## wpiea2022224-print-pdf - Executive Summary

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### Major findings and context
- International oil producers discovered commercially recoverable petroleum reserves of around 11 billion barrels.
- Guyana’s reserves are the third largest in Latin America and Caribbean and one of the highest levels per capita in the world; the present value of oil reserves per capita is higher than, or comparable to, Kuwait, the United Arab Emirates, and Saudi Arabia.
- Oil production presents an opportunity to boost inclusive growth and diversify the non-oil economy, but creates policy challenges due to high volatility of oil prices and terms-of-trade shocks.
- Monetary and exchange rate policies have two key roles:
  - provide a nominal anchor for controlling inflationary pressures and expectations; and
  - serve as an adjustment tool for external shocks and balance-of-payments pressures.
- Guyana’s de jure regime is floating; its de facto regime is a stabilized arrangement with FX interventions and capital controls aimed at smoothing short-term nominal exchange rate fluctuations.

### Recommendation on regime choice and sequencing
- Current recommendation: maintain exchange rate stability via a de facto stabilized exchange rate arrangement (fixed or pegged, crawling or within bands) for the time being.
- Rationale:
  - The exchange rate serves well as the nominal anchor for price stability.
  - Guyana is mostly a price-taker and most exports are priced in U.S. dollars, limiting exchange rate flexibility as a shock absorber today.
  - Projected fiscal developments: overall fiscal and primary fiscal balances are projected to turn to surpluses from 2025 onwards due to rapidly rising oil revenues to the budget; projected accumulation of significant savings into the Natural Resource Fund over the next few years should help provide fiscal and external buffers to sustain a peg.
- Intermediate transition path:
  - Adopt a crawling peg or exchange rate band regime as an intermediate (“soft peg”) step while developing the infrastructure for a floating exchange rate regime and an inflation-targeting framework.
- Medium- to long-term guidance:
  - Gradual shift toward greater exchange rate flexibility is recommended as Guyana becomes a major oil producer, contingent on development of domestic financial and FX markets, effective regulatory and supervisory frameworks, and strengthened monetary policy transmission.

### Conditions and risks to monitor for peg sustainability
- Conditions to sustain a peg:
  - Limit inflation divergence relative to main trading partners, and
  - Keep external imbalances in check to avoid real exchange rate over- or under-valuation that could harm growth.
- If these conditions fail, a peg may become unsustainable and a shift toward greater flexibility may be required even if preconditions for full flexibility are not yet met.

### Key empirical evidence informing policy
- Structural VAR (2000–2019 / 1998Q1–2021Q4 depending on specification) findings:
  - Aggregate supply shocks accounted for around 82 percent of the variance in output over an 18–24 month horizon.
  - This share is likely to grow as oil’s share in the economy increases, strengthening the case for exchange rate flexibility over time.
- Export concentration:
  - UN export product concentration index for 2020 ranks Guyana’s exports among the most highly concentrated in the world: only 42 out of 218 countries have a more concentrated export structure.
- Non-oil exports and relative prices:
  - Empirical evidence (Annex IV / Error Correction Model) suggests Guyana’s non-oil exports are sensitive to movements in relative prices in both the short-run and the long-run; coefficients on the relative price index are highly statistically significant for both long-run equilibrium levels and short-run dynamics.

### Constraints on exchange rate flexibility as a shock absorber
- Special oil-exporter features limiting effectiveness:
  - Oil priced in U.S. dollars on world markets; producers face a perfectly elastic demand curve for oil.
  - High export concentration and import dependence limit the ability of depreciations to switch spending toward non-oil export growth in the short run.
  - Small open-economy characteristics: depreciations may compress expenditures more than trigger export expansion in the short run.
- Monetary policy implications:
  - Abandoning the exchange rate anchor requires an alternative nominal anchor (e.g., money supply or inflation target) and a credible monetary policy framework.
  - A key factor is the extent of exchange rate passthrough to inflation.

