Trinidad and Tobago: Staff Report for the 2016 Article IV Consultation
Author: International Monetary Fund. Western Hemisphere Dept.
Publication Date:
29 Jun 2016
eISBN:
9781475578232
Language:
English
Keywords:
ISCR; CR; government; shortage; debt; a number of government ministry; assumptions in the budget; nominal exchange rate; headline inflation; core inflation; stabilization fund; barrel oil price assumption; Global; debt rule; budget oil price
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This paper discusses economic developments, outlook, and risks in Trinidad and Tobago. The economic output of Trinidad and Tobago has continued to shrink. Ongoing maintenance and further declines in gas and oil production are estimated to have driven energy output 4.7 percent lower (year over year) as of September 2015. The longstanding current account surplus turned into a 5.4 percent of GDP deficit in 2015. The significant terms-of-trade shock implies that the real effective exchange rate has become more overvalued. Risks to growth are tilted to the downside, and much will depend on the authorities' ability to navigate the transition to the lower energy price environment.

Abstract

This paper discusses economic developments, outlook, and risks in Trinidad and Tobago. The economic output of Trinidad and Tobago has continued to shrink. Ongoing maintenance and further declines in gas and oil production are estimated to have driven energy output 4.7 percent lower (year over year) as of September 2015. The longstanding current account surplus turned into a 5.4 percent of GDP deficit in 2015. The significant terms-of-trade shock implies that the real effective exchange rate has become more overvalued. Risks to growth are tilted to the downside, and much will depend on the authorities' ability to navigate the transition to the lower energy price environment.

Recent Developments

1. Trinidad and Tobago’s output has continued to shrink. Ongoing maintenance and further declines in gas and oil production are estimated to have driven energy output 4.7 percent lower (yoy) as of September 2015 (Figure 1). Combined with weak non-energy growth, real GDP declined an estimated 2.1 percent in 2015. Core inflation remained anchored at 2.0 percent yoy in 2015, while headline inflation fell to 1.5 percent (yoy). Unemployment remained low (3.4 percent in September 2015), in part as make-work programs continue to sustain employment. However, more recently, there has been a pickup in layoffs.1

A01ufig1

Real GDP Growth, 2012Q1~2015Q3

(In percent, year-on-year)

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

Source: Central Bank of Trinidad and Tobago.

2. The long-standing current account surplus turned into a 5.4 percent of GDP deficit in 2015 (Figure 2).2 The reversal is mostly due to a sharp drop-off in energy exports. With energy prices having fallen some 40 percent during 2015, exports are estimated to have declined from US$11.8 billion in 2014 to US$9.1 billion in 2015. Relatively expansionary fiscal policy in FY 2014/15 (October-September), growth in consumer credit, and robust foreign direct investment (FDI) raised capital and consumer imports. After an overall balance of payments surplus in 2014, reserves declined US$1.5 billion in 2015, albeit to a still comfortable US$9.8 billion (13.4 months of imports). Heritage and Stabilization Fund (HSF) assets increased by $212 million over the prior 12 months to US$5.8 billion in June 2015.

3. The significant terms-of-trade shock implies that the real effective exchange rate has become more overvalued. Estimates using two methodologies under the EBA-lite framework indicate a sizeable real effective exchange rate gap: 23 percent using the Current Account model, consistent with the large current account gap of -5.6 to -7.6 percent of GDP, and 50 percent under the Real Effective Exchange Rate (REER) Model (though the latter may be exaggerated due to ongoing measurement issues with headline inflation; Annex I). The terms-of-trade shock in 2015 explains some of the overvaluation. However structural impediments, domestic policy gaps relative to other countries and the appreciation of the US and US dollar pegged currencies (60 percent of trade) vis-á-vis the TT dollar are dominant contributors to the REER gap. The nominal exchange rate has been closely managed by the Central Bank of Trinidad and Tobago (CBTT) to stabilize the currency against the US dollar, as its de facto nominal anchor.

4. The authorities began to depreciate the TT dollar in November 2015 amid continued widespread reports of foreign exchange (FX) shortages.3 The rate, which had been maintained within a narrow range of +/- about 1 ½ percent around TT$6.35/US$1 since late 2009, was depreciated by 3 ½ percent through early April 2016. The CBTT injected US$500 million to the market at end-October, 2015 and commercial banks were requested “to ensure all legitimate demands for FX are met (within a reasonable time), with priority accorded to trade-related transactions.”4 Nevertheless, reports of FX shortages, including for current transactions, soon reappeared. In the period since then (November through March), the CBTT has injected smaller amounts of foreign exchange, averaging US$86 million per month. In April, the government announced that the bilateral rate versus the dollar would not be allowed to depreciate more than 7 percent from its September 2015 level, leaving room for another 3.3 percent depreciation from that date.

A01ufig2

Exchange Rate

(TT$/US$, mid-market)

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

5. Fiscal policies in recent years have been pro-cyclical. Despite high energy prices, the budget remained in deficit, in part as non-energy tax bases were underutilized (or, regarding the VAT, undermined with expanded zero-ratings). Expenditures increased as a share of GDP, with transfers and subsidies (including for fuel) rising while capital spending has remained relatively flat. Accordingly, despite the windfall gains in energy revenues, the government debt-to-GDP ratio continued to rise while the assets of the Heritage and Stabilization Fund (HSF) grew only from 14 to 23 percent of GDP during FY2010-FY2015 (Table 2 and Figure 4), with only TT$4.5 billion of a cumulative TT$19.2 billion of energy revenues in excess of budgeted amounts being transferred to the HSF during 2010–14.5

