Guinea: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
25 Jan 2006
eISBN:
9781451815276
Language:
English
Keywords:
ISCR; CR; exchange rate; market; auction mechanism; flexible exchange rate regime; nonbank foreign exchange bureau; trade partner; nominal exchange rate; Currency markets; Exchange rates
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This Selected Issues paper examines the sources of real growth in Guinea. It identifies and quantifies the impact on real GDP growth of both the exogenous shocks and the policy changes that have occurred since 2000. The paper offers, first, some empirical evidence on real GDP growth in Guinea and then analyzes the sources of growth using the standard framework of growth accounting. The paper also analyzes and quantifies the effect that some exogenous shocks and policy changes have had on growth.

Abstract

This Selected Issues paper examines the sources of real growth in Guinea. It identifies and quantifies the impact on real GDP growth of both the exogenous shocks and the policy changes that have occurred since 2000. The paper offers, first, some empirical evidence on real GDP growth in Guinea and then analyzes the sources of growth using the standard framework of growth accounting. The paper also analyzes and quantifies the effect that some exogenous shocks and policy changes have had on growth.

III. Competitiveness and Equilibrium Exchange Rate in Guinea17

A. Introduction

54. The Guinean franc has continuously depreciated in real terms since 1989. By the end of 2004, it had lost about 40 percent of its value in real terms.18 In March 2005, the Guinean authorities adopted a flexible exchange rate regime by ending the official auctions (which had become a vehicle for administrating the rate) and allowing banks and authorized exchange bureaus to buy and sell foreign exchange at the market rate. Since then, the Guinean franc has lost about one–third of its nominal value and has depreciated by about 12 percent in real terms. The cumulative depreciation of the real effective exchange rate from January 1990 to July 2005 now amounts to 51 percent. A depreciation of this magnitude raises the question as to what extent it can be considered as an equilibrium phenomenon and how far it has affected the competitiveness of the Guinean economy. In this paper, we address these questions by estimating an equilibrium path for Guinea's real effective exchange rate between 1975 and 2004 to assess the extent of real exchange rate misalignment. We then review developments in other available indicators of external competitiveness.

55. The outline of the remainder of this paper is as follows. Section B provides a brief presentation of the evolution of Guinea's exchange rate regime. Section C investigates the presence of a long–run cointegration relationship between the real exchange rate and certain explanatory variables and estimates the extent to which the real exchange rate has diverged from its equilibrium level since the 1980s. Section D examines developments in key indicators of external competitiveness other than the real effective exchange rate. Section E concludes the paper.

B. Background and Recent Developments

Developments in the foreign exchange rate regime

56. After achieving independence, Guinea adopted its own currency, the Guinean Syli (GS). The Syli was pegged to the SDR on June 11, 1975 at the rate of GS 24.68 per SDR. The currency became increasingly overvalued, and, by mid–1985, its rate exceeded GS 280 per SDR in the parallel market. With a view to attracting foreign exchange to official channels, the government created a second market for foreign exchange in October 1985. This market was limited to sales to the banking system of foreign exchange originating from capital inflows and nonmining current account receipts. In early January 1986, the Syli was replaced by the Guinean franc (GF) at GF 300 per U.S. dollar in the official market and GF 340 per U.S. dollar in the second market, in which the exchange rate was set at weekly auctions for foreign exchange organized by the central bank.

57. In October 1994, the authorities adopted a flexible exchange rate regime and introduced an interbank market for foreign exchange. The official exchange rate (also called the reference rate) was calculated daily as a weighted average of exchange rates quoted by banks. The introduction of this market was preceded by a series of reforms in the foreign exchange system, including a liberalization of activities of foreign exchange bureaus in 1993, the liberalization of payments and transfers for current transactions, and the possibility for residents to open bank accounts in foreign currency. The foreign exchange bureaus were not allowed to participate in the interbank market. The central bank had indicated that it would intervene in the market only to smooth short–term fluctuations and to meet its net foreign asset objectives.19

58. As described in IMF staff reports published after 1994, the interbank foreign exchange market did not function as intended. Under the apparent influence of the central bank in resisting the depreciation of the exchange rate, commercial banks failed to let the exchange rate reflect market forces. The gap between the interbank market rate and the parallel market rate averaged about 6 percent during 1995–99. The foreign exchange auction system was reestablished in late 1999.