### Exchange rate passthrough and monetary transmission (Annex II)
- ARDL (bivariate) pass-through estimates (monthly data):
  - Pass-through coefficient over 1995M1-2021M9: about -0.40.
  - Pass-through coefficient over 2009M1-2021M9: about -0.55.
  - Note: ARDL methodology may be subject to omitted variable bias because it only models NEER and prices.
- VECM model (accounts for monetary policy reaction and interactions):
  - Long-run exchange rate passthrough to CPI inflation from VECM: around -0.24.
  - VECM ordering and sample: LNNEER LNCBPrate1 LNBASEMNY LNCPI; period covered 2009M1 to 2021M4; lag length = two; 148 monthly observations.
  - A 1 percent appreciation of the NEER has a cumulative (negative) impact on the CPI price level of around 0.24 percentage points after 12 months.
- Monetary policy transmission:
  - Preliminary VAR estimation suggests movements in the key central bank policy rate have no significant impact on monetary aggregates or CPI inflation.
  - The policy rate has been fixed at 5 percent since March 2013.

### Currency substitution and money demand (Annex III)
- ARDL money-demand estimates (quarterly 2000:Q1–2021:Q4) find:
  - No evidence that (expected) exchange rate movements (INFDIFF) affect the demand for broad money (M2) directly (currency substitution) or indirectly via expected returns on foreign assets (asset substitution).
  - Unit-root and cointegration tests: LNM2, LNRGDP, and LN3MNTBILLRATE are I(1); INFDIFF, LNROR6, and LNROR8 are I(0); no cointegration among the I(1) variables.
- Caveat:
  - This absence of evidence may change as the oil industry develops and the amount of foreign currency circulating in the economy increases; currency substitution can decline over time if the central bank builds credibility.

### Financial market structure, capital mobility, and implications
- Guyana’s domestic capital markets are underdeveloped:
  - Provide mostly short-term funding; corporate and government bond markets are minuscule with no secondary market trading; long-term investors mostly hold short-term securities.
  - Financial development index: 0.162 in 2018 versus an average of 0.324 for 176 countries in the sample.
- Policy implications:
  - Transitioning to an alternative nominal anchor requires developing deep, liquid, and efficient financial and FX markets, and systems to monitor, regulate, and manage FX exposures and related risks.
  - High capital mobility and global financial integration constrain independent monetary policy unless the capital account is managed; greater financial integration can increase exchange rate volatility from asymmetric external shocks.
- Role of greater financial market development:
  - Makes implementing a flexible exchange rate regime more feasible and can help manage strong capital inflows; high capital mobility may constrain pegs and narrow-band pegs.

### Key policy conclusions and sequencing (Section VII)
- Two key policy objectives: output stabilization/absorption of external shocks and control of inflation (price stability).
- Short-term policy: maintain exchange rate stability (stabilized arrangement; fixed/peg, crawling peg, or bands) while building buffers and institutional capacity.
- Medium-term objective: move to a more flexible regime as:
  - an alternative credible nominal anchor is in place;
  - monetary policy transmission strengthens;
  - money and FX markets deepen; and
  - regulatory, supervisory, and risk-management frameworks are established.
- Preconditions for moving to flexibility include:
  - a credible alternative monetary policy framework;
  - strengthened monetary policy transmission and effective instruments;
  - well-developed money and foreign exchange markets; and
  - a well-functioning banking system and effective FX intervention mechanisms.
- Timing considerations:
  - Shift toward flexibility should depend on the speed of progress on the preconditions given Guyana’s small size, shallow financial markets, and weak monetary transmission.
  - If domestic inflation diverges significantly from trading partners or external balances deteriorate, there may be a case for moving more quickly to flexibility to avoid real exchange rate misalignment.

### Areas identified for further research (Section V)
- Required analyses prior to choosing an optimal regime:
  - Flexibility of nominal wages and relative prices, and geographic/occupational mobility of labor and capital.
  - Price-sensitivity of Guyana’s exports and imports (short-run and long-run).
  - Strength and channels of monetary policy transmission: links between policy rates, lending/deposit rates, monetary aggregates, and inflation.
  - Extent of currency substitution and exchange rate passthrough dynamics.

*Source: wpiea2022224-print-pdf - Executive Summary; Annex II; Annex III; Section I–VII (IMF Working Paper).*

### Executive Summary ......................................................................................................

### wpiea2022224-print-pdf - Executive Summary ......................................................................................................

