Trinidad and Tobago’s Dirty Peg to the U.S. Dollar

Trinidad and Tobago’s Dirty Peg to the U.S. Dollar and Inflation Galore: Fateful Days for the Economy

• Trinidad and Tobago’s roaring economy has almost reached full-capacity, and now threatens to burst
• Without reining in the inflation rate and loosening its artificial peg to the U.S. dollar, valuable gains in Trinidadian and Tobagonian international trade could be wiped out
• The economy desperately needs diversification away from dependence on energy sector
• In addition to hiking interest rates, other measures, such as better fiscal policy management and the adoption of a more appropriate exchange rate, should be embraced

Bolstered by significant foreign-exchange inflows to its energy sector, Trinidad and Tobago is achieving astounding growth in its GDP. Between 2002 and 2005, the country’s international trade balance increased from U.S. $237.7 million to over U.S. $2.64 billion, leading to large increases in foreign exchange reserves. This explosive economic performance is increasing external and fiscal surpluses as well as reducing public debt. What is most amazing, however, is the disregard shown by the leadership in Port of Spain concerning the very real danger lurking behind this tiger of an economy. Trinidad and Tobago, with its single-sector economy and its managed peg to the U.S. dollar, must track its revenue and make a special effort to prevent a disastrous, inflation-induced bust. Failure to do so would spell disaster for the islands’ price stability and hurt the country’s overall productive capacity.

Trinidad and Tobago’s Interest Rates and Inflation Woes

Trinidad and Tobago’s mounting energy revenues, stemming from increased production and favorable market prices, are leading to very low unemployment rates as well as increased levels of foreign direct investment (FDI). However, with now escalating consumer price inflation, and a tighter labor market, Trinidad and Tobago’s economy is approaching full-capacity. At this rate, in any economy, it becomes extremely likely that the inflation-induced pressure bubble will inevitably burst. The inflation rate, at eight percent, is close to surpassing permissible levels for pegged currencies, and is continuing to rise. Most analysts estimate that Trinidad and Tobago’s inflation rate, which averaged 3.7 percent in 2004, is likely to hit double digits in the next few years.

Most significantly, this inflation-rate statistic is actually being negatively altered by Trinidad and Tobago’s record-breaking gas and oil revenues. This is due to government restraint in raising interest rates in the energy sector so as not to deter investments from the only area supporting the country’s economy. If gas and oil figures were not included in the average, the inflation rates would be seen as bordering on the astronomical. With Port of Spain disproportionately channeling investments into its natural gas and oil production, this sector’s continued stability is not surprising. A complete reliance, however, on a single sector of the economy is rarely a sound approach. More importantly, consumer products, especially food, are experiencing inflationary pressures from the government’s biased allotment of funds to the energy sector.

The Dangers of a Single-Sector Economy

The country’s mushrooming inflation rates are also pushing up salaries, hourly labor costs and the price of consumer goods. As these costs increase, outside investors will be less attracted to labor-intensive projects. As the energy sector benefits from government preference and crowds out investment in other potential activities, Trinidadians and Tobagonians will eventually have to come to terms with the consequences. Ultimately, these policies will result in highly adverse effects on Trinidad’s external competitiveness in non-energy exports. Even construction costs related to energy production are beginning to suffer from inflationary pressures. The ripple effects of a burgeoning inflation rate will eventually affect all segments of Trinidad and Tobago’s economy, with little or no discrimination.

Trinidad and Tobago’s Dirty Peg

Trinidad and Tobago’s reluctance to abandon its currency’s peg to the U.S. dollar has given wings to the country’s flight to an economic recession. Preserving its artificially valued currency has provided a deceptive strength to the T & T dollar, obscuring the real appreciation stemming from the country’s recent economic expansion. If the Trinidad and Tobago currency floated, its value relative to the U.S. dollar would noticeably increased given the positive effects of foreign investment and trade surplus. Since the T & T dollar is kept at a lower pegged rate, foreigners can buy Trinidadians and Tobagonian products, like natural gas and other products, cheaper than if the currency was appreciating as would happen if it freely floated. However, the average Trinidadian’s purchasing power falls as the T & T dollars they are using to buy groceries actually hold more value than the basket of goods they purchase. Continuing this false ratio to the dollar will only fuel Trinidad and Tobago’s rising inflation rate, threatening to destabilize its economy.

A Concerted Approach

Safeguarding against an economic recession caused by Trinidad and Tobago’s managed interest rates, misbegotten currency pegging and increasingly unregulated inflation requires a multilateral solution. So far, the Trinidadian Bank has concentrated all its efforts into managing monetary policy, largely ignoring the fiscal aspect of inflation risks. By directing interest rates and regulating the money supply, the Central Bank has demonstrated behavior typical of countries that have suffered the ruinous effects of a dirty peg. Yet, with higher oil and gas prices, Trinidad and Tobago has been able to side-step weaknesses in its uncompetitive sectors. For example, flushed with large sums of energy revenue, the Central Bank has taken on large-scale construction of roads, railways, factories and medical facilities. However, missing in these mega-projects are the doctors for the new facilities, as well as water sources for those communities desiccated because of the water-guzzling new factories. Port of Spain must redirect government spending so as not to favor sectors of the economy which would otherwise have a better chance of survival in a stronger open-market system.

Over Confident and Crowded Out

The oil and gas windfall has led to large-scale energy investment by the over-confident government. The government’s asymmetrical spending, which benefits the energy sector, crowds out investment from less favored parts of the economy. In the long run, non-energy sectors in Trinidad and Tobago will find themselves unable to compete with imports from abroad. Even complementary enterprises, such as construction for increased energy production, have already begun to feel the squeeze.

With Prudence, a Promising Future

Inflationary expansion and a marked dependence on accelerating energy prices are daunting prospects that necessitate a macroeconomic policy overhaul. Port of Spain must act now while treasury coffers are full and the government has the ability to make well-reasoned choices about the future. Given the current volatility in energy markets, policy makers cannot afford to wait; oil prices were low once and there is no reason to believe that they will remain at the status quo. As such, it is imperative that Trinidad and Tobago’s Central Bank take the inflation rate at its present foreboding face-value and begin to incorporate a multi-tiered approach before its economy reaches a boiling point. This is possible with a balanced and coordinated macroeconomic strategy which addresses three main areas of policy.

The government must tighten its monetary control through better interest rate management. It must redirect energy revenue to prop up the underdeveloped sectors, which, in the future, will require limitations on what are now unabated energy investments. Also, the Central Bank must begin transitioning away from its dirtily managed peg to the U.S. dollar that falsifies the true value of the country’s currency. There is much potential for Trinidad and Tobago’s economy that should not be compromised by careless spending and inappropriate exchange rate policies.

This analysis was prepared by COHA Research Associate Brittany Bond
September 18th, 2006
Word Count: 1200

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