Central Bank Governor Ewart Williams, centre, addresses a news conference at the Central Bank called to announce the release of the April 2006 Monetary Policy Report and the decision to increase the repo rate by seven per cent. Flanking the Governor are the deputy Governors Joan John and Shelton Nicholls.

Photo: Brian Ng Fatt

Last week the editor of the Business Guardian raised the debate: “Do you think we are repeating the same mistakes we made 25 years ago and expecting the outcome to be different from the last time? Or do you agree with the Governor that this country is better prepared to deal with a downturn now than we were 25 years ago?”

Quoting from my column of April 20: “A necessary prerequisite for solving the inflation, foreign exchange and stock market dilemmas facing T&T is to have these two bodies (the Ministry of Finance and the Central Bank) singing from the same hymn sheet in that their signals and actions must be consistent with each other. In fact one can argue that it is the inconsistent signals and actions of these two bodies (real or perceived) that have played a role in this three part problem that we are now facing.”

The Monetary Policy Report (MPR) of the Central Bank for the period ending April 2006 published last week once again brings this point into focus.

We can talk as much as we want about the strength of the economy and the rate at which it is growing, in fact the MPR report indicates that “economic growth is projected to remain robust with real GDP growth currently projected to reach ten per cent in 2006” but that still leaves me with the assertion that we are developing some serious structural issues in the management of the economy and it will become more and more difficult to undo with each passing day.

At the heart of the matter is that the Government, despite the pleas and protestations of almost every single commentator on the economy has embarked on a programme of spending that is by all accounts inflationary. Take the following quotations from the MPR report:

“A major factor underpinning the rising inflationary pressures has been the increase in government spending and its impact on the non-energy fiscal deficit.”

“With government spending increasing from the equivalent of 24.9 per cent of GDP in 2003/2004 to 27 per cent of GDP in 2004/2005, the non-energy fiscal deficit rose from 7.7 per cent to 9.7 per cent of GDP over the period. The evolution of the central government finances in the first six months of fiscal year 2005/2006 suggests that the non-energy fiscal deficit has continued to increase sharply. The monetisation of energy receipts to finance this growing deficit is a major source of liquidity injection and of inflationary pressures.”

“Fiscal policy constitutes a key ingredient to meeting the inflation challenge. Notwithstanding the shortfall in actual relative to budgeted expenditure, the increase in the net fiscal injection has been a main factor in the build-up of inflationary pressures.”

“...a moderation in government spending is a pre-requisite for effective inflation control.”

“As government continued to increase expenditure on upgrading the country’s economic and social infrastructure, the non-oil fiscal deficit widened to $4,911.3 million, for the first six months (October 2005 to March 2006) of the fiscal year. This figure was 56 per cent higher than the deficit ($3,132.1 million) posted in the corresponding period of the previous fiscal year. The increase in this deficit has been a major contributor to the increase in liquidity in the domestic financial system.”

Go back and count them, no less than five separate instances in a 20 page report where the Central Bank is highlighting the role of the fiscal authorities in accentuating the inflation problem that we are currently grappling with. I don’t think it can be made any clearer than this.

Sharing the blame

However the Central Bank must also take some responsibility for the current state of affairs in that it is my view that they have not dealt with the inflation issue head on but instead we have seen action that was less than decisive further exacerbating the problems we now face.

Quoting once more from the MRP: “The repo rate was raised on four occasions in 2005 and three times in the first quarter of 2006, each time by twenty-five (25) basis points. These adjustments brought the Repo rate from 5.00 per cent as at February 2005 to 6.75 per cent as at March 2006. In response to the rise in the Repo rate, the prime lending rates of the commercial banks were adjusted from 8.75 per cent to 10.50 per cent. However, in the presence of excess liquidity, this rise in the quoted prime lending rates (which serves as a base rate) has not been fully transmitted throughout the structure of interest rates in the financial sector. In many cases, banks with ample loanable funds have priced consumer loans below the prime lending rate.”