### Executive Summary
- International oil producers have discovered commercially recoverable petroleum reserves of around 11 billion barrels.
- The discovery promises to transform Guyana's agricultural and mining economy into an oil powerhouse and presents an opportunity to boost inclusive growth and diversify the non-oil economy.
- Oil production creates policy challenges due to high volatility of oil prices, complicating macroeconomic stability in the face of external and terms-of-trade shocks.
- Monetary and exchange rate policies play two key roles:
  - providing a nominal anchor for controlling inflationary pressures and expectations, and
  - serving as an adjustment tool for external shocks and balance-of-payments pressures.
- The current de facto monetary policy framework focused on exchange rate stability is judged most suitable for Guyana at this time because:
  - the exchange rate serves well as the nominal anchor for price stability, and
  - exchange rate flexibility is likely to be weak as a shock absorber since Guyana is mostly a price-taker and most exports are priced in U.S. dollars.
- Empirical evidence suggests Guyana’s non-oil exports may be sensitive to movements in relative prices in both the short-run and long-run.
- Cross-country evidence indicates the competitiveness channel of exchange rate depreciation tends to gain traction over time, strengthening the case for more flexibility in the future.
- Guyana’s projected rapid expansion of oil production and exports should provide adequate fiscal and external buffers to sustain a fixed exchange rate or peg for the foreseeable future, especially if planned public investment expansion does not generate macroeconomic imbalances and is accompanied by a strengthened medium-term fiscal framework.
- A gradual shift towards greater exchange rate flexibility is recommended over the medium- to long-term as Guyana becomes a major oil producer; this requires:
  - development and deepening of domestic financial and foreign exchange markets,
  - establishment of effective regulatory and supervisory frameworks for interbank, domestic debt, and FX markets, and
  - strengthening of the monetary policy transmission mechanism.
- The study does not assess the appropriate level of the exchange rate, nominal or real, and only elaborates on considerations relating to the appropriate exchange rate regime.

### Section I: Introduction
- Guyana’s commercially recoverable petroleum reserves are around 11 billion barrels ― the third largest in Latin America and Caribbean, and one of the highest levels per capita in the world.
- The present value of oil reserves per capita is higher than, or comparable to, oil-producing Gulf countries such as Kuwait, the United Arab Emirates, and Saudi Arabia.
- Key roles for monetary and exchange rate policy highlighted:
  - a nominal anchor for controlling inflationary pressures and expectations, and
  - an effective tool for adjusting to external shocks and balance-of-payments pressures.
- Exchange rate regimes among oil producers vary: floating (Norway, Colombia, Ghana), relatively hard peg (Gabon, Niger, GCC countries), and soft peg with periodic step adjustments (Trinidad and Tobago).
- Guyana’s de jure regime is floating; its de facto regime is a stabilized arrangement with FX interventions and capital controls aimed at smoothing short-term nominal exchange rate fluctuations.
- The study’s objective: identify the most appropriate exchange rate regime(s) and monetary policy framework for Guyana during transition to a major oil producer, without assessing the appropriate exchange rate level.

### Section II: The Case for Maintaining a Stabilized Exchange Rate Arrangement
- Principal argument: current conditions do not favor abandoning the exchange rate as the nominal anchor for price stability.
- As government spending financed by oil revenues increases, larger FX inflows will need sterilization to avoid exchange rate pressures; this increases management costs to maintain stability.
- Greater exchange rate flexibility will ultimately facilitate adjustment to oil price shocks and help maintain price stability and foreign reserves.
- Projected fiscal developments:
  - overall fiscal and primary fiscal balances are projected to turn to surpluses from 2025 onwards due to rapidly rising oil revenues to the budget.
  - projected accumulation of significant savings into the Natural Resource Fund over the next few years should help provide fiscal and external buffers to sustain a peg.
- Conditions to monitor for peg sustainability:
  - inflation divergence relative to main trading partners must be limited, and
  - external imbalances should be kept in check to avoid real exchange rate over- or under-valuation that could harm growth.
- If these conditions fail, a peg may become unsustainable, prompting a shift toward greater flexibility even if preconditions for full flexibility are not yet met.