59. During 2000–02, the shortage of foreign exchange in the official market forced the central bank to move from weekly to monthly auctions in an effort to increase the volume offered at each auction. The depreciation of the official rate was moderate throughout the period (10 percent from January 2000 to December 2002). In addition, the rate of dispersion of the bid prices, as well as the gap between the maximum and the minimum price bid, fell continuously over the period, indicating that bidding was not purely competitive and that the bidders seemed to have knowledge about the outcome. However, the spread between the official (bank) and parallel (nonbank) exchange rates remained low, at about 1.5 percent on average, during the period.

60. Between late 2002 and mid–July 2004, the authorities pegged the official exchange rate against the U.S. dollar and increasingly used the auction mechanism as an administrative vehicle to allocate foreign exchange.20 As Guinea's macroeconomic situation deteriorated, the spread between the parallel and official rates gradually widened from about 2 percent at end–2002 to about 20 percent by late 2003. The official auction of foreign exchange was suspended from November 2003 to July 2004, and commercial banks resorted to providing limited amounts of foreign exchange to some of their privileged clients. The excess demand spilled over into the nonbank market, and, because of the continued deterioration of the macroeconomic situation, the spread between the official and parallel rates widened further to about 35 percent by mid July 2004.

61. To make the exchange rate flexible and ease the pressure on its foreign reserves, the central bank reintroduced the exchange auction market mechanism in mid–July 2004, widened participation in the market to include exchange bureaus, and increased the frequency of the auction to weekly sessions. However, the amounts offered were relatively small (about US$500,000 to banks and US$30,000 to exchange bureaus). The official rate was devalued by 27 percent during the third quarter of 2004 and by a further 10 percent in early 2005. The free market premium narrowed to less than 15 percent at the end of July 2004, then rose significantly after the central bank further restricted access to the official exchange market, advising private sector operators, in writing, to seek foreign exchange in the nonbank market. Despite the devaluation of the official exchange rate, the market premium averaged 25 between August 2004 and February 2005.

62. On March 1, 2005, the central bank abandoned the official foreign exchange auction mechanism and liberalized the foreign exchange market. Since then, the official exchange rate has been determined weekly by a reference rate calculated as an arithmetic average of rates quoted by deposit banks and authorized nonbank foreign exchange bureaus. The central bank has not intervened in the market so far. By end–September 2005, the reference rate had depreciated in foreign currency terms by about 35 percent against the U.S. dollar, compared with the official exchange rate from the last foreign exchange auction at end–February 2005. The pace of depreciation was rapid during the first four months following the adoption of the new foreign exchange regime, mostly resulting from pent–up demand for foreign currency assets and delays in implementing measures to ensure the efficient operation of the foreign exchange market. The depreciation has slowed since mid–July, indicating that the pent–up demand for foreign currency assets has now largely been satisfied.

Developments in the real effective exchange rate

63. Three phases can be distinguished in the evolution of the real effective exchange rate since 1980 (see Figure III. 1).

  • During 1980–89, there was a strong and sustained appreciation of the real effective exchange rate, based on the official exchange rate. This appreciation is explained by the low and fixed nominal exchange rate, at a time when most of Guinea's trade partners had adopted flexible exchange rate regimes, and by Guinea's low inflation rates, generated by administered prices for most consumption goods and services.

  • During 1990–97, the real effective exchange rate depreciated slowly but continuously as the authorities loosened price controls and later adopted modest flexibility of the nominal exchange rate. The slow real depreciation during that period is also explained by the government's efforts to maintain macroeconomic stability and improve the efficiency of the economy by implementing key structural reforms.21

  • From 1998 to 2004, the Guinean franc depreciated by about 28 percent in real terms, following a depreciation of about 48 percent in nominal (effective) terms and an increase of about 40 percent in the relative price index.22 The deterioration in some fundamentals, particularly the terms of trade and capital inflows, the slowdown in the implementation of key structural reforms, and increasing financial imbalances could have contributed to the strong real depreciation during that period.

