Trinidad and Tobago
2005 Article IV Consultation: Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Trinidad and Tobago
Author: International Monetary Fund
Publication Date:
01 Feb 2006
eISBN:
9781451837650
Language:
English
Keywords:
ISCR; CR; economy; government; Trinidad and Tobago authorities; U.S. dollar; oil price; stabilization fund; current account; labor market; balance of payments; public expenditure; unemployment rate; Oil prices; Inflation; Caribbean
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This 2005 Article IV Consultation highlights that the macroeconomic performance and financial developments in Trinidad and Tobago are currently being driven by a highly favorable external environment. Surging oil prices have strengthened the external current account balance, financed an expansion of aggregate demand, and contributed to high levels of liquidity in the financial system. There are tentative signs that the economy is producing at, or near, capacity, and inflation pressures are emerging. Financial markets have generally been buoyant in reflection of the ample liquidity.

Abstract

This 2005 Article IV Consultation highlights that the macroeconomic performance and financial developments in Trinidad and Tobago are currently being driven by a highly favorable external environment. Surging oil prices have strengthened the external current account balance, financed an expansion of aggregate demand, and contributed to high levels of liquidity in the financial system. There are tentative signs that the economy is producing at, or near, capacity, and inflation pressures are emerging. Financial markets have generally been buoyant in reflection of the ample liquidity.

I. Introduction

1. Trinidad and Tobago is a small energy-rich Caribbean economy. The oil and gas sector, including downstream activities, currently accounts for about 40 percent of GDP, over 80 percent of exports, and approximately half of government revenues. However, its contribution to employment is less than 5 percent. Within the Caribbean, Trinidad and Tobago has become a major financial center and a source of capital for regional entities, including sovereigns. Trinidad and Tobago is one of the larger Caribbean nations in terms of GDP and population. Its energy wealth has enabled it to achieve one of the higher standards of living in the region. Nevertheless, income inequality and poverty rates are only at about regional averages, and social and ethnic tensions remain high.

Trinidad and Tobago and the Caribbean: Selected Indicators

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Sources: IMF and World Bank estimates.

Human development index.

Averages for Caribbean except GDP and population, which are totals.

Highest and lowest for each category.

uA01fig01

Energy in the Economy, 2004 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2006, 032; 10.5089/9781451837650.002.A001

Source: Fund staff estimates.1/ For countries other than Trinidad and Tobago, estimated based on earlier years and 2004 oil prices.

2. The political balance is delicate. In recent years, political affiliation has largely split along ethnic lines. The current government, formed by the People’s National Movement party, took office in early 2003 after three successive elections in as many years. The government does not have the qualified parliamentary majority required for many important decisions, significantly complicating the task of policy-making. The next elections are not due until 2007 but may be called earlier—the political environment is already charged in anticipation.

3. Earlier Article IV consultations have emphasized fiscal and financial sector issues, which the authorities are addressing in large part. In fiscal areas, the authorities are proceeding with tax reform and establishing a permanent oil fund. There has, however, been little progress in reforming fiscal management policies and practices. As regards the financial sector, the authorities are implementing their ongoing reform program embodied in the 2004 White Paper. With Fund and Bank assistance, and in conjunction with the current annual consultations, an assessment of the financial sector was also carried out during 2005.

II. Recent Economic Developments

4. Macroeconomic performance and financial developments are being driven by a highly favorable external environment. Surging oil prices have strengthened the external current account balance, fueled the expansion of domestic absorption, and contributed to high levels of liquidity in the financial system. There are tentative signs that the economy is producing at, or near, capacity and inflationary pressures are emerging.

5. The balance of payments is in large surplus. Exports rose by US$1.2 billion (10 percent of GDP) in 2004, significantly outpacing import growth and lifting the current account surplus to 14½ percent of GDP from 9 percent of GDP in 2003. While some of the higher current account receipts were offset by private capital outflows, the overall balance of payments surplus still doubled to US$0.7 billion (6 percent of GDP). With oil prices rising further, these trends are accelerating in 2005—the foreign assets of both the commercial banks and the central bank have continued to rise rapidly this year.

uA01fig02

Oil Price and Foreign Assets 1/

Citation: IMF Staff Country Reports 2006, 032; 10.5089/9781451837650.002.A001

Sources: Trinidad and Tobago authorities; and Fund staff estimates.1/ Banking system.
uA01fig03

Oil Price and Fiscal Balances

Citation: IMF Staff Country Reports 2006, 032; 10.5089/9781451837650.002.A001

Sources: Trinidad and Tobago authorities; and Fund staff estimates.