### Section III: The Role for a More Flexible Exchange Rate Regime
- As Guyana becomes a major oil producer, exposure to terms-of-trade shocks (primarily large changes in oil prices) will increase, supporting consideration of more flexibility.
- Optimal currency area literature: exchange rate flexibility helps absorb real shocks when wages/prices and labor/capital mobility are sticky; dominance of domestic nominal shocks (e.g., money demand) favors fixed exchange rate with an external anchor.
- Empirical exercise (Annex I):
  - a three-equation structural VAR models real output, CPI, and real money balances with shocks identified as aggregate supply (AS), goods market (IS), and money demand (MD).
  - estimation over 2000 to 2019 suggests aggregate supply shocks accounted for around 82 percent of the variance in output over an 18–24-month horizon.
  - this proportion is likely to grow as oil’s share in the economy increases and exposure to real external shocks rises.
- Export concentration considerations:
  - Guyana’s export structure is highly concentrated and likely to remain so until oil growth spillovers diversify the economy.
  - UN export product concentration index for 2020 ranks Guyana’s exports among the most highly concentrated in the world, with only 42 out of 218 countries having a more concentrated export structure, among them seven in the Western Hemisphere.
  - limited diversification strengthens the argument for exchange rate flexibility.

### Section IV: Drawbacks and Challenges of Adopting a More Flexible Exchange Rate Regime
- Special features of oil exporters limit exchange rate effectiveness as a shock absorber:
  - oil priced in U.S. dollars on world markets; producers face a perfectly elastic demand curve and cannot influence world oil prices.
  - in less diversified exporters, non-oil exports contribute little to the export basket, limiting the real exchange rate’s impact on export volumes.
  - import dependence and limited substitution possibilities reduce import responsiveness to relative prices in a small open economy like Guyana.
- Empirical evidence on depreciations/devaluations:
  - effects on growth are similar between small and larger economies, but transmission channels differ.
  - in small open economies, depreciations/devaluations are more likely to compress expenditures than to effect expenditure-switching towards exports, due to adverse income and distribution effects and limited import substitution or rapid export scaling.
  - thus, increasing reliance on hydrocarbon exports and lack of diversification will likely diminish the exchange rate’s effectiveness as a shock absorber.
- Monetary policy implications:
  - abandoning the exchange rate anchor requires another nominal anchor (e.g., money supply) to maintain domestic price stability.
  - key factor: the extent of exchange rate passthrough to inflation — a high passthrough complicates inflation control via interest rates or monetary aggregates and makes the nominal exchange rate a more effective anchor.

*Source: wpiea2022224-print-pdf - Executive Summary (IMF Working Paper).*

### Annex II presents the results of staff estimates of exchange rate passthrough to inflation in Guyana.

### Annex II — Staff estimates of exchange rate passthrough to inflation in Guyana

### Exchange rate passthrough estimates
- Standard estimation: bivariate Auto Regressive Distributed Lag (ARDL) model, monthly data.
  - Pass-through coefficient over 1995M1-2021M9: about -0.40.
  - Pass-through coefficient over 2009M1-2021M9: about -0.55.
  - Methodology limitation: looks only at relationship between the nominal effective exchange rate (NEER) and prices and may be subject to omitted variable bias.
- Model-based alternative: Vector Error Correction (VECM) model that accounts for a simple monetary policy reaction function and simultaneous interactions.
  - Long-run exchange rate passthrough to CPI inflation from VECM: around -0.24.
- Comparative evidence: country cases such as South Africa and Poland show exchange rate passthrough to inflation can fall significantly over time as the interest rate channel of monetary policy strengthens and inflation expectations become better anchored to the inflation target as the central bank builds credibility.

### Currency substitution, money demand, and asset substitution
- Degree of currency substitution:
  - Higher currency substitution and larger holdings of foreign money in circulation make it more difficult for monetary authorities to control the money supply if the exchange rate is allowed to vary.
- Annex III results (ARDL money demand equations for Guyana):
  - Empirical results provide no evidence that (expected) exchange rate movements have any impact on the demand for broad money (M2), either directly (currency substitution) or indirectly by affecting expected rates of return on foreign assets (asset substitution or capital mobility).
  - Footnote: the empirical results indicate that neither the inflation differential between the U.S. and Guyana, nor the U.S. Treasury Bill rate adjusted for the inflation differential, affect the demand for broad money (M2) in Guyana.
- Caveat: this could change over time as the oil industry develops and the amount of foreign currency circulating in the economy increases.
- Reversibility: currency substitution or dollarization can drop significantly over time if the central bank raises credibility and anchors inflation expectations to the inflation target.

