Home' Trinidad and Tobago Guardian : June 11th 2015 Contents BG14 COMMENTARY
BUSINESS GUARDIAN www.guardian.co.tt JUNE 2015 • WEEK TWO
Last week s Monetary Policy
Report (MPR)---put out by the
Central Bank of T&T---attract-
ed some headlines mostly in
the area of government spend-
ing during the first six months
of the fiscal year. But the fun-
damental issues in the MPR largely went under
reported and under analysed.
The bottom line statement from the Governor
of the Central Bank is that after six years of
falling interest rates in T&T this situation is
set to reverse in the coming months. Interest
rates are going to rise and are likely to form
a trend into the foreseeable future.
The tighter monetary stance from the Central
Bank is not new, however, the impact is now
upon us and we should be trying to understand
the implications as it can have fundamental
and far reaching consequences. The repo rate---
which is set by the Central Bank as the rate
at which it will lend to commercial banks---
stood at 2.75 per cent back in September 2014.
Since then, the rate has been increased five
times and is now at four per cent.
A cumulative 125 basis point (1.25 per cent)
increase in the repo rate has not been reflected
in commercial bank lending rates to the same
extent as the prime lending rate has moved by
50 basis points from 7.5 per cent to eight per
cent over the same period.
As I will explain below, that may soon
Central Bank initiatives
Appreciate that the prime lending rate really
affects new borrowings so the transmission
effect of the actions of the Central Bank to the
broader economy has been largely muted.
In fact, the transmission of Central Bank
policy to the wider economy has been a chal-
lenge for the CBTT, I would argue, since 2002.
This has been due to fiscal policies of successive
administrations geared towards political expe-
diency and this being at odds with the longer-
term economic perspective of the Central Bank.
It was back in 2002 that the bank introduced
the repo rate for the first time and announced
a programme of reducing the primary reserve
requirements for commercial banks from 18
to nine per cent. The primary reserve is used
to influence monetary conditions, as it requires
financial institutions to maintain a portion of
their deposits with the Central Bank in a non-
interest earning reserve account.
For every $1 million in deposits in the banking
system, $180,000 had to be deposited at the
Central Bank, which meant those funds could
not be lent.
By reducing the reserve requirement the
Central Bank was, in fact, becoming more
accommodative as more funds was available
for lending with the likely impact that interest
rates would fall.
The overall objective was to reduce the reserve
required and adopt a modern approach of using
the repo rate to manage monetary policy. The
repo rate remains the primary mechanism
through which interest rates can be adjusted
higher or lower.
The repo rate started out at 5.75 per cent in
May 2002 and, consistent with the Central
Bank s stance of a more accommodative mon-
etary policy, was progressively reduced to five
per cent by September 2003.
Lack of co-ordination
The problem back then was that the co-
ordination between the Government and the
Central Bank was lacking.
The government of the day sought to increase
its level of spending and reduce taxation which
added more liquidity to the system. It is that
flood of liquidity coming from two fronts that
resulted in T&T moving from an very acceptable
three per cent inflation environment in the
period prior to a totally unacceptable 12-15 per
cent inflation level by 2009. We have been
unable to bring inflation down in a sustainable
way since that genie was let out of the bottle
The reality is that an economy cannot
progress in any meaningful way if these two
authorities are at cross-purposes and that was
the case for close to a decade.
Further, if the political directorate---both
now and in a post-election scenario---does not
take note of the need for unpopular fiscal
adjustments, as pointed out last week by the
Central Bank Governor, we will experience
another period of dissonance.
Loss of control
By 2005, as government spending continued
unabated, it was the Central Bank that had to
blink, reversing the decision to reduce the
reserve requirements, hiking the repo rate, sell-
ing treasury bills and adding open market oper-
ations (OMO) paper and special deposits to
the mix in an altogether futile attempt to mop
up liquidity and stem the inflation pressures.
In many instances, the Central Bank had to
resort to moral suasion and even that did not
By September 2008, the repo rate was at
8.75 per cent and the primary reserve was at
17 per cent with a secondary reserve at two
With each succeeding year, the bank was
also required to intervene---to a greater extent---
to supply foreign exchange to the market. This
was another way of removing TT dollar liq-
uidity. By selling US dollars to the market and
purchasing TT dollars, the Central Bank was
taking TT dollars out of the financial system.
The point to appreciate: if we were more
judicious in how we converted our energy
windfall denominated in US dollars into TT
dollars, then the Central Bank would not have
had to intervene in the way that we have expe-
I would suggest that as time went by the
Central Bank lost control of monetary policy,
which is its primary remit. This was because
its transmission mechanisms were broken.
Surplus liquidity in the financial system meant
that commercial banks had no consistent need
to borrow from the Central Bank and so the
repo rate became ineffectual. We were back to
using "blunt" policy initiatives such as reserves
and special deposits.
More recently, bonds have been issued in
an attempt to take up excess liquidity and read-
ers should appreciate that these bonds represent
borrowing by the State and also carry an interest
Now we are embarking on another adventure.
The Central Bank has made significant inter-
ventions into the foreign currency market to
the tune of US$1 billion in 2015 and, in the
process, has taken out TT dollar liquidity from
the system. Public offerings of shares, and a
number of bond issues, have had the same
There are signs that excess TT dollar liquidity
is being reduced and that will mean that com-
mercial banks may need to access the repo
market with the Central Bank to meet overnight
As the repo rate is pushed progressively
higher, the transmission mechanism becomes
more effective and interest rates will have to
The mortgage market reference rate, a bench-
mark to bring more transparency to how mort-
gage rates function, was introduced in 2011.
There was a 25 basis point adjustment to this
rate last week for the first time moving the
rate to 2.50 per cent. Expect, therefore, to see
adjustments to mortgage rates over time.
The long-term cumulative impact of these
policy actions is to curb demand with the ulti-
mate objective of keeping inflation in check.
The short-term impact is that as people recog-
nise that interest rates are beginning to rise,
demand is brought forward as people "rush"
to make purchases of cars and other durable
goods thus placing additional demand for for-
"Managing" the exchange rate is a major
objective of any central bank and this is another
reason for what is likely to be a consistent
attempt to push interest rates higher.
The spread between US dollar rates and TT
dollar rates is too low to provide any meaningful
incentive to hold TT dollars. That is another
reason for the current demand for foreign cur-
With the US Federal Reserve set to raise
rates---by my reckoning in September 2015---
unless we engineer an increase in TT interest
rates then the demand for US dollars is going
to increase. The governor indicated as much
in his statement last week. It is my view that
the rate of change of our interest rate increases
has to be greater than the rate of change in
The challenge with higher domestic interest
rates is that it reduces domestic demand, this
at a time when government spending also has
to be curtailed, due to rising and consistent
deficits. It represents a delicate balancing act.
Ian Narine is a broker registered with
the SEC and can be contacted at
The Central Bank has made significant interventions into the foreign currency market to the
tune of US$1 billion in 2015 and, in the process, has taken out TT dollar liquidity from the
system. Public offerings of shares, and a number of bond issues, have had the same impact.
Interest rate balancing act
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