domestic savings to investment reduces capital inflows) (Rodrik and Subramanian, 2008, p. 17).

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! &! Figure 2 Source: Rodrik, D. and A. Subramanian, "Why did financial globalization disappoint?" March 2008 4 Real Exchange Rate Values and Growth Paulo Gala (2007) argues that competitive real exchange rates 25 play an important role in long run growth of developing countries. Gala argues that, "One of the most important real effects of exchange rate levels fo r long term growth is on aggregate investment" (Gala, 2007, p. 276). Following capital account liberalization, foreign capital inflows usually cause the domestic currency to appreciate, which increases the consumption of tradable goods in the economy. T he appreciation of the currency causes real wages to be artificially higher, and consumers are now able to consume more imports. Debt is used to finance import consumption, which can be seen as a savings displacement (Gala, 2002, pp. 274 275). Gala argue s that the real exchange rate determines which !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 25 The real exchange rate defines real wages by setting the prices of tradables to non tradables. Higher real exchange r ates characteristically have lower tradable prices, higher real wages, lower profit margins, higher consumption and lower investment. Lower real exchange rates characteristically have higher tradable prices, lower real wages, and higher profit margins and higher investment (Gala, 2007, p. 275).

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! &$ sectors of an economy are viable. A competitive real exchange rate can shift investment from industries that have decreasing returns to industries that have increasing returns. Gala builds from the work done by Bhaduri and Marglin (1990) by defining an aggregate investment function that depends on capacity utilization and profit margins, and a consumption function that depends on real wages. By using these two functions, it is possible to create a model wher e savings and investment are a function of real wages, which are a function of the real exchange rate. 26 This model can be used to explain the differences in growth patterns between Latin America and East Asia. During the 1980s and 1990 s, Latin American c ountries tended to have h igher exchange rates and used an inward focused industrialization policy. During this same time period, East Asian countries focused on export led industrialization policies and competitive exchange rates (Gala, 2002, p. 286). Ag ain, the real exchange rate is relevant because it affects two important aspects of growth: investment and savings. With higher real exchange rates, Latin American countries were notorious for excessive (high levels of imported goods) consumption and lack of savings whereas East Asian countries, with more competitive exchange rates, were well known for higher savings and investment. As stated earlier, it is important to increase domestic savings to help reduce the real exchange rate, which will help incre ase growth through export led industrialization policies (increases in domestic savings to investment reduces capital inflows) (Rodrik and Subramanian, 2008, p. 17 and Gala, 2002). In the following chapter, an analysis of real exchange rates for Guyana wi ll show that financial liberalization theory neglects the impact real ex change rates have on growth. !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 26 See Gala (2007).

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! &% Chapter III Guyanese Growth Stagnation 1. Real Effective Exchange Rate Building from Khemraj's analysis of growth stagnation and the oligopolistic banki ng sector of the Guyanese financial system, this analysis will focus on the effects of the libe ralization policies of the 1980 s with regards to the real effective exchange rate. According to Rodrik and Subramanian, the real exchange rate appreciates when there is improved access to foreign capital. As a country's exchange rate appreciates, exports become less competitive in the global market and economic growth declines. In the case of Guyana, as the real exchange rate appreciated following libe ralizatio n policies in the 1980 s, GDP growth increased from negative rates to rates above five percent for most of the 1990 s. An increase in the real exchange rate also caused an increase in savings from around 15 percent of GDP in 1989 to over 27 percent of GDP b y 1992. The same effects can also be traced through the increase in gross fixed capital formation during the same time period. Theory tells us that appreciating exchange rates will lead to decreased growth because of uncompetitive exports and an increase in import consumption, however it is possible to experience growth when using an approach that is not strictly bi lateral. (i) Reasons for Using the Real Effective Exchange Rate The real effective exchange rate is the weighted average of a country's currenc y relative to an index of other major currencies adjusted for inflation. Weights for each country are determined by comparing trade balances in terms of one country's currency with the other countries in the index. The purpose of the real effective exchan ge rate is to

PAGE 38

! && determine the value of a country's currency relative to other major currencies (Dunn and Mutti 2004, p. 506). The real exchange rate is the price of one country's currency expressed as another country's currency adjusted for inflation. Using only the real exchang e rate has two disadvantages: (i ) it does not provide a way of measuring the average exchange rate for a currency relat ive to it's trading partners; (ii ) the bi lateral fluctuations of the exchange rate on a day to day basis do not gi ve an adequate picture of the country's competitiveness (Dunn and Mutti 2004, p. 303). Both indicators take into consideration inflation, but the real effective exchange rate is a better indicator of a country's competitiveness in the global economy becau se it is an average of the domestic currency relative to an index that includes all major curren cies such as the United States Dollar, Japanese Y en, the Euro, and the British Pound. By comparing the domestic currency with other major currencies with respe ct to trade balances, the real effective exchange rate gives a more complete view of an economy. The equation used to calculate the real effective exchange rate for the purpose of this analysis is, (3 ) XR t = XR n x P dom P row or rewritten as, (4 ) XR t = P row x XR n P dom where XR t is the real effective exchange rate; XR n is the nominal effective exchange rate, measured as the foreign price of local money; P dom is the domestic price level, measured as consumer or wholesale prices; P row is the price level for the rest of the world, using the country's major trading partners as a proxy, where trade shares are used as weights

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! &' (Dunn and Mutti 2004, p. 305 306). Increases or decreases in the real effective exchange rate differ from bi later al exchange rates because of fluctuations in the domestic and international price levels. For example, an increase in the value P row / P dom all other variables held constant, will result in a real depreciation of the real effective exchange rate. Like a bi lateral exchange rate, a depreciation in the value of the real effective exchange rate is actually an appreciation relative to other countries. (ii) Real Effective Exchange Rate Analysis Figure 3 Source: IMF, International Financial Statistics Year book (Washington, DC: IMF) As stated earlier, there have been three important periods since Guyana received its independence from the United Kingdom in 1966. Figure 3 above shows Guyana's GDP growth as a percentage of GDP from the year 1965 to 2007. The first period is from 1966 to 1975, when the government began a socialist movement and started nationalizing industries such as sugar and bauxite. The first oil crisis occurred in 1973,

