This Selected Issues paper on Trinidad and Tobago highlights that real GDP growth accelerated slightly from 2.4 percent in 1995 to 3.2 percent in 1996. In both years, growth was mainly driven by a good performance of the non-oil sector, which expanded by 3 percent and 3.6 percent, respectively. Construction, distribution, and tourism grew at an especially rapid pace. Manufacturing showed an uneven performance, growing in 1995, but stagnating in 1996, which was owing to the differential effects of trade liberalization on its various subsectors.

Abstract

This Selected Issues paper on Trinidad and Tobago highlights that real GDP growth accelerated slightly from 2.4 percent in 1995 to 3.2 percent in 1996. In both years, growth was mainly driven by a good performance of the non-oil sector, which expanded by 3 percent and 3.6 percent, respectively. Construction, distribution, and tourism grew at an especially rapid pace. Manufacturing showed an uneven performance, growing in 1995, but stagnating in 1996, which was owing to the differential effects of trade liberalization on its various subsectors.

Trinidad and Tobago: Basic Data

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Sources: Country authorities, Social Indicators of Development, 1991-92, the World Bank; and Fund staff estimates.

Official national income account estimates.

Central Government only.

Of the financial system, in percent of liabilities to the private sector.

As percent of current account receipts excluding official transfers.

I. Survey of economic developments

A. Real Sector

Sectoral growth

1. Real GDP growth accelerated slightly from 2.4 percent in 1995 to 3.2 percent in 1996. In both years, growth was mainly driven by a good performance of the non-oil sector, which expanded by 3 and 3.6 percent, respectively. This pattern of growth—a leading non-oil sector and a trailing oil sector—has been observed in four of the last five years, and points to some success in the efforts to diversify the economy. Construction, distribution, and tourism grew at an especially rapid pace. Manufacturing showed an uneven performance, growing in 1995, but stagnating in 1996, which was due to the differential effects of trade liberalization on its various sub-sectors. Agriculture suffered from a drought in 1995, but rebounded in 1996. In general, however, a continued upturn in the more labor intensive segments of the economy has led to a reduction of the unemployment rate to 16 percent.

2. The dominant influence in the oil sector was a decline of crude oil production, due to a natural aging of existing wells. In total, the petroleum sector grew by 0.7 percent in 1995 and by 1.7 percent in 1996. Much of this growth, however, was due to a rapid expansion in the production of petrochemicals and in refining, which recorded double digit increases. Inflation remained subdued and slowed further from an average of 5.3 percent in 1995 to 3.6 percent in 1996.

The energy investment boom

3. An investment boom is underway in Trinidad and Tobago. Contracts have been signed, and in most cases ground has been broken for a large number of projects in the energy sector. These projects followed explorations which have considerably increased the estimates of Trinidad and Tobago’s deposits of natural gas. Most of the upcoming projects will make use of this resource in one way or another. The largest project is the installation of a natural gas liquefication (LNG) plant, followed by two new methanol plants, an ammonia plant, and an iron carbide plant. Investment in these projects is estimated at over US$2 billion over the next several years, which is a large amount compared to the size of the Trinidadian economy (GDP in 1996 was equivalent to about US$5.5 billion). Even after allowing for slippages and delays, the energy sector projects could raise the investment ratio from around 15 percent of GDP in 1996 to 19 percent in the next two years. The construction sector would be the main beneficiary in the initial phase of the gas boom As the main projects are completed by 1999, output in the energy sector is expected to increase sharply, marking the second phase of the gas boom. Taken together, these developments should double the growth rate of real GDP during the years 1998-99 to about 6 percent a year.

Wage compression

4. Most public sector wages have been frozen after 1989, keeping wage expenditures at a manageable level for the budget. However, the structure of public sector wages is inducing distortions in the labor market. First, there is a premium on entry level wages in the public sector over entry level wages in the rest of the economy. This causes job seekers to queue up for public sector jobs and also inflates youth unemployment. Second, salaries for public sector positions requiring higher skills and education have decreased in relative and in real terms, creating a negative wage gap for senior managerial and technical staff between the public and private sectors.1 This has caused an exodus of managerial and technical personnel, in particular from the Ministry of Planning, where the implementation of the public investment program is orchestrated. The expected boom in private energy investment will put strains on the existing public infrastructure and require a significant increase in public capital expenditures.

