Getting the price right: Marla Dukharan, Group Economist, Royal Bank of Canada (Caribbean), on how foreign exchange policy reforms could improve macroeconomic performance in the medium to long term

The Central Bank of Trinidad and Tobago’s (CBTT) current approach to managing foreign exchange (forex), both in terms of how it sets the exchange rate, and how it manages the supply of US dollars in the financial system, has given rise to the development of a black market for foreign currency in T&T, and is affecting the performance of the non-energy sector.

The exchange rate is the single most important price in our country’s economy, more so than the price of oil or natural gas, because our fiscal and export revenues currently have less to do with the price of these commodities, and more to do with the price and availability of US dollars, which directly affects the unofficial price. The TT dollar’s depreciation expectations affect inflation expectations, private consumption and investment behaviour, import and export patterns, non-energy sector investments and activity, and overall economic performance as a result.

The exchange rate, which is set by the CBTT and is not determined by market forces, must therefore be managed in a way that supports the overall long-term well being of our economy. The IMF estimated in 2016 that the TT dollar was 21% to 50% overvalued,meaning that it would otherwise trade between TT$ 8-10: $1, depending on the model used. At unregulated foreign currency exchange offices (known locally as cambios), US dollars are sold for anywhere between TT$8-9, suggesting that the IMF’s calculation is not unreasonable. In addition, an Economic Commission for Latin America and the Caribbean 2016 report showed that the TT dollar is the single most overvalued currency in the Caribbean and Latin America. By maintaining an overvalued currency, the CBTT is in effect subsidising imports, and making our exports more expensive, which has negative implications on economic diversification and expanding the non-energy sector.

The TT dollar has been depreciating since November 2015, at roughly 5% year-on-year (y-o-y) as of January 2017. This pace of depreciation is too slow to meaningfully address the TT dollar overvaluation in the near future, and it will take until March 2020 to get to TT$8 :$1. Also, if we believe that the exchange rate is going to depreciate at a steady pace, our speculative and brought-forward consumption demand only increase, contradicting the aim of the CBTT’s foreign exchange policy approach. A more effective approach would be to have a higher degree of flexibility and market determination in the exchange rate. The CBTT has stated its primary policy agenda is controlling inflation, which has been averaging around 3% since September 2015, despite the TT dollar’s depreciation and value-added tax rate rise in January 2016. Clearly, there is scope for more aggressive TT dollar depreciation.

Regarding US dollar supply, based on the World Economic Forum’s “Global Competitiveness Report 2016-17”, foreign currency regulation was identified as the fifth most problematic factor for doing business in T&T. This factor saw the biggest jump, becoming more problematic by the widest margin, across all factors measured. This is not an exchange rate issue, but a supply issue. The level of reserves stood at roughly 10.6 months of imports, at $9.5bn, in November 2016 — down less than 1% y-o-y. Yet for 2016, the CBTT sold just $1.8bn to authorised forex dealers — 30% less than they injected in 2015. In addition, the public sold 13% less US currency to authorised forex dealers, at $4.3bn in 2016.The CBTT prefers to hold on to US dollar reserves based on expected longer-term weakness in export energy revenues. However, everything is a trade-off, and we must recognise that we are maintaining a high level of reserves at a cost to the economy.

As the IMF’s 2016 Article IV consultation stated, “Queues (for US dollars) now appear to be of macroeconomic significance, due to the delays in obtaining foreign currency for current imports and for debt servicing.” In any event, this approach has backfired to some degree, and limiting US dollar supply has stoked precautionary and speculative demand for US dollars.