This is a clear indication that the measures introduced over the past 15 months were by and large ineffective in that either interest rates may have been increased with greater regularity or the increases could have been larger or other measures may have been pursued with more alacrity.

In fact the MRP is suggesting that “so far, interest rates on consumer lending have lagged behind adjustments in the prime lending rate. The Central Bank will discuss with the commercial banks measures to dampen consumer credit expansion while giving priority to credit for productive purposes.”

First of all if this is the chosen course then this action seems to be past due but on the face of it this also seems to be another step away from open market operations. It is clear that the market is not moving in the direction that we would want it to go as non-productive consumption seems more enticing than saving, investing or borrowing “for productive purposes.”

I am sure the issue of price controls on construction material and rent remains fresh in your minds as well as the argument that people are “hording” foreign currency.

All of these issues are the consequence of the inflationary policies of the fiscal authorities. If these inflationary policies continue we would find ourselves relying more and more on trying to control the market as opposed to working though the market.

Over time the inefficiencies these actions create may be very difficult to undo. This is where I see the parallel with 30 years ago hopefully we will not continue on and end up as we were 25 years ago.

Still what is to my mind the most troubling feature of the MRP is the following statement: “Given the evolution of inflation so far and assuming that the non-energy fiscal deficit could be contained to between 14 to 15 per cent of GDP (compared with 17.5 per cent in the budget), the Central Bank projects inflation for the year as a whole at between six and 6.5 per cent, down from last year’s figure of 7.2 per cent.”

Even this outcome would be outside of the Bank’s target range of four to five per cent.

What is concerning to me is that we almost seem to be hoping that the inflation problem goes away by itself rather than taking firm steps to solve it. The Central Bank is projecting a rate of inflation that is outside of its target range. If that is the case then what is the point of a target range? This target range of four to five per cent is also the range established in the Government’s Vision 20/20 document. Are we on target for Vision 20/20 or not?

Further achieving this inflation rate of 6.0-6.5 per cent is contingent on a non-energy deficit of between 14 to 15 per cent of GDP. The budget is at 17.5 per cent and there is no evidence to suggest that Government spending is going to slow any time soon—especially when there is more and more to suggest that this year will be an election year.

In fact, the only reason to look forward to a slow down in spending is bottlenecks and other administrative delays. In other words any type of slow down would be by accident rather than design.

Given this prognosis why are we not assuming a non-energy fiscal deficit of 17.5 per cent of GDP in keeping with the Budget and projecting inflation based on that? We can then establish policies to bring inflation in check under this scenario and if the non-energy deficit is actually less than Budget then we would be closer to the target range of four to five per cent.

It should be clear that this is the more prudent approach but then that may result in a projected inflation rate of over seven per cent and this may not make good reading.

My guess is that we are going down the same road as last year where if memory serves the projected inflation rate was around six per cent and we ended up at seven even though the target rate was five. This time around we are starting at six to 6.5 per cent under a best case scenario. What if we have another round of flooding during the last quarter of 2006?

The implications of not getting things right was made clear as the MRP further went on to state that “Fiscal containment along with tight monetary policies could also facilitate the orderly management of the foreign exchange market.”

Yet as was the case last year if fiscal containment does not take place and monetary policy is not tight enough then the logical conclusion would be further pressures in the foreign exchange market.

One outcome that is certainly evident is that the “interest rate policy in T&T will need to take into account the objective of inflation control as well as the need to re-establish an appropriate spread between TT and US interest rates in order to discourage capital outflows.”

This suggests that there are more interest rate increases in the offering and if not managed properly this can provide some headwind and crosscurrents to the performance of the T&T Stock Market. It is at this point that we may start to take bigger steps down that slippery slope.

My final point is that quite paradoxically I agree with the Governor. This country is better prepared to deal with a downturn now than we were 25 years ago. If however we were to continue on this road for another few years then I think our past can very well be our future. Next week I’ll explain what I mean in greater detail.

Ian Narine, managing director of Republic Securities Ltd can be contacted via email at inarine@republictt.com