6. The 2014/15 fiscal accounts were hard hit by the decline in energy prices. The deficit expanded to 4.7 percent of GDP, although it was contained from widening further by one-off revenues. The budget deficit had been targeted at 3.1 percent of GDP (GFS basis), based on oil prices of US$80/barrel and (Henry hub) natural gas at US$2.75/mmBtu.6 However, energy-based revenues fell short by 4.4 percentage points of budgeted GDP. While lower energy prices also reduced fuel subsidies, by ¾ of a percentage point of GDP, expenditures were hit by the unbudgeted costs of a multi-year public sector wage agreement. The authorities responded at mid-year with a “variance of appropriations,” which sharply limited expenditures on other goods and services. Capital expenditures of TT$7.2 billion also fell short of budget. Recourse was made to a number of “one-off” revenue measures, notably greater reliance on dividend transfers from the National Gas Company and an income tax amnesty that reportedly brought in an additional 0.3 percent of GDP in revenues.

A01ufig3

Energy Revenue and Fiscal Balances

(In percent of GDP)

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

Sources: Ministry of Finance; and Fund staff projections and calculations.
A01ufig4

Energy Revenue and Expenditure Components

(Percent of Non-Energy GDP)

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

Sources: Ministry of Finance; and Fund staff projections and calculations.

7. Despite the worse-than-budgeted fiscal outturn, the increase in government gross indebtedness was limited by recourse to “one-off” financing. Asset sales, combined with an early loan repayment by a state-owned enterprise (SOE), provided TT$4.8 billion (3 percent of GDP) in financing, almost two-thirds of total requirements. The stock of arrears (especially for VAT refunds), estimated in the 2016 budget statement at TT$5 billion, was also used to help with financing difficulties. As a result, central government debt increased by only 2.0 percentage points of GDP, while external debt actually fell in nominal terms to US$2.1 billion (8.4 percent of GDP).7

8. The sharp fall in energy prices since the new government’s initial introduction of the budget is leading the 2015/16 deficit to surge. With a seemingly conservative US$45/barrel oil price assumption, the budget deficit was initially targeted at 7.5 percent of GDP on a GFS basis (1.7 percent of GDP using the authorities’ accounting convention). 8 This was to be achieved through adjustments totaling over 3 percent of GDP, including tight expenditure control, lower fuel subsidies (in part through hikes in fuel prices), and revenue measures. Base broadening of the value-added tax (VAT), combined with a rate reduction (from 15 to 12½ percent), was expected to yield a net 2½ percentage points of GDP. The budget also continued to rely on above-average SOE dividends. In addition, the government announced plans to use US$1 billion of HSF assets for deficit financing.

9. As energy prices fell further and VAT revenues fell short, the authorities announced additional measures in an April Mid-Year Budget Review (MYBR), aimed at containing further fiscal erosion. Energy price assumptions were revised down to US$35 per barrel for oil and US$2.00 per mmBtu for natural gas. The measures included mid-year cuts of 7 percent of budgeted expenditure, hikes in tobacco and alcohol excises and on excises and duties on large-engine automobiles, further fuel subsidy savings from additional fuel price increases, and, with effect from FY 2016/17, the introduction of a tax on internet purchases. However, even with these measures, given lower energy prices and weaker-than-expected economic activity, staff estimates the deficit could total almost 11 percent of GDP on a GFS basis.

10. The CBTT tightened monetary policy, but the transmission to the economy is unclear. Citing the need to mitigate potential capital outflows (in anticipation of “normalized” U.S. rates), the CBTT raised the repo rate 200 basis points over eight successive meetings, to 4.75 percent, before pausing in January 2016. This pushed lending rates higher, but given still ample, albeit significantly declining, system liquidity, deposit rates remain low, resulting in improved lending margins for banks.9 Private sector credit growth has been concentrated in residential mortgages and consumer credit, while business credit, which had finally shown signs of strengthening, began to taper off in 2015 (Figure 3). Median house prices remained relatively stable in 2015.

A01ufig5

Commercial Bank Deposit and Lending Rate and CBTT Repo Rate

(In percent)

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

Source: Central Bank of Trinidad and Tobago.

11. Banks remain strong despite the weakening economic outlook. The latest indicators (end-December, 2015) show no deterioration in asset quality, with non-performing loans (NPLs) below 3½ percent. In addition, capitalization remains high and balance sheets very liquid, despite recent reductions in excess reserves reflecting increased CBTT sales of FX.10 Though returns have declined, banks remain profitable with ROA and ROE at 2.5 and 18.2 percent, respectively. The ratio of specific provisions-to-impaired assets of 42.1 percent at end-December 2015 has been increasing, but still falls well below the 79.2 percent five-year average prior to the global financial crisis (2003–2007). Continued robust overall credit growth has been a source of risk for the overall health of the financial sector, although the recent slowdown, in line with the slowing economy, has reduced this risk (see Financial Soundness Indicator Map). Banks’ high liquidity and capital exceed prudential norms by significant margins, and provide an ample buffer against any uptick in degradation of loan quality, while CBTT stress tests show banks can withstand considerable levels of financial stress.11 Moreover, the banking system does not appear overly exposed to foreign exchange risk.

12. Some financial reforms have stalled. Insurance legislation to improve regulatory oversight, strengthen prudential requirements, and enhance governance was passed in the Senate, but lapsed in the lower house. It is expected to be reintroduced in 2016. The Occupational Pensions Plan Act, Credit Union Bill and amendments to the Co-operative Credit Societies Bill also await drafting or reintroduction. Implementation of banking regulations to conform with Basel II, which began in 2014, is proceeding, along with the National Financial Crisis Management Plan and the Systemically Important Financial Institutions (SIFI) oversight project.

