Two Fridays ago, on March 27, the Central Bank issued its monetary policy announcement in which it reported that Monetary Policy Committee (MPC) had "agreed to raise the 'repo' rate for a fourth consecutive time by 25 basis points to 3.75 per cent."
One of the more extraordinary aspects of this statement was its headline: "Interest rate hike needed to protect T&T economy."
The obvious questions are:
1) What is the T&T economy being protected against? and
2) Will increasing interest rates provide the protection that the Central Bank seems to believe the domestic economy needs?
In explaining why the MPC "agreed" to increase the repo rate to 3.75 per cent, the Central Bank cited three factors that provide some clues that may help to discern what the domestic economy is being protected against.
The MPC "agreed" to increase rates because of "the potential for higher domestic inflation in the medium term," and because of "the relatively positive growth outlook for 2015."
The third factor–the possibility that the US Federal Reserve may increase interest rates in the third quarter of this year–is beyond the control of the T&T authorities in a way that the first two clearly are not.
The MPC also agreed "to continue with an aggressive programme to absorb excess liquidity so as to strengthen the impact higher interest rates are expected to have throughout the financial system.
On the issue of higher domestic inflation in the medium term, the Central Bank noted that "headline inflation slowed for the third consecutive month in February 2015 to just over 6 per cent from 9 per cent in November 2014."
Why is the Central Bank increasing interest rates if the rate of inflation is declining?
The reason is that "this easing in headline inflation may be short lived, as inflationary pressures are expected to pick up in the rest of 2015 due to a number of factors."
As far as can be determined, the Central Bank says there are three reasons why inflationary pressures are expected to be higher later on in 2015 than in February:
�2 Growth of consumer credit remains robust, increasing by nearly 8.5 per cent in January 2015, suggesting consumers are still willing to spend despite negative sentiment surrounding falling oil prices;
�2 Current and expected settlement of wage negotiations for teachers, civil servants and other public sector workers with considerably large retroactive payments and salary increments will boost consumer spending and further stoke inflationary pressures;
�2 The expansionary fiscal stimulus remains on track. Central Government's spending on its capital programme was higher by 7 per cent in the first four months of the 2015 fiscal year when compared to the corresponding period one year ago.
In picking apart these factors:
a) Higher consumer credit–It seems quite extraordinary, even counter-intuitive, that consumer credit was 8.5 per cent greater in January this year than in January 2014. This means that the consumers of T&T are borrowing to spend this year–when the prices of T&T's energy exports have collapsed–at a pace that is significantly higher than one year ago.
Could it be, then, that the Central Bank is attempting to protect T&T residents from themselves?
What does it mean that consumer are borrowing at a faster rate in 2015 than one year ago?
Is there a link between the "robust" consumer credit and the Prime Minister's speech on the State of the Economy on January 8, in which she said: "I am of the firm view that this is no time for sudden changes in the direction of economic development policies. Such an approach will negatively impact your comfort, investor confidence, business expansion and employment. I am also of the firm view that using a period of challenges to promote fear and panic will be irresponsible, and will have the impact of creating problems where in fact no such problems exist."
From this quote, it is clear to me that this national mood of comfort and wellbeing–in the face of an inevitable future of higher taxes and a reduction in transfers and subsidies–was created by the Prime Minister's "Don't Worry, Be Happy" speech.
Is the Central Bank trying to protect the country from the lack of concern about the future laid bare by the 8.5 per cent increase in consumer credit?
b) Backpay will boost spending–The Central Bank is right when it states that if the Government decides to make lumpsum payments of backpay to public servants and teacher that this will "boost consumer spending and further stoke inflationary pressures." If the Central Bank knows this, one must assume that the Ministry of Finance knows this as well.
So, it must be assumed that Minister of Finance, Larry Howai, is aware that if public servants and teachers get the $2 billion in backpay owed to them as a lumpsum in June or July, they will go out on spend it at amazon.com and in the purchase of cars, fridges, stoves, washing machines, driers and even dishwashers.
And to this figure of $2 billion must be added the $1.75 billion that is due to be distributed to non-assenting holders of Clico's Executive Felixible Premium Annuities and to British American (BAT) holders of short-term investment products by June.
If Mr Howai is aware of that a $3.75 billion tsunami of spending is about to descend on the country that would "further stoke inflationary pressures," what is he going to do about it?
Will he proceed to make lumpsum disbursements of monies to Clico/BAT policyholders and backpay to public servants and teachers–which would suit his party's political agenda to win this year's general election–or will he stagger those payments over a three-month period as the St Augustine campus of the University of the West Indies is doing for its academic and non-academix staff?
Will Mr Howai ensure that there are adequate fixed income and equity investment opportunities–such as the tax-free savings bonds, shares in Phoenix Park Gas Processors and the enhanced tax savings as a result of a $50,000 allocation to annuities–available to public servants, teachers and policyholders?
Or will those public servants, teachers and policyholders who realise that they would be worse off in the long run if they were to go out and blow their lumpsums only have the option of income funds and deposit account earning 1 per cent or less in interest?
If you know something bad is going to happen through your own actions, wouldn't it be the responsible and rational approach to put mitigation measures in place?
Is the Central Bank trying to protect T&T from the political season that we are in?
c) Expansionary fiscal spending–Again, if the Minister of Finance knows that excessive Government spending is going to contribute to a tsunami of consumer credit and spending, what is he going to do about it?
At the start of this piece, the second question that was asked was: Will increasing interest rates provide the protection that the Central Bank seems to believe the domestic economy needs?
The answer is that the conventional thinking is that interest rates take between nine and 18 months to impact economic activity–and this assumes lending rates are going up across the board in T&T.
Clearly they are not, as the Central Bank has been very careful not to increase the mortgage market reference rate from 2.25 per cent as this is something that could really have an impact on the public's sentiment.
All of this does not diagnose what could be the real problem that the Central Bank is attempting to protect T&T from, which is the declining foreign exchange reserves.
There is a link between increasing interest rates and T&T's foreign reserves as the Central Bank attempts to make T&T assets more valuable, but that is a story for another day.