Unemployment2

5. Despite recent declines, the high unemployment rate remains one of Trinidad and Tobago’s most pressing problems. The major part of unemployment is structural and represents a long-term legacy of the deep recession during the 1980s. The decline in the price of oil during these years led to a large deterioration of Trinidad and Tobago’s terms of trade, thus making the improvements in living conditions during the oil boom unsustainable. However, strong unions prevented real wages from adjusting until well into the mid-1980s. This led to a drastic increase in unit labor costs, putting a squeeze on both the government and private firms. Since oil revenues were declining rapidly, the government cut back on public capital spending. Also, private firms scaled down their investment, as profitability fell. These developments together led to a decrease in investment by more than 60 percent in real terms between 1982 and 1988. Real investment has never recovered from this low level, causing the productive capital stock to decline since the mid-1980s. Decumulation of capital helps explaining why a strong reduction in real wages that took place over the same period—by more than SO percent since 1986—had so little impact on the unemployment situation.

Agriculture

6. Agriculture is the most labor intensive sector in the Trinidadian economy and has a considerable potential for absorbing unemployed people. However, the performance of the agricultural sector remains disappointing, despite low wage costs, a competitive real exchange rate, and the fact that—compared to other Caribbean islands—Trinidad and Tobago has an abundance of flat and fertile land. Half of all arable land is owned by the state, mostly through Caroni Ltd., which is the monopoly processor of sugar and by far the largest producer of cane. The company has been running big losses for many years despite preferential trade arrangements with the United States and the European Union. Private agriculture is confined to the fringes of good soil in Trinidad. A loan agreement with the IDB, which targets reform and revitalization of the agricultural sector, was signed in June 1996. However, progress on the central issue of land tenure is slow, as the government is privatizing its land at a rate of no more than 1 percent a year. Privatization of Caroni seems not to be under active consideration because of likely political costs.

B. Public Sector Finances

7. The overall surplus of the nonfinancial public sector narrowed from 3¾ percent of GDP in 1994 to 1½ percent in 1996 (Table 13). The principal reason for this contraction was a decline in the surplus of the public enterprises brought about by the divestment of some of the more profitable enterprises. In this same period the overall balance of the central government strengthened, moving from a small deficit to a surplus of about 1½ percent of GDP.

8. The improvement in the central government finances was at the level of current operations, as capital expenditures remained at about 1¾ percent of GDP over the last two years. Central government revenue increased from 28 percent of GDP to 29½ percent over the period 1994-96, including the receipt of tax arrears of about ½ percent of GDP (Table 14). Also, the revenue level reflected the high oil prices that prevailed in 1996 (an average of US$21.50 a barrel, compared with US$17.50 used for the budget estimates) which, despite the decline in volume from aging wells, more than covered a deterioration in the performance of the VAT and customs revenue. The weakness of the VAT grew out of a decline in enforcement and compliance stemming from weakness in administration, and in particular, in maintenance of the capacity of computer systems.3 The customs revenue decline was in part the result of the progressive reductions of the top tariff rate as foreseen in the CARICOM agreement on a common external tariff but also from a temporary weakening of inspection capacity while new facilities were being constructed at the main port. Further temporary declines in non-oil tax revenue are expected as a result of simplification and lowering of maximum rates for personal and corporate incomes taxes introduced in the 1996 and 1997 budgets (see Section VI. A in this report).

9. Central government expenditure grew from 26¼ percent of GDP in 1994 to 28 percent in 1996 (Table 18). The spending increase was accompanied by a change in composition, as wage and salary outlays fell from 9½ percent of GDP to 8½ percent in the same period, a consequence of the effective freeze on nominal wage rates, and interest payments declined from 5¾ percent of GDP to just under 5 percent, as the stock of debt was reduced. Offsetting these contractions was a rise in transfers and subsidies from under 7 percent of GDP to over 9½ percent, as the central government assumed responsibility for debt service and other financial costs in connection with the privatizing of a number of public enterprises and restructuring of certain utilities.

