Na­tal­ie?Brig­gs

On Fri­day, Sep­tem­ber 26, the Cen­tral Bank an­nounced an in­crease in the re­po rate by 25 ba­sis points, bring­ing it up to 3.0 per cent. In an in­ter­view with chief ed­i­tor-busi­ness, An­tho­ny Wil­son, the day be­fore, Gov­er­nor Jwala Ram­bar­ran ex­plained the rea­son­ing be­hind the move, say­ing the bank was sig­nalling to the mar­ket it want­ed in­ter­est rates to rise.

But the move was al­so cal­cu­lat­ed to get out ahead of the US Fed­er­al Re­serve, which is scal­ing back on its pro­gramme of quan­ti­ta­tive eas­ing. The Fed's de­ci­sion would make US bonds more at­trac­tive in­vest­ment in­stru­ments, rel­a­tive to lo­cal ones, caus­ing a move­ment of funds from here to there.

Ac­cord­ing to the Cen­tral Bank in its re­lease, rais­ing the re­po rate, there­fore, was a move to pro­tect the val­ue of the TT dol­lar, pre­vent cap­i­tal flight to the US and to keep in­fla­tion at man­age­able lev­els by tak­ing up ex­cess liq­uid­i­ty in the sys­tem.Giv­en that in­fla­tion af­fects the po­ten­tial long-term val­ue of items such as pen­sion plans and in­sur­ance poli­cies, the Sun­day BG want­ed to know what in­flu­ence, if any, an in­crease in the re­po rate would have on them.

Re­po rate rise: Lit­tle im­pact on in­ter­est rates and in­fla­tion

The re­po rate is the overnight rate at which com­mer­cial banks bor­row from the Cen­tral Bank. Fi­nan­cial an­a­lyst, Kurt Val­ley, said the way the re­po rate works in the US is dif­fer­ent from the way it works here."In the US for ex­am­ple, when the Fed rais­es their rate, banks that day, bor­row at a high­er price or a low­er price. In Trinidad, noth­ing hap­pens, no one is lend­ing at the re­po rate, no one is sell­ing at the re­po rate."

Ian Nar­ine, head of Guardian As­set Man­age­ment Ltd, and reg­u­lar BG con­trib­u­tor said, "A 25 ba­sis point rise in the re­po rate would not in and of it­self im­pact any as­pect of the mar­ket at this stage."

"As the gov­er­nor point­ed out, the rate move serves to sig­nal that the Cen­tral Bank is seek­ing to bring the cy­cle of de­clin­ing in­ter­est rates to the cur­rent record lows to an end. The ra­tio­nale is sim­ple: the econ­o­my is now out of re­ces­sion and there seems to be suf­fi­cient ev­i­dence that there is no need for such an ul­tra-ac­com­moda­tive pol­i­cy."

In un­der­stand­ing why changes in the re­po rate do not have the im­me­di­ate ef­fect, but are more in the mode of sig­nalling the CB's in­ten­tions as has been ex­plained above, one has to un­der­stand the rate's role in some­thing called the "trans­mis­sion mech­a­nism."In the trans­mis­sion mech­a­nism the re­po rate, in­ter­est rates for loans, as well as sav­ings and in­vest­ments, the price of trea­sury bills and oth­er gov­ern­ment bonds, the for­eign ex­change rate and in­fla­tion are all con­nect­ed.

Ac­cord­ing to the Riks­bank of Swe­den's Web site: "the trans­mis­sion mech­a­nism is ac­tu­al­ly not one but sev­er­al dif­fer­ent mech­a­nisms that in­ter­act. Some of these have a more or less di­rect im­pact on in­fla­tion while oth­ers take longer to have an ef­fect."In mar­kets like the US, as Val­ley ob­served, ad­just­ments to the re­po rate, re­sult in strong, mea­sur­able and more im­me­di­ate ef­fects else­where in the sys­tem.

How­ev­er, in T&T, the re­po rate is not op­er­at­ing this way and, in essence, an in­crease in re­po rate does not au­to­mat­i­cal­ly trans­late in­to a rise in in­ter­est rates–ei­ther for loans or for sav­ings or a re­duc­tion in in­fla­tion or is an ac­cu­rate re­flec­tor of the price of T-bills. The IMF com­ment­ed on this dis­con­nect in a 2011 coun­try re­port, where it said, "the re­po rate does not seem to be an ef­fec­tive mon­e­tary pol­i­cy in­stru­ment."