PAGE 40

! &( causing oil prices to r emain high for much of the 1970 s. The second period of importance is from 1976 to 1988. During this time period, the government nationalized many foreign owned banks, adopted a foreign exchange control scheme, and installed price controls. Perhaps the most interesting time period is from 1988 to th e present day. In 1988, the Guyanese government, along with the IMF, adopted the Economic Recovery Programme to correct the declining growth in gross domestic product (Khemraj 2007a, p. 9 10). For the purposes of this analysis, the years 1965 to 1989 wi ll fall under the category of pre financial liberalization, and the years 1990 to 2007 will fall under the category of post financial liberalization. 27 The move towards a more s ocialist government in the 1970 s led to a repressed financial system which can be attributed to the slow growth rates of Guyana. The stipulations from the IMF in the Economic Recovery Programme were that the government cut funding for state owned enterprises, abandoned interest rate controls on deposits and loans, etc. The effects of such actions would not be realized until the early 1990's. Figure 4 is a graphical representation of the real effective exchange rate for Guyana during the period 1980 to 2007. There is a noticeable real appreciation of the real effective exchange ra te following th e financial reforms of the 1980 s. These reforms have made Guyana's real effective exchange rate float around 100 since the early 1990 s. The stabilization of the real effective exchange rate is one of the causes of Guyana's economic growth post liberalization. !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! %* ;>?@AB9@!?@C!3DAEAF"D!GCDA#C1H!I1A91JFFC!83GI:!KJL!JMAN?CM!"E!$,++/!KC!K">>!JLLBFC!?@J?!?@C! COOCD?L!AO!?@CLC!1COA1FL!KC1C!EA?!"FFCM"J?C>H!EA?"DCJP>C!BE?">!$,+, Q $,,-R

PAGE 41

! &) Figure 4 Source: WDI, World Bank World Development Indicators (Washington, D.C.: World Bank) Figure 5 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicator s (Washington, D.C.: World Bank)

PAGE 42

! &* Figure 5 shows the correlation between the real effective exchange rate of Guyana and GDP growth as a percentage of GDP for the pre liberalization years 1965 to 1989. There is a very weak correlation between the real effe ctive exchange rate and the level of GDP growth showing that the real effective exchange rate had no real impact on GDP growth during this time period. 28 Figure 6 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI World Bank World Development Indicators (Washington, D.C.: World Bank) Figure 6 shows the correlation between the real effective exchange rate and GDP growth as a percentage of GDP for the post liberalization years 1990 to 2007. Following the liberali z ation policies of the late 1980 s, it is clear that there is a negative correlation between the real effective exchange rate and GDP growth. The trend line for this set of data shows that a real appreciation of the real effective exchange rate leads to an increase in GDP growth. The data for th e post liberalization period do not support the arguments !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! %+ S@C!1CJ>!COOCD?"#C!CTD@JE9 C!1J?C!OA1!6BHJEJ!"L!J#J">JP>C!O1AF!$,+Q %--*!O1AF!?@C!UA1>M!=JEV! UA1>M!ANFCE?!0EM"DJ?A1LR

PAGE 43

! &+ of Rodrik and Subramanian (2008) and Gala (2007). There are several reasons for the cause of this, such as increases in gross fixed capital formation, gross domestic savings, and foreign direct investment, which will be discussed later. One of the key ideas behind financial liberalization is to increase domestic savings with the hope that this will l ead to increased investment and economic growth. Figure 7 below shows Guyana's gross domestic savings from 1965 to 2005. Figure 7 Source: WDI, World Bank World Development Indicators (Washington, D.C.: World Bank) The average savings rate as a percentage of GDP from 1965 to 1975 was 22.45 percent. From 1976 to 1989, the average savings rate was 16.72 percent and from 1990 to 2005, the average savings rate was 14.89 percent. Based on this evidence, it seems that the financial libe ralization policies of the 1980 s actually led to a decrease in gross domestic sa vings. According to financial liberalization theory, an increase in domestic savings is

PAGE 44

! &, required to spur investment, which should then lead to increased economic growth. As will be discussed later, there are alternatives to domestic savings as a catalyst for economic growth. Figure 8 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washington, D.C.: World Bank) Figure 9 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washington, D.C.: World Bank)

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! '! Figures 8 and 9 show the correlations between the real effective exchange rate and gross domestic savings as a percentage of GDP for both pre liberalization and post liberalization periods. For this analysis, the effects of the real effective exchange rate on gross domestic savings are not complete because data for the real effective exchange rate are unavailable until 1980. 29 During the pre l iberalization period, a positive correlation shows that a real appreciation of the real effective exchange rate leads to a decrease in gross domestic savings. The average gross domestic savings for the pre liberalization period is 19.24 percent of GDP wh ile from 1980 to 1989 the savings rate was only 16.60 percent of GDP. The negative correlation for the post liberalization period shows that a real appreciation of the real effective exchange rate leads to higher levels of gross domestic savings. Again, data for t he post liberalization period are inconclusive with the theses of Rodrik and Subramanian (2008), and Gala (2007). The average gross domestic savings rate for the post liberalization period of 1990 to 2005 was 14.89 percent of GDP, which is a sig nificant decrease following the adoption of the financial reforms. According to financial liberalization literature, if savings do not increase, then investment is unable to facilitate growth within the economy. However, it is possible that domestic inve stment and other foreign forms of investment, such as foreign direct investment (FDI), are able to impact economic growth domestically. Perhaps the main reason for the economic growth in Guyana following the financial reforms was the sharp increase in g ross fixed capital formation 30 in 1992, which !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 29 It is possible to calculate the real effective exchange rate using the formula provided, but results would vary with data provided by the World Bank. 30 Gross fixed capital formation will be referred to as a type of investment in this analysis.