10. The rest of the nonfinancial public sector reduced its contribution to the overall public sector surplus from 4 percent of GDP in 1994 to zero in 1996. This development reflects a significant downsizing of the public enterprise sector that included the privatization of several profitable enterprises. The downsizing resulted in a decline in overall revenues in this sector by one third, from the equivalent to 42 percent of GDP to 25 percent. In this period, employment in this sector declined by 16 percent and wage and salary expenditure by 22 percent, primarily because of divestments. Among the remaining entities, considerable change has been brought about through merger and restructuring as well as through partial divestment (see Section V.B of this report). Restructuring programs are still underway at the public transport utility and at WASA, the water and sewerage utility, which is now being managed by a private contractor who is implementing a sizeable capital investment program to rehabilitate long-neglected infrastructure. WASA and Caroni, the sugar refiner and agricultural producer, still require financial assistance from the central government, but for the sector as a whole their losses are offset by profitable enterprises such as the telecommunications company and the state-owned gas distribution and oil refining operations. However, for 1996, remittances by the public enterprises to the central government were somewhat less than anticipated in the budget because of price and volume declines faced by the majorityowned ammonia producer and because of an enlargement of the capital investment intentions of the National Gas Company.

11. The government plans to continue the restructuring of public enterprises and utilities and to complete some liquidation and divestment projects that are well advanced, such as for the methanol corporation. Reforms in the agricultural sector that may affect the efficiency of operation of Caroni are being undertaken with the support of an IDB sectoral loan.

C. Monetary Sector

Summary of developments, 1995-96

12. Monetary policy maintained a steady course during 1995, after considerable tightening in the previous year. Net domestic assets of the financial system increased (in terms of private sector liabilities) by 13.2 percent, with credit to the private sector increasing by 3.3 percent, after both showed a negative growth during 1994 (Table 26). Liabilities to private sector grew by 11.5 percent, somewhat slower than in 1994, but higher than the rate of growth of nominal GDP. Interest rates declined, on average, by 100 basis points, reflecting a stable exchange rate and lower inflation.

13. Monetary policy was tightened toward the end of 1995 and further measures were taken during 1996 to relieve pressures on the exchange rate. In 1996, net domestic assets declined in absolute terms, due to a tighter fiscal policy and an increase in public sector deposits at the central bank. Expansion in credit to the private sector accelerated moderately and interest rates rose by 300 basis points.

Monetary policy and instruments

14. The principal goal of monetary policy in recent years has been to ensure the stability of the exchange rate by affecting commercial bank liquidity and loan demand. This policy has been implemented through changes in legal reserve requirements, in the absence of other policy instruments. During 1994, reserve requirements were raised in two steps from 16 percent to 20 percent. In view of the stable money and credit conditions, no further changes in this policy were made until the end of 1995, when evidence of capital flight emerged as surprise elections were called and the exchange rate came under pressure. To reduce liquidity, the central bank requested commercial banks to deposit, on a pro-rated basis, a total of TT$100 million in interest free accounts at the central bank, which implied an effective increase in the required reserves of 1.1 percentage points, on top of the existing 20 percent. Also, in early 1996, the central bank sold US$6 million in foreign exchange to banks to absorb additional liquidity.

15. During 1996, the central bank sold an additional US$54 million in foreign exchange and liquidated most of its holdings of government securities. Also, beginning in February 1996, commercial banks were asked to hold reserves in a secondary reserve account at the central bank, either as deposits or in treasury bills, equivalent to 5 percent of their deposit liabilities.

16. Commercial banks are required to maintain liquid reserves equivalent to 25 percent of their foreign currency deposit liabilities, which can be held in cash, bank deposits, or in selected foreign government securities of up to six-month maturity. This liquidity ratio was reduced from 33 percent to 25 percent in early 1995.