Financial Soundness Indicator Map

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Source: CBTT and Staff estimates

13. The windup of CL Financial Group (CLF) has progressed. A final resolution plan for Colonial Life Insurance Company (Trinidad) Limited (CLICO) and British American Insurance Company (Trinidad) Limited, including phased payments to CLICO’s policyholders and creditors from the monetization of CLICO’s assets, was announced in March 2015. The government announced in April 2016 that CLICO’s shareholdings in MIHL, Angostura, Home Construction, and CL World Brands and its traditional portfolio of insurance policies and other assets would be sold or disposed of in 2016, with a view to repaying all legitimate creditors and policyholders in full. CLICO’s holdings in Republic Bank are to be disposed of in 2017. A plan to monetize assets held directly by CLF is to be announced in due course.

14. The FX market has been experiencing long queues. Market participants reported a worsening situation in the last 18–24 months, with a wait time for most requests of over four weeks (and sometimes considerably longer) for their FX demand to be satisfied, including for making payments and transfers for current international transactions. External payment arrears to creditors have emerged, and some foreign suppliers have reportedly cut off credit lines to local importers.

15. The CBTT’s intervention mechanism is targeted toward reducing market volatility, but by itself has proven insufficient to address the underlying FX imbalance problems. The CBTT manages the TT$ exchange rate mainly through its regulation of the maximum market sell and buy rates, and through FX provision, accounting for approximately one-third of the total market FX supply via discretionary, non-competitive allocations to licensed authorized dealers.12 The CBTT’s FX supply has been insufficient to satisfy bona fide demand, including demand for current international transactions at the exchange rate that is set within limits it determines. Recently, the CBTT increased the frequency of its interventions to approximately every two weeks for better volatility management, without increasing its total FX supply. The CBTT limits sales of its FX intervention funds to meeting only “trade-related” demand, and has encouraged authorized dealers to similarly prioritize sales of FX obtained from other sources.13

16. Progress has been made in improving the business climate. The previous government adopted a new bankruptcy and insolvency law, significantly shortened the time to start a business, streamlined trade clearance procedures and simplified property registration. A public procurement law was adopted, although the new government plans to reform it further. Efforts are now being made to improve the insolvency framework, improve trade facilitation and access to credit, and streamline company registration procedures. Government efforts to transition individuals from “make-work” programs to the private sector have thus far largely failed, although the Government, in its 2016 MYBR, has announced plans to reform these programs with a view to reducing financial support and making them more cost-effective.

17. While data shortcomings continue to constrain staff’s ability to conduct economic surveillance, significant efforts are being made to remedy these shortcomings and discrepancies across data sources. The quality and timeliness of key macro-economic indicators had worsened in recent years due to insufficient attention and resources being provided in this area. However, more recently, the government has begun to make a concerted effort to improve data timeliness and quality. In particular, the new government has launched a process to transform the Central Statistical Office (CSO) into an independent National Statistical Institute, to be launched at the beginning of 2017 (Informational Annex).

Medium-Term Outlook and Risks

18. The economy is expected to shrink for a third year in 2016 given structural impediments, now abetted by cyclical headwinds. Energy output will decline as natural gas, and especially oil fields continue to be depleted, while the petrochemical sector has suffered plant closures and gas shortages that constrain output. However, new gas fields should boost energy production in 2017-2018. Non-energy growth is projected to decline in 2016 on spillovers from job losses in the energy sector as well as the fiscal consolidation.14 These factors would continue to weigh on activity until non-energy growth fully rebounds in 2018. Inflation should remain subdued on weak activity.

19. In staff’s baseline projections, with unchanged fiscal policies and current energy price forecasts, the current account remains in deficit through the medium-term. Although exports recover gradually, in line with energy prices and the new gas production, they remain well below 2014 levels, even by 2021. Slow implementation of supply side structural reforms and the overvalued currency limit the potential for export diversification and growth. Import growth moderates in line with an expected decline in FDI. The drawdown of the HSF and increased official financing are insufficient to address the country’s financing requirement and the overall external position steadily deteriorates to 3.3 months of imports by 2021.

20. Under the baseline, the fiscal deficit rises to a range of 12½ to 13½ percent of GDP over the medium term, resulting in an unsustainable debt buildup. The central government debt to GDP ratio rises to nearly 80 percent of GDP by 2021, while the broader nonfinancial public sector (NFPS) debt ratio rises to almost 100 percent. The Debt Sustainability Analysis’ (DSA) “Heat Map” flashes red regarding the level of debt and gross financing needs, both in the baseline and under various shocks, although this is mitigated by authorities’ strong policy commitment to enhancing revenues and reducing and rationalizing public expenditures (Annex II). That said, the authorities’ ambitious target for revenue collection based on improvements to revenue administration may prove difficult to achieve, although there does appear to be ample scope for gains in this area. In addition, the state-owned Petroleum Co. of Trinidad & Tobago (Petrotrin), which Moody’s downgraded from Ba1 to Ba3 in April 2016, could represent a contingent liability to the government.15

Medium-Term Macroeconomic Framework (Baseline Scenario)

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Sources: Ministry of Finance; Central Statistics Office; and Fund staff estimates and projections.

Includes VAT and Financial Intermediation Services Indirectly Measured (FISIM).

Fiscal data is central government unless otherwise specified and refers to the fiscal year ending in September.

Excluding debt issued for sterilization.

Starting in 2013, assumes no additional contributions to the HSF.

