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.
High oil prices and increasing energy sector output have continued to provide the stimulus for expansion of the economy of Trinidad and Tobago, which marked eleven consecutive years of strong growth in 2004. More recent performance has been equally robust with forthcoming data expected to show growth in the first half of the year remaining in the region of the 6.5 percent seen in 2004.
Trinidad and Tobago’s economic strategy has focused on escaping the historical narrow dependence on oil extraction through diversification of its energy sector. This has involved the intensive development of natural gas resources and the establishment of a large-scale petrochemical and other gas-based industries, a process which was deepened in 2004 with the start-up of two new petrochemical plants. This expansion in capacity helped to fuel a robust energy sector growth rate of 7.9 percent notwithstanding the fact that crude oil production fell significantly during the period. Non-energy sector growth also strengthened appreciably in 2004, though much of this dynamism derived from developments in the energy sector.
Although inflationary pressures were relatively subdued earlier in the year, a sharp pick-up took place in the fourth quarter of 2004 and has been sustained into the current year, pushing the 12-month headline rate to 6.9 percent by September. The acceleration is being fueled largely by food prices, which in September registered a 12-month increase of 23 percent compared with an increase of 2.6 percent in core (non-food) inflation. Rising import prices have also been an important factor in both food and non-food inflation.
The resurgence in inflation and the accompanying rise in inflationary expectations have prompted a shift in the central bank’s monetary policy away from the accommodative stance in place since mid-2002. The bank increased its policy interest rate on three occasions in 2005, from 5 percent to 5.75 percent, triggering a rise of similar magnitude in commercial banks’ prime lending rates and inducing increases in money market rates as well as in long-term interest rates. In explaining the policy shift, the bank also signaled concern about growing demand pressures in the foreign exchange market and the narrowing of interest rate differentials with the United States, which could increase incentives for capital outflows.
The robust growth of the economy has had a positive impact on the labor market, with the unemployment rate averaging 8.4 percent in 2004, down from 10.5 percent the previous year, while more recent data show the rate declining further to 8 percent in June. Heightened non-oil sector activity, particularly in the construction sector as the government accelerates its housing program, and the continuation of construction projects in the energy sector seem set to drive unemployment even further down in the months ahead.
With regard to capacity constraints, the authorities acknowledge that there has been a visible tightening of labor market conditions, which they see as a key source of vulnerability for the economy. In response, the government has been attempting to address labor constraints in various sectors of the economy through the importation of skilled personnel, including medical personnel to address shortages in the health sector. At the same time, firms in the construction sector have been importing skilled labor from the Caribbean area and other sources to meet existing shortfalls.
On the external front, booming energy prices and increases in export volumes in 2004 enabled Trinidad and Tobago to double the balance of payments surplus of the previous year. However, the capital account continued to reflect a deficit, partly as a result of the domestic capital market’s expanding role as a regional supplier of funds. Reflecting the economy’s growing strength, two major international credit rating agencies announced upgrades of Trinidad and Tobago’s external debt ratings, from BBB+ to A- in the case of Standard and Poor’s, and from Baa2 to Baa3 in the case of Moody’s.
The Trinidad and Tobago authorities broadly share the staff’s assessment of the outlook for the economy and of the challenges that lie ahead. While prospects for growth appear bright over the medium term, the authorities are mindful of the growing risks to macroeconomic stability and longer-term sustainability as the economy approaches the limits of its capacity. With signs of an inflationary takeoff already present in the economy, the authorities view containment of this trend as a key short-term priority and avoidance of Dutch disease risks as a critical medium-term challenge. On this latter score, they consider the threat of Dutch disease to be less severe than during the energy boom of the 1970s given the structural changes the economy has undergone since then.
