Trinidad and Tobago
2008 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Trinidad and Tobago
Author: International Monetary Fund
Publication Date:
03 Mar 2009
eISBN:
9781451837711
Language:
English
Keywords:
ISCR; CR; authority; Trinidad and Tobago economy; economy; price pressure; foreign currency; GDP deflator; fiscal year; banking sector; energy price; Energy prices; Inflation; Global; Caribbean
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The staff report for the 2008 Article IV Consultation of Trinidad and Tobago highlights economic developments and policies. Faced with a prospective decline in energy resources, the government has embarked on an ambitious development and diversification strategy. External vulnerability is low as a result of large international reserves and low debt ratios, and the banking sector has entered the period of global turmoil from a position of strength and with little reliance on external borrowing.

Abstract

The staff report for the 2008 Article IV Consultation of Trinidad and Tobago highlights economic developments and policies. Faced with a prospective decline in energy resources, the government has embarked on an ambitious development and diversification strategy. External vulnerability is low as a result of large international reserves and low debt ratios, and the banking sector has entered the period of global turmoil from a position of strength and with little reliance on external borrowing.

I. Background

Supported by a booming energy sector, Trinidad and Tobago’s recent economic performance has been impressive (Table 1 and Figure 1). During 2002–07, real GDP growth averaged 9 percent; per capita income doubled in U.S. dollar terms; both the unemployment rate and the public debt ratio were halved; and the country has acquired one of the strongest credit ratings in the region. Improvements in social, political, and competitiveness indicators, however, have lagged the country’s economic successes.

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.

2008 column refers to data for January-October 2008.

The data refers to fiscal years.

Defined as non-energy revenue minus expenditure of the central government.

Excluding debt issued for sterilization.

2008 column refers to data for December 15, 2008.

Simple average of three spot prices; Dated Brent, West Texas Intermediate, and the Dubai Fateh.

Figure 1.
Figure 1.

Trinidad and Tobago: Comparative Macroeconomic Performance

Citation: IMF Staff Country Reports 2009, 078; 10.5089/9781451837711.002.A001

Sources: Trinidad & Tobago authorities; IMF/WEO; and Fund staff calculations.Note: TTO stands for Trinidad & Tobago, VEN for Venezuela, RUS for Russia, GCC for Gulf Cooperation Council, LAC for Latin America and the Caribbean, CAR for members of CARICOM, excluding Haiti, and ENERGY for Russia, Venezuela, and the GCC (unweighted average).

Selected Caribbean Countries—Key Economic, Social, and Political Indicators

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Sources: IMF World Economic Outlook, World Bank Governance Indicators, World Economic Forum Indices, Transparency International, and UNDP.

A low rank or high percentile indicate relative strength.

2. Faced with a prospective decline in energy resources, the government has embarked on an ambitious development and diversification strategy. With the energy sector, including petrochemicals, accounting for nearly half of GDP, close to 90 percent of recent exports, and almost 60 percent of central government revenue, the prospective depletion of reserves over the next 20 years will require a major economic transformation. The government’s Vision 2020 lays out its strategy for managing this process, with the aim of attaining developed-country status by 2020. It relies on using the gradually declining energy revenues to support downstream activities and a diversified non-energy sector through subsidies and public investment in infrastructure, education, and social programs. However, the associated fiscal stimulus has fueled excess liquidity and inflation.

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Source: Trinidad and Tobago authorities and 2008 Statistical Review, British Petroleum.1/ Data include only proven reserves of oil and gas, and refer to the resource that would be depleted last under current production volumes. TTO - Trinidad & Tobago, COL - Colombia, ECU - Ecuador, RUS - Russia and VEN - Venezuela.

