A. Introduction

46. The primary objective of monetary policy in Trinidad and Tobago is to achieve a low and stable rate of inflation. Monetary policy, therefore, seeks to maintain a suitable level of liquidity, in the context of domestic and external developments, that would encourage economic activity without promoting inflationary pressures. Within this context, the Central Bank of Trinidad and Tobago (CBTT) views a stable foreign exchange market, especially with the government being the major earner of foreign exchange, as critical to keeping inflation low.

47. This chapter discusses monetary and exchange rate policy in Trinidad and Tobago. Section B briefly describes the institutional setting and economic structure within which monetary and exchange rate policy is conducted. Section C outlines the framework under which monetary policy is formulated and implemented. Section D reviews the evolution of monetary and exchange rate policies. Section E concludes with some brief comments on the effectiveness of monetary and exchange rate policy in Trinidad and Tobago and future prospects.

B. Background

48. The financial system in Trinidad and Tobago is quite diversified, with a wide mix of bank and nonbank financial institutions. These include trust and mortgage finance companies, merchant banks, finance houses, insurance companies, development banks, thrift institutions, mutual funds, credit unions, venture capital companies, bureaus de change, and a number of brokerage firms. The financial system also includes a specialized mortgage institution, a Deposit Insurance Corporation, the National Insurance Board, and a Stock Exchange. Commercial banks are the major players with just under half of the total assets of the financial system.

49. The banking system is comprised of six commercial banks, two of which are foreign subsidiaries of international banking groups, while the remaining four are majority or fully locally-owned (two of which have established a commercial presence in various Caribbean territories). Most of the commercial banks have become universal banks, offering a wide range of financial products and services. While commercial banks remain the single largest group of financial institutions, by various standards—including assets, loans, and/or deposits—the share of finance houses and merchant banks in total assets has been growing in recent years (Table 1).

Table 1.

Trinidad and Tobago: Selected Financial and Economic Indicators

Source: Trinidad and Tobago authorities.

^1/Most recent data available.

^2/The repo rate (introduced in May 2002 at 5.75 percent) is the signal rate of the central bank’s monetary policy stance.

^3/Fund staff estimates.

Table 1.

Trinidad and Tobago: Selected Financial and Economic Indicators

		1998	1999	2000	2001	2002	2003	2004 1/
		(In percent of GDP)
Commercial banks
Total assets		69.5	67.5	64.1	69.6	72.8	65.7	60.3
Net credit to public sector		6.4	6.1	3.7	4.8	6.4	4.7	3.1
Credit to private sector		28.0	28.0	26.0	25.6	26.7	23.1	22.4
Trust and mortgage companies
Total assets		12.9	15.5	17.8	16.3	17.2	17.2	16.2
Net credit to public sector		1.9	1.7	2.5	1.6	1.7	2.4	2.2
Credit to private sector		9.0	10.0	11.4	11.3	11.2	11.0	9.2
Finance houses and merchant banks
Total assets		10.5	11.5	9.3	11.4	12.4	12.6	12.6
Net credit to public sector		0.9	0.9	0.5	0.4	0.7	0.5	0.4
Credit to private sector		3.4	5.0	3.6	5.2	4.5	3.9	4.7
		(In percent)
Inflation
End-of-period		5.6	3.4	5.6	3.2	4.3	3.0	3.1
Average		5.6	3.4	3.5	5.5	4.2	3.8	…
Interest rates
Three-month treasury bill		11.9	10.5	10.5	8.3	4.8	4.8	4.8
Repo rate 2/						5.3	5.0	5.0
Basic prime rate		17.5	17.3	16.5	15.0	12.4	9.5	9.5
Monetary aggregates
Base money growth		9.8	6.5	7.9	12.5	-3.9	5.3	-10.9
M3 growth		-7.4	5.6	5.9	12.6	2.7	2.0	8.4
Reserves requirement ratio
Commercial banks		21.0	21.0	21.0	18.0	18.0	14.0	11.0
Nonbank financial institutions		9.0	9.0	9.0	9.0	9.0	9.0	9.0
Memorandum items:
Exchange rate
	TT$ per US$	6.3	6.3	6.3	6.2	6.3	6.3	6.3
	REER (depreciation -)	1.9	4.8	8.2	3.9	-1.1	-6.5	1.3
Real GDP growth		7.8	4.4	7.3	4.0	7.1	13.1	6.2 3/
Nominal GDP (TT$ billions)		38.1	42.9	51.4	54.8	55.1	66.2	79.0 3/
Gross official reserves (US$ millions)		761.9	942	1,405	1,876	1,924	2,258	2662 3/

Source: Trinidad and Tobago authorities.