Ac­cord­ing to the re­port, the lend­ing rate is on­ly mod­er­ate­ly af­fect­ed by an in­crease in the re­po rate and "the re­po rate af­fects the lend­ing rate more through sig­nal­ing rather than through the mar­ket chan­nel. The cur­rent high liq­uid­i­ty makes the re­po rate non bind­ing, as banks have not tapped the re­po win­dow since Feb­ru­ary 2009."

Be­cause of the ex­cess of funds in the fi­nan­cial sys­tem, com­mer­cial banks have no need to bor­row mon­ey from Cen­tral Bank, which means that the abil­i­ty of the re­po rate to in­flu­ence rate changes is lim­it­ed. Nar­ine and Yo­gen­dranath Ram­s­ingh, CEO of Glob­al Fi­nance Ltd, one of the pen­sions ex­perts the Sun­day BG spoke with, pre­dict­ed that if there is a rise in in­ter­est rates, it will be more grad­ual or "pro­gres­sive" as op­posed to im­me­di­ate, just as Gov­er­nor Ram­bar­ran said.

How­ev­er, Val­ley said in­ter­est on sav­ings and in­vest­ments will not rise at all, con­trary to the hopes of the Gov­er­nor, when the re­po rate was raised.

"All that will re­al­ly hap­pen is that banks will raise their prime rates. Peo­ple who have loans tied to the prime will see in­ter­est rates go up, the spread of the banks will in­crease, but the fund­ing costs in sav­ings ac­counts, the check­ing ac­counts, the prime de­posits, those are not go­ing to be linked, there will be noth­ing to dri­ve them up, ex­cept the Cen­tral Bank want­i­ng them to go up," said Val­ley.

The re­po rate rise, in his opin­ion, will do very lit­tle to curb in­fla­tion, be­cause the ex­cess liq­uid­i­ty in the sys­tem does not re­spond to the re­po rate some­thing that the IMF not­ed in the 2011 re­port.

"If it is hard­er for banks to now get sav­ings ac­counts or get check­ing ac­counts or have enough mon­ey to meet their re­serves, then rates will rise. But if you have huge amounts of liq­uid­i­ty, most banks have over and above what they need to meet their re­serve re­quire­ment. If that is so large, what is the re­po rate go­ing to do to change that?"

The ex­pan­sion­ary na­ture of the 2015 bud­get, more­over, will put even more liq­uid­i­ty in­to a sys­tem that is not ad­e­quate­ly struc­tured to ab­sorb it and Val­ley said this could have dire con­se­quences

"When the Fed is do­ing their quan­ti­ta­tive eas­ing and there is too much liq­uid­i­ty in the US mar­ket, they are at the same time, putting mon­ey in­to the mar­ket and sell­ing bonds, long bonds, so they can soak up that mon­ey again. The Cen­tral Bank of T&T has nev­er done that, the mon­ey just keeps pil­ing up like a huge ice­berg and at some point and at some point it is go­ing to have to be cleaned up, oth­er­wise it will gen­er­al­ly lead to in­fla­tion."

As sev­er­al Sun­day BG ar­ti­cles have ex­plored in the past, in­fla­tion is dead­ly to the as­pi­ra­tions of those hop­ing to re­tire in rel­a­tive com­fort, re­duc­ing the fu­ture pur­chas­ing pow­er of dol­lars saved and in­vest­ed to­day.Val­ley's pro­posed so­lu­tion to this prob­lem is for the Cen­tral Bank to in­crease the num­ber of T-bills or Trea­sury Bills and oth­er Cen­tral Bank notes, such as bonds, is­sued to af­fect mon­e­tary pol­i­cy to con­tain in­fla­tion.

Ac­cord­ing to the IMF 2011 re­port, "ex­cess re­serves drove down the in­ter­est rate on 30-day T-bills from 6.9 per­cent at end-2008 to 0.3 per­cent in No­vem­ber 2010."As of 2013, Fi­nance Min­is­ter Lar­ry Howai, put ex­cess liq­uid­i­ty in the sys­tem at $6 bil­lion. (source:news.gov.tt)Val­ley said that the Cen­tral Bank needs to have sev­er­al bond is­sues, both where they and the mar­ket play a role in set­ting the price.

