Public Information Notices
Trinidad and Tobago and the IMF
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On October 22, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Trinidad and Tobago.1
Trinidad and Tobago's economy, which is endowed with large energy reserves, is experiencing a strong energy sector-based expansion due to increased output and high international prices. The energy sector already accounts for about 40 percent of GDP, 83 percent of domestic goods exports, and slightly more than 40 percent of government revenue. Large increases in oil and gas output expected over the next decade will reinforce its central role. As in other energy-rich countries, while energy exports greatly reduce domestic and external resource constraints, they pose their own macroeconomic and governance-related challenges—in particular, for employment creation, poverty reduction, and fiscal transparency.
Real GDP growth picked up sharply in 2003, driven mainly by an expansion in the energy sector, in the context of persistent high unemployment and continued low inflation. Real GDP grew by 13 percent, led by a 30 percent expansion in the energy sector. This was due to a surge in liquid natural gas production as the third LNG plant started operations in April 2003, as well as to increases in the output of crude oil and petrochemicals. The performance of non-energy sectors was mixed: while there was a strong expansion in manufacturing, construction, and financial services, the agricultural sector declined by some 14 percent. The unemployment rate continued to decline and stands at about 10½ percent. However, unemployment has been kept high by a number of structural factors, which have led to a low labor intensity of growth. These factors include the high capital intensity of the energy sector, skill mismatches, labor market rigidities which reduce wage flexibility, and the impact of energy-related inflows on the real exchange rate. It should be noted, however, that using the standard International Labor Organization definition, the unemployment rate would stand at 7½ percent.2 While average consumer price inflation has been close to 4 percent, core inflation (which excludes food price increases) has been about 2 percent.
The overall balance of the consolidated nonfinancial public sector (NFPS) improved sharply in FY 2002/03, although deficits remain in some entities. The NFPS shifted from a deficit of about 4 percent of GDP in FY 2001/02 to a surplus of 2 percent of GDP in FY 2002/03. The turnaround reflected the marked improvement in the finances of the state-owned energy companies due to strong product prices and, in the case of gas, increased output. While most of the energy-related companies, and the telecommunication company, had operating surpluses, a number of enterprises continued to record deficits—in particular, the fuel distribution company and the water utility, whose tariffs have not kept pace with costs, and the sugar company, which incurred large severance payments related to its restructuring. Public sector debt declined by about 4 percentage points of GDP, to 56 percent of GDP as of end-September 2003.
The Central Bank of Trinidad and Tobago (CBTT) continued to maintain a stable exchange rate against the U.S. dollar, which—given the large energy-related inflows—was consistent with a reduction in the policy interest rate and some further build up in international reserves. The exchange rate has remained within a narrow band around TT$6.3 per U.S. dollar—a virtually unchanged level since late 1997—and international reserves have accumulated moderately over the last two years. The CBTT lowered the benchmark repo rate by 25 basis points in September 2003, to 5 percent, which was intended to stimulate growth in the non-energy sector. To improve financial intermediation and level the playing field between banks and non-banks, the CBTT lowered the reserve requirement, from 18 percent to 14 percent, in October 2003. These measures have contributed to a significant reduction in commercial bank lending rates, and an increase in credit to the private sector.
The balance of payments recorded an increased surplus in 2003, despite large capital outflows, reflecting the strong performance of the energy sector. The external current account recorded an unprecedented surplus of 13 per cent of GDP, compared to approximate balance in 2002. The sharp increase in gas output, combined with an upswing in international oil and gas prices, resulted in a boom in total export earnings, which rose by 13 percentage points of GDP, despite a decline in manufacturing exports. The capital account recorded a deficit equivalent to 10 percent of GDP in the context of sizable bond issues by regional governments and corporations, and outward foreign direct investments. Direct investment inflows rose in the context of major energy-related investment projects. At the end of the year, gross official reserves stood at US$2.3 billion, equivalent to 5 months of imports. Public sector external debt declined by 3 percentage points of GDP, to about 15 percent of GDP at end 2003, most of which long-term and from commercial creditors.
Since August 2002, the Trinidad and Tobago dollar has depreciated by 9 percent in real effective terms. This movement reflected mainly the fall in the value of the U.S. dollar, to which the currency has been effectively pegged, against the currencies of Trinidad and Tobago's major trading partners, and in particular the euro. Nonetheless, the Real Effective Exchange Rate remains some 15 percent above its 1997 level.