Figure III. 1.
Figure III. 1.

Real Effective Exchange Rate, 1975–2004

(Index, 2000 = 100)

Citation: IMF Staff Country Reports 2006, 025; 10.5089/9781451815276.002.A003

Sources: IMF staff estimates.

C. Estimating the Long–Run Equilibrium Exchange Rate

64. This section applies the fundamental equilibrium exchange rate (FEER) approach based on the Edwards (1989) model and the Johansen (1995) cointegration methodology to assess the long–run equilibrium level of Guinea's real exchange rate.23 We first briefly present the methodology underlying the FEER approach and then estimate the long–run relationship between the REER and its fundamentals using the cointegration technique. Subsequently, we calculate the path of equilibrium real effective exchange rate (EREER) using the estimated parameters and nontransitory components of the determining fundamentals. The different steps followed by the FEER approach are presented in Appendix I.

The empirical model

65. Following Edwards (1989) and many other studies on developing countries, we include the following variables as the fundamentals underlying the equilibrium real exchange rate: the terms of trade, government current expenditure, total investment, technological progress, and capital inflows. This set of fundamentals was also dictated by the availability of data and by stationarity constraints (see below). The postulated general relationship between the effective exchange rate and the fundamentals is defined as follows:

ln(REERt)=β0+β1ln(TOTt)+β2ln(CGRt)+β3ln(INVt)+β4ln(PRODt)+β5(CAPFt)+et,(1)
A03lev3sec3

where ln denotes the natural logarithm; REER the CPI–based real effective exchange rate;24 TOT merchandise terms of trade; CGR Government current expenditure as a share of GDP; INV total investment as a share of GDP; PROD technological progress index; and CAPF capital flows.

The following are the expected signs of the fundamentals:

  • Merchandise terms of trade, defined as the ratio of the world price of Guinea's exports to the world price of its imports. The expected sign is positive. The terms of trade affect the REER through the wealth effect, with a positive terms of trade shock inducing an increase in the domestic demand and, hence, an increase in the relative price of the domestic economy compared with foreign countries, which results in an appreciation of the REER.25

  • Government current expenditure as a share of GDP. The expected sign is generally ambiguous, because an increase in government spending has to be financed through higher taxes, which would offset the effect on real appreciation through a decline in disposable income. If the increase in government spending were instead financed through money creation, then it would result in an appreciation of the real exchange rate. The outcome may also depend, however, on whether government spending is primarily directed toward nontradable or tradable goods.

  • Investment as a share of GDP. The expected sign is positive. An increase in the investment share of GDP is likely to exert a pure spending effect that raises the demand for all goods and appreciates the real exchange rate.

  • Technological progress. This captures the Balassa–Samuelson effect, according to which productivity improvements will generally be concentrated in the tradables sector and an increase in productivity in a reference economy relative to a foreign country will raise the relative price of nontradables to that of tradables in the reference economy and, hence, cause the REER to appreciate. As in other studies (see, for example, MacDonald and Ricci, 2003; and Aguirre and Calderon, 2005), we use the ratio of GDP per capita in Guinea to the trade weighted average of GDP per capita of Guinea's trade partners. The expected sign is negative, because declining relative output per capita would depress domestic relative to foreign prices.

  • Capital flows. The expected sign is positive. An increase in the capital inflows results in an increase of domestic aggregate demand and, hence, an appreciation of the REER.

Empirical results

66. To estimate equation (1), we must first pay attention to the time–series properties of the individual variables before we estimate the long–run relationship. Since fundamentals are defined as variables that affect the real effective exchange in the long run, they should have the same order of integration as the real effective exchange rate. If the real exchange rate is nonstationary, then any stationary variable cannot be a fundamental. This is because any variable that stochastically drifts permanently away from its mean cannot be affected in the long run by a variable that reverts to its mean.