II. Recent Developments and Near-Term Outlook

3. Direct spillovers from the international financial crisis have been limited, but the country is not immune from contagion (Box 1). External vulnerability is low as a result of large international reserves and low debt ratios, and the banking sector has entered the period of global turmoil from a position of strength and with little reliance on external borrowing. This has limited direct spillovers and should contain the risk of liquidity shocks transmitted through foreign parent banks, should these come under stress. Nevertheless, risks could arise from exposures of large and complex financial conglomerates that operate across the region and deteriorating balance sheets in the event of a further sharp drop in energy and asset prices. In light of Trinidad and Tobago’s position as a regional financial center, its institutions are exposed to potential economic difficulties in neighboring countries, and problems in Trinidad and Tobago could have important ripple effects throughout the Caribbean.

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Source: Trinidad and Tobago authorities.

4. While energy production has slowed, the expansion of the non-energy sector has led to capacity constraints and, together with rising food prices, to double-digit inflation. After an impressive boom period, energy production is slowing, and overall growth is projected to decelerate to 3½ percent this year, down from 5½ percent in 2007 (Figure 3). However, growth in the non-energy sector has remained robust, and with record low unemployment and sharply rising food prices, inflation has accelerated to a projected average of 11¾ percent in 2008—despite a lack of pass-through of the earlier spike in global energy prices.

Figure 2.
Figure 2.

Trinidad and Tobago: Potential Spillovers from Global Financial Crisis

Citation: IMF Staff Country Reports 2009, 078; 10.5089/9781451837711.002.A001

Sources: Bloomberg, JP Morgan, Datastream and Trinidad and Tobago Stock Exchange.1/ RBTT was acquired by Royal Bank of Canada in June 2008.
Figure 3.
Figure 3.

Trinidad and Tobago: Real Sector Developments and Outlook

(In percent, unless otherwise indicated)

Citation: IMF Staff Country Reports 2009, 078; 10.5089/9781451837711.002.A001

Sources: Trinidad & Tobago authorities; and IMF staff estimates.

Potential Spillovers from Global Financial Crisis

Trinidad and Tobago is well placed to weather the crisis (Figure 2):

  • External vulnerability is low, as demonstrated by a large current account surplus, official reserves that cover about 10 months of imports and more than 100 percent of broad money, favorable credit ratings, and comparatively low risk spreads on government bonds.

  • Disruptions in financial markets have been limited, as both money and foreign exchange markets have continued to function normally. However, the possibility of contagion and an associated tightening of market conditions cannot be ruled out, if global tensions persist.

  • Banks have entered the global financial turmoil from a position of strength, being well capitalized, liquid, and profitable. Although four institutions, comprising about half of all banking sector assets, are owned by Canadian and U.S. parents, banks are funded mainly through domestic deposits and equity, as opposed to external borrowing. This has helped contain direct spillovers.

  • Institutional arrangements have also alleviated vulnerabilities. The requirement that insurance companies must hold at least 80 percent of their statutory funds in domestic assets has limited their exposure to foreign assets. Also, the upper threshold of the deposit insurance system, while not high, implies a large coverage.

However, Trinidad and Tobago’s financial sector and economy are not immune from contagion, with the following channels warranting particular attention:

  • Large financial conglomerates. The financial system is dominated by conglomerates, with engagements in commercial banking, investment banking, insurance businesses, as well as non-financial activities. The 2005 FSAP pointed to high levels of cross-shareholding and related lending across various subsidiaries, as well as considerable leverage at the group level. Moreover, a substantial portion of major conglomerates’ revenue, in a range of 20–40 percent, is attributed to activities in the wider Caribbean. Thus, a shock originating in one country could be rapidly transmitted throughout the region.

  • Exposure to energy prices. A further sharp deterioration in energy prices could have significant adverse implications, particularly if it forces a strong fiscal retrenchment with spillovers to domestic consumption, investment, and consequently, asset prices—notably real estate and equity. This would, in turn, affect bank collateral against the backdrop of recent buoyant growth in consumer loans, as well as asset positions of insurance companies and pension funds, that are heavily invested in the domestic stock market.