Monetary policy remains firmly committed to maintaining domestic price stability, which the authorities acknowledge is shaping to be an increasingly demanding challenge in the context of continuing strong liquidity growth. The central bank intends to remain vigilant and to act decisively to mitigate inflationary pressures. The exchange rate will be managed to provide support to the goals of monetary policy and to respond flexibly to developments in the real economy. At the same time, the central bank, in conjunction with the Fund, is continuing to look closely at ways of addressing structural peculiarities in the foreign exchange market, including its highly oligopolistic nature, to enable it to function more effectively.
Notwithstanding the challenges ahead, the authorities are determined to capitalize on the opportunity offered by the present circumstances to raise the long-term growth potential of the economy, by scaling up the level of investment in human capital and in social and economic infrastructure. Education has emerged as a key focus of the 2005/06 budget, highlights of which included the introduction of free tuition for nationals enrolled at public tertiary institutions and plans for an ambitious program to construct three new campuses for the University of Trinidad and Tobago. The UTT was recently established to ensure an output of industry-ready graduates with specialized skills and to strengthen the focus on research and development activities that are relevant to the needs of the country and industry related. Whereas these expenditures would increase the non-energy deficit, especially in the short term owing to construction outlays, the improvement in the quality of the labor force is expected over time to contribute towards a more sustained development of the non-energy sector.
With the aim of accelerating infrastructural development in line with its long-term vision and increasing the rate of implementation of its investment program, the government proposes to outsource project management responsibilities for identified projects to fifteen special-purpose state entities. This approach will enable the government to address the challenges of skill shortages and cumbersome bureaucratic procedures that have traditionally constrained implementation of the PSIP, but is not intended as a permanent mechanism. The authorities have stressed their commitment to the highest standards of good governance, transparency, and accountability in the operations of these entities.
Our authorities fully share the view that raising the level of fiscal savings, as recommended by staff, is an important element of macroeconomic policy, and of the strategy to protect the budget from the volatility of oil prices and to share the benefits of the oil and gas patrimony equitably across generations. With this in mind, the government has reconceptualized its planned revenue stabilization fund as the Heritage and Stabilization Fund and has substantially increased the size of its contributions pending formal establishment of the Fund through enactment of legislation currently being prepared with the assistance of an international consultant. While in the 2005 Budget the government had undertaken to transfer TT$1.4 billion to the Interim Revenue Stabilization Fund, it in fact transferred TT$2,593 million compared to TT$1,263.2 million in 2004. This brought the balance in the Fund to TT$5439.0 million, equivalent to about US$907 million. For fiscal 2006 government has budgeted to deposit a further TT$1,862.8 million to the Fund.
Over the longer haul structural reforms of the non-energy tax regime are expected to impact positively on the productivity of the tax base and ultimately help to attenuate the expansionary effects of the non-energy deficit. As a first step, the government has moved to simplify the direct tax regime by the removal of most special purpose allowances and has identified as potential targets for reform some aspects of the indirect tax system that are inhibiting its performance, including the level of excise tax rates, the extent of zero rating under the VAT system, and the level of VAT refunds. The government is also actively considering recommendations to expand the tax base through the introduction of a comprehensive capital gains tax and a complete overhaul of the present property tax system. In addition, the 2005-06 budget announced the establishment, in the Ministry of Finance, of a Tax Policy Unit with a mandate that includes the continuous assessment of the tax regime in Trinidad and Tobago.
In the financial system, the authorities are in the process of implementing an ambitious and far-reaching program of institutional strengthening in line with the government’s 2004 White Paper. A major focus of the reforms is the strengthening of financial sector legislation, improving regulation and supervision, and the development of a framework of cross-border supervision of financial conglomerates. The recently concluded FSAP has identified a challenging agenda which the authorities are committed to implementing as expeditiously as resources allow, and in this regard they have sought technical assistance from the Fund. Nevertheless, given resource and capacity constraints the authorities have stressed the need for prioritization and sequencing of reforms, in keeping with their own assessment of what may be feasible within given timeframes.
In closing, our authorities thank Management and staff of the Fund for their excellent support for Trinidad and Tobago and for the productive policy dialogue held in the course of the recent Article IV mission.