Macroeconomic issues relating to the large early withdrawal from the NRF

In the previous column, I noted several positive features of the Natural Resource Fund (NRF) Act of 2021. I also outlined several potential downsides such as the possibility for employing unnecessary financial consulting in the face of a legally-mandated passive investment strategy, the power relations between the officers of the Fund and government given the degree of control in the Guyanese society, and the abandonment of the macroeconomic committee that could have served the wider society by providing relevant information. One point I did not make, but is worth mentioning, is consulting and advising fees could eat way a large share of the annual rate of return on the Fund.

Before we move into the task for today’s column, I must mention that there are substantial similarities between the APNU+AFC’s NRF Act of 2019 and the recent one. The 2019 Act established the sensible investment mandate. However, it also opened the door for the said unnecessary consulting fees – a situation that was carried forward into the recent Act.

In spite of the numerous similarities, it is the withdrawal rule from the Fund that really separates these two Acts. Like the one in 2019, the recent NRF clearly establishes that Parliament must debate and vote on the annual withdrawals. It also determines that withdrawals must be deposited into the black box otherwise known as the Consolidated Fund. As we discuss the withdrawal rule, it is important to note that the NRF must be held in foreign currency, namely the world’s dominant currency: the US dollar. The Consolidated Fund, however, is held in Guyana dollars – thus presenting an interesting mismatch that the policy makers will need to navigate.

One of the criticisms coming from the PPP/C claims that the withdrawal rule of the 2019 Act was nebulous as there was no clear number attached. There is some merit to this argument, I think. The previous Act tasked the then proposed macroeconomic committee (MC) in advising the Minister on the “economically sustainable amount” (ESA) and the Minister is expected to formulate budgets bearing in mind the best withdrawal in a given year. On the surface, this sounds like a very good idea, but the MC could not have fully settled on an ESA unless there is general agreement – even better if it could come from broad political consensus – on what should be the aggregate savings in the Fund over a given time horizon, say a three-year or a five-year average.

Think of the agreed aggregate saving as the ideal level of water in a bathtub, say two feet. If the leakage from the bathtub is greater than the inflow from the faucet, then the ideal level of water is unsustainable. Therefore, the MC cannot determine an ESA unless there is an agreement on how much will be saved over a given horizon. The subsequent sustainable withdrawals have to be consistent with the aggregate agreed saving. For professional macroeconomists, the technical term of the ideal aggregate saving (or water in the bathtub) is a stationary state.

Sustainability, for our purpose, means that the stationary state is not changing over some time horizon. And that stationary state could be updated as more barrels of oil are pumped and there is consensus for altering the amount saved in the Fund. As a result, we would have had a MC that really cannot say what’s the real ESA with the exception of one rule: that interest earnings plus new deposits outpace annual withdrawals. The question is, would politicians, facing an imminent election and demanding base voters allow money inflows to exceed money outflows, especially if the group of politicians has a majority in Parliament?

The notion of making annual economically sustainable withdrawals has been expunged from the 2021 Act. Instead, sustainability has been replaced with a “first schedule” and supplementary emergency withdrawals. The first schedule means that the entire amount of US$607.5 million (or G$127.5 billion) can be withdrawn from the NRF and deposited into the Consolidated Fund (CF) in order to support spending in the 2022 budget. For context, the 2021 Budget projected G$383.1 billion. Therefore, the first-schedule withdrawal would amount to 33.3% of the 2021 budget.

I am somewhat sympathetic to Vice President Jagdeo’s recent lamentation that he cannot stand by and save for future generations when there are many who are poor in the present generation. However, I thought that a few large early withdrawals would be directly linked to a few earmarked capital projects that can improve people’s quality of life. Since capital projects like roads or the proposed bridge take more than one year to complete, I expected to see the secured withdrawals linked to said projects, an outcome that would imply several withdrawals, not a single one. Withdrawing everything and depositing into the CF means the country is losing interest income and capital gains.

Nevertheless, we must discuss the implications of the first-schedule withdrawal. The first consequence would be to further boost the government’s balance at the Bank of Guyana (BoG). The muchdiscussed overdraft on this account was securitised after Parliament increased the domestic debt ceiling early last year. The account is now in a surplus of G$50.3 billion as at November 2021. Money is fungible and once deposited in the CF, it is available for any use as the government sees fit given its parliamentary majority. Except for those of us who are into NeoChartalist academic literature, the CF and the extended BoG balance are like a black box. This is why it might have been better to sterilise the injected funds in a subaccount of the CF and earmark them for nationally-agreed capital projects (I know, I am a dreamer!). Moreover, funds deposited this year could be used in subsequent years for political advantage.

The CF is important for another reason. Only when payments are emitted from this account they enter the monetary system and produce favourable multiplier effects or unfavourable pressure on the demand for foreign exchange. Given that Guyana largely imports all its machinery and fuel, as well as most of what it consumes, we can expect the large expenses to stimulate the demand for hard currencies. Hopefully, the private oil economy will continue to bring in hard currencies at an amount that exceeds the import leakages.

How does the US dollar balance in the NRF end up into the CF in terms of Guyana dollars? The managers of the Fund will need to sell the US dollars to an entity or entities in Guyana. They can sell to the private sector, thereby swapping out Guyana dollars for US dollars. More likely, the managers will sell to the government, or more accurately the government’s bank – the Bank of Guyana. The BoG will create reserves out of thin air (one of the privileges of not completely dollarizing the economy and why I oppose dollarization) and credit these into the government’s CF. Therefore, the US dollars merely switch from the NRF to BoG international reserves. However, sales of foreign currency to the private sector will result in a different, and less desirable, chain of events. It is important to note that neither the 2019 nor 2021 Act has legal provisions for distinguishing these mechanisms.

The latter scenario is one of the main reasons why I was adamant in my previous column (and in this May 2020 essay (“Oil, ethnic conflict, and necessary and sufficient reforms”) that the BoG should not be mixing its management of the foreign reserves with the NRF. The BoG’s foreign reserves and the NRF are meant for different purposes; therefore, they must be managed separately. Readers will point out an obvious conflict of interest here if the Act is not clear in separating them, which I believe is the case. Therefore, I still do not understand why the Act empowers the BoG to seek financial consulting services to invest a percentage of the NRF. The central bank has been reliably investing the people’s foreign reserves for over 50 years.