Last week Friday, the Central Bank took the decision to reduce reserve requirement from 14 per cent to 10 per cent.
The Central Bank explained it took the decision, at a special meeting last week Friday, because of a recent decline in excess reserves of commercial banks—the deposits held by banks at the Central Bank in excess of the required reserve ratio of 14 per cent of prescribed liabilities (deposits and short term borrowings). The daily average of excess reserves measured $2.76 billion from July 1 to July 18, 2024 compared to $3.91 billion in June 2024.
Economist Dr Ronald Ramkissoon explained to the Sunday Business Guardian that the decline in liquidity was caused by an increase of Government borrowing on the domestic market, increased private sector borrowing as well as the sale of foreign exchange by the Central Bank to the commercial banks, which pay for foreign exchange with TT dollars.
On whether he subscribed to the view the decline was mostly as a result of Government borrowing on the local market and the prospect of additional Government borrowing to the end of the fiscal year, Ramkissoon said data provided by the Central Bank supported this position.
The bank’s May Monetary Policy Report, published this month, states Government borrowed $8.1 billion on the domestic market over the eight months to May 2024, compared to $4.7 billion over the same period last year.
On whether this decline in liquidity could have been reversed by open market operations and reliance on the inter-bank lending arrangement (or even on repos), Ramkissoon responded, “In its May 2024 Policy Report the Central Bank said that it would use both direct (reserve requirement) and indirect (open market operations) instruments of monetary policy in managing commercial banks’ liquidity. I assume that the Monetary Policy Committee of the Central Bank would have considered using open market operations and inter-bank lending but might have considered the costs and feasibility of the former as well as the size of the inter-bank market.
“In any case, the reduction in the reserve requirement is in keeping with the Central Bank’s expressed intention for some time now, of moving towards greater market instruments and less reliance on direct instruments such as the still high (by international standards) reserve requirements.”
Ramkissoon also looked at the decline in the reserve requirement and how much money had been “liberated” as a result of the 4 percentage point reduction.
He explained, “If at 14 per cent, the reserve requirement was approximately $13.6 billion, then some additional $4.0 billion would now be available to the commercial banks for onlending. The effect of this might be an expansion in lending at existing rates.”
Regarding the impact the Central Bank’s decision would have on lending and deposit rates at commercial banks, the senior economist said the reduction in reserve requirement normally results in an increase in liquidity, which, in turn, can cause lending and deposit interest rates to fall.
However, he said whether loan rates fall depends on several factor such as the size and timing of Government borrowing and the effective demand for loans.
“Interestingly, the earlier May 2024 Monetary Policy Announcement says it expects domestic rates to increase and US rates to decline towards the end of 2024, thereby narrowing the US/TT interest rate spread. Also, the Bank has to monitor external conditions especially any movement in US interest rates.
“If US rates remain stable in the short run as some analysts expect, the Central Bank would want to be careful in lowering domestic rates thereby widening the spread between US and domestic rates with adverse consequences for capital flows. In any case the Central Bank did not state that lower rates are an objective of its intervention,” said Ramkissoon.
He noted that the Central Bank’s emphasis seems to be on better liquidity management in the banking system as sudden and not insubstantial drawdowns in the recent months seem to have raised banks’ concerns about liquidity. Hence its special meeting on July 19,” Ramkissoon added.
Economist Dr Vaalmikki Arjoon, also attributed the decline in excess liquidity largely to Government borrowings, citing that in the first eight months of the fiscal year, the State issued over $8 billion in bonds to meet budgetary obligations and refinance existing debt.
Additionally, Arjoon said the $400 million NIF2 bond issue also contributed to lowering liquidity to a lesser extent.
“Furthermore, the US$750 million debt in June raised in the international market and the US$160 million HSF withdrawal in December 2023 reduced some of the excess liquidity as these US-dollar funds were converted to TT dollars by the Central Bank. To a lesser extent, commercial banks’ forex purchases from the central bank also account for some of the drop in excess liquidity, as they used excess reserves to pay for the US dollars,” Arjoon added.
He also noted that lowering the reserve requirement by four per cent will instantly and significantly increase excess liquidity by approximately $3.88 billion, but noted that such a move is usually taken when liquidity has been declining for a prolonged period or there are severe global shocks that require a large injection of liquidity to sustain economic activities.
However, Arjoon also agreed it is highly likely that increasing liquidity to such an extent in this manner largely aims to create additional space for Government borrowing.
“With our current dismal revenue earnings due to lower global LNG prices, it is highly probable that the state will seize this opportunity to borrow more from the domestic market for budgetary spending, especially with an election year approaching, to avoid restricting expenditure and sustain economic activities,” Arjoon said.
He added this highlighted an even deeper problem – an unsustainable debt level where additional debt is taken for primarily recurrent expenditure and not necessarily enhancing productive capacity. He noted that for the first eight months already, the Government borrowed over $13 billion for budgetary obligations and to make principal payments.
Additionally, Arjoon stated although the Central Bank maintained the repo rate, the increased liquidity in the banking system could exert downward pressure on interest rates, making loans cheaper for consumers and businesses.
This, in turn, he explained can stimulate more borrowing and private sector investment.
“Indeed, in the first half of this fiscal year, non-energy sector revenues have increased by over $4.1 billion compared to the same period last year. Creating more opportunities for private sector borrowing through this excess liquidity can therefore bolster private sector investments, job offerings, and overall profitability, which is crucial given that taxes on income and profits fell by over $6.3 billion in the first half of this fiscal year compared to the same period last year,” Arjoon said.
However, he noted this is contingent on the private sector having adequate access to the liquidity and not being crowded out by Government borrowing. Arjoon also noted that with added Government and private sector spending, there will be a higher demand for forex and potential inflationary effects.