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! '$ accounted for over 50 percent of GDP. This is not to say that gross fixed capital formation spiked and returned to norm al levels immediately. Below, F igure 10 shows the fluctuations in gross fixed capital form ation from 1965 to 2005. For the pre liberalization period of 1965 to 1989, gross fixed capital formation averaged 24.10 percent of GDP, whereas from 1990 to 2005, gross fixed capital formation averaged 29.82 percent of GDP. When the post liberalization period is broken down into the high growth years of the early 1990 s, to the slo w growth years of the late 1990s and early 2000 s, there is a large contrast that must be acknowledged. From 1990 to 1997, gross fixed capital formation averaged around 35.88 pe rcent of GDP, compared to an average of 23.76 percent of GDP for the years 1998 to 2005. The reasons for these differences will be focused on later in the discussion. Figure 10 Source: Source: WDI, World Bank World Development Indicators (Washington, D .C.: World Bank)

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! '% The real appreciation of the real effective exchange rate and the subsequent surge in gross fixed capital formation paved the way for the success of the Guyanese economy from 1990 to 1997. During the pre liberalization period, a scatter plot of gross fixed capital formation as a function of the real effective exchange rate varies, but there is a positive correlation between the two. As the real effective exchange rate increased, gross fixed capital also increased. Figure 11 shows the r elationship between the real effective exchange rate and gross fixed capital from 1980 to 1989. Figure 11 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washington, D.C. : World Bank) With the exception of the years 1988 and 1989, all of the points correspond with high real effective exchange rates and investment rates between 20 and 30 percent of GDP. For the pre liberalization period, the averages for the real effectiv e exchange rate and gross fixed capital are 499.28 and 26.14 percent of GDP respectively.

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! '& During the post liberalization period, the real effective exchange rate averaged 96.54, and gross fixed capital formation averaged 29.82 percent of GDP. Below, F ig ure 12 shows the relationship between the real effective exchange rate and gross capital formation from 1990 to 2005. Figure 12 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indic ators (Washington, D.C.: World Bank) The correlation between the two is negative, meaning that a real appreciation of the real effective exchange rate lead to an increase in gross fixed capital formation. Most of the points are situated around the averag e real effective exchange rate for the period, but percentages of gross fixed capital formation vary The outlier in this sample is the year 1992, where gross fixed capital was 52.49 percent of GDP. The increase in gross fixed capital is not significantl y higher than the pre liberalization period, with the exception of the year 1992. From the analysis above, gross domestic savings as a percentage of GDP have decreased and gross fixed capital has increased by an average of three percent from pre liberaliz ation. Again, these results are inconclusive with the theories of Rodrik and

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! '' Subramanian (2008) and Gala (2007) who state that an appreciation of the real effective exchange rate will lead to decreased savings, gross fixed capital formation, and GDP growth Perhaps the distinction should be made between investment and foreign direct investment (FDI). Foreign direct investment is the investment of foreign assets into domestic facilities, structures, and companies and is part of a country's national fina ncial accounts. Foreign investment into domestic stock markets is not considered a type of foreign direct investment because it is still recognized as an investment into equity. Investments in a compa ny's equity are considered "hot money," which means tha t it is easily removed at the first sign of trouble. Foreign direct investment is considered to be more durable and less likely to leave the country, which makes this type of investment beneficial to economic growth (Dunn and Mutti 2004, p. 4 5) Figure 13 Source: Source: WDI, World Bank World Development Indicators (Washington, D.C.: World Bank)

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! '( From 1970 to 2006, net inflows of foreign direct investment accounted for an average of 4.92 percent of GDP. When broken down into subsets of pre liberalizatio n and post liberalization, it becomes clear why foreign direct investment has played such an important part in the development of Guyana's economy. From 1970 to 1989, foreign direct investment averaged only 0.49 percent of GDP, and from 1990 to 2006, it a veraged 10.13 percent of GDP. In 1992, foreign direct investment peaked at 39.81 percent of GDP : simultaneously gross fixed capital formation spiked at over 50 percent of GDP. Figure 13 shows the fluctuations of foreign direct investment over the years. Following the spike of net inflows in 1992, foreign direct investment has declined, but is substantially higher in the post liberalization years following the financial reforms. Figure 14 Source: IMF, International Financial Statistics Yearbook (Washin gton, D.C.: IMF) and WDI, World Bank World Development Indicators (Washington, D.C.: World Bank) When tested against the real effective exchange rate, the differences between the pre and post liberalization periods for foreign direct investment are surpri singly similar to the scatter plots for gross fixed capital formation. Figures 14 and 15 show the trends of

PAGE 51

! ') foreign direct investment as a function of the real effective exchange rate. From the years 1980 to 1989, the average for the real effective excha nge rate was 499.28, with foreign direct investment averaging only 0.25 percent of GDP. The slightly positive correlation shows that a real appreciation of the real effective exchange rate leads to decreased levels of foreign direct investment. 31 Figure 15 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washington, D.C.: World Bank) Compared to the post liberalization period, the higher levels of the real effective excha nge rate and the socialist structured government discouraged foreign investment. From 1990 to 2005, the average for the real effective exchange rate of 96.55 was significantly lower than that of the pre liberalization period. Foreign direct investment al so became a larger percentage of GDP, peaking at 39.81 percent of GDP in 1992 and !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 31 During the early part of the 1980's many industries in the economy were still nationalized because of the move towards a more socialist government in the 1970's

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! '* averaging 10.07 percent of GDP for the post liberalization period. The negative correlation between the real effective exchange rate and foreign direct investment indicates that real appreciation of the real effective exchange rates is more beneficial to attracti ng foreign investment. From F igure 13, it is clear that a real appreciation of the real effective exchange rate has lead to increases in foreign direct investment. However, one must note that the socialist policies of the 1970s and the 1980 s severely limited the percentage of foreign direct investment available. One can also argue that the phenomena of globalization had not yet become as widespre ad as it was durin g the 1990 s. The effects of the real appreciation of the real effective exchange rate in Guyana following financial reform ar e not conclusive with the theories of financial liberalization. Following th e financial reforms of the 1980 s, the real appreciat ion of the real effective exchange rate should have lead to lower levels of GDP growth, gross domestic savings, and gross fixed capital formation. Instead, the real appreciation of the real effective exchange rate led to an increase in GDP growth, gross d omestic savings, and gross fixed capital formation. As mentioned in the previous chapter, Paolo Gala argues, "One of the most important real effects of exchange rate levels for long term growth is on aggregate investment" (Gala, 2007, p. 276). Rodrik and Subramanian (2008) also state that in saving constrained economies, interest rates will be high and increases in foreign capital will tend to increase investment more than consumption ( GAM1"V!JEM!.BP1JFJE"JE! %--+/!NNR!$% Q $):R When the capital account is l iberalized, domestic interest rates are reduced and the economy becomes open to foreign capital flows. This increases the availability of foreign finance to help boost domestic investment. Gala (2007) adds that