  • Size of financial sector. A financial sector crisis would also have significant direct income and wealth effects, with financial services accounting for about one-quarter of non-energy GDP, 9 percent of total employment, and 70 percent of the country’s stock market capitalization at end-2007 (corresponding to about 50 percent of GDP).

5. Following years of expansionary policies, declining energy revenues will lead to a deterioration in the fiscal position. While the government’s balance sheet improved over the past five years, due to booming energy prices, the non-energy deficit doubled to about 15 percent of GDP (28 percent of non-energy GDP) in FY2007/08 (Table 3). This reflected high capital spending but also rapidly growing transfers and subsidies. The 2008/09 budget (October – September) was based on an oil price of $70 per barrel and would have implied broadly unchanged expenditures, as a share of GDP. However, with updated energy price projections, the same spending envelope would now translate into a deficit of about 3½ percent of GDP.

Table 2.

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.

In millions of US$, end of period.

Table 3.

Trinidad and Tobago: Summary of Central Government Operations 1/

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Sources: Data provided by the Trinidad and Tobago authorities; and Fund staff estimates and projections.

Fiscal year data from October to September.

Excluding debt issued for sterilization.

World Economic Outlook; fiscal year basis.

Trinidad & Tobago: Selected Fiscal Indicators, 2004–08 1/

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Sources: Country authorities; and Fund staff estimates.

Central government operations are reported on a fiscal year basis, with 2004 corresponding to 2003/04 (Oct.-Sept.).

Based on latest WEO energy price projections.

Excluding debt issued for sterilization.

6. The fiscal expansion has also complicated monetary policy, especially in the context of a de facto peg to the U.S. dollar. The Central Bank of Trinidad and Tobago (CBTT) has responded to the rapid expansion in broad money, driven by the fiscal spending of large energy revenues, with successive increases of the repo rate; stepped-up open market sales of treasury bills and bonds; and increases in reserve requirements (Table 5 and Figure 4). While the resulting interest differential with the U.S. has not triggered large capital inflows—likely reflecting limits in the substitutability of financial assets—the de facto peg has circumscribed the CBTT’s ability to mop up liquidity more aggressively through foreign exchange sales and to reduce inflation via an exchange rate appreciation. Nevertheless, the CBTT’s tightening measures have eventually been effective in slowing private credit growth, which should decline further in response to a weaker economic outlook and a prospective tightening of lending standards, notwithstanding still ample liquidity in the banking system.

Table 4.

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, including BOLT and leases.

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

Refers to gross debt, and it includes government guaranteed debt and letters of comfort.

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

Table 5.

Trinidad and Tobago: Monetary Survey

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Source: Central Bank of Trinidad and Tobago.

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

Figure 4.
Figure 4.

Trinidad & Tobago: Monetary Conditions

Citation: IMF Staff Country Reports 2009, 078; 10.5089/9781451837711.002.A001

Sources: Trinidad & Tobago Authorities; and Fund staff estimates.1/ Figures for 2008 are for August 2008.2/ Figures for 2008 are percentage changes from end-2007 to August 2008.3/ Data for commercial banks and trusts and mortgage companies.

7. Looking ahead, economic growth and inflation are projected to slow in the face of a deteriorating external environment. Recessions in advanced economies, their spillovers to the tourism-dependent economies of the region, and sharply lower prices for energy products are projected to reduce growth to 2 percent in 2009. This, together with falling international food prices, should help dampen domestic price pressures. Nevertheless, the base effect of this year’s food price shock, combined with still tight capacity constraints and labor market conditions, is projected to limit the decline in headline inflation to 7½ percent in 2009. At the same time, the external current account surplus is projected to decline by 15 percentage points to about 12 percent of GDP, in response to falling energy export earnings, with an assumed oil price decline of about US$43 per barrel to US$54 in 2009. These projections, however, are subject to an unusually high degree of uncertainty, given the unsettled global outlook and volatile commodity prices.

