Trinidad and Tobago adjusts financial policies in light of lower energy prices

At first glance, the newly elected government of Trinidad and Tobago, which took office in September 2015, faces a formidable first year, marked by one of the deepest slumps in energy prices seen in recent decades. This has pushed the economy into recession and forced the authorities to embark on a difficult programme of fiscal austerity.

However, the crisis is not without opportunity for the country’s new leadership and may also be the moment for new policies aimed at economic diversification to gain further traction. Given that T&T has a safety buffer in the form of strong foreign currency reserves and a sovereign wealth fund, there is likely room to manoeuvre.

Energy & Export Focus

T&T is a largely energy-based and export-focused economy. The predominant activity is oil and gas production, and associated downstream processing. While gas, more than oil, is the key extractive industry, the country is also among the largest exporters of methanol and ammonia, and an important supplier to the US.

Moreover, T&T is considered one of the most diversified economies in the English-speaking Caribbean, with significant manufacturing, financial services and ecotourism sectors. Manufacturing exports include food, beverages and tobacco, chemicals and non-metallic minerals, assembly and related products, and cement.

The country imports vehicles, heavy machinery and transport equipment, food and beverages, mineral fuels and lubricants. Its main trading partners include other members of the CARICOM bloc, the US, Gabon, Colombia, Argentina, China, Norway, Puerto Rico, Brazil, the UK, Peru, Chile, Spain, Russia, Canada, France and Japan.

According to the Central Bank of T&T (CBTT), GDP in current prices reached TT$165.29bn ($25.5bn) in 2015, with the energy sector representing some 32.1% of the total, down from 40% in 2010, while non-energy activities accounted for 67.4%. Agriculture comprised the remaining 0.5%.

In 2015 the main subsectors within the non-energy area by order of importance were distribution (21.8%), finance (12.8%), government services (8.8%), construction (6.5%), transport (5.9%), manufacturing (5.6%), education (2.4%), personal services (1.5%), electricity and water (1.3%), and hotels and guest houses (0.4%).

The country has a relatively open economy, with imports equivalent to 40.9% of GDP and exports reaching 65.4%, according to the “Global Competitiveness Report 2015-16” by the Word Economic Forum (WEF). Average import tariffs are relatively high by international standards, at 11.9%.

T&T also ranks as one of the more affluent countries in the region. Gross national income per capita stood at $20,070 in 2014, as per World Bank figures, one of the highest levels in Latin America. This was more than double the regional average of $9912 and stood above the mean for high-income non-OECD countries, which was $18,937.

Rankings

T&T ranked 89th out of the 140 countries surveyed in the WEF’s 2015-16 global competitiveness index (GCI). However, this ranking – which has been relatively stable in recent years – is open to a variety of interpretations.

While scoring in the lower half of all countries surveyed suggests there is room for improvement, T&T ranked as the second-best country in the Caribbean of those economies covered by WEF, just behind Jamaica (86th) but ahead of neighbouring Guyana (121st) and Haiti (134th).

In the context of Latin America, however, T&T’s profile appears more mixed. The twin-island nation trails behind the economies of Chile (35th), Panama (50th) and Costa Rica (52nd), but ranks ahead of a number of others, including El Salvador (95th), the Dominican Republic (98th) and Nicaragua (108th).

The GCI is prepared by analysing a range of qualitative and quantitative criteria across 12 categories or pillars. Relative to the average for Latin American and the Caribbean, T&T was on a par in terms of the quality of its institutions, innovation, business sophistication, and goods and labour market efficiency. The country was below average for market size but scored better than the average for infrastructure, macroeconomic environment, technological readiness, health and primary education, higher education and training, and financial market development. According to the survey, some of the areas in need of improvement in terms of doing business in the country were identified as a poor work ethic in the labour force (20.1% of respondents), corruption (14.7%), inefficient government bureaucracy (14.4%), and crime and theft (12.2%).