6. In recent years, the nonenergy fiscal deficit has widened substantially due to higher expenditures, although the overall balance remains in surplus. An already expansionary budget for FY 2004/05 was supplemented by a mid-year amendment that implied a deterioration of the central government’s nonenergy deficit (the overall deficit, excluding energy revenues) by 4½ percent of GDP in a single year.1 While budgetary execution was initially running behind schedule, the authorities’ preliminary estimates indicate a sharp pick-up in spending during the last few months of the fiscal year that ended in September 2005. Nevertheless, as the increase in energy revenues outpaced the expansion of the nonenergy deficit, the overall surplus is estimated to have increased in FY 2004/05, to about 3¼ percent of GDP from 2 percent the previous year.

7. The economy is growing robustly on the back of the strong balance of payments and the expansionary fiscal stance. Real GDP grew by 6½ percent during 2004. While this is lower than the outturn of 13 percent growth during 2003, the latter was driven primarily by the coming on stream of some large energy projects. The nonenergy sector has remained vigorous, growing by just under 6 percent on the back of a surge in government spending financed by the oil bonanza. The latter has also led to a boom in construction. The unemployment rate fell to single digits and ended 2004 at 7¾ percent, the lowest in about four decades.

uA01fig04

Real GDP Growth and Unemployment

(In percent)

Citation: IMF Staff Country Reports 2006, 032; 10.5089/9781451837650.002.A001

Sources: Trinidad and Tobago authorities; and Fund staff estimates.
uA01fig05

Inflation and Interest Rate

(In percent)

Citation: IMF Staff Country Reports 2006, 032; 10.5089/9781451837650.002.A001

Sources: Trinidad and Tobago authorities; and Fund staff estimates.

8. Monetary conditions have largely been accommodative, although signs of accelerating inflation have led to a recent shift toward tightening. The monetization of energy receipts by the government to finance the nonenergy deficit is the major source of liquidity injection into the financial system. The monetary impact of these injections was amplified in 2004 by changes in commercial banks’ reserve requirements.2 As a result, monetary conditions were easy throughout 2004 and early this year. This ample liquidity, coupled with the structural segmentation of the foreign exchange market, has helped soften pressures for an appreciation of the currency—at end-September, the exchange rate stood at TT$6.25 per U.S. dollar, little changed from the average level of about TT$6.30 per U.S. dollar that has prevailed for the past several years. Signs of inflation pressures have, however, recently emerged—headline inflation has crept up to 7 percent for the 12-month period ending in September 2005, up from 2¾ percent a year and a half ago. In response, the Central Bank of Trinidad and Tobago (CBTT) has raised the benchmark repo rate on three occasions this year, each time by 25 basis points. However, following the successive rounds of tightening in the United States, the differential vis-à-vis U.S. interest rates remains narrower than at the start of the year and the real interest rate is negative.

9. Consumers are being shielded from rising international oil prices. Electricity, water and petroleum products, whose prices are administratively fixed, account for nearly 10 percent of the retail price index basket. There have been no substantive increases in administrative prices for petroleum products since 2003, leaving local gasoline prices currently at about two-thirds of the level in neighboring Caribbean countries. Electricity prices have also been unchanged for several years. Direct budgetary subsidies for petroleum products and electricity amounted to nearly 2 percent of GDP during FY 2004/05.

10. Financial markets have generally been buoyant in reflection of the ample liquidity, and credit ratings are up. Insurance, pension funds, finance companies, and mutual funds—belonging to a few regionally active conglomerates—have all experienced rapid asset accumulation, with mutual fund investments reaching roughly two-thirds of bank assets and stock market capitalization approaching 140 percent of GDP in 2004. The financial system as a whole increased credit to the private sector by 18 percent in 2004, a leap compared with single-digit annual growth since 2001. The banking soundness indicators generally improved in 2004, as the capital adequacy ratio increased to 22.7 percent and return on assets reached 3.7 percent. The overall stock market index climbed by 55 percent during 2004 and by a further 15 percent through May 2005 before falling back to the end-2004 level. In August 2005, Standard and Poor’s raised the sovereign foreign currency debt rating to A-, providing a boost also to the credit worthiness of local companies.

11. The budget for FY 2005/06 submitted to parliament on September 28, 2005 envisages a significant further expansion of the nonenergy deficit, to be financed by higher energy revenues. The authorities reoriented the tax system to generate greater collections from the energy sector while sharply reducing income tax rates and expanding allowances for the nonenergy sector. As a result, several hundred thousand taxpayers have been removed from the tax net. The authorities also introduced numerous other changes to both direct and indirect taxes. Altogether, nonenergy revenue receipts are expected to decline by some 3¾ percent of GDP during FY 2005/06. At the same time, expenditures are budgeted to increase by a further 2 percentage points of GDP, relative to the estimated outturn for FY 2004/05, including on account of a number of one-off items. Cumulatively, this implies a doubling of the central government’s nonenergy deficit over two years—from 9¼ percent of GDP in FY2003/04 to 18¼ percent of GDP now projected for FY 2005/06. Just over half of this deterioration, or 5¼ percentage points of GDP, is on account of higher non-interest expenditures, mostly under the “current” heading (Tables 1 and 2). A large overall surplus is nevertheless still projected for FY 2005/06 on account of increased energy revenues.