^1/Most recent data available.

^2/The repo rate (introduced in May 2002 at 5.75 percent) is the signal rate of the central bank’s monetary policy stance.

^3/Fund staff estimates.

View Table

Table 1.

Trinidad and Tobago: Selected Financial and Economic Indicators

		1998	1999	2000	2001	2002	2003	2004 1/
		(In percent of GDP)
Commercial banks
Total assets		69.5	67.5	64.1	69.6	72.8	65.7	60.3
Net credit to public sector		6.4	6.1	3.7	4.8	6.4	4.7	3.1
Credit to private sector		28.0	28.0	26.0	25.6	26.7	23.1	22.4
Trust and mortgage companies
Total assets		12.9	15.5	17.8	16.3	17.2	17.2	16.2
Net credit to public sector		1.9	1.7	2.5	1.6	1.7	2.4	2.2
Credit to private sector		9.0	10.0	11.4	11.3	11.2	11.0	9.2
Finance houses and merchant banks
Total assets		10.5	11.5	9.3	11.4	12.4	12.6	12.6
Net credit to public sector		0.9	0.9	0.5	0.4	0.7	0.5	0.4
Credit to private sector		3.4	5.0	3.6	5.2	4.5	3.9	4.7
		(In percent)
Inflation
End-of-period		5.6	3.4	5.6	3.2	4.3	3.0	3.1
Average		5.6	3.4	3.5	5.5	4.2	3.8	…
Interest rates
Three-month treasury bill		11.9	10.5	10.5	8.3	4.8	4.8	4.8
Repo rate 2/						5.3	5.0	5.0
Basic prime rate		17.5	17.3	16.5	15.0	12.4	9.5	9.5
Monetary aggregates
Base money growth		9.8	6.5	7.9	12.5	-3.9	5.3	-10.9
M3 growth		-7.4	5.6	5.9	12.6	2.7	2.0	8.4
Reserves requirement ratio
Commercial banks		21.0	21.0	21.0	18.0	18.0	14.0	11.0
Nonbank financial institutions		9.0	9.0	9.0	9.0	9.0	9.0	9.0
Memorandum items:
Exchange rate
	TT$ per US$	6.3	6.3	6.3	6.2	6.3	6.3	6.3
	REER (depreciation -)	1.9	4.8	8.2	3.9	-1.1	-6.5	1.3
Real GDP growth		7.8	4.4	7.3	4.0	7.1	13.1	6.2 3/
Nominal GDP (TT$ billions)		38.1	42.9	51.4	54.8	55.1	66.2	79.0 3/
Gross official reserves (US$ millions)		761.9	942	1,405	1,876	1,924	2,258	2662 3/

Source: Trinidad and Tobago authorities.

^1/Most recent data available.

^2/The repo rate (introduced in May 2002 at 5.75 percent) is the signal rate of the central bank’s monetary policy stance.

^3/Fund staff estimates.

50. The foreign exchange market has some unique features, which include:

• A small number of major foreign exchange suppliers with earnings derived from the energy sector;

• The Central Bank is an important supplier of foreign exchange to the market, as government receives energy-related taxes and royalties in foreign currency, and sells these to CBTT;

• Six licensed traders (all commercial banks) with activity dominated by one or two major players; and

• Very little activity from bureaux de change, as earnings from the tourism sector are relatively low.

51. In April 1993, exchange controls on current and capital transactions were abolished and the Trinidad and Tobago dollar was allowed to float.¹⁵ Under the floating regime, which lasted for about four years, the TT dollar depreciated substantially. However, since 1997, the exchange rate has been de facto pegged at about TT$6.3 per U.S. dollar. While, in principle, the exchange rate became market-determined, the lumpiness and volatility of foreign exchange inflows, coupled with market imperfections, required that special institutional arrangements be put in place to govern the operations of the foreign exchange market. These included:

• An Agreed Minute on the operations of the market—key elements of which were the guidelines on the daily setting of buying and selling rates, as well as the upper limit on the spread between the buy and sell rates. This cap ensured that no single foreign exchange dealer could make “super profits” on foreign exchange transactions;

• A Code of Conduct for market participants—this allowed for an appropriate dispute mechanism among foreign exchange traders; and

• A Sharing Arrangement—given the lumpiness of inflows from a few large earners, there was concern that the two largest players would dominate the foreign exchange market, and cause undue volatility in the exchange rate. This arrangement allowed foreign exchange purchases to be shared equally among dealers.

