Guyana: Upgrade from 6/7 to 5/7 for medium-to long-term/short-term political risk
Guyana embarked on a remarkable transformation thanks to oil exploration
Guyana embarked on an impressive economic transformation as oil discoveries are being exploited and exported since the end of 2019. Firstly, the world’s newest oil producer was the fastest-growing economy in 2020 posting an eye-popping 43.4% real GDP growth rate in 2020, despite the relatively low oil prices and the Covid-19 pandemic. With crude oil production projected to increase by more than sixfold by 2026, Guyana’s economic transformation has only just begun. High real GDP growth is expected in the coming years before falling to 3% in 2024 (see graph 1). Moreover, the IMF expects Guyana’s nominal GDP level (in USD) to double by 2025 compared to 2020, an impressive growth forecast. On top of that, the economic growth expectations might be revised upwards as of 2024 if other oil discoveries come on stream. Secondly, oil exports also led to an improvement of the current account balance to -14% of GDP, coming from -34% of GDP in 2019 (see graph 1). Indeed, oil exports have been a major source of export revenues for Guyana as of 2020, complementing the historical sources of current account revenues: gold, rice, sugar and bauxite. Oil might even take over gold (accounting for about 40% of current account revenues in 2019) as the dominant source of export revenues in the near future. Oil exports are expected to increase current account revenues and sharply narrow the current account deficit further in the coming years. That said, the large-scale imports of equipment for oil extraction will continue to weigh on the current account balance, leading to a relatively gradual improvement of the current account balance. The current account deficit is nevertheless easily financed by large FDI. Thirdly, debt-to-GDP and debt-to-current account revenue ratios are expected to improve thanks to oil exploitation and exports. External debt stood at a moderate level of about 33% of GDP at the end of 2019, and is likely to decrease in the coming years. This is a turnaround for the small economy compared to 2003. Back then, external debt was at a high 97% of GDP before the country reached the completion point under the HIPC initiative and hence benefited from debt relief. Also external debt service – already low as a large part of external debt has been granted on concessional terms – is expected to decrease in the coming years due to the oil boom. Notwithstanding, Guyana may lose access to concessional financing in the future as it develops. Therefore, Guyana is expected to be more dependent on financial markets in the coming years with the risks associated to it. Hence, as the macroeconomic fundamentals of Guyana quickly improved since oil exports came on stream, Credendo decided to upgrade the MLT political risk from category 6/7 to 5/7.
A resource curse looms but a Sovereign Wealth Fund might help to avoid it
Despite the spectacular economic growth numbers, the non-oil sector suffered in 2020, driven particularly by a large decrease in service-sector activities and work stoppages at gold and bauxite mining operations. As vaccination goes slowly and the whole population might never even get vaccinated (a possibility in many emerging countries), the services sector is expected to continue to suffer in the coming years due to social distancing measures. Given the large windfall of oil revenues, especially in a difficult business environment created by the Covid-19 pandemic, the country will have to be very cautious not to fall in the resource curse and overly depend on only the oil sector. The resource curse has indeed been witnessed in many countries after a natural resource discovery. The exploration of the commodity can lead to higher corruption, less democracy, lower saving rates, poor management of the public finances, poor MLT economic growth performance, more (violent) unrest, excessive currency appreciation eroding the competitiveness of other sectors (called ‘the Dutch disease’) and highly volatile current account revenues.
So far, all of Guyana’s oil revenues are being held in a Sovereign Wealth Fund (SWF) – Guyana’s Natural Resources Fund – established in 2020, which is a cash deposit banked at the Federal Reserve Bank of New York. The SWF has seen a sharp rise in assets and as of March 2021, a total of USD 267 million has been deposited (3% of GDP). In order to avoid a resource curse, sound management of the Natural Resources Fund will be critical. Nonetheless, to date the government has yet to establish an investment mandate for the intended use of the oil revenue. Interestingly, the current set-up of the oil revenues means Guyana’s oil earnings do not directly feed into government revenues or circulate throughout the domestic economy. Though public finances are currently healthy (see graph 2), projected fiscal deficits and in addition large infrastructure plans might tempt the government to set up an arrangement in which it can use (a part) of the oil revenues directly in the future.
Short-term political risk rating might see a further upgrade in the future
Foreign exchange reserves have been gradually improving in the past year while short-term external debt remains at a low level, explaining the recent upgrade of the short-term political risk rating to category 4/7. Yet, foreign exchange reserves stand at a rather low level, especially since the country has a managed a floating exchange rate against the USD. Looking forward, the dramatic rise in oil exports can bring significant appreciation pressure on the Guyanese dollar. Nonetheless, the central bank is likely to intervene as excessive appreciation can erode the competitiveness of non-oil sectors. As a result, nominal foreign exchange reserves are likely to increase in the coming years, putting upward pressure on the short-term political risk rating.
Guyana faces domestic ethnic tensions and external strains with neighbouring Venezuela
Guyana experiences both domestic and external tensions, explaining the moderate political violence risk rating in category 4/7. On the one hand, Venezuela has a longstanding claim on two-thirds of Guyanese land and maritime territory (also where the discovered oil lies) even though the current border was mutually agreed on in 1899. Venezuelan president Maduro has recently caused an increase in tensions by detaining fishing boats in claimed waters. More incidents of this nature are in the cards. Indeed, Maduro is likely to make more (vocal) claims on Guyana in the coming months in order to evade critics on Venezuela’s faltering economy. The border dispute is currently with the International Court of Justice but it could take several years before a final ruling is issued. Yet, despite those recent tensions, an armed conflict remains unlikely. Venezuela’s deteriorating economy makes military intervention highly unlikely while US support (both diplomatic and military through joint maritime security exercises) for Guyana’s stance further minimises the risk. On the other hand, racial division exists in the country between the Afro-Guyanese community (29% of the population) and Indo-Guyanese community (39%). Nonetheless, although the last presidential elections were heavily challenged, the political transition was rather peaceful.
Analyst: Jolyn Debuysscher – J.Debuysscher@credendo.com