Monday, December 18, 2017

Floating of the TT dollar: 20 years later

Twenty years ago, over the Easter weekend in April 1993, top executives of the Central Bank gathered with the leaders of the com­mer­­­­­­­­­­­­cial banks at the offices of the Cen­­­tral Bank. It was an historic week­­end in the annals of economic policy-making and public-private sec­­­­tor co-operation in this country. Trinidad and Tobago moved from an exchange rate system which had been pegged to the US dollar since 1976, and before that to the pound sterling, to one which would be allowed to vary.

Previous Policy Disasters

The move was fraught. Ten years earlier, the country’s foreign exchange reserves had begun a rapid decline as oil prices collapsed and fiscal deficits mounted. In the face of the seemingly unstoppable fall in reserves, the Bank, not without trepidation, considered the possibility and the modalities of devaluation as a means of dealing with the problem.

Initially, the George Chambers administration would not counten­ance touching the exchange rate. Instead, the Bank reluctantly agreed to expand exchange controls to mer­­­­­­­­chandise imports with the introduction of the EC-Zero system. That proved to be a bureaucratic nightmare and a policy disaster. In another ill-advised move, a dual-exchange rate system was implemented in December 1985. The country’s foreign exchange reserves plunged from over US$3 billion in 1981 to less than US$500 million in December 1986, at which point the People’s National Movement (PNM) was swept ignominiously from power and the National Alliance for Reconstruction (NAR) took over the reins of government. The NAR administration unified the exchange rate at $3.60 in January 1987 and then devalued to $4.25 in April 1988.

But in April 1993, confidence was still low and battered following the terrible recession from 1984, which had caused massive erosion of wealth and incomes due to the de­val­uations, cuts in the salaries of public servants, the debt restructuring, the conditionalities imposed by the International Monetary Fund (IMF) programme, the introduction of value added tax (VAT) and, by no means least, the attempted coup in July 1990.

Liberalising the Capital Account

Returned to government in 1991, the PNM had included in its manifesto the “abolition of exchange con­­­trols”. When the Bank was asked to operationalise this, it sought clarity on what the government understood by “the abolition of exchange controls”. The Bank was told that all exchange controls were to be abolished, on both the cur­rent and the capital account, though it seemed to me that the implications of capital account liberalisation were not fully appreciated by the politicians.

To appreciate the enormity of this challenge, while many countries had adopted floating exchange rates since the breakdown of the Bret­ton Woods system in the 1970s, most retained controls on the capital account, that is transactions involving the movement of capital into and out of the country, for example, the ability to acquire a company overseas or even buy shares on stock exchanges abroad.

Japan, one of the largest economies in the world, maintained capital account controls at that time. Bar­­­bados maintains exchange controls on the capital account up to today. Movements of capital could exert significant changes in a freely floating exchange rate over a short period of time, with adverse impact on local prices of food and essential goods and could engender speculative pressures on the exchange rate.

How to Float?

If all exchange controls were to be abolished, how then was the exchange rate to be established from day to day? The Bank was of the view that the exchange rate could not be permitted to float freely. It would become a one-way bet and the exchange rate would plummet. While the country’s foreign exchange reserves were beginning to recover, they would not be enough to defend an exchange rate in free fall.

Intellectually, the Bank’s research department was fairly well prepared. We had done extensive research on exchange rate regimes, developed effective exchange rate indexes and studied the flows of foreign exchange into and out of the economy. Amoy Chang Fong, then director of bank operations, had an excellent grasp of the dynamics of the operation of the foreign exchange market. I myself had had a close look at the Jamaican system and was clear that it was not to be emulated.

Standard IMF prescriptions for a free-floating exchange rate would lead to disaster. We had had enough policy disasters in respect of the external accounts.