8. Although the real exchange rate is close to its estimated equilibrium, the deficit in the non-energy current account will need to shrink to preserve long-term sustainability. As in many energy-exporting countries, an assessment of Trinidad and Tobago’s exchange rate yields ambiguous results. A cursory examination of real exchange rate trends shows that while the CPI-based rate has appreciated in recent years, relative unit labor costs have fallen, helped by the impact of capital investments on manufacturing productivity. A more methodical assessment provides similarly mixed results (Box 2). Even though the real effective exchange rate appears to be broadly in line with current fundamentals, a forward-looking assessment, that takes explicit account of the prospective decline in energy reserves, suggests the need for a significant reduction in the non-energy current account deficit to preserve long-term sustainability. This analysis is subject to a number of caveats, however, including potentially higher export capacity in the non-energy sector as a result of current investments.

A01ufig04

Exchange Rate (2003 = 100)

Citation: IMF Staff Country Reports 2009, 078; 10.5089/9781451837711.002.A001

Sources: Central Statistical Office and IMF Information Notice System.

III. Policy Discussions

9. The discussions focused on two challenges: preparing for the risk of contagion and preserving macroeconomic stability with falling energy revenues and still high inflation. Although contagion has been limited, there was agreement about the importance of preparing for the possibility of more severe spillovers from the global financial crisis by strengthening the crisis-response framework and developing contingency measures. At the same time, the authorities need to safeguard fiscal and external sustainability in the face of falling energy revenues, while containing harmful second-round effects on inflation, just at a time when the external environment is deteriorating dramatically.

A. Preparing for the Risk of Contagion

10. The authorities were keenly aware of the risks arising from the worldwide financial crisis and were determined to react swiftly, should the need arise. Even though they considered the country’s financial sector to be relatively secure, due to high liquidity and strong capital positions, they realized that even ample liquidity in the system was no guarantee for banks’ willingness to lend to each other or to domestic firms. Thus, the CBTT was monitoring the situation closely and was prepared to respond promptly to signs of problems, taking note of measures that have recently been taken by other central banks to ease and broaden access to liquidity and to preserve interbank lending. The CBTT has also requested financial institutions to conduct regular stress tests of their most important exposures. The mission welcomed this, while urging the CBTT to accelerate its development of in-house capacity for stress testing and its work on a crisis-management plan, in conjunction with regional supervisors.

Exchange Rate Assessment1

Exchange rate assessments for nonrenewable resource exporters are complex. During a commodity price boom, improved terms of trade lead to an increase in the equilibrium real exchange rate. In these circumstances, unless the actual real exchange rate moves in tandem, regression-based analyses typically suggest that the currency is undervalued—a conclusion that is also supported by an implicit large current account (CA) surplus. On the other hand, large CA surpluses tend to be temporary, reflecting the appropriate desire to save for the future, when the nonrenewable resources are depleted. Analyses that focus on external sustainability and take the prospective depletion of these resources explicitly into account can incorporate such intertemporal aspects. However, they are normative in nature and depend on a number of assumptions—the resource prices, the pace of extraction, and the effect of resource-financed spending on economic growth—as well as on the specific definition of sustainability.

In the case of Trinidad and Tobago, a regression-based analysis suggests that the real effective exchange rate (REER) is in line with fundamentals. As the terms of trade have improved through 2008, and both tradable sector productivity and government consumption have risen, the equilibrium real exchange rate has increased. However, so has the actual REER, with the result that the two rates are closely aligned on the basis of staff’s estimated model.

In contrast, an analysis that focuses on long-term external sustainability suggests that the large deficit in the non-energy CA is unsustainable. In this analysis, the sustainable non-energy deficit is defined as the deficit that can be financed indefinitely from the wealth generated by the nonrenewable energy resources. It is obtained using three alternative definitions: a constant non-energy CA in real terms; in percent of non-energy GDP; or in real per capita terms. In each case, the sustainable deficit is lower than the current and projected deficits, but the magnitude of deviations differs considerably between 5½ and 12 percentage points of GDP over the medium term. An important caveat to this analysis is, however, that investments that raise the CA deficit in the medium term may durably boost export capacity in the non-energy sector. Thus, the long-term CA could be much stronger than what is projected over the medium term, without the need for a real depreciation of the currency.