PAGE 53

! '+ following capital account liberalization, f oreign capital inflows cause an appreciation of the exchange rate, which causes real wages to be artificially higher. Consumers are able to consume more imports and tradable goods in the economy. This type of consumption is financed by debt, which can b e seen as a savings displacement (Gala, 2002, pp. 274 275) The reason for a negative correlation between the real effective exchange rate and GDP growth during the post liberalization period is the result of foreign financing. Following liberalization, t he economy became open to foreign finance, which explains the spikes in gross domestic savings, gross fixed capital formation, and foreign dire ct investment in the early 1990 s. Rodrik and Subramanian (2008) explain the reason for the increases in investme nt, but they do not explain why savings increase. An appreciation of the exchange rate should lead to decreased savings, but if deposit interest rates for domestic commercial banks are higher than those abroad, there will be an inflow of c apital to help i ncrease domestic savings. As the deposit rate decreases, foreign capital will move to countries with higher rates of return. From 1990 to 2002, Guyana had an average deposit interest rate of 27.07 percent, while Jamaica, a country that underwent similar financial liberalization reforms, had an average deposit interest rate of 27.39 percent. From 1993 to 2006, Guyana had an average deposit interest rate of 7.48 percent, while Jamaica had an average deposit interest rate of 15.44 percent. The oligopolisti c banking sector has allowed the spread between loan interest rates and deposit interest rates to widen following financial liberalization by increasing loan interest rates and decreasing deposit interest rates. Foreign capital is thus likely to exit Guya na and enter a country with higher rates of returns.

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! ', 2. Loan deposit interest rate spread Fluctuations in the real effective exchange rate are not the only factors that affect economic growth, so it is important to reexamine the ideas expressed in Khemraj (2006a, 2007a, 2007b, 2008a) regarding excess liquidity and the interest rate mark up that h as become a permanent fixture in developing countries. Again, b y understanding banks' liquidity preferences, it is easier to understand their behavior in developin g countries such as Guyana. In these developing economies, a bank requires a minimum loan rate that will compensate for risks, marginal transaction costs, and the rate of return on a safe foreign asset before making a loan to a borrower. In the event tha t the borrower is unable (or unwilling) to pay the minimum rate, the bank will accumulate non remunerative excess reserves or excess liquidity. This phenomenon has created a liquidity preference curve that is flat at a very high interest rate (Khemraj 200 8a). The significance of this liquidity preference curve is that it shows that non remunerative excess reserves and loans become perfect substitutes at very high interest rates. By demanding a minimum loan rate and accumulating excess reserves, the oligo polistic banking sector has put a restraint on the growth of the Guyanese economy. (i) Loan deposit interest rate spread Analysis To complement the analysis of the real effective exchange rate and its impact on economic growth through gross domestic savin gs, gross fixed capital formation, and foreign direct investment, this analysis will focus on the effects of the domestic l oan deposit interest rate spread Figure 16 shows the loan deposit interest rate spread from 1974 to 2007.

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! (! Figure 16 Source: I MF, International Financial Statistics Yearbook (Washington, D.C.: IMF). There is a definite progression towards a higher spread over time, with lower spreads during the pre liberalization period and higher spreads during the post liberalization period. The average spread during the pre liberalization period from 1974 to 1989 32 was 3.05, while the average spread during the post liberalization period from 1990 to 2007 was 8.81. When the post liberalization period is broken down into the growth years from 1 990 to 1997, and the stagnation years from 1998 to 2007, the average spreads are 6.24 and 10.87 respectively. There is clearly a reason behind the steady increase in the loan deposit interest rate spread following financial liberalization, and as Khemraj points out, that reason is the oligopolistic banking sector. Using the same analysis as with the real effective exchange rate, the loan deposit interest rate spread differed dramatically between the pre and post liberalization periods. !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 32 These are the years for which data is available in the pre liberalization period.

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! ($ During the pre lib eralization period, the spread remained relatively stable at an average of 3.06, however average growth from 1974 to 1989 was 1.04 percent of GDP. Figure 17 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, Wor ld Bank World Development Indicators (Washington, D.C.: World Bank) As can be seen from F igure 17 above, the positive correlation implies that a higher spread leads to higher GDP growth. M ost of the data points are focused around a spread of three due to government controlled interest rate programs in place at the time. During the pre liberalization period, the government did not venture far from the average spread, meaning that higher loan rates were accompanied with higher deposit rates. GDP growth re mained negative during the late 1970s and the early 1980 s, as the transition to a more socialist government began to place an increased burden on the government. As the government began to liberalize financial markets, and the once nationalized banks beca me privatized, the spread between loan interest rates and deposit rates began to widen and have an adverse affect on GDP growth. For the entire post

PAGE 57

! (% liberalization period of 1990 to 2007, GDP growth averaged 3.37 percent of GDP, while the loan deposit int erest rate spread averaged 8.81. Figure 18 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washington, D.C.: World Bank) While GDP growth on average has been significant ly higher following liberalization, the spread has increased at a rate that has become detrimental to growth in a small developing economy. Figure 18 above shows the relationship between the loan deposit interest rate spread and GDP growth for the years 1 990 to 2007. The trend line shows that as the spread increases, GDP growth decreases. This data is relevant to Khemraj's analysis, because as loan rates increase, borrowers may be unwilling or unable to pay the intere st rate, which is itself a mark up ab ove the minimum rate (Khemraj 2008a). The interest rate mark up leads to the accumulation of non remunerative excess reserves, and loans that would be made at the natural rate are not made.

