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Inflation low but negative real returns persist

Today, we at Bourse take a look at the local financial system with respect to inflation, liquidity and the negative real yields which have persisted for TT Dollar fixed income investors.

Inflation Abates
According to data from the Central Statistical Office, headline inflation – as measured by the Retail Price Index – decreased to 3.3 per cent year on year (y-o-y) in April, from 3.9 per cent in March and 5.6 per cent in December 2013. Food inflation – the main driver of headline inflation – continued its downward trend to 4.1 per cent in April from 10.2 per cent in December 2013. Core inflation (inflation ex-food prices) increased to 2.7 per cent in February 2014.
Construction and distribution sectors maintained their upward trend for the first quarter of 2014, with cement sales increasing 7.5 per cent (y-o-y), new car sales increasing in excess of 12.5 per cent (y-o-y). It should be noted that for the year ended December 2013, Real GDP experienced growth of 1.5 per cent (y-o-y) and is projected to be 2.5 per cent (y-o-y) in 2014.
According to CBTT statistics, activity in lending has picked up the pace. As at March 2014, Private Sector Credit Growth increased year-on-year by 5.7 per cent, while growth in Loans to Incorporated Businesses advanced 3.3 per cent. Figure 1 highlights lending growth rates to the private sector and incorporated businesses.

Fixed Income Investors Toil
Despite this growth in lending, our financial system remains awash with liquidity. Daily average excess reserves at the CBTT were TT$8.4 billion in May 2014, up from TT$6.3 billion in March 2014. The continuing buildup of excess reserves is symptomatic of deposits building in the financial system at a faster rate than financial institutions can lend (see Figure 2).
The result has been a depression of interest rates across the local capital markets. In particular, fixed income investors continue to bear the pain of negative real returns in a low interest rate environment with persistent (albeit lower) inflation. Figure 3 illustrates the difference between the headline inflation rate and the yield on a 10-year Government of Trinidad & Tobago TT-Dollar bond over the last 3-years.
While the Central Bank has been working to address the buildup of excess liquidity (with the aid of increased borrowing limits under the Treasury Bills and Treasury Notes Acts), it will undoubtedly take a considerable effort and/or liquidity event to nudge interest rates on an upward trajectory. This view is put forward with the knowledge that banking reserve ratios are at already elevated levels (17 per cent), so that the CBTT’s ability to mop-up liquidity beyond Open Market Operations becomes somewhat limited.

Bond Market Developments
On the horizon, several pending private and public bond issues promise to absorb at least some liquidity from the financial system.
The Central Bank recently opened an auction for a TT$1 billion Government of Trinidad & Tobago Bond with a 7-year tenor and a coupon rate of 2.20 per cent. This on its own may not achieve much in terms of reducing liquidity in the financial system, although it is expected to be well-subscribed given the paucity of TTD fixed income assets.
Neal & Massy Holdings Limited (NML) has approached the capital market for a private placement of TT$1.2 billion, TT$700M of which will be for refinancing purposes with $500M to be raised as new funding. Up to three separate tranches are expected to be issued the range of 7-15 year tenors.
Telecommunications Services of Trinidad & Tobago Ltd. (TSTT) is also in the capital market to raise TT$1.8 billion in debt financing as it undergoes major organisational change. The financing comprises part of its five-year strategic plan to turn around the company’s fortunes.

Next move for investors?
Investors may recall Bourse’s 2014 Investment Themes, which included:
1. Target Positive Inflation Adjusted Returns
2. Lengthen your Investment Horizon
3. Diversify across Currencies
4. Diversify across Asset Classes

It is clear that the local TTD fixed income environment makes it difficult to achieve the first theme of positive inflation adjusted returns. Even when lengthening your investment horizon to 10 years in GORTT bonds, real returns remain negative. It is imperative then, that investors look beyond the shores of Trinidad & Tobago to preserve their purchasing power and grow their wealth. To do so, investors who have access to hard currency may consider USD-denominated fixed income assets, which would provide positive real returns. Diversifying across asset classes also makes sense, as equities may provide better dividend yields (the Trinidad and Tobago Composite Index provides an average dividend yield of around 3 per cent) as well as the potential for capital appreciation through selective stock picks.
For more information please contact Bourse Securities Limited, at 628-9100 or email us at research@boursefinancial.com.
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