52. The CBTT has a key role in the foreign exchange market in Trinidad and Tobago. As the central bank is the major recipient of foreign exchange, it must supply the market with foreign currency to avoid large reserve increases that could be difficult to sterilize.¹⁶ While some central banks in similar positions seek to establish rules for intervention that limit the effect on the exchange rate, in recent years the CBTT has maintained a de facto peg and supplied foreign exchange to the market as required. There is a tacit agreement among market participants that the exchange rate should not move outside of a notional band.

53. With over 30 percent of the budget financed from energy-related taxes, paid in foreign currency and sold to the CBTT, the non-energy fiscal deficit is a major source of liquidity in the banking system. The cumulative fiscal injection from this deficit was usually around TT$500 million (2.7 percent of 1997 GDP) per annum.

C. Framework Underlying Monetary Policy

54. The framework for monetary policy originates in the Central Bank of Trinidad and Tobago (CBTT) Act (1964). The Act (amended in 1994) defined the Bank’s purpose as “…the promotion of such monetary, credit and exchange rate conditions as are most favorable to the development of the economy of Trinidad and Tobago.” In pursuit of this goal, the Bank conducts monetary policy to achieve a low and stable rate of inflation. Given the sensitivity of domestic prices to exchange rate movements, the central bank views the maintenance of an orderly foreign exchange market as an important factor in the formulation and implementation of monetary policy.

55. The financing of the budget is a key factor in the formulation and conduct of monetary policy, as this is a major source of liquidity in the system. Once the budget is approved, the CBTT makes an estimate of how much open market operations (OMOs) would be required to manage liquidity based on fiscal needs, and a confluence of other factors, which include current and projected macroeconomic developments, particularly in the energy sector, and the timing of government bond issues. The CBTT’s estimate of OMOs is approved by the Minister of Finance as part of the budgetary process.

56. Historically, the framework for monetary policy may be separated into two distinct periods—prior to and after 1996. Prior to 1996, monetary policy was conducted through direct instruments—mainly reserve requirements, the rediscount rate, and selective credit controls, supported by moral suasion. Since 1996, open market operations, mainly through outright sales of short-term government securities (largely three-month treasury bills), have became the major monetary policy instrument. While there is currently no formalized operational framework for the execution of monetary policy, the CBTT has in place a system of primary dealers (all commercial banks) through which open market auctions are transacted.¹⁷ OMOs are conducted to influence the level of interest rates in the short term money market. The central bank, therefore, maintains daily contact with market participants to obtain information on market activity, and to apprise them of existing and/or projected levels of liquidity and other developments, including credit conditions.

57. The central bank introduced a new framework in May 2002 based on the use of its repo rate to signal the stance of monetary policy. The main features of this new arrangement are outlined in Box 1 below. When the new framework was introduced, the CBTT resolved to keep excess liquidity at low levels in order to enhance the effectiveness of the repo rate as a policy signal. Consequently, over the 12-month period ending October 2002, the CBTT sold almost TT$1.7 billion interest-bearing treasury notes, which resulted in a substantial reduction in the Special Deposit Account. Since then, the CBTT has conducted OMOs almost daily.¹⁸

58. The impact of open market operations in Trinidad and Tobago is felt mainly through short-term interest rates, as the value of the currency has remained basically unchanged for several years. Open market operations, through sales of short-term government securities, influence short-term interest rates through changes in liquidity. Appropriately timed intervention in the foreign exchange market, through sales of foreign currency, also serves to reduce excess liquidity in the banking system. Short-term interest rates are also affected through changes in reserve requirements. In October 2003, the CBTT announced a phased reduction in the reserve requirement for commercial banks from 18 percent to 9 percent by March 2005. In order to offset the impact of this monetary injection on the economy, special issues of government bonds will continue to be issued simultaneously to absorb the resources released.