Under New Management

Economic policy-making in T&T saw notable changes in 2015, with two key steps taken in September and December 2015. Following the victory of the Peoples’ National Movement in the general elections on September 7, Keith Rowley was sworn in as the new prime minister two days later, on September 9. Rowley subsequently appointed Colm Imbert as the new minister of finance. Given that the country’s fiscal year runs from October 1 to September 30, the new government had very little time to prepare its budget for FY 2015/16, which began on October 1, 2015.

Imbert presented the new government’s budget to Parliament on October 5, 2015, speaking five days after the new financial year had already started. In part because it was not possible to conduct a full audit of the public sector’s finances in the short time available, the minister said there would be a more substantial mid-year budget review. This was held on April 8, 2016 and was used to announce additional fiscal measures (see analysis).

A second important change came in late December, when the government announced it had dismissed Jwala Rambarran as governor of the CBTT and appointed Alvin Hilaire, who had been serving as deputy governor, to replace him. Although the CBTT operates with a degree of autonomy from the government, it had become evident that there were serious policy disagreements.

Appointed three years earlier by the previous administration, Rambarran had responded to criticism over foreign currency shortages by naming the main local companies buying foreign exchange. He said he had done so because the public had a right to know that a large proportion of the country’s scarce foreign exchange was being used in the import and distribution trade. However, local companies and the government took the view that this was a violation of commercial confidentiality.

Rambarran also declared that the economy was in recession, reportedly without prior consultation with the government. Broadly speaking, the business community reacted positively to the change in leadership, believing it was ushering a period of improved policy coordination between the CBTT and the Ministry of Finance.

A Tough Year

In its March 2016 Economic Bulletin, the CBTT said that after negative growth of -1% in 2014, the economy contracted by 2.1% in 2015, as per provisional data. In the fourth quarter of 2015 GDP was down 3% year-on-year (y-o-y), reflecting a 5% contraction in the energy sector and a 1.8% decline in the non-energy sector.

Apart from lower prices, the energy sector was affected by dwindling output from mature oil fields and plant shutdowns for maintenance and infrastructure work. Results in the downstream sector were more mixed, with LNG output falling in the second half of 2015. Refinery output, meanwhile, increased after the completion of upgrades at the state-owned Petrotrin plant, and ammonia and urea produce was up from a relatively low base in 2014. However, industrial production was impacted by the closure of the ArcelorMittal steel plant in the face of low international steel prices. After adopting temporary layoffs in November 2015, the company announced the closure of its facility in the Point Lisas Industrial Estate – the largest steel mill in the Caribbean – in March 2016, resulting in the loss of some 644 jobs. This tracked broader employment trends in 2015. Weaker economic performance over the year had an impact on the country’s labour market, with unemployment rising from 3.3% in late 2014 to 3.5% by the fourth quarter of 2015.

Financial Impact

Low energy prices have taken a toll on public finances. Government revenue fell by 6.2% in FY 2014/15, according to the CBTT, with a 35% decline in energy collections outstripping increases in non-energy and capital receipts. While government spending contracted by 1.6%, the fiscal deficit widened to TT$7bn ($1.1bn), or 4.2% of GDP, exceeding both the 2.3% target and the actual deficit recorded in the preceding fiscal year, which was 2.6%. Early signs for FY 2015/16 suggest the deficit will continue. According to data from the Ministry of Finance, there was a TT$1.8bn ($277.2m) deficit in the first four months of the new financial year.

The slump in commodity prices has also had a major impact on the balance of trade. Export receipts fell by 26.6% y-o-y in the first nine months of 2015, while imports declined by 18.6% over the same period. Non-energy imports, however, continued to grow, rising by 12.3% y-o-y.

As a result of the unfavourable movement in the terms of trade in 2015, the current account registered a $38.7m deficit, equivalent to 0.2% of GDP, in the first nine months of the year – the first such deficit seen in the country since 2012.

Despite the overall drop in imports, the CBTT said demand for foreign exchange had remained “persistently high”. In the second half of 2015 foreign currency sales by authorised dealers were up 3.4% and conversions of foreign currency into local currency by foreign exchange earners were down 11.4%, with this trend continuing into early 2016.