67.Table III.1 (Appendix III) provides unit root tests for the fundamental variables using augmented Dickey–Fuller (ADF) statistics. The results show that all the variables are integrated at level 1 and are stationary in the first differences, suggesting that it is legitimate to search for a cointegration relationship among these variables. The determination of the level of integration has to be treated with caution, however, because the ADF test has less power in short time series.

68. The estimation results are presented inTable III.2 (Appendix III). The top panel of the table shows the long–run parameters (the β's) together with their standard errors, and the bottom panel provides the feedback coefficient estimates (the α's). The estimated coefficients represent elasticities in the case of terms of trade, government current expenditure, investment, and technological progress and semi–elasticities in the case of capital flows. The coefficients are significant for the terms of trade, government current spending, and capital inflows. The coefficient for total investment and technological progress is not different from zero at the percent significance level, as attested by their chi–square. The results of the cointegration tests are shown in Table III.3 and 4 ( Appendix III). The outcome of the diagnostic tests indicates that only the ARCH test rejects the null hypothesis. The trace statistic points to a single cointegrating vector.

The long–run relationship between the real effective exchange rate and the fundamental variables is represented by the following equation:

ln(REERt)=0.966ln(TOTt)-0.719ln(CGRt)-0.117ln(INVt)-0.277ln(PRODt)+0.043(CAPFt).(2)
A03lev3sec4

  • The terms of trade are positively correlated with the REER, indicating that an improvement in the terms of trade would result in an appreciation of the long–run equilibrium real exchange rate through a possible wealth effect;

  • Government current spending has an unexpected negative (depreciating) impact on the real effective exchange rate, which could be an indication that government spending in Guinea did not have a lasting positive impact on domestic prices.

  • Investment is also negatively correlated with the REER. The effect is not, however, significantly different from zero.

  • The long–term negative impact of technological progress confirms that Guinea's declining output per capita relative to its trade partners would depreciate the real exchange rate. The effect is not, however, significantly different from zero.

  • As predicted, capital inflows have a small yet statistically significant positive impact on the REER.

69. The magnitude of the estimated elasticities for the terms of trade and government current expenditure is striking. A 10 percent improvement in the terms of trade would appreciate the real exchange rate by about 10 percent, and an increase of 10 percent in government current spending would depreciate the REER by 7 percent. For the six member countries of the Economic and Monetary Community of Central Africa (CEMAC), Tsangarides (2005) found an elasticity of 2.27 for the terms of trade and -0.44 for government consumption. However, the magnitude of each coefficient may strongly depend on the characteristics of each economy, as well as on the quality and length of the data series.

70. The bottom panel of Table III. 2(Appendix III) shows the feedback coefficients for the cointegrating vector, or the short–run relationship of the EREER and its fundamentals. The coefficient for D[ln(REER)] is positive, suggesting that, in the face of any deviation from the long–run equilibrium, the fundamentals do not jointly move the system back to equilibrium. The coefficients for CGR and CAPF are insignificantly different from zero, which could indicate that these fundamentals are not weakly exogenous with respect to the parameters of the cointegrating relationship.

71. The long–run relationship obtained by estimating the equation of the REER with its fundamentals above permits the calculation of EREER, defined as the level of the REER that is consistent in the long run with the equilibrium values of the explanatory variables. Based on the long–term coefficients obtained from the cointegration analysis, the series of EREER is computed using the long–term components of the fundamentals. These components are estimated by using a simple five–year moving average, which is the simplest smoothing method that is generally used in the literature.26

72.Figure III.2 shows that Guinea's REER went through a period of overvaluation in the early 1980s, with the actual REER exceeding its equilibrium level. After the introduction of a new currency in January 1986, accompanied by the adoption of a more flexible exchange rate system, the real exchange rate remained close to its estimated equilibrium level until about 1997. Since then, the gap between the actual REER and its equilibrium level has slowly widened. These last episodes coincided with lax fiscal and monetary policies, increased political uncertainty, and sluggish implementation of structural reforms.27 An interesting further step to this study would be to examine how fiscal and monetary shocks, as well as short–term deviations of fundamentals from their equilibrium levels, affect the level of real exchange misalignment.

