The tale of the weeping businessman and a more interventionist Central Bank 

27 February 2015


The cries of the business community

Over the last six months the business community has been vociferous in it cry that the supply of foreign exchange in Trinidad and Tobago is inadequate and that the lack of supply is crippling their trading activities.
This may be an over exaggeration but there is no doubt that it is not as easy to source United States dollars as it used to be. If you have been following the previous four blog entries in this macro-economic series you will have some idea as to why this is the case.

Who supplies the foreign exchange in Trinidad and Tobago?

Under normal trading conditions the Central Bank typically supplies 25% of the available foreign exchange in Trinidad and Tobago with the remaining 75% being supplied by the commercial banking system.

What has caused the shortage in foreign exchange?

It is a combination of three factors that have combined to create a shortage in available foreign exchange in Trinidad and Tobago. The first of these factors is supply side, the second demand side, the third to a very large degree is speculatory in nature.
The supply of foreign reserves has constricted due to a significant fall in energy export earnings. Trinidad and Tobago remains after all an oil and gas economy.
On the demand side of the equation elevated domestic liquidity has fuelled a strong climb in consumer credit and stimulated increased demand for imported consumer durables (these have to be paid for in foreign currency).
On the speculatory side negative national sentiment surrounding the sharp fall in oil prices witnessed over the last six months has aggravated unsatisfied demand for foreign exchange as demands from the public and the business community have been brought forward.

What is the Central Banks position on the shortage?

First off recognise that the Central Bank doesn’t get involved in the day to day relationship that exists between the commercial banks and their customers. To a large degree it is up to the commercial banks to decide how much, when, and why it will allocate foreign reserves to the end customer.
This does not mean that the Central Bank cannot influence that relationship. The Central Bank manages the foreign exchange reserves of Trinidad and Tobago. These reserves are effectively the country’s insurance against economic shocks. When shocks occur (such as significant shortages in the supply of dollars) the Central Bank will make use of those reserves to fill in the gaps in supply in an effort to insulate the economy against those shocks. The extent to which it has done this over the last year is contained in the table below.Softly softly does it
The Central Bank has taken a prudent approach to the interventions conducted to date. Recognising that the reserves cannot simply be surrendered but have to be managed, interventions have been structured to ease but not totally alleviate the shortage in foreign exchange.
This is a simple and prudent policy. Twenty five years ago the reserves of Trinidad and Tobago stood at only US$100m. Enough roughly for four days of current imports.
Time to reflect – perhaps – that the country has come a long way in 25 years.

Foreign exchange markets – the position for the next three years

The Central Bank expects the imbalance in foreign exchange markets to continue to grow over the next two to three years and this means that the Central Bank will continue to intervene in the market to soften the effect of shortages in the supply of foreign exchange.
This view is supported once one considers that the energy sector in Trinidad and Tobago will continue to experience supply disruptions as both BPTT and British Gas continue with their cost rationalisation exercises. Moreover oil markets are likely to take some to time to settle into a new equilibrium.

Have the interventions had a material impact on the level of reserves?

The significant interventions made by the Central Bank over the last 12 months have not had a significant impact on the level of reserves maintained. In January 2015 net official reserves stood at US$11.1 billion representing 12.5 months of import cover. Compare this to the position in June 2014 when reserves were US$10.2 billion.

 

                       Central Bank Interventions (Suppy of US Dollars)
             Calendar Year 2014             Calendar Year 2015
Total Cumulative Total Cumulative
January         160,000,000         160,000,000         400,000,000         400,000,000
February          140,000,000         300,000,000         150,000,000         550,000,000
March           50,000,000         350,000,000         550,000,000
April           10,000,000         360,000,000         550,000,000
May         250,000,000         610,000,000         550,000,000
June           50,000,000         660,000,000         550,000,000
July         205,000,000         865,000,000         550,000,000
August         175,000,000     1,040,000,000         550,000,000
September         100,000,000     1,140,000,000         550,000,000
October         250,000,000     1,390,000,000         550,000,000
November         325,000,000     1,715,000,000         550,000,000
December                             –       1,715,000,000         550,000,000
    1,715,000,000         550,000,000

How the Central Bank intervenes in the economy

Over the last four blog entries we have covered a significant amount of macro-economic theory in an attempt to describe how markets interact on an international scale.
Our analysis wouldn’t be complete if we didn’t close this series of blog entries by wrapping up with a description of the main mechanisms the Central Bank uses to influence economic conditions in Trinidad and Tobago.

Indirect methods utilised by the Central Bank to intervene in the economy

There are two indirect methods the Central Bank can utilise to intervene in the economy, and if you have been following this series of blog entries you will be familiar with them:

The Repurchase Rate (Repo Rate)

The repo rate was introduced in May 2002. It is the rate at which the Central Bank is prepared to provide overnight financing to commercial banks that are on a temporary basis not able to meet their immediate liquidity requirements. The repo rate is used to by the Central Bank to influence the structure of commercial banks interest rates. A change in the rate is an important signal of the Central Banks current monetary stance. We were introduced to this rate in the blog entry entitled “Interest rates and exchange rates – a macro-economics 101”.

Open Market Operations

The content of this blog entry has covered this method. The Central Bank conducts open market operations through the purchase and sale of government securities to alter liquidity conditions in the financial system. As we have seen in Trinidad and Tobago over the last nine months high levels of liquidity when the country is very close to full capacity can increase the credit supply and drive inflation.
If the Central Bank considers that liquidity levels are too high it will sell securities through an auction system to remove that excess liquidity. The resources removed from the system are usually sterilised (meaning they are removed from the economy totally).
If the Central Bank considers that the liquidity levels in the economy are not sufficient then it will buy securities back therefore adding to the liquidity in the system.
Managing both the liquidity and foreign exchange conditions in the economy, as discussed in this blog entry, are a classic example of the Central Bank undertaking open market operations.

Direct methods/instruments used by the Central Bank to intervene in the economy

There are three main direct methods the Central Bank can utilise to intervene in the economy. These are:

The primary reserve requirement

Licensed financial institutions are required to hold a percentage of their prescribed liabilities at the Central Bank on a non-remunerated basis. The Central Bank has the power to alter this percentage in order to impact on the liquidity within the banking system.  This rate currently stands at 17%.

The secondary reserve requirement

The Central Bank has the power to request licensed financial institutions to hold a certain percentage of their prescribed liabilities in a secondary reserve. The secondary reserve requirement currently stands at 2%.

The Special liquidity facility

In addition to the primary reserve and secondary reserve requirement the Central Bank can request that the commercial banks deposit a proportion of their liabilities in an interest bearing facility at the Central Bank. This facility requirement is not currently exercised by the Central Bank.

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