17. Open market operations were initiated in September 1996, with the auction of three-month and six-month treasury bills in the amount of TT$ 150 million, of which TT$90 million was sold. A second auction of TT$150 million in treasury bills was held in October, but the auction was canceled owing to inadequate bids. Largely in response to the disappointing results of the second auction, the central bank increased the unremunerated reserve requirement to 23 percent, but withdrew its earlier request to banks to hold TT$100 million in interest free deposits. As a result, the net increase in the effective reserve requirement was 1.9 percentage points.

Credit flows

18. Total net credit by the financial system declined by the equivalent of 1.7 percent of GDP, compared with a 5.8 percent increase in 1995 (Table 27). Net credit from the monetary authorities turned substantially negative in 1996, whereas credit extended by commercial banks and trust companies grew by smaller amounts than in 1995, reflecting the impact of credit tightening measures as well as the high real lending rates (see below).

19. The public sector’s claim on credit extended by commercial banks has been quite been small, with the private sector receiving upward of 90 percent of the total (Table 30). Consumption loans, as a percent of total private sector credit, declined during 1995-96, after steady increases over the past several years, reflecting, in large part, the high level of real interest rates and increased attention now being paid to the creditworthiness of borrowers and the quality of pledged collateral.4 Loans to businesses, particularly those going to service sector enterprises and to other financial institutions, increased as a share of the total, while those for agriculture, construction, and real estate declined slightly. The latter may reflect the growth of specialized credit institutions and the attraction of relatively lower interest rates they charge on loans (see below).

20. Commercial banks’ loan/deposit ratio has shown a declining trend, reflecting higher reserve requirements as well as the attraction of holding investment assets (including government securities) as substitutes for loans. The overall loan/deposit ratio (including in foreign currency) declined sharply from 85 percent in 1993 to 64 percent in 1994 as the reserve requirement was raised and banks significantly increased their holdings of public and private sector securities. In 1996, banks’ investment portfolio grew to over 40 percent of deposit liabilities, while the size of the loan portfolio was largely unchanged at around 65 percent of deposits.

Monetary liabilities

21. Liabilities to the private sector grew by 11.5 percent in 1995 and by 12.4 percent in 1996, implying in both years declining money velocity. These declines were in line with past trends and about normal in a low inflation environment. As a percent of GDP, liabilities to the private sector rose from just below 50 percent in 1994 to 55 percent in 1996, with a large part of this growth accounted for by the rapid expansion in banks’ quasi-money and capital and reserves liabilities (Table 28).

22. Foreign currency deposits at commercial banks have risen sharply since financial markets were liberalized in 1993. Such deposits increased from only 3 percent of banks’ total deposit liabilities in mid-1992 to 26 percent by end-October 1996. The issue of currency substitution is discussed in Section IV.D of this report

Interest rates

23. Interest rate controls were ended in mid-1994 and since then interest rate changes have reflected market forces, including the impact of monetary policy measures. Lending rates generally declined in 1995 as credit conditions were eased and the inflation rate came down sharply. Commercial banks’ lowered their prime lending rate by nearly 1 percentage point to 14 percent and the treasury bill rate declined by more than 1 percentage point to 8.5 percent. Deposit rates also declined but most rates remained positive in real terms.

24. Commercial banks’ liquidity came under severe pressure during 1996 as monetary policy was gradually tightened. Commercial banks increased their basic prime rate from 14 percent to 15.5 percent in February and further to 17.5 percent in October. Other lending rates were similarly adjusted, the yield on treasury bills rising nearly 3 percentage points to nearly 12 percent by the end of the year. Interest rates on longer maturity deposits increased significantly but remained about unchanged on lower maturity deposits, reflecting the fact that these deposits are not very sensitive to interest rate changes (Table 34).

25. The spread between commercial bank deposit and lending rates has increased over recent years and this trend continued in 1996, when the average spread rose to above 8 percentage points. The large size of the spread reflects the banks’ cost of meeting reserve requirements as well as the degree of competitiveness among banks.5

Nonbank sector

26. The nonbank financial sector, comprising finance houses, trust and mortgage companies, and thrift institutions, has grown rapidly in recent years, reflecting more favorable treatment of such institutions under current laws, as well as their specialization in areas with large growth potential6 Their combined liabilities to the private sector more than doubled between 1992 and 1996, almost twice the rate of increase of commercial bank liabilities. During 1996, their lending to the private sector, at TTS3.5 billion, was about one third that provided by commercial banks; their lending to the public sector at TT$1.2 billion, was about two thirds that of commercial banks (Table 32). The rapid expansion of the nonbank sector has been due to the advantage of lower reserve requirements and a lower interest rate spread.