21. Risks to growth are tilted to the downside and much will depend on the authorities’ ability to navigate the transition to the lower energy price environment (Annex III). Given still ample bank liquidity, monetary tightening’s impact on the non-energy economy will likely be subdued, but may have a lagged effect. Absent sufficient exchange rate flexibility, renewed US dollar appreciation against the currencies of Trinidad and Tobago’s trading partners would inhibit export diversification, while failing to address FX shortages would restrain economic activity as businesses are unable to make critical imports or pay suppliers in a timely manner. More worryingly, the expected erosion in the reserves position, while already significant in staff’s baseline, could be exacerbated if currency speculation or precautionary demand for U.S. dollars pick up, both of which are much more likely should FX shortfalls persist. In the longer run, future energy investment will depend not only on future expected energy prices, but on whether the investment regime is seen to be appropriate to the new environment. Most critically, the government must demonstrate that its medium-term strategy safeguards fiscal sustainability in order to maintain consumer and business confidence. “De-risking”, as in other Caribbean countries, is becoming an area of concern for the authorities, particularly for institutions with perceived high risk profiles, including private members clubs and money remitters, though less so for the large commercial banks.

Policy Discussions

Fiscal Policy

22. Given the need for sizable and sustained fiscal adjustment, staff encouraged the authorities to formulate and announce early on a comprehensive multi-year adjustment package. If sufficiently ambitious, this would signal the authorities’ commitment to fiscal sustainability despite challenging circumstances. A measured pace of implementation will allow time for rational policy formulation while spreading out the negative multiplier effects from contractionary policies. Staff estimated that, in addition to measures included in the FY2016 budget plus the MYBR, (which together total some 3 ½ percentage points of GDP), adjustments totaling 8 ½ percent of GDP would keep the central government (NFPS) debt/GDP ratio at 48 (68) percent by 2021.

23. Staff welcomed the initial non-energy revenue measures and the authorities’ intentions to do more. The new budget included increases in business levies and a narrowing of the VAT’s zero-rated bracket, albeit while reducing the rate from 15 to 12½ percent. The government announced its intention to re-introduce property taxation and to fast-track a Gaming and Betting Control Act, with potential to raise some ½ percent of GDP in revenues. Also, the government intends to reap sizable revenues from improved tax administration, in part through improved information sharing between the Board of Inland Revenue (BIR) and the Customs and Excise Division (CED). Staff agreed these efforts would help in reducing undue reliance on energy-sector revenues. However, staff advocated a more comprehensive VAT review to assess the scope for further base-broadening and increased collection efficiency. Staff also advocated increasing excises on cigarettes, alcohol and soft drinks, which would not only raise revenues, but could discourage consumption of products with potentially adverse health outcomes. It also saw scope to further enhance property taxation, a relatively non-distortionary revenue source.

Phasing of Measures - Active Scenario

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Source: IMF staff calculations.

Includes improved public revenue administration and further VAT reforms, as needed.

To be identified in public expenditure review. This can also include lower transfers to be achieved by increased public utility tariffs.

24. Staff welcomed the announced spending cuts of TT$ 4 billion (2.5 percent of GDP), but urged a comprehensive review of expenditure programs to best achieve the government’s economic and social policy goals within tightened financial constraints. Particular attention should be focused on reviewing “make-work” programs (the CEPEP and URP), given the widespread view that they are undermining incentives in the private labor market, although due regard should be given to social concerns. The government’s free tertiary tuition program (GATE) could be made more cost-efficient, including by means-testing and tightening eligibility requirements. Staff also continued to urge the phasing out of fuel subsidies, noting their inefficiencies, deleterious side effects (pollution and congestion) and inequitable benefits (Box 1). Transfers to state-owned enterprises and statutory authorities also represent an important burden and could be reduced if commercial enterprises were run on a more profitable basis, including through pricing policies that allow for greater cost-recovery. Finally, staff advocated that revenue increases and cuts to current expenditure should be large enough to allow for an increase in growth-enhancing public investment.

Medium-Term Macroeconomic Framework (Active Scenario)

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Sources: Ministry of Finance; Central Statistics Office; and Fund staff estimates and projections.

Includes VAT and Financial Intermediation Services Indirectly Measured (FISIM).

Fiscal data is central government unless otherwise specified and refers to the fiscal year ending in September.

Excluding debt issued for sterilization.

Starting in 2013, assumes no additional contributions to the HSF.

The Impacts of Fuel Subsidies in Trinidad and Tobago1

Energy subsidies in Trinidad and Tobago, established in 1974, increased dramatically during the period of rising global crude oil prices, stimulating a debate on the costs and benefits of subsidy reforms. From 2006-15, cumulative fuel subsidies amounted to TT$31 billion, or an average of around 2 percent of GDP per annum. Total subsidies and global crude oil prices are strongly positively correlated. As oil prices trended up between 2009 and 2014, fuel subsidies rose to 2.3 percent of GDP. As crude oil prices plummeted in 2015, subsidies dropped to 1.4 percent of GDP.

A01ufig6

Crude Oil Price and Fuel Subsidy, 2006-2015

(percent of GDP)

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

Source: Ministry of Energy and Energy Industry; and Fund staff calculations.

Fuel subsidies have imposed a significant fiscal cost. Initially, a Petroleum Production Levy (PPL) was imposed on petroleum producers to pay the difference between the international and domestic prices of fuels. During 1974-1992, the PPL covered the entire value of the subsidy. However, an amendment in 1992 constrained the levy to 3 percent of producers’ gross income (although it was increased to 4 percent in 2003, where it still stands). Moreover, in 2003 businesses that produced less than 3,500 barrels of oil per day were exempted from the levy. Thus, an increasing share of fuel subsidies has been paid by the government, with the PPL covering less than 20 percent of total costs during the past five years.

