Trinidad and Tobago’s Response to the Pandemic (Monetary Policy)
Trinidad and Tobago’s 2020 Projected Real GDP growth rate is expected to be -4.5%. The negative number may appear alarming to those unaware of our country’s past GDP figures. However, as seen below, Trinidad and Tobago’s GDP has taken up temporary residence below the x-axis for the past four years.
Therefore, when we confirmed our first Covid-19 case and the country was placed on a “Stay at Home” order with an indefinite expiry date, the government was tasked with the unenviable job of outlining economic measures to help alleviate the effects of this pandemic.
From looking at the measures, it was clear that the main objective was to inject liquidity by increasing government spending and the money/credit supply — The hallmarks of expansionary policy.
See below for all the measures the Government has implemented thus far.
As I attempted to dissect each of them it was noticeable that most were self-explanatory with the exception of those related to the Central Bank of Trinidad and Tobago. So I’ve decided to explore the related measures further.
The actions related to the Central Bank are termed monetary policy (and those related to the government are called fiscal policy). Monetary policy refers to steps taken by the central bank to alter total output and price through changes in bank reserves, reserve requirements, or its target interest rate. These factors are used to influence the money supply.
Monetary policy can be either Expansionary or Contractionary and are used to increase or decrease the money supply (respectively). As the names suggest expansionary policies are used to help grow the economy in times of an economic downturn (like now) and the latter is used to curb an overly-rapid economic expansion.
Below are further details for the measures related to the Central Bank as presented by the Ministry of Finance:
- A reduction in the reserve requirement for the commercial banks from 17% to 14%.
By definition, the reserve requirement or reserve ratio is the requirement for commercial banks to hold reserves in proportion to the size of deposits.
Deposits are classified as liabilities to banks because they have an obligation to return the money when customers make withdrawals. Therefore, it makes sense to have a minimum reserve requirement proportional to your liabilities.
Another concept is the money multiplier which is a function of the reserve requirement. This is an important monetary policy tool used to control the amount of money in the banking system.
Example: Money Multiplier = 1/0.1 =10
The above example means the bank must hold $0.10 of each deposited dollar in reserves, but can loan out the remaining $0.90 of the deposited dollar. The value of 10 is the amount of money that can be created from a deposit of $1. It can be seen that a smaller reserve requirement amplifies the money multiplier effect.
2. Reducing the repo rate from 5% to 3.5%.
The Repurchase Rate or repo rate is the interest rate at which the Central Bank is willing to lend money to commercial banks. These rates are based on short-term collateralized lending rates. For example, if the Central Bank wants to increase the money supply, it might buy bonds (usually government bonds) from banks with an agreement to sell them back in the future. This is known as a repurchase agreement.
Effects of (1) and (2):
The reduction in the reserve requirement from 17% to 14% and the reduction of the repo rate from 5% to 3.5% will inject an additional $2.6 billion into the commercial banking system. These measures will increase liquidity.
Due to the reduction in the repo rate, it is expected that the prime lending rate should decrease by 1.5% giving a rate of 7.75%. Just to note, the prime lending rate is the interest rate at which banks lend to customers with good credit. It makes sense, if the bank can borrow at a cheaper rate, so can you, given that you’re a creditworthy customer.
Finally, there will be a further reduction in the prime lending rate to 6%. This is to reduce the spread between lending rates and deposit rates. The spread is the gap between the lending rates and the deposit rates. A narrower spread usually reflects efficiencies in the banking system because savers get higher expected returns while borrowing becomes cheaper.
As a result of these measures, customers will now have more money on hand therefore consumer spending will increase. An increase in consumer spending aids economic expansion because it drives demand which in turn increases supply.
The other measures are related to fiscal policy and they are also aimed at injecting liquidity in the economy to encourage consumer spending. The explanations above just simply states how the policies are intended to work. In reality the government may not achieve their objectives due to factors they can not control. Some of these include hesitation of the general public to return to some level of normalcy after the pandemic due to warranted concerns, decline in tourism and the volatility of the oil and gas industry.
Essentially time will reveal its impartial verdict on the efficacy of these measures.
***The views expressed in this article are based solely on the author’s independent research and opinion. This article does not constitute any corporate financial advice or investment recommendations and therefore should not be relied upon for any investment activities or used for any predictive purposes. It is strongly recommended that readers perform their own research and/or speak with a qualified investment professional before making any decisions.