D. External Sector

Exchange and trade arrangements

Exchange rate

27. On April 13, 1993, the Central Bank of Trinidad and Tobago abandoned the peg of the Trinidad and Tobago dollar to the U.S. dollar and allowed the currency to float freely. After a initial realignment, the exchange rate remained stable throughout 1994 and the first half of 1995, as the rate of inflation converged toward the rates of the main trading partners, and the real effective exchange rate remained broadly stable.

28. Downward pressures on the exchange rate emerged in the latter part of 1995 at around the time of the national elections. The authorities viewed these pressures as inconsistent with economic fundamentals, and the central bank stepped in to prevent the exchange rate from falling below TT$6 per U.S. dollar by selling foreign exchange and requiring the commercial banks to maintain special deposits at the central bank. These pressures persisted during most of 1996. In late September 1996, the central bank abandoned its support of the floor of TT$6. During October and November the rate fluctuated in the range of TT$6.06-6.20 and, at the end of 1996, stabilized at about TT$6.25.

29. External competitiveness, as measured by the real effective exchange rate, remained about unchanged between April 1993 and September 1996. In late 1996, the nominal devaluation resulted in a fall of the real effective exchange rate of some 4 percent.

Trade system7

30. Trinidad and Tobago accepted the obligations of Article VIII of the Articles of Agreement of the Fund in December 1993 and there are no restrictions on current transactions. Within the schedule of tariff reductions established by the CARICOM agreements, on January 1, 1996 the customs duty rates on most goods were reduced to a range of 0-25 percent; higher rates were maintained only for the import of: agricultural products (40 percent); luxury goods, clothing, and fabrics (25-30 percent); and motor vehicles (35 percent). On January 1, 1997 the maximum rate for most goods was reduced to 20 percent.

Balance of Payments

Overall

31. The overall balance of payments surplus narrowed to less than 1 percent of GDP in 1995 as net official inflows declined and short-term private outflows, attributed to election uncertainties, led to a negative capital account balance (Table 36). In 1996, the resumption of international borrowing by the public sector and record high private capital inflows swung the balance of payments to a strong surplus, equivalent to some 4 percent of GDP in 1996 (Table 37).

32. Gross official reserves of the central bank were about level in 1995 at US$360 million—about two months of imports of goods and nonfactor services. In conjunction with resumed international borrowing, gross official reserves increased to US$560 million in 1996, and rose to the equivalent of 3.6 months of imports.

33. The external terms of trade improved by 8 percent in 1995, led by a substantial increase in the price of crude oil and chemicals, Trinidad and Tobago’s main exports (Table 41). In 1996, however, it deteriorated by some 2 percent: although the international price of crude oil increased over its 1995 level, the prices of chemicals declined to their average levels of the last ten years while the prices of most imports increased substantially.

Current account

34. In 1995, the favorable developments of the terms of trade, the effects of tight fiscal and monetary policies, and a sizable increase in nontraditional export volumes resulted in a solid performance of the trade account and a current account surplus of some 5 percent of GDP. In 1996, however, the trade account surplus contracted sharply because of a number of factors: on the export side, there was a decline of export values after the rapid growth of the previous two years, reflecting in part a decline in export prices; on the import side, imports of raw materials and intermediate goods grew rapidly, reflecting the renewed investment activity (already evident since 1995) and some precautionary restocking related to exchange rate uncertainty. As a result, the current account surplus declined to 2 percent of GDP. Throughout the entire period under review, the service account remained in deficit but improved considerably.