A01ufig7

HSF and Fuel Subsidy, FY2007-FY2015

(TT$ million)

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

Sources: Ministry of Finance; and Fund staff calculations.

The resources spent on fuel subsidies have significantly contributed to procyclicality and might better have been saved in the HSF.2 The fiscal contribution to the HSF has been declining since the global financial crisis while until recently the cost of the fuel subsidy was trending upward, driven by rising oil prices. Had the government contributed the amount spent on fuel subsidies since 2008 to the HSF instead, the Fund would now be worth an additional US$3.6 billion, 62 percent higher than where it currently stands.

There is strong evidence that fuel subsidies disproportionately benefit higher income people. According to CSSP (2014) and Chester (2015), low income earners, accounting for 50 percent of the population in 2014, gained only 27 percent of total fuel subsidies compared to 36 percent for the richest 15 percent of households. The average monthly subsidy for the richest households was 95 and 68 percent higher than for low and middle income households, respectively.

A01ufig8

Average Fuel Subsidies by Income Group, 2014

(TT$ per month)

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

Sources: Central Statistical Office - Continuous Sample Survey of Population (2014); and Chester (2015).

Post-tax subsidies in Trinidad and Tobago are mostly driven by the negative externality from natural gas and petroleum products.3 Based on staff calculations, global warming accounted for more than 50 percent of post-tax subsidies, or around US$2.1 billion, in Trinidad and Tobago in 2015. Pre-tax subsidies account for US$0.8 billion, vehicle externalities for another US$0.6 billion, local air pollution for US$0.3 billion and foregone consumption tax revenues for US$0.2 billion (0.9 percent of GDP).

Trinidad and Tobago is one of the top subsidizers for vehicle-related externalities in the world.4 The total cost of the traffic externality amounts to US$598 million in 2015. This amounts to an annual per capita traffic externality cost of US$441, placing the country among the top 12 subsidizers in the world. Moreover, the estimate is based on regional averages, and is quite likely a large underestimate of congestion costs, given the much higher incidence of automobile ownership in Trinidad and Tobago.

A01ufig9

Composition of Post-Tax Subsidies, 2015

(billions of US dollars)

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

Source: Fund staff calcuations.
A01ufig10

Estimated Vehicle Externalities, Top 20 Countries in 2015

(US$ per capita)

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

Source: IMF Fiscal Affairs Department IMF.
1 See Trinidad and Tobago—Selected Issues, “Fuel Subsidies in Trinidad and Tobago: Fiscal, Distributional, and Environmental Impacts.” May 5, 2016.2 The saving (withdrawal) rule of the HSF is triggered when actual energy revenue exceeds (falls below) budgeted revenue by at least 10 percent. Contributions, however, are mandatory, whereas withdrawals are discretionary.3 Post-tax subsidies arise when the price paid by consumers is below the supply cost of energy plus an appropriate “Pigouvian” (or “corrective”) tax that would reflect the negative externalities associated with energy consumption and an additional consumption tax that should be applied to all consumption goods (i.e., the value added tax).4 Vehicle-related externalities include traffic congestion, accidents, and road damage caused by the additional usage of vehicles due to fuel subsidies.

25. Staff presented the case for adopting a countercyclical fiscal rule, while cautioning there is no fiscal space for such a countercyclical rule now given the projected size of deficits under the baseline. However, once the country has adjusted to the current economic and fiscal stress, which will require a multi-year adjustment, a fiscal rule could be adopted to ensure that fiscal policy in the future supports the twin goals of debt sustainability while still playing a stabilizing, countercyclical role (Box 2).16

A Fiscal Rule for Trinidad and Tobago

As an energy dependent economy, Trinidad and Tobago has experienced large swings in national wealth. While its sizable endowment of oil and gas improves national welfare, heavy dependence on energy means that large swings in the value of the country’s resources complicate fiscal policy formulation. The sharp drop in energy prices since 2014 represents a measurable drop in the nation’s net worth.

A01ufig11

Trinidad and Tobago: Public Wealth and Liabilities

(Share of GDP)

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

Sources: TTO authorities; and Fund staff estimates.

Trinidad and Tobago’s fiscal policies have been highly pro-cyclical. For instance, the country ran fiscal deficits even as oil prices rose dramatically from early 2011, with oil prices above US$80 per barrel through mid-2014. The fiscal deficits were expansionary even as the energy price boom was already pouring additional financial resources into both the public and private sectors of the economy. The deficits increased government debt and led to only moderate increases in Heritage and Stabilization Fund, a sovereign wealth fund (SWF). Going back further, Trinidad and Tobago’s fiscal history shows that booms in energy revenue have been associated with significant worsening of the non-energy fiscal balance, as increasing energy revenues were spent on non-energy expenditures.

Once the situation permits, the authorities should look to adopt a multi-year fiscal rule that will help to stabilize economic activity while saving adequately for future generations. Given the size of the current fiscal gap, policies in the coming years will, by necessity, require pro-cyclical fiscal consolidation to stabilize the debt position.

A01ufig12

Energy Revenue and Fiscal Balances

(In percent of GDP)

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

Sources: Ministry of Finance; and Fund staff projections and calculations.

An appropriately designed rule should take into account the trade-off between the rule’s effectiveness in promoting debt sustainability and economic stabilization versus its implementation complexity. There are four types of fiscal rules: budget balance rules, debt rules, expenditure rules, and revenue rules. Debt rules by definition are more effective than other types of rules in promoting debt sustainability; however, they are not binding when debt is well below the limit. On the other hand, while cyclically-adjusted rules can work the best to temper the impact of economic fluctuations, they require substantial institutional and forecast capacity to implement.