Figure III.2.
Figure III.2.

Guinea: Actual and Equilibrium Exchange Rate, 1980–2004

Citation: IMF Staff Country Reports 2006, 025; 10.5089/9781451815276.002.A003

Sources: IMF staff estimates.

73. It is important to interpret these results with caution. Although the econometric results seem statistically significant, the derivation of the equilibrium real exchange rate ultimately depends on the assumptions underlying the calculation of the equilibrium values of the fundamentals. In an economy like Guinea's, with data deficiencies and without long time series, the values of the parameters may not capture the true nature of the relationship the model is intended to represent.

D. Alternative Indicators of Guinea’s External Competitiveness.

74. The real depreciation of a currency is often associated with an increase in an economy's external competitiveness. If the association were valid, the gradual depreciation of the Guinean franc in real terms over the past fifteen years would have generated an improvement in Guinea's export performance. The facts contradict, however, the theoretically predicted outcome: Guinea's export performance in the past several years has been weak in two particular aspects. First, Guinea's exports–to–GDP ratio averaged about 24 percent during 1994–2004, a level well below the country's past performance and the average for sub–Saharan Africa and most of Guinea's neighbors from the West African Economic and Monetary Union ( Table III.6, Appendix III). Second, Guinea's efforts to diversify its export base have had only limited success, and Guinea continues to depend heavily on three mining products: bauxite, alumina, and gold ( Table III.7, Appendix III). The estimated equilibrium exchange rate is one indicator that shows that relying on the evolution of the REER in assessing that of external competitiveness would be misleading. This section looks at other competitiveness indicators that could help explain Guinea's disappointing export performance, particularly the evolution of relative prices between tradables and nontradables and survey–based indicators of the business environment and governance.28

Developments in the internal real exchange rate

75. Most economists working on developing countries consider that the internal real exchange rate, defined as the ratio of the domestic prices of nontradable to tradable goods, is a more appropriate measure of competitiveness because it is the key relative price influencing resource allocation, and thus production, consumption, and ultimately external balance. Although the theoretical concept of the internal real exchange rate is reasonably straightforward, its empirical measurement raises the difficult practical problem of finding operational counterparts for the required price indices of tradable and nontradable goods. As a result, the literature uses a variety of approximations. In this paper, we depart from the two-good framework of the Swam–Salter “dependent economy” model by dividing the economy into three goods: exports, imports, and domestic goods. We consider that a two–good framework would be less appropriate for the following two reasons. First, the two–good framework aggregates imports and exports into one composite tradable good and assumes implicitly that the relative prices of imports and exports (terms of trade) are fixed. Guinea's experience proves that fluctuations of the terms of trade are so important that they cannot be ignored. Second, the aggregation of exports and imports in one composite tradable sector would generate a price index that is not directly related to standard national accounts price indices for either production or expenditure and does not then reflect the incentives generated by a change in internal real exchange rate either on the supply side or on the demand side of the economy.

76. The three–good framework produces two internal real exchange rate measures corresponding to the relative prices of exports and imports in terms of nontraded goods:

IRERx═ Pd / Px

and

IRERm═ Pd / Pm,

where Pd is the price of the domestic goods, and Px and Pm are the domestic prices of exported goods and imported goods (measured in domestic currency terms), respectively. A small open economy can still influence Px and Pm through trade taxes and similar policies. IRERx could be considered an indicator of the internal price competitiveness of exportables in production relative to domestically produced and consumed goods. It is a measure of the incentives guiding resource allocation between the domestic sectors producing these two categories of goods. A decrease in IRERx would indicate a gain in competitiveness for the exportable sector. Similarly, IRERm is an indicator of the internal price competitiveness of domestic goods relative to importables (or imported goods). The derivation of the proxies used in estimating these two internal real exchange rates is explained in Appendix II.