A01ufig05
Sources: Central Statistical Office, IMF Information Notice System, Fund staff estimates.

In sum, the exchange rate assessment yields different results, depending on the methodology and time frame underlying the analysis. This explains why recent appreciation pressures in the presence of a high overall CA surplus are compatible with the assessment that the non-energy CA will need to strengthen over time to preserve long-term sustainability. Fiscal adjustment will be key in this regard.

1See Appendix I for details.

11. The authorities agreed that the global situation added urgency to the enactment of improved financial sector legislation and the strengthening of supervisory practices. The mission welcomed the passage in the lower house of Parliament of a new Financial Institutions Act, which was subsequently also passed by the Senate. Its swift implementation will be crucial to enhance the central bank’s ability to supervise the country’s complex financial sector and lay the foundation for follow-up legislation in the areas of insurance, securities, pensions, and credit unions. The mission encouraged the authorities, in implementing the improved framework, to (i) press for changes in conglomerates’ holding structures, with a clear separation of financial and non-financial activities; (ii) review risk-management practices and enforce prudential standards on a consolidated basis; and (iii) coordinate closely with regional and international supervisors on the basis of clear home/host country responsibilities. The authorities confirmed their commitment to act accordingly.

B. Preserving Macroeconomic Stability

12. There was broad agreement on the need to adjust fiscal policy to already lower energy prices and the possibility of considerably slower growth in 2009. Even though the government has cushions to weather shocks, spending adjustment will be needed to contain a rapidly deteriorating fiscal position and safeguard sustainability under more difficult circumstances. The mission welcomed the authorities’ commitment not to tap into the savings accumulated in the Heritage and Stabilization Fund (HSF) and recommended maintaining nominal spending in FY 2008/09 at the level of the previous year. While the authorities were still debating the overall spending envelope at the time of the visit, they have since identified savings (beyond those on fuel subsidies) of nearly 2½ percent of GDP relative to the budget—about ½ percent of GDP more than suggested by the mission. These cuts will be achieved by spending restraint across all ministries and the postponement of a range of projects that were scheduled to commence this fiscal year. As a result, expenditures will be 2 percentage points of GDP lower than in the previous year, and the central government deficit would be contained at 1 percent of GDP under current energy price projections. In the event of an even larger decline in energy prices and economic activity in 2009, the mission advised the government to let automatic stabilizers operate to cushion the adverse impact on the domestic economy.

13. Beyond the immediate challenges, the mission argued that further policy adjustments would be needed over the coming years to preserve long-term sustainability. While public spending on infrastructure and education are important components of the government’s development strategy, the magnitude of the recent fiscal expansion has been excessive. It has not only contributed to high inflation and risks of Dutch disease, but also implied large non-energy deficits that cannot be sustained in the longer term. To generate adequate savings in the HSF that would allow the country to benefit permanently from its existing energy wealth, the mission urged a further reduction in the non-energy deficit over the medium term, combined with a return to more conservative energy price assumptions. Informed by an analysis of long-term sustainability, it advised the government to reduce the non-energy deficit by another 4 percentage points of GDP beyond the 2 percentage points already identified for the current fiscal year (Box 3). This would reverse the increase in primary spending, as a share of GDP, that has occurred since 2002/03 when energy revenues were only about 2 percentage points of GDP lower than projected for 2008/09.

14. The authorities acknowledged the need to preserve long-term sustainability, but stressed the importance of growth-enhancing investments and economic diversification. While they recognized that fiscal policy had contributed to inflation, they pointed out that the key driver—the surge in food prices—was a global phenomenon whose inflationary impact should soon recede or even be reversed. At the same time, the government considered infrastructure and human capital investments critical for removing supply bottlenecks and enhancing productivity. Thus, while they were committed to accumulate additional savings in the HSF, they also believed that increased tax revenues from a growing non-energy sector would help reduce the non-energy deficit over the medium term. The planned Central Revenue Authority will be instrumental in further strengthening revenue administration, while the soon-to-be established macro-fiscal unit in the Ministry of Finance will provide the analytical underpinnings for sustainable medium-term expenditure planning.