While the CBTT said it had completely offset the net foreign exchange sales gap in the eight months to March 2016, the T&T dollar nonetheless saw further depreciation. After its value slid by around 0.8% against the US dollar in 2015, the T&T dollar depreciated by a further 2.5% in the three months to March 2016, according to the CBTT.

The CBTT also highlighted signs of declining business and consumer sentiment. Both indices range from 100 (unanimous optimism) to -100 ( unanimous pessimism). The consumer confidence index declined to -30.8 in the first quarter of 2016, down from -18.9 in the same period in 2015, with consumers showing growing pessimism over the cost of living, the economy and the purchase of consumer durables. The business confidence index, meanwhile, also posted a decline, falling from 17 and 18 in the third and fourth quarters of 2015, respectively, to 2 in the first quarter of 2016. The business community was mainly concerned by an adverse global economic environment and low levels of demand.

Lower demand saw annual headline inflation ease to 3.3% in March 2016, down from 5.2% one year earlier. However, food inflation remained volatile, falling sharply at the end of 2015 before rebounding in February 2016 as the scope of value-added tax was widened to include more food products.

In anticipation of interest rate movement by the US Federal Reserve, the CBTT raised its repo rate three times in the second half of 2015 to reach 4.75% by December. However, no further changes were made in the first half of 2016.

Despite the CBTT’s shift to monetary tightening, sector-wide bank lending continued to post strong growth throughout the second half of 2015, albeit at higher interest rates. In line with the CBTT’s repo rate hikes, the median prime lending rate of commercial banks inched up by some 68 basis points to reach 8.93% as of the end of 2015 before stabilising at around 9% in mid-January 2016.

Excess liquidity in the commercial banking system, as measured by commercial bank holdings at the CBTT in excess of statutory reserve requirements, declined by 16% between the first and second half of 2015, but began to rise again in the first quarter of 2016 (see Banking chapter).

Credit Downgrades 

A range of international organisations, including ratings agencies, have commented on T&T’s economic performance and policy options. In March 2016 the IMF voiced concerns about the country’s economy, noting that structural reforms were required to unlock its growth and diversification potential. The IMF did, however, express support for the new government’s initial policy response, praising it for measures such as widening the tax base, cutting fuel subsidies and announcing plans to rationalise the public sector. While the IMF noted that T&T benefitted from a well-educated workforce and stable government, it warned that inadequate savings and investment could lead to “uncomfortable” levels of debt.

In April 2016 international ratings agency Moody’s said it was downgrading T&T’s government bond and issuer ratings to “Baa3” with a negative outlook. This came on the heels of another ratings downgrade in March 2015, when Moody’s revised T&T’s rating from “Baa1” to “Baa2” and cut its outlook from stable to negative, citing fiscal deficits, declining oil and gas prices, and limited prospects for economic diversification.

In its April 2016 ratings action, the agency again cited low energy prices which, despite fiscal consolidation efforts, were expected to negatively impact the economy and government finances through to 2018. Moody’s said it expected GDP to contract by 2.5% in 2016 and remain subdued, with growth of about 1% per annum in 2017 and 2018.

Standard & Poor’s (S&P) also downgraded T&T’s rating in early 2016. While the agency maintained a “A/A-1” long and short-term credit rating for the country in December 2015, the outlook was revised to negative. Then, in April 2016, S&P lowered T&T’s long-term sovereign credit rating to “A-”, maintaining a negative outlook. According to the agency, this “reflected at least a one-in-three chance that prolonged low energy prices and potentially low GDP growth prospects could result in a steadily rising debt burden, resulting in a downgrade in the next two years”. S&P’s also noted that successful implementation of fiscal reforms and a gradual economic recovery would be needed to stabilise the government’s growing debt burden.