77. Figure III.3 compares the evolution of the three categories of real exchange rates. Two observations can be drawn from the figure. First, as expected, the three categories of real exchange rate have generally moved in the same direction. However, the two internal real exchange rates have been more volatile than the external real exchange rate. Moreover, the relative price of exportables has been even more volatile than the relative price of importables, because of the much greater cyclical variations in export prices. This higher volatility increases uncertainty, which is not captured by the real effective exchange rate and is detrimental to the export sector. Second, the relative price of exports in 2004 is almost at its 1990 level, while that of imports (or import–competing sector) has improved by almost 30 percent. This effect is also not reflected in the external real exchange rate.29

Figure III.3.
Figure III.3.

Guinea: Internal and External Real Exchange Rate, 1986– 2004 (1990 ═ 100)

Citation: IMF Staff Country Reports 2006, 025; 10.5089/9781451815276.002.A003

Sources: IMF staff estimates.

Survey–based indicators of the business environment and governance

78. Two broad surveys with information on Guinea are available on the World Bank web site. The first one is the Doing Business survey, which covers 186 countries. The second one is the worldwide survey on governance, which produces worldwide governance indicators (see Kaufmann, Kraay, and Mastruzzi, 2005) and covers 199 countries.

79. Results of the Doing Business survey for Guinea point to key structural impediments to developing a competitive private sector. On 5 of the 10 indicators, Guinea ranks in the lowest 30 percent of all 186 countries ranked (Figure III.4). It performs particularly low on the cost of starting a business, obtaining licenses, getting credit, and paying taxes. Guinea also performs also below the average for sub–Saharan Africa on 13 of the 39 subindicators ( Table III.5, Appendix III). In particular, the minimum capital required to start a business, the number of steps and days involved in obtaining a license, the cost to register a property, and the number of years required to resolve bankruptcies are higher than the average in sub–Saharan Africa.

Figure III.4.
Figure III.4.

Guinea’s Rank on Indicators of Business Environment, 2004–05

(Percentile rank, based on 186 countries)

Citation: IMF Staff Country Reports 2006, 025; 10.5089/9781451815276.002.A003

Source: World Bank, Doing Business Project, 2005.

80. Most of the indicators for governance in Guinea have also not significantly improved over the past eight years and some have even deteriorated (Figure III.5). These indicators include government effectiveness, regulatory quality, rule of law, and control of corruption. The government effectiveness indicator combines information on the quality of public service provision, the quality of the bureaucracy, the competence of civil servants, the independence of the civil service from political pressures, and the credibility of the government's commitment to policies. Regulatory quality includes measures of the incidence of market–unfriendly policies, such as price controls or inadequate bank supervision, as well as perceptions of the burdens imposed by excessive regulation in areas such as foreign trade and business development. Rule of law includes measures of perceptions of the incidence of crime, the effectiveness and predictability of the judiciary, and the enforceability of contracts. Control of corruption includes perceptions of corruption defined as the exercise of public power for private gain. Guinea also ranks below average on important dimensions of governance compared to other sub–Saharan African countries (Figure III.6).

Figure III.5.
Figure III.5.

Guinea: Evolution of Governance Indicators, 1996–2004 (Scale:-2.5 to 2.5)

Citation: IMF Staff Country Reports 2006, 025; 10.5089/9781451815276.002.A003

Source: Kaufmann, D., A., Kraay, and M. Mastruzzi, 2005,."Government Matters IV: Governance Indicators for 1996–2004"
Figure III.6.
Figure III.6.