### Monetary policy transmission, financial markets, and capital mobility
- Evidence on monetary transmission in Guyana:
  - Preliminary VAR estimation by staff suggests movements in the key central bank policy rate have no significant impact on monetary aggregates or on CPI inflation.
  - Context: the policy rate has been fixed at 5 percent since March 2013.
- Financial market structure:
  - Guyana’s domestic capital markets are underdeveloped and mostly provide short-term funding; both corporate and government bond markets are minuscule; there is no secondary market trading; long-term investors mostly hold short-term securities.
  - Adopting an alternative anchor would require developing deep, liquid, and efficient financial and foreign exchange markets, and systems to monitor, assess, regulate and manage foreign exchange exposures and related risks.
  - Public Debt Policy 2021-2024 objective: promote development of the domestic financial market through the issuance of government securities across a range of tenors to provide benchmarks for private entities.
- Implications of capital mobility and global financial integration:
  - Rey (2013) argument summarized: independent monetary policies for small, open economies are possible if and only if the capital account is managed directly or indirectly; with freely mobile capital, the global financial cycle constrains national monetary policies.
  - Financial policy trilemma (Schoenmaker 2013): only two of (1) national control over financial policies and regulation, (2) financial integration with global capital markets, and (3) financial stability can be attained simultaneously.
  - Montiel and Pedroni (2019): even if independent monetary policy is feasible, countries may not wish to pursue it because greater financial integration increases exchange rate volatility caused by asymmetric monetary policy shocks.
- Trade and exchange rate interactions:
  - Short-term response of trade flows to exchange rate movements can be asymmetric—reducing imports but exerting little immediate effect on exports due to trade pricing in dominant currencies.
  - Global value chains and dollar dominance have weakened the effectiveness of exchange rate flexibility as an instrument for absorbing shocks.
  - Empirical counterpoint: the competitiveness channel of depreciation gains traction over time and offsets negative effects from balance sheet or financial channels.
- Financial market development and feasibility of regimes:
  - Greater financial market development makes implementing a flexible exchange rate regime more feasible.
  - High capital mobility may constrain pegs and narrow-band pegs; greater exchange rate flexibility can help respond to strong capital inflows and discourage short-term speculative inflows.

### Key areas for further research (Section V)
- Required analyses before choosing an optimal exchange rate regime and monetary policy framework:
  - How flexible are nominal wages and relative prices, and how mobile is labor and capital geographically and occupationally?
  - How price-sensitive are Guyana’s exports and imports?
    - Annex IV (Error Correction Model) evidence: non-oil exports are sensitive to movements in relative prices in both the short-run and the long-run; coefficients on the relative price index are highly statistically significant for both long-run equilibrium levels of non-oil exports and short-run dynamics.
  - How does the monetary policy transmission mechanism work in Guyana and how effective is it?
    - How strong are links between policy rates, lending/deposit rates, monetary aggregates, and inflation?
    - How strong is exchange rate passthrough to inflation?
    - What is the extent of currency substitution?
- Policy inference:
  - Evidence of flexible nominal wages, relative prices, and mobile labor/capital would weaken the argument for moving to a more flexible exchange rate regime.
  - Evidence that non-oil exports respond to relative price movements would suggest the exchange rate could be an effective instrument for absorbing external shocks.
  - More insight into monetary transmission would inform pre-conditions, policy measures, and timing for moving to an interest-rate or monetary aggregate-based nominal anchor.

### Transitioning toward a more flexible exchange rate regime (Section VI)
- Countries have used crawling pegs and band regimes as intermediate steps toward greater exchange rate flexibility to allow markets to adjust while retaining the exchange rate as a nominal anchor.
- Country experiences (Costa Rica, Kazakhstan, Russia, Angola studied by Al-Sadiq, Bejar and Ötker (2021)) show:
  - Gradually building tools to support or manage exchange rate flexibility prepares markets for an eventual float and addresses ‘fear of floating’ concerns.
  - Supporting policies and infrastructure are important to make exit from a peg sustainable and limit exchange rate overshooting.
  - In Kazakhstan, fiscal space from abundant oil revenues and a large sovereign wealth fund helped keep the fiscal position strong and limit adjustment risks.
- Policy recommendation for Guyana:
  - If a more flexible exchange rate would best serve Guyana’s needs, consider adopting a crawling peg or exchange rate band regime as an intermediate step while developing the necessary infrastructure for a floating exchange rate regime and inflation targeting framework.