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! (& When the data for the post liberalization period is broken down i nto the growth years of 1990 to 1997, and the stagnation years of 1998 to 2007, the correlations are the opposite of the period as a whole. From 1990 to 1997, as the loan deposit interest rate spread widened, GDP growth also increased. The same holds tru e for the data from 1998 to 2007. During the early 1990 s, loan and deposit interest rates were at record highs following the financial libe ralization policies of the 1980 s, which led to a surge in gross domestic savings and gross fixed capital formation i n 1992 The additional inflow of foreign direct investment and foreign capital, along with the peak in gross domestic savings and gross fixed capital formation, acted as catalysts for the high levels of ec onomic growth in the early 1990 s. Figure 19 So urce: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washington, D.C.: World Bank) As mentioned earlier, the theory behind financial liberalization is that by liberalizing financi al markets and allowing interest rates to rise to their natural rate,

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! (' domestic savings will increase, and this will lead to an increase in investment and e conomic growth. Above, F igure 19 illustrates gross domestic savings as a function of the loan deposi t interest rate spread for the pre liberalization period 1974 to 1989. As shown in the scatter plot, an increase in the loan deposit interest rate spread correlates with higher gross domestic savings. Again, the spreads are heavily cor related around an a verage of three because of the repressive interest rate control mechanisms used by the government during this time period. Government controls on loan and deposit interest rates explain the centralization of the points, but do not explain the wide fluctua tions in levels of gross domestic saving s The wide variations in the gross domestic savings rate change almost simultaneously with the cha nging levels of economic growth and the varying degrees in the deposit rate. At the height of the movement towards a more socialist government in 1983, gross domestic savings was less than three percent of GDP. The average level of gross domestic savings from 1974 to 1989 was 18.47 percent of GDP and from 1990 to 2005 it was 14.89 percent of GDP Although gross dome stic savings rates were higher on average during the pre liberalization period, these higher savings did not necessarily translate into higher economic growth as the average GDP growth rate for the years 1974 to 1989 was 1.04 percent. During the post l iberalization period from 1990 to 2005, the spread between loan interest rates and deposit interest rates began to widen as nationalized banks became privatized. Again, the average savings rate for the post liberalization period up to 2005 was 14.89 perce nt of GDP. When the loan deposit interest rate spread is plotted against gross domestic s avings as in F igure 20 below the trend line is negative, indicating that as the spread increases gross domestic savings decrease

PAGE 60

! (( Figure 20 Source: IMF, Internat ional Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washington, D.C.: World Bank) After th e financial reforms of the 1980 s, the spread between loan and deposit interest rates steadily increased fro m 3.58 in 1990 to 11.95 in 2005. On average, the spread for the years 1990 to 2005 was 8.25, while the average spread for the years 1974 to 1989 was 3.06. One explanation for the increasing loan interest rates and decreasing deposit interest rates is the oligopolistic banking sector. As suggested earlier, decreasing deposit interest rates in Guyana following initial ec onomic growth in the early 1990 s has forced foreign capital to move to countries with higher rates of return on deposits such as Jamaica. While the domestic deposit interest rate is more likely to affect savings, the domestic loan interest rate is what drives or halts domestic investment, t hough the two are interconnected Prior to financial liberalization, the government controlled interes t

PAGE 61

! () rates for loans and deposits and this helped establish a consistent pattern of gross fixed capital formation as a percentage of GDP, as shown in F igure 10. This pattern continued during the post liberalization period, with an exception duri ng the years 1992 to 1993, when gross fixed capital formation was over 40 percent of GDP. Usin g the same analysis as before, F igure 21 shows the results of gross fixed capital formation as a function of the loan deposit interest rate spread during the pre liberalizati on period. Figure 21 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washington, D.C.: World Bank) Again, the points are centralized around a spread of three because of government interest rate ceilings. The correlation for the figure is positive, which implies that as the loan deposit interest rate spread increases, gross fixed capital formation also increases. The opposite is true for the post liberalization period, where a negative correlation shows that as the loan deposit interest rate spread increases, gross fixed capital f ormation decreases as shown in F igure 22. During the pre liberalization period, the highest spread between

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! (* the loan and deposi t interest rates was less than four while during the post liberalization period, the highest spread was almost twelve. Figure 22 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washingt on, D.C.: World Bank) By examining the relationships and trends between the loan deposit interest rate spread and GDP growth, gross domestic savings, and gross fixed capital formation, the notion that oligopolistic forces drive the Guyanese financial syst em become s more concrete. Following financial liberalization, the liquidity preferences of the commercial banking industry have require d a minimum loan rate before making a loan to a borrower. In most cases, the borrower is unable (or unwilling) to pay t he minimum rate, and the commercial banks accumulate non remunerative excess reserves or excess liquidity. This type of behavior is detrimental to economic growth, especially for a small developing economy. As has been shown through out the analyses, high er spreads between the domestic loan interest rate and the domestic deposit rate are negatively correlated with

PAGE 63

! (+ GDP growth. Lower levels of GDP growth are caused by the negative effects that an increasing spread has on gross domestic savings and gross fix ed capital formation. Minimal competition amongst commercial banks has created an oligopolistic banking sector that slowly supports growth stagnation through increased spreads. 3. Guyana Lending Rate U.S. 3 month Treasury Bill Rate Using the theory of t he oligopolistic banking sector, banks use a mark up loan rate, which can be derived from a concave profit function of a representative bank, or by using the assumption of a Cournot oligopoly banking model (Khemraj 2008b). (5 ) r L (1+ m) = r F + MC + MC S& M Equation 5 shows that profit maximizing banks will mark up the loan rate (r L ) over the rate of return on a foreign asset (r F ), the marginal cost of production (MC), and the marginal cost of screening and monitoring (MC S&M ). The mark up factor (m) is det ermined by the preferences of the bank itself (Khemraj 2008b). For purposes of th is analysis, the United States 3 month Treasury b ill rate will be the foreign asset used as the benchmark rate that banks consider when determining the interest rate mark up. Foreign assets must be used as benchmark rate for several reasons: (i) i n small developing economies such as Guyana, an oligopolistic banking sector has significant bidding power in the local market for government securities, thus they do not take these rates as a given as banks in more compet itive financial systems; (ii) t he deposit rate is unable to act as a benchmark rate because it is also influenced by oligopolistic forces; (iii) f oreign assets make up a large percentage of commercial banks' portfol ios. As mentioned in Rodrik and Subramanian (2008), the higher interest rates are in the United States, the lower the volume of capital inflows into developing countries will be (Rodrik and Subramanian