Governance Indicators, Comparison of Guinea with Sub–Saharan Africa

(Percentile rank, 2004)

Citation: IMF Staff Country Reports 2006, 025; 10.5089/9781451815276.002.A003

Source: Kaufmann, D., A., Kraay, and M. Mastruzzi, 2005,.“Governance Matters IV: Governance Indicators for 1996 – 2004”

E. Conclusion

81. This paper shows that there has been an important loss of external competitiveness in Guinea in the last few years, based on several indicators,. First, the analysis based on the estimated equilibrium real exchange rate suggests that, while the REER depreciated continuously after 1989, it has become overvalued over the past six years. Second, the assessment of internal real exchange rate indicators shows that the relative price of exportable to domestic goods has been very volatile and has resulted in a loss of competitiveness for the exportable sector. Third, the examination of survey–based indicators concludes also that the loss of external competitiveness has been compounded by many other structural features that are detrimental to an export–oriented development strategy.

82. Strengthening the competitiveness of the external sector should continue to be one of the key objectives of the Guinean authorities’ medium–term program. To this end, they should place emphasis on accelerating ongoing structural reforms aimed at improving the quality and availability of public services, strengthening the judicial framework and governance in the public sector in general and in the mining sector in particular, and reducing the active presence of the public sector in productive activities. By reducing factor costs, boosting labor productivity, and improving the quality of business environment and infrastructure, these reforms would create the conditions for an increase in domestic and foreign private investment in the export–oriented sectors.

83. Regarding exchange rate policy, the decision made by the authorities on March 1, 2005, to abandon the foreign exchange auction and liberalize the foreign exchange operations goes in the right direction of closing the gap between the actual and the equilibrium real exchange rates. The nominal exchange rate of the Guinean franc vis–à–vis the U.S. dollar has depreciated by about 35 percent in foreign currency terms since end–February 2005, and the cumulative depreciation of the real effective exchange rate over the first eight months of 2005 amounted to 18 percent. The challenges for the authorities remain to create a liquid and efficient foreign exchange market, notably by (i) increasing information flows in the market on foreign exchange data,(ii) implementing a comprehensive surveillance of market transactions to ascertain the underlying sources and directions of foreign exchange flows,(iii) eliminating regulations that stifle market activity, and (iv) reducing barriers that may exist between and within the different segments of the foreign exchange market.

Appendix I Methodology of the FEER Approach

The FEER approach follows four steps:

  • In the first step, historical data are used to estimate a long–run relationship between the real exchange rate and its fundamental determinants using cointegration techniques:
    qt=ft′β+et,(1)
    article image
    where qt represents the real exchange rate, f't the vector of the fundamentals, β the vector of cointegrating coefficients, and et is the error term. Once cointegration is established, the significance of each variable in the cointegrating vector is tested. The fundamentals are also tested for weak exogeneity for the robustness of the model. The long–run relation identified by the cointegration test must also be validated by short–run adjustments captured by the following error–correction mechanism (ECM):
    Δqt=αet-1+Σi=1rγiΔqt-i+Σi=0sδiΔft-i+Σi-0sμiΔwt-i+vt.(2)
    article image

    The ECM indicates that the change in the exchange rate is affected by past deviations from the equilibrium, by its past changes, and by changes in fundamentals and other short–run variables, wt. If, for instance, the exchange rate in the last period was overvalued relative to the fundamentals, then et−1 is positive, and, in this period, the real exchange rate corrects itself by an amount dictated by the coefficient α (adjustment speed). In accordance with convergence toward long–run equilibrium, this coefficient has to be negative, significant, and less than one (in absolute terms).

  • The second step consists in estimating “normal” or “sustainable” values for the fundamentals by decomposing ft into permanent fPt and transitory components fTt:
    ft=ftP+ftT.(3)
    article image

  • In a third step, permanent components of the fundamentals and the estimated regression coefficients (β) are used to construct an equilibrium path for the real exchange rate

    qtE=ftPβt.(4)
    article image

    The estimated series of the equilibrium real exchange rate (qtE) would vary over time to the extent that there are changes in the fundamentals.

  • In the final step, the degree of real exchange rate misalignment is computed as the difference, at any moment in time, between the equilibrium and the actual real exchange rate.