_Annex II — results of staff estimates of exchange rate passthrough to inflation in Guyana (from wpiea2022224-print-pdf)._

### Section VII: Policy Conclusions

### Section VII: Policy Conclusions

### Overall policy objective and recommendation
- Two key policy objectives: output stabilization / absorption of external shocks, and control of inflation (price stability).
- Current recommendation: maintain exchange rate stability via a de facto stabilized exchange rate arrangement for the time being; a stabilized exchange rate arrangement, either a fixed or pegged rate, crawling or within bands, appears the most suitable.
- Rationale:
  - Guyana’s projected rapid expansion of oil production and exports, with the overall fiscal and primary fiscal balances both projected in surpluses from 2025 onwards due to rising oil revenues, should provide adequate fiscal and foreign exchange buffers to sustain a stabilized exchange rate arrangement over the foreseeable future.
  - These buffers would help Guyana to absorb shocks while addressing infrastructure gaps and human development needs.
- Intermediate step: adopt a crawling peg or exchange rate band regime (a ‘soft peg’) as an intermediate step toward a floating exchange rate because necessary infrastructure to support a floating regime and inflation targeting can only be developed gradually.

### Conditions and sequencing for moving to greater flexibility
- Medium-term objective: move to a more flexible regime as domestic financial and FX markets deepen, monetary policy transmission strengthens, and an alternative nominal anchor becomes credible.
- Preconditions to support a flexible regime:
  - An alternative monetary policy framework with a credible anchor;
  - Strengthened monetary policy transmission with effective instruments;
  - Well-developed money and foreign exchange markets supported by appropriate regulations and risk management tools;
  - Well-functioning banking system;
  - Effective foreign exchange market intervention mechanisms.
- Timing considerations:
  - Shift toward flexibility should depend on the speed of progress in the areas above, given the small size of Guyana’s economy, its shallow financial markets, and a weak monetary policy transmission mechanism.
  - The very sound public finances projected support a measured approach in timing.
  - However, if domestic inflation diverges significantly from trading partners and external balances are not kept in check, there may be a case for moving more quickly to a flexible regime to avoid significant over- or under-valuation of the real exchange rate.

### Empirical findings supporting transition over time
- Non-oil exports sensitivity:
  - Empirical evidence suggests Guyana’s non-oil exports are sensitive to movements in relative prices, both in the short-run and long-run—this argues in favor of moving to a more flexible regime over the medium-term or when conditions permit.
- Competitiveness channel:
  - Cross-country evidence shows the competitiveness channel of exchange rate depreciation tends to gain traction over time and offsets negative balance sheet or financial channel effects—also favoring greater flexibility over time.
- If the economy remains heavily commodity-dependent, the argument for exchange rate flexibility would be even stronger.

### Output stabilization / absorption of external shocks — key factors and implications
- Size of the economy:
  - Small economy → argues for a fixed exchange rate, or peg to a basket of currencies.
- Nature of output shocks:
  - Staff empirical analysis (2000 to 2019) suggests aggregate supply shocks accounted for around 82 percent of the variance in output over an 18-24 month horizon.
  - Increasing dependence on oil and oil-related exports would likely make the economy more vulnerable to real / terms of trade shocks.
  - Main argument for moving towards a more flexible foreign exchange rate regime.
- Diversification of exports / output:
  - Guyana’s exports are highly concentrated: only 42 out of 218 countries have a more concentrated export structure → argument for greater flexibility.
- Openness:
  - Guyana is a small, fairly open economy. Openness could argue both for a fixed exchange rate or narrow bands due to potential trade costs of frequent adjustments, and for more flexibility because openness increases vulnerability to external shocks.
  - Overall, Guyana’s dependence on commodity exports suggests the case for a more flexible exchange rate regime is likely to predominate.
- Fiscal flexibility:
  - Projected rapid expansion of oil production and exports, with the overall fiscal and primary fiscal balances both projected to turn to surpluses from 2024 onwards as a result of rapidly rising oil revenues to the budget.
  - Guyana's abundant oil and other natural resources should provide adequate fiscal and external (FX) buffers to sustain an exchange rate peg over the foreseeable future.
- Sensitivity of exports / imports to exchange rate movements:
  - A priori, dependence on commodity exports priced in dollars suggests export earnings unlikely to be responsive to exchange rate movements and the Marshall-Lerner condition unlikely to be satisfied in the short-term unless import volumes decline.
  - Empirical staff estimates provide some evidence that non-oil exports may be sensitive to movements in relative prices, both short-run and long-run.
  - Conclusion: exchange rate instrument unlikely to be an effective short-run shock absorber, but effectiveness likely higher over the medium to long term.

