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.