Appendix II Internal Real Exchange Rate

The internal real exchange rate (IRER) measures a relative price between two different categories of domestic goods: tradables and nontradables. In this study, we use the indirect approach to measure the IRER by using a representative aggregate price index that includes both tradables and nontradables. There are three categories of goods in the economy: importables, exportables, and nontradables. In a three–good framework, there are two internal real exchange rates: the relative price of nontradables to exportables and the relative price of nontradables to importables. We use a proxy for each of these relative prices.30

First proxy: the relative price of domestically produced and consumed goods to imported good (IRER1)

The aggregate price index used for this proxy is the consumer price index (CPI), assumed to be a weighted average of the price of domestic goods (Pd) and the price of imported goods (Pm) in domestic currency terms:

CPI=(pm)α(pd)1-α,(1)
A03app02

where α is the share of imported goods in the CPI basket.

IRER1 is defined as

IRERm=Pd/Pm.(2)
A03app02

Reorganizing and substituting (2) in (1), IRER1 can be expressed as

IRERm=(CPI/Pm)1/(1-α).(3)
A03app02

We used EDSS (IMF) data for the CPI and the price of imports (Pm). The share of imports of foods and consumption goods in total private consumption is used as a proxy for α.

Second proxy: the relative price of domestically produced and consumed good to exported good (IRERx)

The aggregate price index used for this proxy is the GDP deflator, assumed to be a weighted average of the price of export good in domestic currency terms (Px) and the price of domestic good (Pd):

Pg=(Px)β.(Pd)1-β,(4)
A03app02

where β is the share of real exports in total real output.

IRERx is defined as

IRERx=Pd/Px.(5)
A03app02

By substituting (5) into (4), we obtain

IRERx=(Pg/Px)1/(1-β).(6)
A03app02

We used EDSS (IMF) data for the GDP deflator, the price of exports (Px), and the estimation of β.

Appendix III

Table III.1.

Unit Root Tests Variable Levels and Difference

article image

D denotes the difference operator.

Based on Augmented Dickey–Fuller tests with an intercept but no linear trend. Two asterisks (**) next to the statistics indicates that the corresponding hypothesis cannot be rejected at the 1 percent confidence interval.

Table III. 2.

Results of Cointegration Estimation Normalized Variable: ln (REER)

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* and ** indicate significance at the 5 percent and 1 percent level, respectively.

Table III.3.

Johansen Cointegration Tests

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Note: The trace test indicates 1 cointegrating equation at the 0.05 significance level.
Table III. 4.

Diagnostic Tests

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Note:* denotes rejection at the 5 percent level.
Table III. 5.

Guinea’s Rank on Indicators of Business Environment and Governance During 2004–05

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Source: World Bank, Doing Business Project, 2005.
Table III. 6.

Exports of Goods and Services, 1990 – 2004(In percent of GDP)

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Sources: IMF, World Economic Indicators, various years.

WAEMU: West Africa Economic and Monetary Union

Table III. 7.

Guinea: Exports of Goods, 1991–2004

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Sources : Guinean authorities; and IMF staff estimates.

Statistical Appendix

Table 1.

Guinea: Selected Social and Demographic Indicators

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Sources: World Bank, World development Indicators;UN, Human development Report, 2004; and IMF staff estimates.

Data for 2003.

Data for 2002.

Table 2.

Guinea: Selected Economic and Financial Indicators, 2000–04

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Sources: Guinean authorities; and IMF staff estimates and projections.

In percent of broad money stock at beginning of period.

Includes expenditure for restructuring.

Table 3.

Guinea: GDP at Current Prices by Demand Component,2000–04

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Sources: Guinean authorities; and IMF staff estimates.
Table 4.

Guinea: GDP at Constant 1996 Prices by Sector, 2000–04

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Sources: Guinean authorities; and IMF staff estimates.
Table 5.

Guinea: Consumer Price Index, 2000–04

(Period average)

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Sources: Guinean authorities; and IMF staff estimates.

Change in CPI methodology in 2003 resulted in a break in the data series.

Table 6.

Guinea: Consumer Price Index, 2000–04

(End of period)

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Sources: Guinean authorities; and IMF staff estimates.

Change in CPI methodology in 2003 resulted in a break in the data series.