15. The mission saw scope for further targeted expenditure restraint that would be conducive to long-term growth. While acknowledging the benefits of many public investment projects, it argued for:

  • a careful prioritization, phasing, and monitoring of projects, combined with an overall streamlining of public sector activities to avoid duplication and inefficiencies;

  • a better-targeted approach to social programs, which would also permit more effective support to those in need; and

  • more generally, a significant reduction in the amount of transfers and subsidies, that has increased sharply in recent years.

In this regard, the mission welcomed the recent increase in electricity tariffs and the price of premium gasoline, but argued for a comprehensive approach to phase out unproductive subsidies that distort investment and consumption decisions, discourage conservation, and expose firms and households to an inevitably sharper adjustment, when windfall revenues from energy disappear. The authorities agreed that there was scope for prioritizing and coordinating expenditure more effectively, and were already reviewing different programs for that purpose. At the same time, they stressed that a further reduction in subsidies needed to be phased in carefully. In the case of water, for example, a move to a pricing system based on usage required major investments to improve service delivery and establish meters.

Fiscal Sustainability Analysis

The large non-energy deficits of recent years are not sustainable. Sustainability is defined here as maintaining a constant primary non-energy deficit, in real terms, that could be financed permanently from projected energy revenues. As the economy grows, this constant primary deficit—which is estimated at about 8 percent of GDP (15 percent of non-energy GDP) in FY 2007/08—would shrink in relation to GDP to 6½ percent (12 percent of non-energy GDP) by 2012/13 (Figure 5). With an actual primary non-energy deficit of just above 12½ percent of GDP in 2007/08, the needed adjustment would amount to some 6 percentage points of GDP over the medium term under a front-loaded adjustment path. In contrast, an unchanged primary deficit would cause a depletion of net assets by 2019, requiring a sharp fiscal adjustment of almost 25 percent of non-energy GDP thereafter.

A01ufig06
Sources: IMF’s World Economic Outlook; and staff calculations.1/ Simple average price per barrel of Dated Brent, West Texas Intermediate, and Dubai Fateh.2/ Price per thousands of cubic meters at the Henry Hub terminal in Louisiana.

This assessment is predicated on energy prices that, despite the recent decline, remain significantly above their longer-term historical averages. The analysis implicitly assumes that a significant part of the increase in real energy prices since the mid-1990s is permanent, reflecting greater global demand. Alternatively, the sustainable non-energy primary deficit would be 5 percent of current GDP (and 4 percent of GDP in 2012/13), if real energy prices fell back to their historical averages. Other factors that would change the assessment include possible discoveries and exploration of new reserves or changes in the energy tax regime.1

Prospective energy price volatility can create additional challenges. Even if energy prices remain at higher levels, on average, the temporary decline from the global economic slowdown could become steeper. Indeed, energy prices have previously been below their long-run average for sustained periods. Should this be the case, assuming the same pattern of volatility observed in the past, it would also have an adverse impact on sustainability.

1Proven, possible, and probable reserves, as of end-2007, are assumed to have extraction probabilities of 100 percent, 75 percent, and 50 percent, respectively.
Figure 5.
Figure 5.

Trinidad and Tobago: Fiscal Sustainability Analysis

(In percent of non-energy GDP, unless otherwise indicated)

Citation: IMF Staff Country Reports 2009, 078; 10.5089/9781451837711.002.A001

Sources: Trinidad and Tobago authorities; IMF’s World Economic Outlook; and Fund staff calculations.1/ Current policies beyond FY 2008/09 are defined as keeping Central Government spending in line with revenues under current energy price projections.2/ The volatile path of energy prices is derived by calculating the historical absolute deviations from the average real prices of oil and gas, and applying the same pattern of deviations to projected prices.