PAGE 64

! (, 2008, p. 13). Domestic investment should respond well to capital inflows when an economy is saving constrained. If this is true, domestic investment should be lower in developing countries when interest rates in the United States are high. (i) Guyana Lending Rate U.S. 3 month Treasury Bill Rate Analysis Fig ure 23 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF Figure 23 is a time series for the spread between the Guyanese domestic lending rate and the U.S. 3 month Treasury bill rate from 1974 to 2007 The spread reached a n all time high in 1991, but has been decreasing since then: it was just over 10 percentage points in 2007. This graph alone does not prove that the spread between the Guyanese domestic lending rate and the U.S. 3 month Treasury bill rate has any impact o n growth. Figure 24 below takes into account the effects of foreign assets such as the United States 3 month Treasury bill on domestic growth in Guyana.

PAGE 65

! )! Figure 24 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washington, D.C.: World Bank) During the pre liberalization period, when the spread between the Guyanese lending rate and the U.S. 3 month Treasury bill rate is plotted against GDP growth, a negative correlat ion is shown. As the spread increases, GDP growth decreases and even becomes negative. Although there is a negative correlation between the spread and GDP growth, the points do not centralize around a certain spread value. With domestic interest rates c ontrolled by the government, the variation in the spread is largely due to changes in the U.S. 3 month Treas ury bill rate. As is shown in F igure 25 below, during the post liberalization period, as the spread between the Guyanese domestic lending rate and the U.S. 3 month Treasury bill rate increases, GDP growth increases as well. The average spread during the pre liberalization period was 4.47, while the average spread during the

PAGE 66

! )$ post liberalization period is 15.01. If the data points from 1990 to 1992 ar e omitted, most data points lie around the newly calculated average of 12.39. Figure 25 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washington, D.C.: World Bank) On e would assume that a spread around this area is sufficient to lead to economic growth, but there are several factors that contribute to GDP growth such as gross domestic savings, gross fixed capital formation, and gross domestic credit to the private sect or. The analysis of solely GDP growth as a function of the spread between the Guyanese lending rate and the U.S. 3 month Treasury bill rate is inconclusive. Following the structure of the previous analyses, the Guyanese lending rate and U.S. 3 month Trea sury bill rate spread is plotted aga inst gross domestic savings in F igure 26 to determine if any relationship exists. For the pre liberalization period, the correlation between the spread and gross domestic savings is positive, but has a very

PAGE 67

! )% weak correla tion. The average spread during this time period was 4.47, and the average level of gross domestic savings was 18.47 percent of GDP. In the case of this particular analysis, during the pre liberalization period the spread between the Guyanese lending rat e and the U.S. 3 month Treasury bill rate had little to no effect on gross domestic savings. Figure 26 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washington, D.C.: World Bank) During the post liberalization period, as the spread increases, so does gross domestic savings. The average spread for the entire period is significantly higher than the pre liberalization period at 15.64, while the average level of gross dom estic savings is slightly lower at 14.89 percent of GDP. Aga in, if data from 1990 to 1992 are removed,

PAGE 68

! )& all data points centralize around the average spread of 13.2, 33 and the average level of gross domestic savings becomes 13.69 percent of GDP. Thus the a nalysis for the Guyanese loan interest rate and U.S. 3 month Treasury bill spread for the post liberalization period is almost identical to the results found when the spread is plotted against GDP growth. Figure 27 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washington, D.C.: World Bank) When the spread between the Guyanese loan interest rate and the U.S. 3 month Treasury bill is correlated with gr oss fixed capital formation in F igure 28, the correlation between the two is negative. As was the case with the correlations between the spread and growth, and the spread and gross domestic savings, the data is not centralized and !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 33 The spread for this analysis is slightly higher because data for gross domestic savings is only available up to 2005. We can assume that if data for gross domestic savings were available for 2006 and 2007, that the average spread would be equal 12.39.

PAGE 69

! )' there is a very weak correlation. Because of interest rate control mechanisms used by the government during the pre liberalization time period, a relationship between the Guyanese lending rate and the U.S. 3 month Treasury bill rate cannot be identified. The average spread for the pre liberaliza tion period was 4.47, with gross fixed capital formation totaling an average of 25.91 percent of GDP. Figure 28 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washingto n, D.C.: World Bank) For the post liberalization period of 1990 to 2005, 34 there is a positive correlation between the spread and gross fixed capital formation. Figure 29 shows that as the spread increases, gross fixed capital formation also increases. T he average spread from 1990 to 2005 was 15.64, and the average level of gross fixed capital formation was 29.82 percent of GDP. As was the case with GDP growth, and gross domestic savings, if data from !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! &' !OA1FJ?"AE!JL !J!NC1DCE?J9C!AO!6H!J#J">JP>C!BN!?A!%--(R

PAGE 70

! )( 1990 to 1992 is ignored, most data points lie around an average of 13.2 35 where the average level of gross fixed capital formation is 27.37 percent of GDP. Figure 29 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washing ton, D.C.: World Bank) To complete the analysis of the effects of the Guyanese loan interest rate and U.S. 3 month Treasury bill spread on GDP growth, domestic credit to the private sector must be taken into consideration as it acts as a catalyst for econ omic development. As mentioned earlier, prior to 1991, monetary policy in Guyana focused primarily on direct instruments such as interest rate controls, a credit ceiling, and direct lending to the government and select private en tities (Khemraj 2007b, p. 103). When the spread is graphed against domestic credit to the private sector during the pre liberalization period, there is a strong positive correlation. Figure 30 shows that as the spread between the !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 35 Again this average is for the spread from 1990 to 2005, and would equal 12.39 if dat a were available for gross fixed capital formation in 2006 and 2007.