Subsidy Adjustment

Given its relatively high degree of import dependence, T&T continues to be exposed to external inflationary pressures, caused, among other things, by volatility in the price of imported foodstuffs. In FY 2015/16 there was also concern that higher fuel prices might lead to a surge in inflation after the government decided to take advantage of low oil and gas prices to begin removing subsidies on fuel.

The government increased super gasoline and diesel prices in two 15% steps in October 2015 and April 2016. By April 2016, super gasoline prices were no longer subsidised, and the diesel subsidy had been reduced to around TT$1 ($0.15) per litre.

This was seen as a move with long-term benefits, helping to curb the fiscal deficit and encourage the use of renewable energy sources. While subsidy rationalisation was projected to have some negative short-term effects on inflation, lower government spending, weaker demand and rising unemployment should all help to offset the impact of higher energy costs on headline inflation.

Diversification Drive

Looking ahead, the fiscal deficit, as well as unemployment and poverty levels, are projected to increase, much as they did following the 2008-09 global financial crisis, while the economy undergoes an economic transition, Tomas Bermudez, T&T country representative at the Inter-American Development Bank, told OBG. “But remember that T&T still has a strong balance sheet. For the foreseeable future this will still be an energy economy, although it needs to begin diversifying its sources of income,” he said.

Bermudez added that there were a number of diversification opportunities that the country could develop, including tourism and global back-office service provision, but it was important that the government first focus on creating a more conducive environment for innovation and diversification. This would require improvements in the ease of doing business, reduction in bureaucracy, changes to the tax code and a streamlining of Customs procedures.

At the UN Economic Commission for Latin America and the Caribbean (ECLAC), economists agreed that the country needs to diversify, but noted that progress on this front has proven to be elusive.

“We are having an oil slump now, just as we had one in the 1980s”, Willard Phillips, economic affairs officer at ECLAC, told OBG. “But if you ask me to choose which one I’d prefer to deal with, I’d say the one in the 1980s, because back then we had a bigger agriculture sector, accounting for around 7% of GDP, and that made us less import dependent than we are now,” he added.

Sheldon McLean, another ECLAC economist, said that one approach to the crisis was to boost non-energy exports, but noted that this was a difficult task because T&T’s trade complementarity with its traditional market, the US, was waning. “To diversify exports successfully, you need to pick the right sectors and support them through trade finance, public-private partnerships and innovation,” he said.

“We have a robust financial services sector and a relatively strong food and beverage manufacturing sector, although from an international competitiveness standpoint, local manufacturing benefits from subsidised fuel and electricity costs,” Marla Dukharan, group economist at RBC Financial, told OBG. While she believes diversification is important, she felt there was insufficient progress in this regard to provide greater resilience to the local economy. Around 40% of government revenue traditionally comes from the energy sector; however, this also benefits the non-energy sector through government transfers and subsidies, spending on goods and services, and via wages and salaries paid to public sector workers. “So what this means is that the non-energy sector is heavily driven by the energy sector. Real diversification therefore needs to be truly export driven,” Dukharan said.

According to Garvin Joefield, head of the economic intelligence unit at Republic Bank, the country does not have a strong foreign exchange earner outside of the energy sector. “Manufacturing is actually a net user of foreign exchange, with high import content, and it represents only 8% of GDP, so it won’t, on its own, allow us to export our way out of trouble in the short-term,” he told OBG. “However, it remains a viable option to help drive the country’s diversification thrust,” Joefield added.

Efforts are under way to develop non-energy sectors. “One of the initiatives to diversify the economy is to build out the international financial centre, which can create as many as 22,000 new jobs directly and indirectly, and add TT$8.5bn ($1.3bn) to our GDP,” Varun Maharaj, CEO of T&T International Financial Centre, told OBG. “The other initiative is to build a capital risk programme where the government and the private sector get involved in financing our small- and medium-sized enterprises.”