Table 1.

Trinidad and Tobago: Selected Economic and Financial Indicators

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Sources: Trinidad and Tobago authorities; and Fund staff estimates and projections.

The data refers to fiscal years 2000/2001–2008/09.

Refers to gross debt. The baseline projections assume a significant increase in government deposits at the CBTT, and accordingly lower net debt.

For 2005, average up to July.

Defined as expenditure minus nonenergy revenue of the central government.

Table 2.

Trinidad and Tobago: Summary of Central Government Operations

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Sources: Trinidad and Tobago authorities; and Fund staff estimates and projections.
Table 3.

Trinidad and Tobago: Consolidated Nonfinancial Public Sector

(In percent of GDP)

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Sources: Trinidad and Tobago authorities; and Fund staff estimates and projections.

Refers to gross debt. The baseline projections assume a significant increase in government deposits at the CBTT, and accordingly lower net debt.

Includes BOLT and leases.

Includes Public Transport Company, Electricity Company, Water Authority, Airport Authority and Port Authority.

Includes CARONI, MTS, NFM, NFM, NHSL, NPMC, NQCL, NGC, PETROTRIN, PLIPDECO, SWMCOL, TIDCO, TANTEAK, TRINGEN, TTST, and UDECOTT. Data for National Housing Authority was not available.

Table 4.

Trinidad and Tobago: Summary Accounts of the Central Bank

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Source: Central Bank of Trinidad and Tobago.

Proceeds of treasury bills and treasury notes used for open market operations.

Table 5.

Trinidad and Tobago: Monetary Survey

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Source: Central Bank of Trinidad and Tobago.

Include investment note certificates, secured commercial paper, and other asset-backed instruments.

Table 6.

Trinidad and Tobago: Summary Balance of Payments

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Sources: Central Bank of Trinidad and Tobago, Central Statistical Office; and Fund staff estimates and projections.

Includes net errors and omissions.

III. Outlook for 2005–06 and the Medium Term

12. In the short run, Trinidad and Tobago’s outlook remains favorable, owing to high oil prices and expanding energy production. In the baseline scenario, overall real GDP growth is expected to pick up modestly, to 6¾ percent in 2005, and accelerate to over 10 percent in 2006 before stabilizing at around 3 percent over the medium term. The spike is mostly due to the expected coming-on-stream in late 2005 of a new liquefied natural gas (LNG) facility. As regards the nonenergy sector, despite some moderation, growth is projected to be higher during 2005–06 than the recent average. Buoyant demand from the expanding government sector should, in particular, provide a further boost to overall activity, offsetting some weakening of agriculture. Emerging capacity constraints imply, nevertheless, that some of this demand will inevitably manifest itself in higher prices. Core inflation is, therefore, projected to pick up further in 2005–06. The impact on headline inflation of the expansionary fiscal stance should, however, be less pronounced, if food prices, responsible for most of the recent increase in overall inflation, stabilize as expected. All in all, consumer price inflation for 2006 is projected at 8 percent, up sharply from the range of 3–4 percent during 2001–03, prior to the oil-price induced boom.

13. Current staff baseline projections envisage high energy receipts and robust growth also into the medium term. Under currently projected extraction rates for natural resources and expected WEO oil prices, the current account surplus will remain very large, albeit on a declining trend over the medium term. Annual growth of the nonenergy sector is projected to stabilize at about 4–4½ percent over the medium term, broadly in line with the average outturn during 2001–04. Overall GDP growth would be slightly lower as growth in the energy sector decelerates after the completion of the LNG plant. The nonenergy deficit should gradually improve beyond FY 2005/06 if, as the authorities currently envisage, one-off items from this year’s budget are not replaced and the nonenergy tax base is expanded and compliance improved (see paragraph 31). This would then enable inflation to gradually trend downwards, albeit remaining above that of recent years throughout the medium term.