Merchandise trade

35. Exports rose by 26 percent in 1995 but contracted by 2 percent in 1996 (Table 38). The increases in 1995 were primarily led by high international prices of petrochemical products and an increase in the volume of non-oil exports (Table 41). In 1996, however, the prices of chemicals returned to normal levels, and the volume of nontraditional exports declined sharply. During the period under review, Trinidad and Tobago diversified its export markets. The share of exports to the United States fell, although the absolute value sold to this destination continued to increase. The major increases in the export shares were registered by the European and Latin American destinations. Although the share of exports to CARICOM countries remained broadly constant, the absolute value sold increased (Table 40).

36. Imports rose by 37 percent in 1995 and by a further 8 percent in 1996 (Table 39), reflecting renewed investments in the petrochemical sector and precautionary restocking. Also, imports of crude oil for refining became important during periods of labor strikes in the oil fields. The United States accounted for the major share of imports, and its share increased from 43 percent in 1994 to 45 percent in 1995. Although the share of imports from CARICOM countries remained substantially constant, the absolute value sold increased (Table 40).

Services, income and transfers

37. An improvement in net earnings from communication services and a decrease in interest payments in the income account were the most relevant trends in the invisibles accounts. As a result, net outflows associated with service and income transactions decreased to US$306 million in 1995 and are estimated to have further decreased to US$275 million in 1996.

Capital account

38. Transactions on the capital account switched from a record surplus of US$285 million, (6 percent of GDP), in 1994, to a deficit of US$169 million (3 percent of GDP) in 1995 and back to a surplus of US$179 million (3 percent of GDP) in 1996 (Table 37). These fluctuations of the overall capital account reflect three distinct trends recorded in its private sector, public sector, and commercial bank subaccounts. First, the private sector capital inflows recovered to a record US$330 million in 1996 from the effects of election uncertainties in 1995, which had reduced the level of foreign direct investment and retained profits to US$103 million. This recovery was most evident in retained profits and new direct foreign investments. Second, the public sector reduced the volume of borrowing from official lenders following large divestiture operations in 1994, but returned to the market in late 1996 for US$150 million in lower cost funding. Third, commercial banks continued to accumulate foreign assets in conjunction with the expansion of credit activity associated with international trade; this trend was only temporarily suspended in the second half of 1995 when the commercial banks drew down their foreign assets to meet the increased demand for foreign currency in the domestic market.

External debt

39. The external debt to GDP ratio declined to 37 percent in 1995 and leveled off to 36 percent in 1996, reflecting the authorities’ decision to take advantage of international capital market accessibility and lower interest rates to refinance part of the external debt (Tables 42 and 43). Consequently, the debt-service export ratio declined to 17 percent in 1995 and to 14 percent in 1996. In 1996 Trinidad and Tobago’s credit rating was raised by Standard and Poors to BB+, as a result of the overall positive performance of the external sector.

1

For example, in 1988 a highly skilled “Engineer I” in the public service earned 3.3 times as much as a low-skilled “Typist I.” In 1995, however, this ratio was down to 2.9, meaning a reduction of the relative wage ratio of about 40 percentage points for the engineer.

2

Section II of this report develops a model of the labor market that explains the persistence of high unemployment in spite of large declines in the real wage.

3

To deal with these problems, the authorities requested and received technical assistance advice from the Fund which is now being implemented.

4

Bank supervision has been strengthened since the coming into effect of the Financial Institutions Act of 1993 which, among other things, provides for the enhanced scrutiny of banks’ loan portfolio and larger set-asides for substandard loans (see Section IV. C).

5

Banks’ intermediation cost, in particular the interest rate spread, is more fully discussed in Section IV.A.

6

Until mid-October 1996, reserve requirements applied to nonbank institutions remained at 5 percent of deposits while for commercial banks this was steadily increased, as noted, to 20 percent. From mid-October, reserve requirements cm all types of financial institutions were raised by 3 percentage points. The new reserve ratio of 8 percent for nonbanks is still substantially lower than the 23 percent rate applicable to commercial banks.

7

A detailed description of the exchange and trade system at the end of January 1995 is contained in Exchange Arrangements and Exchange Restrictions, Annual Report 1995, IMF. This section provides an update, to December 31 1996, of that annual report.