The Interest Rate and Foreign Exchange Environment in Trinidad and Tobago

3 February 2015


The Repo Rate in Trinidad – a brief background history

The repo rate in the Republic of Trinidad and Tobago averaged 5.3% in the period from 2002 to 2014 reaching a high of 8.75% in September 2008 and a low of 2.75% in 2012.
Following two consecutive increases in the repo rate of 25 basis points in September and December 2014 the Central Bank yesterday increased the rate an additional 25 basis points from 3.25% to 3.5%.

Why has the repo rate increased for the last consecutive three quarters?

There are three factors behind the trend of increasing the repo rate since September 2014.
First there is an increased expectation that rates in the United States will rise from the current level of 0-0.25% to around 1% at some point in 2015 (this is addressed in an earlier blog entry). To this end, following a meeting in December 2014, the Fed issued a guidance note explaining that the medium course of its monetary policy is to increase rates to this level by the end of the year.
Second the economy of Trinidad and Tobago is fast approaching full capacity. There are a number of key indicators to suggest that this maybe the case. Unemployment remains low at just over 3%, with many within the business community reporting a shortage of labour, especially in the skilled job market. Moreover consumer credit is expanding at a strong pace (primarily to fund the purchase of imported consumer durables). To this end the Central Bank has intervened consistently in foreign exchange markets to make good shortfalls in the availability of foreign currency while at the same time “mopping-up” some of the excess liquidity in the economy.
Third the non-energy sector in Trinidad and Tobago continues to perform well having delivered respectable growth for 15 consecutive quarters to December 2014. The non-energy sector has been boosted by both the strengthening economy in the United States (as a major trading partner) and the knock on effect of lower oil prices stimulating an increase in economic activity in many of the tourism based economies within Caricom.

Why an increase in interest rates in the United States impacts on Trinidad and Tobago

If the United States increases its policy rate (the term used for its repo rate) in 2015 this will be the first time it has done so in eight years. The effect of such an increase (assuming no change in the rate in Trinidad and Tobago) would be to see a flow of funds outwards from Trinidad to the United States as rational investors seek a better return. In other words an increase in rates in the United States – ceteris paribus – makes investments in United States comparatively more attractive than those in Trinidad and Tobago dollars.

Other factors – the negative impact of inflation in the economy

Headline inflation was recorded at 8.5% in December 2014 significantly above the 5.5% recorded at the start of 2014. Two factors have contributed to this increase. Inflation in food prices has remained in double digit territory for six consecutive months to December 2014 reaching a high of 17%. Rising food prices can be attributed to lower domestic agricultural output caused by a cessation of planting by Caroni Green Limited and the negative effects of heavy rainfall and flooding of large areas of agricultural land. The second factor that has had a significant impact on inflation is higher public spending by central government increasing the level of liquidity.
The inflation of food prices is a cause for great concern as it will have a significant and painful effect on those with lower disposable income.

Falling oil prices – good for our neighbours bad for Trinidad and Tobago?

The last bi-annual economic bulletin published by the Central Bank at the date of writing of this blog entry (August 2014) indicated that authorised foreign currency dealers purchased just over 70% of foreign exchange from  energy companies. Overall energy accounts for 85% of Trinidad and Tobago’s merchandise exports, and energy based receipts account for approximately 50% of central governments revenue.
Falling oil prices therefore have a significant effect on both government revenue and the availability of foreign exchange on local markets.
Internationally lower oil prices are likely to assist some of our neighbours. Lower energy prices reduce costs and stimulate economic activity particularly – as discussed above – in the tourism based economies.

Oh and don’t forget it’s an election year – pouring oil on the inflation fire

Faced with declining oil prices the current government of Trinidad and Tobago has substantially revised downwards its energy price assumptions as set in the 2014/15 national budget. However the government intends to return to the original fiscal deficit target of 2.5% of GDP. The implications of this is that the government is likely to maintain its expansionary fiscal stance effectively adding pressure to the high level of liquidity in the system (current levels are approximately $6 billion). Ultimately this will increase inflationary pressure but it is an election year and should we expect anything else?

The undesired effects on business lending – business confidence remains low?

Throughout the 2012 when the Central Bank was pursuing a policy of trimming the repo rate in order to stimulate economic activity business lending continued to contract. In other words lower rates were not encouraging a strong revival in private sector investment because confidence in the future remained at best pessimistic.
Excess liquidity in the economic system throughout 2013 and 2014 has not changed this position with many business leaders remaining pessimistic about the immediate future for the economy of Trinidad and Tobago.

What will the Central Bank be doing in the coming months?

Expect the Central Bank to increase the tempo of its foreign exchange interventions in the coming months as it attempts to ensure that shortfalls in foreign exchange markets are kept to a minimum and excess liquidity is mopped up and quarantined from the economy.

Definitions and key concepts used above

Repo Rate: the rate at which the central bank of a country lends money to commercial banks in the event that the commercial bank has a shortfall in funds. The central bank use the repo rate to stimulate desired changes in the economy. For example central banks will often increase the repo rate to attempt to control inflation as an increase in the repo rate acts as a disincentive for the commercial banks to borrow.
Prime Lending Rate: this is the lowest rate on loans granted by the commercial banks to customers. This rate is sometimes referred to as the “Best Customer” rate. Ipso facto the closer the granted rate is to prime the better the customer.
Basis point: A unit that is equal to 1/100th of 1%.

 

Comments are closed.