A minor refresher on the Trinidad Exchange Rate System – 101

15 February 2016


An overview of this series of blog entries

In our first blog entry in this series we looked at the phenomenon of currency devaluation and specifically why countries often chose to devalue a currency under a managed or fixed floating regime. In this entry we look at the history of the Trinidad and Tobago exchange rate against the currency of our primary trading partner – the United States dollar.

From the end of World War 2 to the creation of the Central Bank

From the end of World War 2 in 1945 to the creation of the Central Bank in 1964, monetary policy and matters of monetary management were conducted by several different institutions.

The British Caribbean Currency Board, which was established in 1951, issued and redeemed currency with little or no consideration of both prices and credit conditions in the Trinidad economy. To all intents and purposes the credit policies of the foreign banks were managed from their international Head Offices and foreign exchange matters were administered by the Exchange Division of the Ministry of Finance.

The role of the Central Bank of Trinidad and Tobago

The Central Bank of Trinidad and Tobago, which was established by the Central Bank Act of 1964, is responsible for the issue and redemption of currency, the maintenance of monetary and financial stability, performing the role of banker to the central government and the commercial banks, and perhaps of most importance, acts as the protector of the external value of the Trinidad and Tobago Dollar against other currencies.

The Central Bank is the only institution that is authorised to issue currency in the form of notes and coins. The Central Bank is also responsible for the design of the currency, the maintenance of its integrity, and the provision of an adequate supply of currency to satisfy the demands of the public through open market operations.

How has the Central Bank operated in practice?

With the passage of the Central Bank Act, the Central Bank of Trinidad and Tobago took responsibility for the overall conduct and performance of monetary policy. Broadly speaking monetary policy refers collectively refers to those actions and decisions undertaken by the Central Bank to create appropriate monetary conditions in line with the developmental objectives of the country (usually these come from the dictates of the government). The conduct of monetary policy is influenced significantly by the pace, level, and direction of economic activity, the fiscal operations and initiatives of the government, capital inflows and outflows from the country, and the operations of the commercial banks. All of these factors impact on the level of liquidity in the system and in turn affect inflation, foreign exchange reserve holdings and ultimately add pressure to the exchange rate.

The Central Bank’s monetary policy objectives and tools have had to constantly adapt to the needs of a rapidly changing domestic and international economic environment and perhaps of greatest significance to material changes in the oil and gas prices set on international markets. With this in mind the monetary policy framework of the Bank has as its primary objectives, the maintenance of:

  • a low and stable rate of inflation in the domestic economy
  • an orderly foreign exchange market
  • an adequate level of foreign exchange reserves

An early history – hitching the dollar to the skirts of the Queen’s Pound

At the time the Central Bank was created the Trinidad and Tobago was part of the Sterling Area. This provided for full convertibility of the local currency to Sterling, with the Ministry of Finance administering exchange controls against other currencies.

During this early period the Trinidad and Tobago dollar was pegged to Sterling so that whatever effected the pound also had an impact on the value of the dollar. The late 1960’s was a difficult period for the United Kingdom still struggling with recovering from the economic impact of World War Two, rapid social change, and a diminishing and crumbling Empire.

In 1967, when the UK pound was devalued, the Trinidad and Tobago dollar was adjusted by the same amount to maintain its parity with Sterling. This devaluation, perhaps more than any other single event, meant that the days of pegging the Trinidad and Tobago dollar to Sterling were numbered.

Pegging to the Great Yankee Dollar

In 1970 the administration of exchange controls was shifted from the Ministry of Finance to the Central Bank. At this time Sterling was subject to exchange controls and the Trinidad and Tobago Dollar Peg was moved from sterling to the United States dollar at an initial rate of TT$2.40 to one United States dollar. The Defence Finance Regulations of 1942 under which the Trinidad and Tobago dollar had been pegged to sterling was replaced by the terms and conditions of the Exchange Rate Control Act of 1970.

The Great Oil Crash of the mid 1980’s – into the jaws of the IMF and the World Bank

160215 Blog Picture 2In the second half of the 1980’s Trinidad and Tobago passed through a major economic and financial crisis caused primarily by a major slump in oil prices and mismanagement. As oil prices tumbled and both oil revenue and the level of foreign reserves fell, Trinidad and Tobago experienced sustained periods of inflation, acute balance of payment deficits, and major difficulty servicing its external debt obligations.

The EC Zero System and the end of the PNM – Not!

In an effort to address the economic difficulties the PNM administration under George Chambers instructed the Central Bank to operate a dual exchange rate regime coupled with an exchange rate control system that aimed to severely curtail the outflow of foreign exchange from Trinidad and Tobago. Under the EC Zero System, strict foreign exchange budgeting was pursued that allowed traditional importers of goods to receive an allocation of foreign currency on a quarterly basis for the year ahead.

The EC Zero System proved to be a nightmare to operate and maintain. During the period it operated Trinidad and Tobago’s foreign reserves fell from US$3 billion to under US$500k.

Not surprisingly on the 18th December 1986 George Chambers led the PNM to its worst election performance winning only 3 of the 36 seats in Parliament.

The NAR Years – the era of Robbie – Not!

The NAR abandoned the EC Zero System unifying the exchange rate at TT$3.60 to one United States dollars in January 1987. As a result of worsening economic conditions in part caused by the stringent economic restrictions (the structural adjustment program) placed on the government by both the IMF and the World Bank, the Trinidad and Tobago dollar was devalued in April 1988 to a rate of TT$4.25 to one United States dollar.

History tells us that the NAR floundered on a bed of disunity, increased unemployment, a 10% cut in public sector salaries, the unpopularity of the austerity policies pursued, and ultimately the coup of 1990.  At the general election of 1991 they retained only the two seats in Tobago and the PNM returned to power.

The return of the PNM and the rise of the modern exchange rate system

In their manifesto for the 1991 the PNM had promised to abolish all exchange rate controls including those that had been designed to stop the outflow of capital funds.

Consequently, between the 7th and 13th April 1993, trading in foreign exchange was suspended and the exchange rate between the United States dollar and Trinidad and Tobago dollar was adjusted to TT$5.76 per one United States dollar.

As part of the process of switching towards a managed floating rate a number of institutional reforms were implemented at the same time. These included:

  • Not allowing the commercial banks to set a selling rate above a target rate set by the Central Bank.
  • Setting a wide spread between the buying and selling price for foreign currency to allow the commercial banks to earn a generous commission on the buying and selling of foreign currency.
  • Allowing bureau de change to be opened effectively opening an alternative source to earn foreign exchange for the commercial banks and other approved entities.
  • Allowing the commercial banks to establish US$ dollar accounts for both individuals and companies. We know from recent disclosures by the Prime Minister that these accounts hold balances totalling over US$3 billion.
  • Allowing citizens and companies to establish accounts overseas.

Next Week

Next week our series of articles on devaluation concludes with the third part which addresses whether devaluation of the Trinidad and Tobago dollar against other major trading currencies is inevitable and address the consequences of such a devaluation, should it happen.

Closing thoughts – is the fete now done and is it time to get back to work?

Firstline Securities Limited offers comprehensive coverage of local and international markets. Firstline also offers a number of unique opportunities to put surplus cash to work in the energy, real estate, retail, construction and other sectors, either as your asset manager or investment advisor. Please contact us for more details at info@nullfirstlinesecurities.com or at 868.628.1175, we can discuss your investment needs in detail and craft a portfolio that makes sense for you. We look forward to hearing from you.

Comments are closed.