The Central Bank, on Friday July 19th, reduced the cash reserve requirement imposed on commercial banks from 14 per cent to 10 per cent. I found the announcement perplexing. First, it came just a few weeks after its previous monetary policy announcement on June 28th. In that release, the Bank stated that: “Financial sector liquidity remained ample during the second quarter of 2024, in the face of an increase in domestic financing by the Government. Commercial banks’ excess reserves at the Central Bank averaged $4.2 billion in the first half of June 2024, marginally lower than in May 2024 ($4.3 billion)”.
In its release on July 19th, the Bank justified the reduction in the reserve requirement by citing the fact that system liquidity (excess reserves) in the first two weeks of July had averaged $2.77 billion compared to $3.91 billion in June.
The decline in the first two weeks of July compared to June was about 29 per cent. But it is strange that the Central Bank would act based on such a short period of data. In fact looking at the excess reserves data, in January 2024, average excess reserves were about $3.0 billion and that prompted no alarm. Its release of June 28th noted that there was some ‘skewness’ in liquidity among banks leading to activation of the inter-bank market. The published data on inter-bank borrowing go up to April, but in December 2023, inter-bank borrowing reached $1.26 billion, but again that did not prompt any alarm.
It may be that the Bank thinks that the decline in excess reserves is permanent. But if it thinks so, what data has led it to that conclusion? System liquidity is impacted significantly by foreign exchange outflows. However, when the data on foreign exchange sales to the public are examined up to the end of June, those data do not disclose any surge or acceleration in outflows. In fact, because of government’s external borrowing (US$750 million in mid-June), net foreign exchange reserves jumped at the end of June. Nor did the Bank inject more than its usual US$100 million into the system in June.
The other factor which can impact system liquidity is a significant increase in short-term borrowing by the government. Normally, this would be done by issuance of treasury bills or treasury notes. But the available data disclose no increase in the treasury bill issue outstanding nor an increase in the discount rate on treasury bills. Alternatively, certain banks may have lent to the government causing their liquidity to decline sharply and driving them to access the inter-bank market. This might be the ‘skewness’ referred to by the Central Bank in its June 28th release.
One might think that if system liquidity was declining, the commercial banks would take the rational business decision and increase interest rates on deposits to attract deposits into the system. But interest rates have not moved at all, neither on deposits nor on loans.
What compounds my perplexity is that the reduction in the reserve requirement by 4 percentage points releases almost $4 billion from the cash reserves! This marks a significant relaxation in monetary policy which is likely, other things being equal, to expand credit and increase the demand for foreign exchange when our foreign exchange reserves are already under stress and, given the outlook for natural gas and petrochemicals exports, will remain stressed for the foreseeable future.
The explanation for this significant change in the stance of monetary policy provided in the Bank’s media release does not add up. Central banks usually do not act whimsically on the basis of a few weeks of data. Moreover, the idea of moving toward the use of open market operations is illusory. There must be more in the mortar than the pestle. My fear is that monetary policy has been relaxed significantly merely to accommodate increased government borrowing. I may be wrong, but I have no doubt we will soon find out.
Dr Terrence Farrell served as deputy Governor of the Central Bank of T&T