Properties of Different Types of Fiscal Rules Against Key Objectives

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Source: IMF Fiscal Affairs Department.Note: Positive signs (+) indicate stronger property, negative signs (-) indicate weaker property, and zeros (0) indicate neutral property with regard to objective.

Given high revenue volatility and limited forecasting capacity, Trinidad and Tobago could consider a rule that targets the non-energy primary balance, supplemented by a rule covering nominal primary expenditure. Such a combination has a number of virtues. It would be simple and transparent, and appropriate to the country’s current institutional capacity. Targeting the non-energy primary balance would help ensure convergence of the debt ratio, while a primary expenditure rule would insulate expenditures from volatile energy revenues and help ensure the buildup of sufficient buffers in good times.1

1 While an SWF can be useful to help save commodity revenues, it is not necessarily, by itself, adequate to prevent overspending in good times.

Authorities’ views

26. The authorities concurred that the size of adjustment needed would require a substantial multi-year effort. The government intends to implement property and gaming taxes and agreed to give serious consideration to raising excise taxes by bringing rates more in line with regional levels, an effort that was announced, as noted, in the MYBR with increased excises on alcohol and tobacco. The government is also placing a lot of emphasis on improved revenue administration, and believes that pursuing greater information sharing among revenue generating agencies, tightening rules on transfer pricing, and increasing resources devoted to tax enforcement will, over time, substantially increase revenue yields. Energy taxes may also need to be revisited in light of lower energy prices, with the dual goals of continuing to incentivize new investment while safeguarding public revenues.

27. The authorities agreed on the need to rein in expenditures, especially transfers and subsidies. They agreed to seek a comprehensive review of social expenditures from the World Bank both to reduce costs and improve program efficiency, while still providing a social safety net to protect the most vulnerable citizens. The authorities also agreed on the need to remove fuel subsidies, and announced their intention to do so in a phased manner in the MYBR, using the savings to improve the social safety net and reduce transportation costs for low-income groups. They intend to propose a new pricing mechanism for public discussion that would henceforth pass through world oil price changes to local fuel prices. The authorities also intend to review a number of specific programs, especially CEPEP and URP, with a view to achieving cost efficiencies. Finally, the authorities acknowledged that it will be important to clear expenditure arrears, which will likely require recourse to domestic financing.

28. The authorities emphasized efforts to enhance transparency and consult the private sector, aimed at seeking buy-in for the fiscal consolidation required to adjust to new circumstances. The authorities inaugurated a National Tripartite Advisory Council with representatives from labor, businesses and government, to find ways to share the sacrifices required for medium-term stability. Separately, they have commenced a national discussion on energy subsidies and are starting discussions with the energy industry on reforming energy taxes.

Monetary and Exchange Rate Policy

29. Staff supported the pause in monetary policy tightening as appropriate given the headwinds to growth. This will give time to assess the lagged impact of tightening already in the pipeline and to gain greater clarity on the pace of the U.S. hiking cycle. Staff argued the CBTT is not currently in a position to ease policy until confidence is restored in the FX market. In fact, should FX pressures increase or inflation expectations rise, the CBTT may need to resume policy tightening. It will also need to carefully monitor and manage excess liquidity in the banking system, which has declined significantly due to appropriate sterilization operations by the CBTT. Contingent on a credible fiscal consolidation, a restoration of confidence in the FX market, and sufficient exchange rate flexibility, it may be possible in the future to implement more accommodative monetary policy to support economic activity, provided also that inflation and inflation-expectations remain “well-behaved”. Similarly, as financial system liquidity is unwound, the CBTT could consider reducing bank reserve requirements, which are comparatively high, at 17 percent. More broadly, staff recommended that the authorities make clearer the CBTT’s priorities among its multiple mandated objectives.

30. In staff’s view, pressures in the FX market have arisen for a variety of reasons, including both significant changes in underlying fundamentals and incentives that have set in motion adverse expectations dynamics. Most obviously, the fall in energy prices has served to sharply diminish the supply of FX to the market. However, expansionary fiscal policies and growth in consumer credit have also contributed to demand. Importantly, expectations appeared to be playing a significant role in amplifying FX demand pressures for two reasons. First, ongoing shortages have led to strong incentives to hoard FX for precautionary reasons when it does become available. Second, the lack of flexibility in the nominal exchange rate (vis-à-vis the US dollar) has led to increasing expectations that the exchange rate cannot hold, leading to speculative outflows aimed at taking advantage of a weakening currency. In the MYBR, the Finance Minister attempted to quell such speculative pressures by announcing that the exchange rate would not deviate “at this time” by more than 7 percent from the rate that prevailed in September 2015, meaning that a floor on the rate would be set at a further 3.3 percent depreciation from the April 8, 2016 rate (the date of the MYBR).

31. Exchange rate policy needs to take into account both the impact on market expectations, and the major fiscal and external adjustments needed in the face of the sharp declines in energy prices. The recent depreciation is welcome as it should provide some incentive to favor switching expenditure towards domestic goods from foreign goods (both by residents and foreigners). However, it remains to be seen whether depreciation, even to the new exchange rate floor, is sufficient to bring the market into greater balance given the degree of estimated currency overvaluation.

