Open market operations: Recent monetary policy has involved gradual tightening of interest rates and interventions on foreign currency markets

As a result of falling hydrocarbons prices in 2014-16, and the consequential drop in export revenue, the Trinidad and Tobago dollar has come under increasing pressure and has been slowly depreciating. During the same period there was both a change in government – in September 2015 – and a change in the top leadership of the Central Bank of T&T (CBTT) – in December 2015. Despite some shifts in emphasis over the course of 2015 and in early 2016, the broad monetary policy pursued was a combination of gradual interest rate tightening and interventions on the foreign currency markets. This helped ease the pace of depreciation of the TT dollar, preventing what the authorities might see as too sharp or sudden a fall. Excessively rapid depreciation of the currency is seen as having undesirable effects.

Rising Repo Rate

During 2015 the CBTT applied three increases of 25 basis points (bps) to the country’s key repo interest rate, taking it up to 4.75% by December of that year. This was then followed by a relative pause in the first quarter of 2016. The authorities appear to have taken the view that it is necessary to keep in step with the process of interest rate tightening in the US, so as to prevent capital flight.

Meanwhile in April 2016 Colm Imbert, the minister of finance, ruled out the possibility of an abrupt devaluation of the currency. It was also evident that the CBTT was rationing the supply of dollars to the currency market. This policy aimed to defend the country’s foreign currency reserves, which stood at $9.5bn in March 2016, or 11 months of import cover. According to an RBC Royal Bank report in April 2016, the CBTT projected this figure to contract to $8.5bn or 10 months of imports by the end of 2016.

Mortgage Rates

Despite its decision to hold the repo rate unchanged, in the same month the CBTT increased the mortgage market reference rate (MMRR) to 3%, up from 2.75%, citing increased yields on 15-year Treasury bills and the rising cost of funds for commercial banks. Mortgage lenders are required to use an MMRR-plus pricing formula for their loans, where the extra margin takes into account additional factors such as the borrower’s credit rating, the location of the property, the deposit-to-loan ratio, and the size and quality of the collateral offered. George Sheppard, president of the Securities Dealers Association of T&T, pointed out that the policy of gradually tightening the repo rate that commenced under the previous government had a beneficial effect on bank profits. “The repo rate is benign in the context of excess liquidity in the commercial banking system. It doesn’t matter what the repo rate is, if commercial banks can borrow among themselves they won’t feel the need to borrow from the CBTT at a higher repo rate,” he told OBG. But with the commercial banks’ prime rate benchmarked to the repo rate, the effect was that the banks were raising their lending rates but not raising their deposit rates.

Long Term

As a result, spreads and profitability increased. This created a situation where, in a slowing economy the banks have appeared to be doing even better than before, and better than many of their customers. However, Sheppard warns that this apparent immunity to the winds of recession is not real or sustainable on the long term. Margins could eventually be affected by an increase in non-performing loans and crucially, the banks will find themselves needing to pay more to depositors, narrowing their spreads as excess liquidity in the system is absorbed. In his view the banking sector will find itself under pressure to reduce costs and become more efficient.

Taking all of these factors into account, analysts expect the repo rate to reach 5.25% by the end of 2016. The CBTT is likely to hold off further tightening the repo rate as US interest rates gradually rise, for fear of intensifying the current recession. Hence, the most likely scenario is one in which there is no more than a moderate monetary tightening cycle.