Trinidad and Tobago. Transfers and Subsidies

(In Percent of GDP)

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16. There was agreement that the challenge for monetary policy was to combat inflation without intensifying the prospective slowdown in economic activity. The mission agreed with the successive tightening of monetary policy in response to rising inflation rates and rapid credit growth, and shared the CBTT’s concerns about second-round effects on inflation in still tight labor markets. While the CBTT believed that inflation would be more persistent than projected by staff, both parties concurred that pressures were likely to ease with falling international food prices and a weaker economic outlook. Thus, once concerns of second-round effects diminished, the CBTT would have scope to ease monetary policy by reversing the earlier increases in reserve requirements, while managing liquidity flexibly through open market operations. In this context, the mission welcomed the introduction of additional sterilization paper in the form of treasury bonds, which should facilitate domestic liquidity management and a more effective transmission of repo rates to domestic interest rates.

17. The mission also encouraged the authorities to move, over time, to a more flexible exchange rate policy, consistent with its de jure regime of a managed float. It was agreed that the current turbulent times were not right for a fundamental shift in exchange rate policies. However, the mission argued that once global conditions have stabilized, a gradual move to more exchange rate flexibility could bring important advantages. It would cushion the impact of large swings in the terms of trade; provide an additional tool for managing domestic liquidity and inflation in an environment of volatile energy revenues and capital flows; provide impetus to the development of foreign exchange markets; and more generally, discourage currency mismatches and associated vulnerabilities in private sector balance sheets. The authorities stressed that the lumpiness of foreign exchange transactions within a narrow market required active management to prevent excessive volatility. Overall, they felt that exchange rate stability had served the country well and that the system provided sufficient flexibility, if needed.

C. Supporting Viable Diversification

18. The mission commended the authorities for their readiness to confront the country’s development challenges in a pro-active manner in their Vision 2020. It concurred with the rationale for investing in physical and human capital to support the development of a diversified, knowledge-based economy before energy resources are depleted. At the same time, it alerted the authorities to three important risks in the implementation of their strategy:

  • macroeconomic instability and competitiveness problems, when spending becomes too large;

  • waste and mismanagement, when projects are not carefully prioritized, phased, and monitored; and

  • future competitiveness and viability problems, when firms become overly dependent on government support and artificially low energy prices.

The authorities acknowledged that the mission’s suggested fiscal adjustment measures would help reduce these risks. At the same time, they stressed the need for the government to be an active promoter of diversification, pointing to successes in developing a profitable downstream energy industry—which would not have occurred in the absence of direct government involvement.

19. The mission encouraged the government to focus efforts primarily on measures that would improve the overall business climate. Global comparisons of competitiveness suggest that Trinidad and Tobago’s ranking has slipped, with considerable room for improvement in areas such as contract enforcement, property registration, and public service delivery. In this context, the mission welcomed the envisaged enhancement of information-technology-based service provision, stressing that further improvements in the business climate would also buttress the authorities’ plans for establishing an International Financial Center (IFC)—the prospects of which may have become more challenging in light of global financial developments. The authorities acknowledged that the IFC’s success will depend on finding the right niches that could also provide links and synergies with existing businesses and expertise. At the same time, they agreed with the mission that a modern regulatory framework and market infrastructure are important requisites, not just for the IFC but also to promote financial deepening and efficient resource allocation, more generally, pointing to their ongoing efforts to modernize the tax, legal, and regulatory frameworks.

Ease of Doing Business Indicators

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Source: World Bank Group, Doing Business, (www.doingbusiness.org)

Ranking among 181 countries.

“No practice” observed for Trinidad and Tobago.