Executive Board Assessment
Executive Directors noted that strong expansion in energy output and high international prices have boosted Trinidad and Tobago's growth, exports, and fiscal revenues, giving rise to substantial fiscal and external current account surpluses, while inflation has remained low. These favorable developments have greatly reduced domestic and external resource constraints. However, Directors observed that significant macroeconomic challenges remain, notably to boost non-energy investment and growth in order to reduce the persistent high unemployment rate and the dependence of the budget on energy-based revenues. This will require determined implementation of a sound policy framework that promotes external competitiveness and economic diversification.
Directors emphasized that a key element of such a growth-oriented policy framework would be prudent fiscal management, which should also provide for sustainable consumption of energy resources. They welcomed the budget surplus achieved in FY 2003/04 and anticipated that—given the strength of projected energy-based revenues—the government is in a position to maintain substantial surpluses over the medium term. To this end, expenditure should continue to be managed prudently, based on a comprehensive public expenditure review. Directors advised the authorities to continue to contain the growth of the wage bill and transfers to households. This would allow capital expenditure to grow more rapidly than in recent years in order to better address the country's infrastructure and social sector needs. However, it will be important to ensure that public investment projects are of high quality and, more generally, to improve the effectiveness of government spending. Over the long term, the envisaged move to output budgeting and a fully-funded pension scheme for government employees will help maintain fiscal discipline.
Directors observed that, notwithstanding the strong energy revenue outlook, it is important to move ahead with long-standing plans for tax reform and strengthening tax administration. They were encouraged that the authorities are at an advanced stage of preparation of a new energy tax regime, aimed at better capturing the rents from natural gas, and supported the authorities' request for Fund technical assistance for a reform of non-energy taxes, revenue from which has been eroded by exemptions and weak compliance. While plans to strengthen the revenue stabilization fund to cover the natural gas sector are welcome, Directors noted that a more comprehensive approach is needed, not only to smooth out the budgetary use of energy resources, but also to ensure that such use is sustainable over an appropriately long period. This would address inter-generational equity considerations and allow time for economic diversification efforts to take hold. In this context, the authorities should consider the scope for institutionalizing fiscal procedures that would help ensure a continued budget surplus position over the medium term.
Directors considered that the defacto peg of the exchange rate has facilitated low inflation and helped shield the non-energy sector from pressures towards exchange rate appreciation from energy-related inflows. They concurred that competitiveness issues are best addressed through prudent macroeconomic policies and structural reforms. However, they welcomed the commitment by the authorities not to resist depreciation pressures, and to allow greater exchange rate flexibility if needed to protect the international reserve position and increase the economy's ability to cope with external shocks. Directors felt that the central bank has generally struck an appropriate mix in its liquidity management between sales of foreign exchange and open market operations. They noted that the recent expansion in the auction system for government securities should enhance the role of open market operations in managing liquidity, as well as promote development of the capital market. They also supported the reduction of reserve requirements to lower bank intermediation costs.
Directors stressed that persistent high unemployment, the decline in non-energy exports in 2003, and the underlying pressures toward real appreciation reinforced the importance of targeted structural reforms to enhance external competitiveness in the non-energy sector and support medium-term growth. They, therefore, welcomed the authorities' broad reform agenda, and encouraged its full specification and steadfast implementation. Regarding public sector reform, Directors commended the restructuring of the state-owned sugar company in conjunction with a significant safety net for the large work force affected. Looking ahead, Directors attached importance to the planned restructuring of the port operations, efforts toward greater efficiency in the public utilities, and initiatives to improve transparency and accountability in the public entities. It will also be critically important to address the unemployment problem in a determined manner, including by tackling labor market rigidities, and fostering the right mix of labor skills through appropriate education and training. Directors welcomed other ongoing supply-side reforms, notably liberalization of the telecommunications sector.
Directors stressed the importance of the ongoing program to modernize and upgrade financial regulation and supervision, noting Trinidad and Tobago's increasing exposure in the regional financial market. In this context, Directors welcomed the recent expansion of the central bank's supervisory responsibilities to cover the insurance and pension sectors, and encouraged the authorities to vigorously pursue their broad legislative agenda for the financial system. They also encouraged the government to move ahead with its plans for reforming the National Insurance Scheme and the regulatory environment for private pension schemes. Directors welcomed the authorities' request to participate in the Financial Sector Assessment Program in 2005.
Directors noted that Trinidad and Tobago provides core statistics to the Fund that are broadly adequate for surveillance. Nevertheless, they encouraged further strengthening of the statistical system, especially in the areas of public enterprise account, and the capital account of the balance of payments. Directors welcomed the authorities' decision to participate in the General Data Dissemination System.
IMF EXTERNAL RELATIONS DEPARTMENT