Ian Narine
?The ugly "R" word is here again. Just as it was at the change of the last government in 2010, T&T is once again faced with the prospect of a recession. On the last occasion, the catalyst was the global financial crisis followed by the CL Financial debacle. A morbid recovery over the past couple years now seems to be giving way to another period of decline in GDP this time brought on by collapsed energy prices.
A recession can be defined as two consecutive quarters of negative growth in gross domestic product (GDP) although there are other ways in which such a phenomenon can be defined.
While politicians tend to focus on whether GDP growth is positive or negative and pat themselves on the back when moving from negative to positive, I have always advocated that we need to establish the parameters necessary for T&T to grow consistently at a rate of at least five per cent annually and then implement effectively. A growth rate of five per cent is, in my view, the minimum growth rate necessary to take us to a developed country status within the timeframes established.
My favourite analogy is to equate the economy to a commercial aircraft. If the plane flies too high–as we did in the last decade–the engines eventually stall because of the high altitude and it crashes. If it flies too low–as was the case over the past couple years–then any form of turbulence at low altitudes will also cause the plane to crash. The optimal approach is to establish a reasonable and consistent flying altitude that will allow you to get safety to your destination and to chart a path from the runway to that cruising altitude.
If we are to move out of our current "low growth then into recession" cycle this is what our economic planners have to configure starting with the 2016 budget.
The fiscal measures, as defined in the budget, also have to be coordinated with the monetary policies of the Central Bank of T&T. While both institutions should be and remain independent, the level of co-ordination that is necessary is one that has not been seen since I started writing this column in 2004 and which transcends different CBTT governors and political administrations.
Last week, the CBTT raised the repo rate for the seventh consecutive time by 25 basis points taking the CBTT's overnight lending rate (the repo rate) to 4.5 per cent. Some commentators have spoken out against this move but it is one that I support. To be clear I am not arguing the reasons given by the CBTT for raising rates but rather I am putting forward my rationale for why we should have higher levels of interest rates in T&T.
There can be different reasons for the same policy response.
Non traditional risks
The traditional view is that low interest rates makes credit more accessible and affordable and so stimulates economic activity leading to growth in GDP. If on top of low interest rates we introduce various structural reforms that improve productivity then we will get the growth stimulus that we are seeking.
We have already heard comments from the current administration about making workers more productive and, if this is achieved, and business utilise assets more productively then one can expect that GDP will rise.
This is the basic argument for keeping rates low and, historically, this is what has worked in the past. I suggest that this time around keeping interest rates low is not going to be a panacea for sustainable growth simply because rates have already been too low for too long and to keep adopting this policy will cause problems down the road.
Recognise that there are limits to economic expansion based on an expansion of credit. If we have not yet approached those limits, then keeping rates low for any considerable period going forward will likely take us to those limits. It then becomes extremely difficult to move out of this situation and just as is the case in the US, Europe and Japan the result is persistent low growth with frequent dips into recession.
Appreciate that when rates are reduced or kept low and consumption is based on credit, what is in effect happening is that demand is being brought forward.
So the ultra accommodative policies of low interest rates and an overvalued currency have brought forward significant demand for motor vehicles, property and the attendant furnishings and other forms of consumption. This has not even brought us to a GDP growth rate of two per cent and, in fact, our compounded annual GDP rate over the past five years is -0.8 per cent.
If we continue to simply attempt to bring forward future demand then we eventually run out of borrowing capacity and the credit cycle collapses on itself.
Further we are an aging population and low interest rates also means low rates of return for savers. These savers will soon retire and find themselves dependent on the State for support. Would it not be better to afford these citizens the opportunity to secure their future for themselves?
Neutral rate
Rather than focusing on low interest rates the first place to start is for the government of the day to facilitate the more efficient workings of the T&T economy. The Index of Economic Freedom–developed by the US-based Heritage Foundation and the Wall Street Journalhas scored T&T for 2015 at 13th in the region behind El Salvador, Dominica, Costa Rica, Jamaica, Barbados, St Vincent, St Lucia with Chile being the number one ranked country in the region.
For reference T&T scored below its average score in the sub areas of property rights, investment freedom (which speaks to the flow of capital), financial freedom (which speaks to banking efficiency and the level of government control within the financial services sector) and the universal agreed issue of "freedom from corruption" where our score of 38 was equal to or lower than all of the aforementioned countries.
It is my view that addressing these issues will have a greater impact on sustainable economic growth than maintaining low interest rates as to do otherwise will lull both the consumer and the State towards a debt crisis in years to come.
Persistently low rates allow debt levels to accumulate and this eventually affects the credibility of the borrower. Seven years of fiscal deficits with more to come has already negatively impacted the credit rating of the country. The morbid economic activity of the past few years was fueled by consumer spending most of which was funded by debt. It means, therefore, that the debt profile of consumers has also increased.
We should therefore be seeking to engineer a "neutral" interest rate environment, one that is not accommodative but also not restrictive. I would suggest that benchmarking our 10-year interest rate to 250 to 300 basis points above the 10 year US treasury rate would achieve this objective.
Some may argue that our level of national borrowings still leaves us with capacity and we also have capacity to borrow on the external market and that we should use this borrowing capacity to stimulate economic growth. I counter by asking for the name of one country that has the demographic profile (aged society) that T&T has that managed to grow itself out of a debt problem without debt forgiveness of some sort. If we were to go the route of relying on credit fuelled GDP growth, we are simply relying on a rebound in energy prices to take us out of the hole.
We also need to understand that surplus liquidity and low interest rates–features of our economy for the past decade–give rise to inflation in asset prices. Assets back most of credits, as prudent lending should dictate. Rapid growth in credit creation increases the rapid growth in the value of the underlying assets based on demand dynamics. To the casual observer, the portfolio of loans seems low risk as there is surplus collateral to cover the loans.
However, during a period of adjustment, the same factors that contributed to the expansion amplifies the contraction. If demand is brought forward to the point where there is oversupply in the future or, in the case of property, excessive credit creation pushes asset prices beyond that which is ordinarily affordable then a correction in asset prices will take place. Here the value of the liability remains constant while the value of the collateral falls. A state of over collateralisation can quickly reverse and write-downs and defaults become real risks. A 1980s style recession will be the most likely outcome.
A delicate balancing act is now required and any missteps can have significant consequences.
Ian Narine can be contacted via email at ian.narine@gmail.com