Public Information Notice No. 07/127

Public Information Notice: IMF Executive Board Concludes 2007 Article IV Consultation with Trinidad and Tobago

October 11, 2007

On September 10, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Trinidad and Tobago.¹

Background

Endowed with important oil and gas reserves, Trinidad and Tobago has the second highest GDP per capita in Latin America and the Caribbean. The energy sector accounts for over 40 percent of GDP, about 90 percent of exports, and about 60 of government revenues. In terms of broader social and development indicators, its Human Development Index ranking is above the regional average. Trinidad and Tobago is also a regional financial center and a significant source of capital flows to sovereign and private entities in the Caribbean.

In 2006, real GDP grew 12 percent reflecting the first full year of activity of a major gas processing plant, which brought growth in the energy sector to about 20 percent. Growth in the nonenergy sector was also robust at 6½ percent, driven by construction, manufacturing and financial services. Turning to 2007, the economy is expected to grow by some 6 percent, reflecting a temporary reduction in energy output early in the year. The nonenergy sector is projected to grow at about 7½ percent on the continued strength of construction and manufacturing, and supported by government spending and the expansion of credit to the private sector.

The external accounts are solid and net foreign assets continue to accumulate at a rapid pace. In 2006, the current account posted another strong surplus—26 percent of GDP—and foreign direct investment (FDI) flows remained healthy, while portfolio outflows accelerated. International reserves, including deposits in the Heritage and Stabilization Fund (HSF), continued to accumulate rapidly, reaching US$6.5 billion. In 2007, the current account surplus will narrow reflecting higher imports of capital goods related to large scale projects financed with FDI. Net foreign assets are projected to turn positive.

The government's balance sheet continues to strengthen. In FY2005/06, the central government's budget surplus increased to 7 percent of GDP, its gross debt fell to 18 percent, and deposits in the HSF reached 8 percent. However, due to the rapid increase in public spending the nonenergy deficit widened to 15 percent of GDP—exceeding the long-term sustainable level. In FY2006/07 the budget surplus is expected to decline to 4 percent of GDP, and the nonenergy deficit to further increase slightly owing to higher public investment. Capital spending by public enterprises has also increased rapidly in recent years owing to investments in infrastructure for the gas processing industry. Looking forward investment is projected to remain high as Petrotrin's refinery would be upgraded to remain competitive.

Strengthened management and improved policy coordination with the treasury allowed the central bank (CBTT) to regain control over liquidity. The monetary policy rate was hiked to 8 percent in October (for a cumulative increase of 300 basis points since early 2005). Foreign exchange sales were stepped up in 2006 and the unsatisfied demands for foreign exchange disappeared. Open market operations were intensified, the ceiling on CBTT sales of treasury bills was increased, and the treasury bills rate was allowed to rise. Liquidity management was also assisted by the placement of TT$2.4 billion in long-term treasury bonds. Despite the tighter liquidity conditions, credit to the private sector continued to grow rapidly (19 percent) albeit at a more moderate pace than in 2005. The tightening of liquidity conditions and measures to increase competition in food distribution led headline inflation to fall from a peak of 10 percent in October 2006 to 7.3 percent in June 2007. Inflation is projected to continue to exceed that of trading partners.

The real exchange rate misalignment has narrowed but remains sizable. The TT dollar appreciated 4½ percent in real effective terms in 2006 as domestic inflation exceeded that of trading partners. The impact of the appreciation on narrowing the misalignment was partially offset by improved terms of trade, increased net foreign assets, and the rapidly growing public spending that raised the equilibrium real exchange rate.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. Directors commended Trinidad and Tobago's strong economic performance, led by the buoyant energy sector. They welcomed the robust economic activity, large fiscal and external surpluses, decline in public debt, and build-up of external reserves.

Directors noted that the major challenge facing the authorities is to implement a prudent mix of macroeconomic and structural policies to enable the efficient absorption of energy revenues and to reduce the country's vulnerability to energy shocks. They welcomed the authorities' strategy of investing in human and physical capital to support the development of the nonenergy sectors, while saving abroad part of the energy windfall. At the same time, Directors reiterated their concern that the sustained increase in public spending and widening nonenergy fiscal deficit, with the economy operating near full capacity, could exacerbate inflation pressures and jeopardize fiscal sustainability.

Against this background, Directors supported a gradual tightening of fiscal policy. They underscored that the nonenergy deficit needs to be reduced to a sustainable level. The ongoing structural fiscal initiatives will be important in this regard, as well as expenditure restraint. Some Directors recommended that fuel and utility subsidies be phased out, in conjunction with a strengthening of the social safety net.

Directors welcomed the proposed adoption of a medium-term fiscal framework. They regarded the establishment of the Heritage and Stabilization Fund as a key element of the strategy for efficient management of energy revenues, and encouraged the authorities to emulate successful international experiences as they develop the Fund's investment guidelines. Directors also supported plans to strengthen public debt management.

Directors commended the improvements in monetary management, which have helped to contain inflation. They encouraged the authorities to remain focused on containing inflation in light of rising domestic demand and labor costs, and to avoid price controls. They called for better coordination of fiscal and monetary policies to improve liquidity management, and stressed that wage increases should be linked to productivity gains rather than inflation.

Directors noted the appreciation pressures on the TT dollar in the context of buoyant energy exports. Some Directors were in favor of a nominal appreciation, especially as it would also help reduce inflation. Some other Directors, however, noted the uncertainties regarding the estimate of exchange rate misalignment, and that nominal appreciation may have only a limited effect on inflation because of local supply bottlenecks.

Directors welcomed the authorities' emphasis on economic diversification, and commended efforts to improve the business environment and spur investment in the non-energy sectors. They urged continued efforts to create the conditions for the development of industries that are self-sustaining over the long term without permanent government subsidies. Directors also welcomed plans to continue to strengthen financial regulation and supervision, and to develop the secondary market for government securities.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.