PAGE 71

! )) Guyanese lending rate and the U.S. 3 month Treasury bill rate increases, domestic credit to the private sector also increases. Figure 30 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washington, D.C.: World Bank) Again Rodrik and Subramanian (2008) argue that higher interest rates in the United States tend to lower the volume of capital inflows into developing countries (Rodr ik and Subramanian 2008, p. 13) Domestic investment should respond well to capital inflows wh en an economy is saving constrained. If this is the case, domestic investment should be lower in developing countries when interest rates in the United States are high. Based on Figure 30 above, as the spread increases, the level of domestic credit to th e private sector increases as well. That is, since the government controlled loan interest rates, increases in the U.S. 3 month Treasury bill rate increase d the spread value. This forced domestic credit to the private sector to increase because of lower capital inflows which follows the theory of Rodrik and Subramanian (2008).

PAGE 72

! )* Figure 31 Source: IMF, International Financial Statistics Yearbook (Washington, D.C.: IMF) and WDI, World Bank World Development Indicators (Washington, D.C.: World Bank) The opposite holds true for the post liberalization period. As the spread increases domestic credit to the private sector decreases Since interest rate controls are removed during this time period, 36 rising loan interest rates cause the spr ead to increase, which decreases domestic credit to the private sector. From the data analysis of the effects of the Guyanese lending rate and the U.S. 3 month Treasury bill rate spread, there is evidence that suggests a spread around 12 is able to facilitate economic g rowth and development in Guyana. For the pre liberalization period, a negative correlation between the spread and GDP growth shows that a higher spread between the U.S. 3 month Treasury bill rate and the Guyanese lending rate did not benefit growth. For the post liberalization period, a higher spread has led to higher levels !!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!! 36 Alternatively influenced by oligopolistic market forces

PAGE 73

! )+ of economic growth. A higher spread has had a positive effect on gross domestic savings and gross fixed capital formation, as shown by Figures 27 and 29, which can explain the positi ve correlation between the spread and GDP growth. As stated earlier, domestic investment should be lower in developing countries when interest rates in the United States are high. As the spread increased during the pre liberalization period, domestic cre dit to the private sector increased as well. Because of interest rate control mechanisms, a higher interest rate in the United States forced domestic credit to the private sector to increase because of lower capital inflows During the post liberalization period, the Guyanese lending rate was higher than the U.S. 3 month Treasury bill rate, which lead to increased domestic investment. Both of these correlations follow the theory of Rodrik and Subramanian (2008)

PAGE 74

! ), Summary and Concluding Remarks Financial liberalization policies adopted by Guyana in the 1980 s were designed to promote economic growth through increased savings and investment. Financially repressed systems are usually described as having interest rate ceilings, directed credit, and high reserv e requirements. Liberalized financial markets are characterized by free floating interest rates, and a reduc tion in quantitative controls that allow financial intermediaries greater control in the financial system. In a financially repressed system, inter est rate ceilings prevent competition between the private and the public sector, but higher interest rates under a liberalized system will not necessar ily attract the best borrowers. The McKinnon Shaw Hypotheses have four common elements: (i) a savings fu nction that responds positively to the real rate of interest on deposits and the real rate of growth in output; (ii) an investment function that responds negatively to the effective real loan rate of interest and positively to the growth rate; (iii) a gove rnment fixed nominal interest rate which holds the real interest rate below its equilibrium level; (iv) and inefficient non price rationing on loanable funds (Fry 1997, p. 755). Liberalizing interest rate markets allows the rates to float towards their na tural value, causing an increase in savings and investment. However, s ome of the assumptions made in financial liberalization literature such as perfect information and profit maximizing competitive behavior by commercial banks, may or may not be met Imperfect information can lead to adverse selection and moral hazard, while high er interest rates attract a larger proportion of high risk borrowers. The

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! *! McKinnon Shaw Hypothesis assumes that perfect competition exists amongst commercial bank s but most s mall developing economies have oligopolistic banking sectors in which a few firms dominate the market. Before proceeding with financial liberalization policies, the soundness of the institutional framework surrounding the financial system must be determin ed The state plays an important role in regulating the system and maintaining confidence in the currency and also plays a role in deepening and developing financial markets. Traditional financial liberalization theory also fails to recognize the import ance of stock markets in economic development. Higher interest rates encourage firms to issue equity and provide an easy means of access for foreign investors into emerging markets through foreign capital inflows. As is seen i n Chapter II, the study of th e history and structure of the Guyanese financial system is imperative when examining the effects of the libe ralization policies of the 1980s and early 1990 s. Market forces have determine d the loan, deposit, and Treasury bill rates under the liberalized s ystem. Credit rationing programs and directed credit to priority sectors have been discontinued. Nationalized banks have become privatized and compete with foreign banks in the domestic economy. The government has also abandoned exchange rate control me chanisms and the currency has been allowed to fluctuate. The economy has become open to foreign capital inflows and has experienced a subsequent real appreciation of the real effective exchange rate. The analyses in Chapter III provide a context in whic h to view the financial liberalization policies of the IMF stabilization program. The study of the real effective exchange rate is used as a means to determine the effects of foreign capital inflows on economic growth. After the adoption of financial libe ralization policies, an economy

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! *$ becomes open to foreign capital and a real appreciatio n of the exchange rate follows. An appreciation of the exchange rate level leads to artificially inflated incomes which fuel consumption l ed growth instead of investment led growth, which can be seen as a savings displacement. The study of the real effects of exchange rate levels on long term growth possibilities is beneficial because of their inf luence on aggregate investment. The negative correlation between the real effective exchange rate and GDP growth during the post liberalization period can be explained by foreign financing. When the economy opened to foreign finance, a spike in gross domestic savings, gross fixed capital formation, and foreign direct investment led to high er levels of ec onomic growth in the early 1990 s. An appreciation of the exchange rate should lead to decreased savings, but if deposit rates in commercial banks are higher domestically than abroad, there will be an inflow of capital to help in crease domestic savings. As the deposit rate decreases, foreign capital will move to countries with higher rates of return. The analysis of the Guyanese loan deposit interest spread reinforces the idea of market power in an oligopolistic banking sector. Under a liberalized system, the liquidity preferences of the commercial banking industry in a small developing country such as Guyana require a minimum loan rate befo re making a loan to a borrower. High interest rates deter investment and the commercial banks accumulate non remunerative excess reserves or excess liquidity. Guyanese banks demand excess reserves because of oligopolistic interactions in the loan and Treasury bill markets Higher spreads between the loan interest rate and the deposit interes t rate correlate with lower levels of GDP growth. The high interest rates and low deposit rates deter savings and investment,