"I think they should, in­stead of hav­ing a sin­gle price op­tion, let them have a mul­ti-price op­tion, so that peo­ple who want to buy the bond, and want to get rid of liq­uid­i­ty, can buy the bond at the price they want and the mar­ket re­al­ly clears. And that is how peo­ple with ex­cess liq­uid­i­ty will elim­i­nate that ex­cess liq­uid­i­ty and then, we will re­al­ly know where the price of bonds are and we will have a re­al­ly mar­ket de­ter­mined yield curve, in­stead of a yield curve that is high­ly in­flu­enced by the Cen­tral Bank."

The T-bill's con­nec­tion to sav­ings and in­vest­ments

Val­ley ex­plained that be­cause in­ter­est rates for T-bills and oth­er gov­ern­ment bonds are more re­flec­tive of how the mar­ket ac­tu­al­ly func­tions than the re­po rate, in­creas­es in these in­ter­est rates have the abil­i­ty to car­ry up the in­ter­est rates of sav­ings and in­vest­ments, par­tic­u­lar­ly in the case of items like mon­ey mar­ket and mu­tu­al funds."That is more in­dica­tive of ris­ing rates, than the gov­ern­ment chang­ing the re­po rate. That sig­nals that rates are ris­ing."

Ef­fect on pen­sions and in­sur­ance

On this is­sue, Nar­ine said, "Over the longer term if we get in­ter­est rates on a steady up­ward glide path then new bonds is­sued will have a high­er coupon rate thus lead­ing to in­creased cash flows for fixed in­come in­vestors. This is good for long-term in­vestors like pen­sion plans and in­sur­ance com­pa­nies."

The prob­lem lies with in­ter­est rates on cur­rent bonds prod­ucts. Both Nar­ine and Ram­s­ingh said be­cause the re­la­tion­ship be­tween in­ter­est rates and bonds is in­verse, a high­er in­ter­est rate on these, will even­tu­al­ly re­duce their val­ue."The fund man­ag­er's abil­i­ty to ad­just the port­fo­lio mix will be re­quired, de­pend­ing on the sen­si­tiv­i­ty of the as­sets or li­a­bil­i­ties to changes in in­ter­est rates," said Ram­s­ingh.

Based on this, Ram­s­ingh said de­fined ben­e­fit pen­sions will be hard hit as in­creas­ing in­ter­est rates will have the ef­fect of re­duc­ing their ben­e­fit oblig­a­tions based on present ver­sus fu­ture val­ue com­pu­ta­tion.Mean­while, he said fu­ture re­tirees with de­fined con­tri­bu­tion pen­sions and de­ferred an­nu­ity plans may ben­e­fit from an in­crease in in­ter­est rates.

How­ev­er, work­ing with the as­sump­tion that the re­po rate will be ef­fec­tive in rais­ing in­ter­est rates on its own, Lloyd Ince, man­ag­ing di­rec­tor of The Con­sult­ing In­ter­face, said the mea­sure would "ul­ti­mate­ly ben­e­fit pen­sion­ers and pen­sion plans", by pre­serv­ing pen­sion­ers' pur­chas­ing pow­er and im­prov­ing "the out-look for long-term yields from sub­se­quent bonds and in­come se­cu­ri­ties held by pen­sion funds."

He saw the in­crease in the re­po rate work­ing to re­duce the mon­ey sup­ply and there­by de­creas­ing ag­gre­gate de­mand, forc­ing prices down­ward. Mean­while, ris­ing in­ter­est rates fu­elled by a re­duc­tion in the mon­ey sup­ply, "the price of mon­ey, or in­ter­est rates, will push up­wards."

"It re­duces a per­plex­ing prob­lem that cur­rent­ly faces such funds, as the 20-year nom­i­nal bond yield-curve in many cas­es falls be­low cer­tain base-re­turns guar­an­teed by cer­tain pen­sion prod­ucts. This fact has been even more trou­bling, when the said curve is ad­just­ed for in­fla­tion." Ince said that the ad­just­ment of the re­po rate gave a sense of promise that this long­stand­ing threat to long-term sav­ings and in­vest­ments is fi­nal­ly be­ing dealt with.