32. If not, one option would be to pursue a substantial depreciation to a level more commensurate with balancing FX demand and supply, and then allow the currency to fluctuate within a fairly wide band. This could still give the market some flexibility to provide signals about fundamental pressures, while helping expectations to coalesce around a given rate and introducing two-way market risk so as to minimize speculation about further depreciation. At the same time, the high level of external buffers, in the form of FX reserves and a still substantial HSF, affords the authorities a range of options.17

33. Any changes to the exchange rate regime should be introduced as part of a broader fiscal and structural reform package. Keeping the benefits of a weaker currency from being eroded through inflation would require a firmly-implemented incomes policy, as well as monetary policy that is alert to second-round effects of the currency move. In addition, clear communications about the reasons for such reforms, and to clarify the “rules of the game” regarding how the FX regime will be operated in the future, would be critical to restoring market confidence. Staff also pointed to the fiscal benefits, as a currency depreciation would allow for a smaller active fiscal adjustment (as revenues in foreign exchange are converted into larger amounts of local currency), and thus have a less adverse impact on growth.

34. Staff noted that private sector market participants continued to confirm queues for FX, including for current international transactions, notwithstanding official reserves equivalent to over 13 months of imports. Staff acknowledged that the issue has been long-standing, although it became exacerbated as queues have become relatively long and external payment arrears have emerged, most likely starting in late 2014 as the impact of the fall in energy prices began to flow through to the FX market. Queues now appear to be of macroeconomic significance, due to the significant delays in obtaining FX for current imports and for debt servicing.18

35. Trinidad and Tobago’s current exchange rate regime gives rise to an exchange restriction and two multiple currency practices subject to Fund approval. The exchange restriction arises from the authorities’ restriction of the exchange rate (i.e., fixing the exchange rate and prohibiting banks from trading at any rate depreciated from this fixed rate), while not providing enough foreign exchange to meet all demand for current transactions at that rate, leading to undue delays and external payment arrears. The multiple currency practices arise due to the absence of a mechanism to prevent more than a two percent deviation at any given time among several multiple effective rates for spot exchange transactions, which are also regulated by the authorities.

Authorities’ views

36. The authorities explained that while the CBTT has multiple objectives, monetary policy was primarily aimed at controlling inflation. Concerns about potential interest rate differentials vis à vis the United States, seen as an important driver of capital flows, were also a motivating factor behind interest rate hikes. At the same time, domestic rates had now been raised to a sufficiently high level that there was some space to hold rates to avoid creating disincentives for investment.

37. The CBTT felt their exchange rate policy was clearly understood, was aimed at minimizing volatility, and would be guided by the presumption that the terms of trade shock is permanent. They agreed that the exchange rate had a role to play in balancing supply and demand for FX, and that the rate would eventually find its level. Official intervention in the FX market would continue to take place via biweekly auctions, and the rate and volumes at each intervention would be informed by economic conditions at the time, particularly anticipated FX inflows and outflows. The central bank would not try to equilibrate the market at each point in time, given that this would lead to either an undesirably large loss of reserves or a high degree of volatility in the exchange rate, given the need to adjust to the major terms-of-trade shock.

Structural Policies

38. Staff welcomed the authorities’ efforts to improve the business climate and urged them to sustain these efforts to help achieve long overdue economic diversification.19 Despite repeated efforts at diversification, there has been little success since 2000, when the development of the LNG industry started to increase the country’s dependence on global energy markets. To date, cumbersome regulations and administrative procedures and land scarcity are among the main concerns about starting a business.20 Reforming government “make-work” programs to make them less distortionary would raise labor productivity and in the long run, social welfare. Staff continued to emphasize the need for reforms to make the public service more efficient, notably to increase the flexibility of employment decisions so that staff can be allocated to their best uses and strong performance is rewarded. In this regard, staff welcomed the new administration’s significant reduction in the number of government ministries, which sends an important signal about streamlining the public service.

39. Staff noted the need for fiscal structural reforms. A unified revenue authority, which the present government would like eventually to establish, could be one mechanism that would greatly improve the information flow between the BIR and CED. Staff called for delivering advance tax rulings promptly, since significant delays in such rulings are reportedly holding back investment decisions. The planned formation of a tax policy unit, with the help of technical assistance from the Fund, would greatly facilitate this. Staff commended the authorities for their improvements in debt monitoring, and urged that the next step now be taken, with the system being used to enhance debt management.

40. Staff urged the authorities to move forward on long-pending legislation for improving insurance supervision. This should be followed by legislation to improve supervision of credit unions, undertake occupational pension reform and address key AML/CFT shortcomings arising from the recently conducted Caribbean Financial Action Task Force (CFATF) evaluation (including ensuring robust AML/CFT supervision and publication of the national risk assessment). Finally, it is hoped that the long-standing issues related to CL Financial may be resolved relatively soon, both to provide clarity to markets and to eliminate any residual claims against, and uncertainty about, the government’s finances.

41. Staff strongly endorses the process to establish a renewed data institution, through the establishment of an independent and autonomous National Statistical Institute (NSI). The task force to establish this has made significant headway in a short amount of time, and staff welcomes the intention to pass legislation this year to establish the NSI. In the meantime, the CSO has already reduced data backlogs, particularly in trade statistics. Per CARTAC suggestions, the CSO also has a plan to produce quarterly GDP statistics and update the Producer Price Index (PPI), although the timeline will depend on the availability of staff resources.

Authorities’ views

42. The authorities concurred on the need for further structural reforms, made more urgent in light of energy price declines. Important financial legislation, including the long-delayed Insurance Bill, procurement reforms, and gaming legislation, are immediate priorities. The government is pressing ahead with creation of a tax policy unit and hopes, at some point, to find political support for establishing the unified revenue authority. The need to establish a renewed, vigorous independent data institution also remains a critical priority, although fully rebuilding capacity to achieve best practice will take some time.