### Price stability / choice of nominal anchor — key factors and implications
- Financial market development:
  - Guyana has a small and relatively underdeveloped domestic financial market, with a financial development index of 0.162 in 2018 compared with an average of 0.324 for the 176 countries in the sample.
  - Implication: allow limited movements of the exchange rate in the short run; transition to a more flexible regime should be gradual as financial markets and regulatory systems develop.
- Strength of monetary policy transmission:
  - Preliminary VAR results suggest the monetary policy transmission mechanism in Guyana needs significant strengthening if an alternative nominal anchor to the exchange rate is to be adopted—links between interest rates, monetary aggregates, and inflation appear weak at present.
  - Adopting an alternative nominal anchor would require developing deep, liquid and efficient financial and FX markets, strengthening the monetary policy transmission mechanism, and systems to monitor, assess, regulate, and manage FX exposures and related risks.
- Exchange rate pass-through to inflation:
  - Staff estimates using a VECM model suggest the exchange rate pass-through to inflation is relatively modest, at around 0.25-0.30 over 24-30 months.
  - Not a major constraint because evidence from other countries suggests passthrough can fall over time as the interest channel strengthens and inflation expectations become better anchored.
- Currency / asset substitution:
  - High degree of currency substitution / dollarization strengthens the case for a fixed exchange rate because it makes money supply control harder and exchange rate more volatile and sensitive to credibility issues.
  - Staff estimation of money demand functions provide no evidence that (expected) exchange rate movements have any impact on the demand for broad money.
  - Note: currency substitution can drop significantly over time if the central bank increases credibility and anchors inflation expectations.

### Annex I — Structural VAR findings (technical summary)
- Model: three-equation structural VAR for real output (y), CPI inflation (inf), and real money balances (m-cpi-y) with identification of aggregate supply (AS), goods market (IS), and money demand (MD) shocks.
- Data and unit roots:
  - Sample period: 1998Q1 to 2021Q4.
  - Tests indicate y, cpi, and m-cpi-y are I(1); Johansen tests suggest m – cpi is not co-integrated with y; m-cpi-y appears to be I(1) while ∆(m-cpi-y) is stationary.
- Identifying long-run restrictions:
  - No long-run effect of aggregate demand (IS) shocks on output;
  - No long-run effect of money demand (MD) shocks on output;
  - No long-run effect of aggregate demand (IS) shocks on velocity (money balances as proportion of nominal GDP).
- Variance decomposition results (Table A1):
  - Aggregate supply shocks account for around 82 percent of the forecast error variance in output over a 18–24 month horizon.
  - This proportion is likely to grow over time as the share of oil in the economy increases.
- Impulse responses: accumulated impulse response functions plot cumulative responses of real GDP growth to one standard deviation perturbations of the three structural shocks.

### Annex II — Exchange rate pass-through to CPI inflation (technical summary)
- ARDL results:
  - Bivariate ARDL using monthly data suggests exchange rate pass-through coefficient increased from about -0.40 over 1995M1-2021M9 to about -0.55 over 2009M1-2021M9.
  - The latter period estimate (-0.55) is above the regional average of -0.38 for Central America and the Caribbean for the same period.
  - ARDL may be subject to omitted variable bias because it does not model monetary policy reactions.
- VECM results:
  - VECM ordering: LNNEER LNCBPrate1 LNBASEMNY LNCPI; period covered 2009M1 to 2021M4 (148 monthly observations); lag length = two.
  - A 1 percent appreciation of the NEER has a cumulative (negative) impact on the CPI price level of around 0.24 percentage points after 12 months.
  - Long-run exchange rate pass-through coefficient to CPI inflation is around -0.24.
- Unit root and variable definitions used:
  - LNCPI – log of the CPI index;
  - LNNEER – log of the nominal effective exchange rate, period average;
  - LNBASEMNY – log of broad money;
  - LNCBPrate1 – log of (1 + the Central Bank Policy Rate (discount rate)).