The critical difference between our foreign exchange flows and those of, say, Jamaica was that based on an arrangement made in 1969, long before floating was contempla­ted, oil taxes in Trinidad and Tobago were paid by the companies in US dollars. The Central Bank gets the US dollars and credits the government with the TT dollar equivalent. The Central Bank therefore holds a large proportion of the country’s foreign exchange reserves and is a net seller of foreign exchange to the commercial banks.

The second important institutional fact was that we had a small number of commercial banks who could easily be assembled around a table. In addition, our commercial bankers had historically been very co-operative and compliant in their dealings with the Central Bank, based in no small measure on the authority established and exercised over the banks by Victor Bruce in the early years. It helped, of course, that the Central Bank, as net seller, could exercise significant leverage in the foreign exchange market as well.

Based on these institutional facts, the new exchange rate system was constructed over that Easter weekend, trading in foreign exchange having been suspended for a week, from April 7 to 13. It involved firstly, an immediate adjustment of the exchange rate from $4.25 to $5.76, an adjustment that was thought to be sufficiently large and credible. The new exchange rate had to stick. A small adjustment would have lacked credibility and caused pressure on the exchange rate from the very outset. Too large an adjustment could reignite inflationary pressures. But the rate agreed on with the bankers was not arbitrary. The work done by the Bank’s research department had suggested a range for the real and nominal exchange rates which would be conducive to export promotion and the medium-term stability of the balance of payments.

Secondly, the commercial banks were not allowed to set a selling rate above a level signalled by the Central Bank. Doing so would prompt a very early call from the Central Bank. Thirdly, the banks got a very generous spread between the buying and selling rates. Fourthly, bureaux de change could be established on the grant of a licence by the Bank. This was intended to cre­ate an alternative source of foreign exchange to the banks but, in fact, has never been needed. Fifthly, banks were allowed to establish US dollar accounts in local banks for any individual or company. Sixthly, anyone could now legally establish a bank account overseas since exchange controls were abolished.

In addition to these institutional chan ges in the foreign exchange mar­ket, interest-rate policy and fiscal policy had to be supportive of the new regime. The differential be­tween local and foreign interest rates had to be large enough to act as a meaningful disincentive to portfolio capital outflows, and fiscal surpluses would be helpful in restraining aggregate demand as the new regime settled down.

A Rare Policy Success

In this underachieving society, we have not had very many exemplary policy successes. The Pt Lisas strategy directed by Ken Julien in the 1970s was one, as was the introduction of VAT in 1989, architected by Selby Wilson and Michal Christian. The (managed) flotation of the TT dollar over that Easter weekend in 1993 was, in my estimation, one of the best planned and executed po­li­cy interventions undertaken since Independence. There were no leaks of what the Bank was planning. The details were kept within a very small group within the Bank. Of course, when the bankers were requested to cancel their plans for that Easter weekend and keep their top executives available, there was naturally much speculation. But there was little or no capital flight in the run-up to the suspension of trading and the meetings over that fateful weekend.

The managed float has also turned out to be highly successful, both on its own terms and compared with the experience of other developing countries which floated before and since. When the United Na­tional Congress (UNC) adminis­tra­tion came to power in 1995, no attempt was made to interfere with the new regime. The nominal exchange rate has moved to $6.41 today, and while there are so-called “queues” for foreign exchange, the system has functioned well and remains stable. The country’s foreign exchange reserves today are high at US$11 billion. Moreover, foreign currency accounts in local banks held by ordinary citizens and companies now total over US$3 billion. Whether the real exchange rate is still appropriate is a complex question for another time.

This is an important 20th anniversary which might perhaps otherwise pass unnoticed. Marking it can be a reminder that we are capable of doing things well in this country. Hopefully, this account of the floating of the TT dollar may also be a source of inspiration to those who even now may be trying to steer policy-making away from the voops, vaps and vikey-vie approaches of the last ten years, which have served us very poorly indeed.

—Dr Terrence Farrell is a former deputy Central Bank governor and CEO of One Caribbean Media Ltd