Foreign Exchange Bottleneck

A lack of availability of foreign currency has emerged as a significant bottleneck for many companies operating in T&T and a source of considerable controversy in relations between the government, the CBTT, commercial banks and the local business community (see Banking chapter). As a result of lower oil and gas prices, the supply of foreign currency – and particularly US dollars – has fallen sharply, while demand from importers and individuals concerned over a possible depreciation of the T&T dollar has risen. The CBTT has responded by drawing down some of its foreign currency reserves to meet excess demand, rationing the supply of US dollars and continuing to manage a floating exchange rate in such a way as to achieve a gradual depreciation of the currency. This policy has included a gradual tightening of interest rates intended to limit the possibility of capital flight. In 2015 foreign currency reserves at the CBTT dropped by 13.5%.

Policymakers appear to be seeking a balance between rapid depreciation of the local currency on the one hand and overvaluation on the other, which would cause a rapid drawdown of foreign currency reserves. As part of the budgeting process (see analysis), the new government set a policy of preserving foreign currency reserves equivalent to at least six month’s of import cover, while allowing up to $1.5bn from its Heritage and Stabilisation Fund to be used to cover the current account deficit.

In the mid-year budget review, Imbert said the T&T dollar would depreciate by no more than 7% against the US dollar from the September 2015 level of TT$6.3275. This statement was broadly seen as an attempt to reduce uncertainty and speculative pressures on the national currency.

Debt Level

Many Caribbean economies have seen an increase in overall debt levels in recent years. According to Moody’s, the build-up of debt in the region was not sudden or caused by the global financial crisis, but happened gradually over many years. The debt-to-GDP ratio now stands at over 60% for 12 of the 20 Caribbean countries for which Moody’s has data. Of those, six have debt-to-GDP ratios above 80%, and four have ratios in excess of 100%. The build-up of debt was partly attributed to the cyclical nature of economies in the region, which are exposed to external shocks and disasters such as tropical storms and hurricanes. Moody’s noted that there was also a regional tendency for fiscal deficits to widen, up from an average of 1.7% of GDP during the 1990s to 3.3% throughout the 2000s and 3.4% thus far in the 2010s.

However, Moody’s notes that while beginning to trend up, T&T’s debt ratio nonetheless compares favourably with others in the region. In 2015 debt to GDP in T&T stood at 42.5%, well below the Caribbean average of 65.4%. This in part reflects the country’s relative affluence thanks to past years of strong hydrocarbons-based export revenues. In December 2015 the government announced its intention to cap the country’s debt-to-GDP ratio at no more than 60%, suggesting the twin-island nation still has a comfortable operating margin to cope with a few more years of lower energy revenues. Also significant is the country’s location south of the hurricane belt. According to figures from the IMF, the probability of a hurricane striking T&T in any given year is less than 10%, compared to nearly 25% for Jamaica.

Outlook

In spite of renewed efforts to pursue diversification, T&T’s GDP is expected to decline in 2016 as a result of lower hydrocarbons earnings and output. This, along with uncertainties in the broader global economy, are expected to see a 2% contraction in GDP, according to the CBTT, with inflation remaining close to its 10-year average of 6% per annum. For its part, the IMF projects T&T’s GDP will shrink by 1.1% in 2016 but will resume growth in 2017, expanding by some 1.8%.

Activity in non-energy sectors such as construction, manufacturing and distribution is also on track to post declines in 2016, the CBTT suggested, not least because of the public sector austerity programme. However, the announcement of a public-private partnership to encourage construction of homes for middle- and low-income families could yield some benefits on this front.

The economic research team at Republic Bank took a similar view, noting that by the third quarter of 2016, the government was expected to accelerate some areas of its public investment programme, which could provide some stimulus to the economy.

Although the labour market is also likely to be weak, reflecting retrenchments in the energy sector, reported staff shortages in manufacturing and hospitality suggest there may be some opportunity for labour to be reallocated.

While energy prices remain low, prospects for increased natural gas output could drive renewed GDP growth in the years ahead. Greater natural gas production from EOG Resources’ Sercan field appears promising, while BP T&T is also increasing production at its onshore compression project. A further boon is expected to materialise in 2017, when the Juniper gas field enters production.