The year is 1998, ten years ago and a while before, T&T
started to see the record levels of oil and gas revenues
which have been the hallmark of our more recent past. At
that time the Central Banks reserve requirement was
21 per cent on local currency deposits and nine per cent
for non-banks. For the record, the reserve requirement is
the portion of deposits that banks must themselves deposit
with the Central Bank. These deposits earn no interest return
and therefore serve the purpose of reducing the amount of
funds available to a bank from which they can lend to customers.
A higher reserve requirement means that banks will need
to increase rates or see a fall in income. Back in 1998
with a 21 per cent reserve requirement, the prime lending
rate was as high as 17.5 per cent and the interest rate
spread between deposit and borrowing rates was around ten
The Memorandum of Economic and Financial Policies of the
Government of T&T for 1999/2000 indicated that high
lending rates are an impediment to the development of small
and medium-sized firms which are (or at least should be)
the main source of new jobs given the capital intensive
nature of the energy sector.
The recent presentation by the Governor of the Central Bank
at the T&T Petroleum Conference provides some data to
support this point. The energy gross domestic product (GDP)
as a percentage of Total GDP is estimated at 43 per cent
for 2007 while energy sector employment to total employment
is just four per cent.
Further, we are expecting the energy sector to show growth
of just 4.4 per cent in 2007 compared to 21.4 per cent in
2006 while the non-energy sector growth is expected to be
consistent year-on-year at 6.6 per cent.
If high lending rates are an impediment to growth in the
non-energy sector, why is it then that the likely outcome
from the February 22 repo rate announcement by the Central
Bank is a rise in interest rates? The bank indicated that
they have raised the repo rate to 8.25 per cent and also
increased the reserve requirement from 11 to 13 per cent.
The increase in the reserve requirement marks what for all
intents and purposes has been a failed policy initiative.
Fiscal vs monetary policy
It was in 1999 that the policy of reducing the reserve requirement
was articulated with the intention being to reduce the figure
to bring it in line with the reserve requirement for non-banks
which is nine per cent. It was the pursuit of this measure
that resulted in the sharp declines in interest rates that
the country has enjoyed over the decade. This trend is now
being reversed but the policy objective was never achieved.
The reason for the increase in the reserve requirement and
general tightening of the liquidity position by the Central
Bank is clear and understandable. Inflation continues to
rise and what is now most worrying is that core inflation
which excludes food and other volatile elements has risen
to 5.7 per cent up from 3.9 per cent in Decemberthe
highest monthly increase since this indicator was established
in 2003. Isnt it now time for the politicians and
those in authority to treat this issue of inflation with
the seriousness that it deserves and effectively deal with
the issue instead of trying to deflect and window dress?
Core inflation is at 5.7 per cent, headline inflation is
at ten per cent. To put it into perspective the Vision 2020
document which is supposed to guide our progress to developed
country status puts a headline inflation target of five
per cent. Core inflation now exceeds this target. The last
time we were above ten per cent the Governor of the Central
Bank described us as being on a slippery slope, clearly
he was right then and the evidence is there for us to see
The objective of the latest move by the Central Bank is
to reduce the level of demand (consumption) in the economy.
The trends are clear with the median home price now standing
at $1.1 million up from $425,000 in 1999 and imports of
consumer goods representing 15.5 per cent of total imports
in 2007 up from 11.8 per cent in 2006.
More than understanding what is happening we must also go
a step further and try to understand why it is happening.
One of our challenges speaks to the shift away from a manufacturing
and production emphasis to one of import and distribution.
Increasing interest rates should help to curb consumption
(demand) and so reduce the level of imports. All of this
is being done in an attempt to control inflation but it
will also negatively impact expansion in the non-energy
sector. Recall as well that it was the steady rise in interest
rates in the US over the past couple of years which saw
property prices peak, then fall and the level of foreclosures
Easier to import
We need to understand the underlying reason for a shift
to import and distribution from the more indigenous productive
sectors in order to appreciate the problem we are trying
to solve. Lets take a simple example and bear in mind
the constraints of trying to explain this issue via the
limited space of a newspaper column.
We have two people selling coconuts around the Queens
Park Savannah. One sources his coconuts from an estate in
Cedros and the other imports his coconuts from, say, Brazil.
In January 2007 both vendors sell at the same price of $6
a nut with the importer making slightly less profit because
of shipping costs.
Fast forward to January 2008 and the inflation rate in T&T
is ten per cent but in Brazil lets say it is five
per cent. It means then that the cost of the coconut will
move to $6.60 since the vendor who is sourcing locally has
to pay a higher price. His price increases because the owner
of the estate in Cedros has to pay higher wages, finds it
difficult to source workers, the workers that he does find
are transient so there are frequent errors and output is
of low quality. In addition it now costs more to transport
the goods to Port-of-Spain and traffic congestion means
that it also takes more time to do so.
Roads in this rural area are in a state of disrepair which
means that vehicle maintenance costs are also higher.
However, the vendor importing the nuts has no such problems.
His costs have only increased by five per cent ($6.30).
However, he can afford to charge the same $6.60 since this
is what his competitor is charging. The 30 cent differential
is now a further profit for him.
Eventually the vendor who is sourcing locally will get wise
to the situation and maybe seek to import as well. The price
is not going to come down though, since it was clear that
consumers were able to afford the $6.60 price in the first
instance. If you see this as price gouging as some have
argued then appreciate that it is being facilitated by misaligned
The customer gets the product, may complain about the price
but is still prepared to pay. The vendor makes more profit
than originally intended so those two parts of the equation
are happy. The real loser in all this is the owner of the
coconut estate who is finding it more difficult to compete
because of circumstances outside his control.
Substitute the coconut estate for any other type of agricultural
produce, for these same factors are contributing to the
high food prices.
Go a step further and look at it from the perspective of
any local manufacturer and you will appreciate the problem
The simple point to all of this is that we have not managed
our fiscal resources so as to maintain our competitiveness
in the non-energy sector. The reality is that there are
always checks and balances to every system and in the long
term there is really no place to hide. Every economist will
tell you that you should not have an inflation rate that
exceeds that of your trading partners. The above example
clearly explains why that is so.
Our target inflation rate four years ago was 5 per cent.
We have consistently exceeded that and there is a price
to pay for such extravagance.
In the final analysis we can either increase interest rates
or adjust our currency in order to influence demand. However,
if we continue to operate a non-energy deficit then we are
not addressing the supply of money. This is where the real
problem lies. We have been lead to believe that the solution
lies in increasing the supply of goods as this will cause
a reduction in prices. The truth is that the solution lies
in reducing the supply of money in the economy.
The Central Bank has attempted to do this through many different
avenues, however, so long as their policy objectives are
not supported by the fiscal authorities then they are fighting
a losing battle. The fact that the reserve requirement never
got to nine per cent after ten years is testament to that.
Ian Narine is a stockbroker registered by the SEC. Please
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