Staff Appraisal

43. In recent years, Trinidad and Tobago has under-saved and under-invested in its future given the size of energy revenue windfalls, with the consequence that there is currently no scope to pursue countercyclical policy. Even current low debt levels and substantial financial cushions are insufficient to withstand the size of the terms of trade shock that now needs to be confronted. If ignored (and barring an unexpected sharp rebound of energy prices), the imbalances that are now starting to build could lead the country to uncomfortable levels of debt and external financial cushions in a few short years. In turn, that could necessitate a very rapid pace of adjustment, with the attendant severe dislocations and associated deflationary consequences.

44. The new government has made a strong start on the difficult fiscal adjustments needed to bring the economy back into balance. They introduced new revenue measures with the FY 2015/16 budget, and introduced further adjustment measures mid-year when it became clear that even the seemingly conservative energy price assumptions in the budget were being outpaced by events. While these measures have been in the right direction, staff believes it will be important to provide a strong medium-term framework to guide an overall multi-year adjustment effort. While it would be neither possible nor advisable at this time to try to fully spell out all the measures required, the government should work towards a broad set of medium-term fiscal goals, backed by quantified estimates of measures where feasible, while leaving some scope to adjust the size of the adjustment as the situation unfolds. At the same time, the government should spell out broad intentions in areas where reforms will be desirable, regardless of how the economy evolves. In this regard, the government’s intention to pursue a comprehensive expenditure review is welcome, as are the intentions to review government “make-work” programs and the GATE program. More broadly, staff welcomes the government’s intention to develop a medium-term macroeconomic programming capacity, as well as a tax policy unit, with the help of Fund technical assistance. In addition, staff believes that once the fiscal path is back on track, a fiscal rule could help avoid the pro-cyclicality that has characterized economic management for decades.

45. Monetary and exchange rate policy can work to support economic activity once confidence in the government’s medium-term strategy is established. For now, both monetary and exchange rate policy will need to be primarily oriented towards external balance. This will especially require giving confidence to the private sector that FX will be available on demand for legitimate current transactions. In turn, this will require both fundamental measures to restore underlying balance in the supply and demand for FX, while also undertaking confidence-building measures to reduce the adverse impact that expectations are currently having in exacerbating the demand for FX. In this sense, while the country has options, a depreciation that helps switch expenditures towards domestic activity and reduces current expectations that have been giving the market a one-way bet on the currency, could actually serve to stabilize the market. However, it would be essential to introduce any significant change to the exchange rate regime as part of a comprehensive package of demand management and growth-enhancing reforms, accompanied by a clear communications strategy that guides the private sector to a new equilibrium.

46. Staff does not recommend Executive Board approval of the retention of the measures giving rise to the exchange restriction and multiple currency practices described in paragraph 35 above since there is no clear plan and timetable to eliminate these measures, and for measures giving rise to the exchange restriction, since they are also not maintained for balance of payments reasons.

47. With regards to structural reforms, the new government is building on some of the achievements of the previous government, and also introducing welcome new priorities. Early successes in passing critical legislation on insurance supervision and the new NSI, while progressing on a tax policy unit, could constitute an effective initial package of structural reforms. In addition, early commencement of an effort to design reforms in the areas of government “make-work” programs, GATE and in particular, to kick-start an effort to diagnose the reasons for inefficiencies in the public sector would go a long way towards establishing the government’s reformist bona fides.

48. It is proposed that the next Article IV consultation take place on the standard 12-month cycle.

Figure 1.
Figure 1.

Trinidad and Tobago: Key Economic Developments

(In percent, unless otherwise indicated)

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

Sources: Trinidad & Tobago authorities; and Fund staff estimates.1/ In percent of labor force.
Figure 2.
Figure 2.

Trinidad and Tobago: External Sector Developments

(In billions of U.S. dollars, unless otherwise indicated)

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

Sources: Trinidad & Tobago authorities; and IMF staff estimates.
Figure 3.
Figure 3.

Trinidad and Tobago: Monetary Sector Developments

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

Sources: Trinidad and Tobago authorities; and Fund staff estimates.
Figure 4.
Figure 4.

Trinidad and Tobago: Fiscal Sector Developments 1/

(In percent of fiscal year GDP, unless otherwise indicated)

Citation: IMF Staff Country Reports 2016, 204; 10.5089/9781475578232.002.A001

Sources: Trinidad & Tobago Authorities; and Fund staff calculations.1/ Central government only unless otherwise specified.
Table 1.

Trinidad and Tobago: Selected Economic Indicators

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Sources: Trinidad and Tobago authorities; UN Human Development Report; WEO; and Fund staff estimates and projections.

Includes VAT and Financial Intermediation Services Indirectly Measured (FISIM).

The data refer to fiscal year October-September.

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

Excluding debt issued for sterilization. Does not include arrears on the fuel subsidy.

The current account balance for 2011 and thereafter has been revised to re-classify dividend payments from the "other private sector capital" account to the "factor income" account.

Before 2009, Henry Hub price in Louisiana. From 2009, the average of Henry Hub and Asian LNG prices.

Table 2.

Trinidad and Tobago: Summary of the Central Government Operations 1/

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

Fiscal year data from October to September.

Excluding debt issued for sterilization. Does not include arrears on the fuel subsidy.

Table 3.

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.

Starting in 2011 dividend payments have been re-classified from the “other private sector capital” account to the “factor income” account.

Includes net errors and omissions.

Excludes the IMF SDR allocation.

Consists of petroleum, natural gas and petrochemical exports less fuel imports.

In millions of US$, end of period.

WEO simple average of three spot prices: Dated Brent, West Texas Intermediate, and Dubai Fateh.