14. The macroeconomic environment is likely to be less benign if large nonenergy deficits persist. An illustrative scenario considers the impact of overall expenditures remaining broadly at budgeted FY 2005/06 levels in relation to GDP (implying an increase in non-interest expenditures as interest costs are forecast to decline with continuing overall fiscal surpluses) (Table 7 and Figure 1). In this scenario, the fiscal stance would aggravate pressures for a real exchange rate appreciation (Box 1). While in the short run, output could be somewhat higher than under the baseline, the demand pressures could lead to entrenched high inflation, crowd out the private sector, and ultimately have a detrimental impact on growth prospects over the longer term. The build-up of windfall savings would be less than in the baseline, also implying, with unchanged energy reserves between the two scenarios, that there would be less wealth from energy resources available for the future.

Table 7.

Trinidad and Tobago: Illustrative Medium-Term Scenarios

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Sources: Trinidad and Tobago authorities; and Fund staff estimates and projections.

Fiscal data refers to fiscal years ending September 30.

Refers to gross debt. The baseline projections assume a significant increase in government deposits at the CBTT, and accordingly lower net debt.

Figure 1.
Figure 1.

Trinidad and Tobago: Alternative Medium-Term Macroeconomic Outlook

Citation: IMF Staff Country Reports 2006, 032; 10.5089/9781451837650.002.A001

Source: Fund staff estimates.1/ Cumulative central government overall balance.

Oil Prices and the Real Exchange Rate

A permanent increase in oil prices could exert significant upward pressures on the long-term real exchange rate of the Trinidad and Tobago dollar. The precise magnitudes remain very uncertain; depending, inter alia, on the response of private capital flows and other Trinidad and Tobago-specific parameters, including relative preferences between imports and domestically produced goods. However, two simple conceptual frameworks, using parameters obtained from cross-country studies, are suggestive of sizeable pressures emerging.

The first approach draws on the outcome of an extensive study undertaken by the Fund’s Research Department.1 The cross-country study has identified four variables (net foreign assets, relative per capita income, relative manufacturing output, and commodity prices) as core factors behind the movements of the real exchange rates of 39 countries between 1980 and 2003. According to the long-term relationship identified by the study, an improvement in the terms of trade by 10 percent raises the equilibrium real exchange rate by about 5 percent, after controlling for the effects of other variables. Relative to mid-2004, current WEO projections imply an improvement in Trinidad and Tobago’s terms of trade by nearly 30 percent over the medium term.

The second approach considers the extent of real exchange rate realignment required to offset current account imbalances caused by a large swing in the terms of trade.2 Standard assumptions about capacity constraints, labor mobility and income elasticity of consumption imply that for every 1 percent increase in permanent income, consumption of traded goods would need to rise by about 2 percent in Trinidad and Tobago in order to balance supply and demand in goods and labor markets. Depending on the elasticity of substitution between traded and nontraded goods, the adjustment in relative prices necessary to bring about such an adjustment may be of a broadly similar magnitude. A simple calibration suggests that the long-term purchasing power of the population of Trinidad and Tobago may have risen by some 10 percent due to the recent rise in trend oil prices, implying that if high oil prices persist, the real exchange rate may need to move by as much as 20 percent over the medium term.

1/

Equilibrium Real Exchange Rates: Estimates for Industrial Countries and Emerging Markets (mimeo, June 2005).

2/

Obstfeld, Maurice and Kenneth Rogoff, “Perspectives on OECD Capital Market Integration: Implications for U.S. Current Account Adjustment,” in Federal Reserve Bank of Kansas City, Global Economic Integration: Opportunities and Challenges, March 2000, pp.169–208.

Table 8.

Trinidad and Tobago: Indicators of External and Financial Vulnerability

(In percent of GDP, unless otherwise indicated)

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Sources: Central Bank of Trinidad and Tobago; Standard and Poor’s; Trinidad and Tobago Stock Exchange; and Fund staff estimates and projections.

Long-term foreign currency rating upgraded in June 2004.

Include commercial banks only.

As at end-August.

Weighted average discount rate.

Adjusted for inflation.

Table 9.

Trinidad and Tobago: Public Sector Debt Sustainability Framework, 2000–10

(In percent of GDP, unless otherwise indicated)

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Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.

Derived as [(r-π(1+g) -g+αε(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with γ interest rate; π growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and ε = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as γ-π(1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

On a fiscal year basis (Table 10 is based on calendar years).

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Figure 2.
Figure 2.

Trinidad and Tobago: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2006, 032; 10.5089/9781451837650.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance.3/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2006, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).
Table 10.

Trinidad and Tobago: External Debt Sustainability Framework, 2000–10

(In percent of GDP, unless otherwise indicated)

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Derived as [r - g - ρ (1+g) + εα (1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, ε = nominal appreciation (increase in dollar value of domestic currency), and α = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(1+ g) + εα(1+ r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (ε > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both noninterest current account and nondebt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.