IV. Staff Appraisal

20. Following a period of strong growth and large energy earnings, the authorities are now facing the challenge of adjusting to a deteriorating external environment. The main immediate tasks are to prepare for the risk of contagion from the global financial crisis, while preserving macroeconomic stability in the face of declining energy revenues and still high inflation.

21. Trinidad and Tobago is better placed than many countries to weather the international financial crisis, but is not immune from contagion. Direct spillovers from the global turmoil have been limited, reflecting low external vulnerability and a fundamentally sound banking system. However, falling energy prices and the possibility of a more severe global slowdown than is currently envisaged pose risks, including from exposures of regional conglomerates and the possibility of rising non-performing loans.

22. The authorities are encouraged to accelerate the implementation of important financial sector legislation and to strengthen their crisis-response framework. The recent adoption of a new Financial Institutions Act is a crucial step for enhancing the central bank’s power to effectively supervise the country’s complex financial sector, while also laying the groundwork for important follow-up legislation. At the same time, it will be important to identify contingency measures that would ease and broaden market access to liquidity in the event of emerging tensions, and to accelerate work on a robust framework for in-house stress-testing and a joint regional crisis-management plan.

23. The government’s recent decision to trim fiscal spending is an appropriately prudent response to lower energy prices. The magnitude of the announced cuts, equivalent to some 2 percentage points of GDP relative to 2007/08, should be sufficient to contain the deficit at 1 percent of GDP under current energy price projections and is an important first step in a much needed effort to strengthen the public finances. The adjustment strikes a reasonable balance between containing a fiscal deterioration and limiting a procyclical withdrawal, and also provides room for the operation of automatic stabilizers in the event of an even sharper decline in energy prices or economic activity.

24. Further policy adjustments will be needed over the coming years to preserve long-term sustainability. Non-energy deficits at the level of recent years will not be sustainable in the context of declining non-renewable energy resources. To allow future generations to benefit from the country’s existing energy wealth, the authorities should reduce the non-energy deficit to about 8½ percent of GDP over the medium term—an adjustment of 4 percentage points of GDP beyond the tightening envisaged for the current fiscal year. Such adjustments are feasible without sacrificing development objectives, mainly through better prioritization and targeting of programs that have expanded rapidly in recent years. Importantly, restraint over the medium term would avoid a much larger, forced, adjustment in the future.

25. Monetary policy faces the challenge of reducing inflation without intensifying the prospective slowdown in economic activity. Following an appropriate cycle of policy tightening, the CBTT has scope to respond to an easing of price pressures with a gradual loosening of monetary policy, provided second-round effects on inflation are contained. In such circumstances, reversals of earlier increases in reserve requirements should be combined with a flexible management of liquidity through open market operations, which has been facilitated by the welcome introduction of additional sterilization paper.

26. The authorities should also consider moving, over time, to a more flexible exchange rate. Once global conditions have stabilized, a gradual move to more exchange rate flexibility could bring important advantages in stabilizing the domestic economy, managing liquidity, strengthening market development, and discouraging currency exposures.

27. The authorities are commended for their readiness to confront the country’s development challenges in a pro-active manner in their Vision 2020. Investments in physical and human capital are important to achieve this vision and develop a diversified, knowledge-based economy before energy resources are depleted. At the same time, excessive spending entails risks for macroeconomic stability and future competitiveness. Thus, the authorities are encouraged to shift the focus of policies away from subsidies and direct government involvement toward improvements in the business climate and the provision of high-quality public goods and services.

28. It is recommended to hold the next consultation on the standard 12-months cycle.

Table 6.

Trinidad and Tobago: Summary Accounts of the Monetary Authority

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Sources: Central Bank of Trinidad and Tobago; and Fund staff estimates.

Proceeds of treasury bills and treasury notes used for open market operations, in millions of TT dollars.

Table 7.

Trinidad and Tobago: Indicators of External and Financial Vulnerability

(In percent, 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.

2008 data refer to end-November.

2008 data refer to end-March, unless otherwise indicated. Includes commercial banks only.

2008 data are from January through September.

Adjusted for inflation.