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! *% lowering GDP growth. Thus, an oligopolistic banking sector can create growth stagnation because of minimal competition. The re lationship between the Guyanese lending rate and the U.S. 3 month Treasury bill rate varied with each analysis. As the spread increased, economic growth increased. Savings and investment also increased as the spread widened, but domestic credit to the pr ivate sector decreased as the spread widened. Since interest rate controls are removed during this time period, rising loan interest rates cause the spread to increase, decreasing domestic credit to the private sector. For the post liberalization period, the spread tends to centralize around 12, suggesting that oligopolistic forces are present. The state of the banking sector following these analyses prompts a need for government involvement in economic development programs. Private commercial banks w ill continue to pursue profit optimization goals rather than pursue macro developmental objectives. While there is no need for a relapse towards financial repression, the state does possess the power to positively enhance competition. Due to the market s ize of the Guyanese economy, only a few oligopoly banks can function effectively. Development finance corporations can introduce quantity and price competition by making long term loans to private investors (Khemraj 2006b). However there is a possibility that an overstimulation of bank credit to the private sector can have negative effects on the balance of payments. Consumption led expenditures can put pressure on the balance of payments because of the nature of a small economy, but investment led expen ditures are not likely to be problematic as long as the capacity to export grows with money and credit.

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! *& While a narrative approach and descriptive statistics for real exchange rates and interest rate spreads have given further insight into the possibiliti es for growth stagnation following financial liberalization, there is still further work to be done. Future work on this subject requires the use of formal inferential statistics and econometric analysis.

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! *' References Arestis, P. and P. Demetriades. (1999 ). "Financial Liberalization: The Experience of Developing Countries," Eastern Economic Journal, vol. 25(4), Fall, pages 441 457. Bagehot, W., Lombard Street. Homewood, IL: Richard D. Irwin, [1873] 1962 Edition. Bencivenga, V. and B. Smith (1991). "Finan cial Intermediation and endogenous growth." Review of Economic Studies vol. 58, pages 195 209. Bhaduri, A. and S.A. Marglin. (1990). "Unemployment and the real wages: the economic basis for contesting political ideologies," Cambridge Journal of Economics, vol. 14, December. Central Intelligence Agency. (2008). The World Factbook: Guyana. Updated 18 December 2008, accessed 14 January 2008, from . Campbell, J.Y. and N.G. Mankiw. (1990) "Permanent Income, Current Income and Consumption," Journal of Business and Economic Statistics vol. 8(3), pages 265 279. Chang, H., H. Park, and C.G. Yoo. (1998) Interpreting the Korean crisis: financial liberalisation, industrial policy and corpora te governance," Cambridge Journal of Economics 1998, vol. 22, pages 735 746. Das, U. and G. Ganga (1997). "A retrospect and prospect on the reform of the financial sector in Guyana." Social and Economic Studies 46 (2&3), pages 93 129. Dell'Ariccia, G., E. Friedman and R. Marquez. (1999). "Adverse Selection as a Barrier to Entry in the Banking Industry," The RAND Journal of Economics Blackwell Publishing for The RAND Corporation, vol. 30(3), pages 515 534, Autumn. Demetriades, P. and K. Luintel. "'Finan cial Repression' in the South Korean Miracle," Paper presented at the Econometric Society European Meeting, 1996, Rungsted, Denmark. Dunn, R.M., and J.H. Mutti. International Economics New York: Routledge, 2005. Fry, M.J. (1997). "In favour of financial liberalization," The Economic Journal, Blackwell Publishing for the Royal Economic Society, vol. 107(442), pages 754 770, May. Ganga, G. (1998). "Stabilization and financial adjustment in Guyana," Money Affairs vol. 11, pages 147 168.

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! *( Gala, P. (2007). "R eal Exchange Rate Levels and Economic Development," Cambridge Journal of Economics, vol. 32, pages 273 288. Gemech, F. and J. Struthers. "The McKinnon Shaw Hypothesis: Thirty Years on: A Review of Recent Developments in Financial Liberalization Theory," Pa per presented at Development Studies Association (DSA) Annual Conference on "Globalisation and Development", 2003. Glasgow, Scotland. Gibson, H.D. and E. Tsakalotos. (1994). "The scope and limits of financial liberalization in developing countries: A cri tical survey," Journal of Development Studies, vol. 30(3), pages 578 628. Gupta, R. (2004). "A Generic Model of Financial Repression," PhD thesis, Department of Economics, The University of Connecticut. Gurley, J.G. and E.S. Shaw. (1955). "Financial Aspe cts of Economic Development," The American Economic Review, The American Economic Association, vol. 45(4), pages 515 538, September. Haslag, J.H. and J. Koo. (1999). "Financial Repression, Financial Development and Economic Growth," Working paper 9902, Re search Department, The Federal Reserve Bank of Dallas. Ishmael, O. (2007). "The Rush Towards Privatization 1989 1992," Guyana Journal vol. 13(7), July 2008. Hicks, J. A theory of economic history. Oxford: Clarendon Press, 1969. Kapur, B.K. (1976). Al ternative Stabilization Policies for Less developed Economies ," Journal of Political Economy University of Chicago Press, vol. 84(4), pages 777 795, August. Khemraj, T. (2006a). "Fiscal sustainability and foreign dependency: the case of Guyana." Transitio n Issue 34, pages 72 85. Khemraj, T. (2006b). "Excess Liquidity, Oligopoly Banking, and Monetary Policy in a Small Open Economy," Phd thesis, Department of Economics, The New School for Social Research. Khemraj, T. (2007a). "The missing link: the financ e growth nexus and the Guyanese growth stagnation," Department of Economics, New College of Florida. Khemraj, T. (2007b). "Monetary Policy and Excess Liquidity: The case of Guyana," Social and Economic Studies vol. 56(3), pages 101 127, September. Khemra j, T. (2008a). "Excess liquidity, oligopolistic loan markets, and monetary policy in LDCs," DESA Working Paper No. 64, United Nations. Khemraj, T. (2008b) "The W.A. Lewis legacy of industrialization and Caribbean

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