*Source: IMF Staff, Section VII: Policy Conclusions, wpiea2022224-print-pdf.*

### Annex III. Evidence for Currency Substitution in

### Annex III. Evidence for Currency Substitution in Guyana

### Data and model specification
- Sample: quarterly data over the period 2000: QI—2021: Q4.
- Data sources: Bank of Guyana, Haver Analytics, IFS Statistics; quarterly GDP interpolated from annual data using the Denton methodology.
- Dependent variable:
  - LNM2 = (Log of) M2 divided by the CPI index for Guyana
- Main explanatory variables:
  - LNRGDP = (Log of) real GDP (quarterly interpolations from annual data using the Denton methodology)
  - LN3MNTBILLRATE = (Log of) the three-month Guyana Treasury Bill rate
  - INFDIFF = Current period inflation differential between Guyana and the United States – proxy for expected depreciation of the Guyana dollar
  - LNROR6 = (Log of) the three-month US Deposit Rate + INFDIFF (proxy for expected rate of return on foreign financial assets)
  - LNROR8 = (Log of) the three-month US Treasury Bill rate + INFDIFF (alternative proxy)
  - S1, S2, S3 = Seasonal quarterly dummies
- Estimation approach:
  - Unit-root testing (Phillips-Perron and Augmented Dickey Fuller) and cointegration testing (Johansen maximum eigenvalue and trace tests, ARDL Bounds tests).
  - Given lack of cointegration among the I(1) variables, an Auto-Regressive Distributed Lag (ARDL) model with stationary variables was estimated.
  - Dependent variable in ARDL: D(LNM2) — the first difference of real money.
  - Explanatory variables in ARDL included: D(LNRGDP), D(LN3MNTBILLRATE), INFDIFF, LNROR6 / LNROR8, and seasonal dummies.

### Unit-root and cointegration findings
- Phillips-Perron test results (at the five percent significance level):
  - LNM2, LNRGDP, and LN3MNTNBILLRATE are nonstationary, i.e., 1(1).
  - INFDIFF, LNROR6, and LNROR8 are stationary, i.e., I(0). (Note: Augmented Dickey Fuller tests suggest LNROR6 and LNROR8 may be nonstationary.)
- Johansen maximum eigenvalue and trace tests indicate:
  - The I(1) variables LNM2, LNRGDP, and LN3MNTBILLRATE are not co-integrated.
- ARDL Bounds tests:
  - Also provide no evidence of co-integration among the I(1) variables.
- (Unit root and cointegration test outputs are available from the author on request.)

### ARDL model purpose and identification
- The ARDL specification was used to test whether expected depreciation affects money demand:
  - Directly through INFDIFF (evidence of currency substitution).
  - Indirectly through LNROR6 / LNROR8 (evidence of capital mobility or asset substitution).
- The model allows for either positive or negative effects of expected exchange rate movements on money demand, reflecting potential wealth effects versus substitution effects.

### Empirical results
- Main empirical outcome:
  - The ARDL estimates (reported for specifications using LNROR6 in Table A4 and LNROR8 in Table A5) provide no evidence for either currency substitution or asset substitution in Guyana.
- Model diagnostics:
  - CUSUM and CUSUMSQ plots applied to the ARDL model with LNROR6 indicate no evidence of significant structural instability over the estimation period.
  - Goodness-of-fit measures (R-squared and adjusted R-squared) are described as reasonable, particularly given that the dependent variable is in first differences.
- Robustness:
  - Replacing LNROR6 with LNROR8 yields very similar results and similar goodness-of-fit measures.

### Interpretation and caveats
- The model estimates do not provide empirical support for presence of currency substitution or asset substitution in Guyana.
- Important caveat (citing literature):
  - Following Cuddington (1983) and Savastano (1990), inclusion of the expected rate of depreciation in a money-demand equation does not generally suffice to distinguish currency or asset substitution from either imperfect capital mobility or a high elasticity of demand for substitutes to domestic money.
- Implication:
  - Results should be interpreted with caution; absence of evidence in this specification is not definitive proof of absence of currency or asset substitution under all circumstances.

*Source: Annex III. Evidence for Currency Substitution in Guyana — Managing Guyana’s Oil Wealth: Monetary and Exchange Rate Policy Considerations, Working Paper No. WP/2022/224*

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_Source: https://www.imf.org/-/media/files/publications/wp/2022/english/wpiea2022224-print-pdf.pdf_