D. Evolution of Monetary and Exchange Rate Policy

59. Institutional arrangements in the immediate post-Independence era left little or no room for an active monetary policy in Trinidad and Tobago. The country remained under the Sterling Area arrangements, the key elements of which were free convertibility and maintenance of a fixed parity with sterling. By the mid-1970s, the importance of sterling in Trinidad and Tobago’s external transactions had been long superseded by that of the U.S. dollar. This, together with a steep and steady depreciation of the international value of sterling, led to the breaking of the sterling peg in May 1976, in favor of a link with the U.S. dollar at a rate of TT$2.40=US$1.

60. From 1974–82, the economy of Trinidad and Tobago performed extremely well, reflecting the sharp increase in oil prices. As oil prices subsequently began to weaken and economic activity declined, resulting in large fiscal and external payments deficits, economic policy shifted toward stabilization. Within this context, the CBTT raised the discount rate from 6.00 to 7.50 percent in 1983, and set the CRR at 17 percent. However, as economic activity continued to decline, the CBTT eased monetary policy slightly in 1986 by (i) lowering the CRR from 17 percent to 15 percent, (ii) negotiating a reduction in commercial bank interest rates; and, (iii) relaxing installment credit guidelines.

61. The recession in 1983, compounded in 1986 with the collapse of oil prices, led Trinidad and Tobago to adopt an IMF-sponsored stabilization and structural adjustment program in 1988, which included the reform of the financial system. This heralded a process of reform and liberalization of the economy, which culminated into a shift to a flexible exchange rate regime in 1993 and correspondingly, a fundamental change in the conduct of monetary policy. The focus of monetary policy shifted to short-term liquidity management, through the use of market-oriented policy instruments, and away from direct instruments of monetary control. The CBTT used open market operations, supported by appropriately-timed intervention in foreign exchange market, to manage liquidity.

62. During 1994–98, the central bank’s sales of foreign exchange were limited, though there were periods of greater need for such sales, associated with the lumpiness in foreign currency inflows from the energy sector. During 1993–95, the CBTT’s sales in the foreign exchange market amounted to US$42 million, compared to purchases from commercial banks of US$150 million. By end-1996 this was reversed, with the CBTT selling US$102 million to the market, reflecting in part uncertainties associated with the change in political administration.

63. As the demand for foreign exchange rose toward the end of the nineties, the CBTT became more active on the selling side of the market, which had the effect of stabilizing the exchange rate. Recent years have been marked by a shift in the capital account of the balance of payments toward higher investment outflows.¹⁹ In 2003, the CBTT sold almost USS500 million to the market, up from US$309 million in 2002 (compared to a small net purchase from commercial banks in 2001).

64. Over the last two years, the CBTT has pursued an accommodating monetary policy in the context of weak credit demand, slow growth of the non-energy sector, low inflation, a strong balance of payments, and record low international interest rates. The benchmark repo rate was reduced to 5.25 percent in September 2002 from 5.5 percent. Short-term money market rates, and commercial bank interest rates, have moved broadly in line with the changes in the repo rate. In September 2003, the repo rate was again lowered to 5 percent. In a further effort to bring interest rates down and in keeping with the announced phased reduction in CRR, reserve requirements were reduced from 18 percent to 14 percent in October 2003.²⁰ These actions led to a decline in interest rates, and contributed to a sharp increase in credit to the private sector of 19 percent for the 12-month period ending April 2004.

E. Conclusion

65. Monetary and exchange rate policy in Trinidad and Tobago has been fairly successful in containing inflation (with increases in retail prices averaging about 4½ percent over the last 10 years), albeit above that of its major trading partners. Excluding food prices, which tend to be volatile, core inflation averaged some 1 percent a year. Given the structure of the foreign exchange market and the potential for wide fluctuations in the exchange rate, associated with highly volatile oil prices, the central bank had to supply the market with foreign exchange to cover periodic shortfalls. This has resulted in an orderly foreign exchange market, and a stable exchange rate, considered crucial for keeping inflation low in a system dominated by foreign exchange inflows to the government.

66. The central bank’s expanded monetary policy framework has improved transparency and the transmission of monetary policy signals. The market appears to recognize the repo rate as the key indicator of the prevailing monetary policy stance, and short term rates do appear responsive to changes in it.

67. The authorities have moved to strengthen monetary policy further with the introduction of an expanded auction system in July 2004. The system now includes long-term government securities, and a broader primary dealer arrangement to include nonbank financial institutions in the open market auctions. This is intended also to promote the development of a secondary market in government securities, and is expected to further enhance the efficacy of monetary policy The move toward harmonization of reserve requirements across financial institutions will further support these objectives.