CMMB raises inflation forecast

Published: Wednesday September 3, 2008

In light of the recent Central Bank announcement on inflation and the repo rate, CMMB has raised its inflation forecast for the rest of this year. We hold the view that inflation has not yet peaked and will continue to edge upwards in the coming months, ranging between 13 - 15 per cent.

A combination of factors will provide the basis for sustained elevated inflation in Trinidad and Tobago. Firstly, with the Government proceeding with its rapid pace of expenditure, we expect that net fiscal injections will continue to add liquidity to the domestic financial system. This will, as we have seen thus far, fuel domestic aggregate demand, and will be the key source of inflationary pressures going forward. High food prices on the international market will also continue to feed into headline inflation locally and adding to the inflationary pressures on food will be the impact of more flooding and inclement weather on locally produced food. These factors will cause food inflation to hover around 20 - 25 per cent in the short to medium-term.

The 50 bps hike in the repo rate as well as the 200 bps increase in the reserve requirement for commercial banks for the year so far has resulted in a 100 bps increase in the prime lending rate and a mere 11 bps increase in commercial banks' ordinary savings deposit rate. While the intent of this action by the Central Bank was to discourage consumption and curb the expansion in credit, all it had produced thus far is an 89 bps increase in the spread income accruing to commercial banks. Monetary policy appears ineffective in a situation such as the one prevailing now, as the impact of expansionary fiscal policy is completely nullifying the impact of tighter monetary policies, exacerbated by an unfavourable external environment.

Currently, the inflation rate is at a 14-year high of 11.9 per cent. Core inflation, which is a key gauge of inflationary pressures emanating from within the economy, fell slightly to 6.2 per cent in July, compared to 6.4 per cent in the prior month. Based on the factors mentioned above, we expect that inflation will remain at elevated levels and should range between 13.00 - 15.00 per cent for the rest of 2008, with a bias to breach the upper end. Given this expected trend together with the gradual tightening in TTD liquidity, interest rates should also increase.

Currently, the 90-day Treasury Bill is yielding around 7.17 per cent and on the 180-day, the yield is at 7.39 per cent.We therefore expect about a 50- 100 bps increase in the shorter end of the TTD yield curve, with the larger increases seen at the very short end of the curve, specifically, the 90-day T-bill. The repo rate should also increase by a further 50 bps to reach 9 per cent by the end of 2008; a historic high from its initial rate of 5 per cent.


We reiterate our policy recommendations for fighting the inflation battle:


1. Reducing the pace of government expenditure to limit net fiscal injections into the economy, and subsequently tightening the liquidity situation.


2. Reducing the food import bill, by providing incentives for agriculture locally (thereby using the energy windfall to diversify the economy)


3. Temporary removal of import duties on basic / staple food items


4. Proper price controls to ensure the cost saving is passed on to the consumer when VAT and duties are removed or when there are declines in international prices, for example, wheat.


Additionally, one medium term measure is to adjust the foreign exchange regime - removing the TT/US peg, and replacing it with a peg to basket of currencies of our major trading partners, as well as oil prices, to remove the susceptibility of the TT dollar to a weakening USD. This will help control the impact of imported inflation.

Reducing the level of liquidity is paramount in the central bank's fight against inflation. And this means that the Two Towers must work in unison. The Central Bank is helpless as long as the liquidity injected into the system by the government outweighs that which it can legitimately absorb through tighter monetary policy.


Source: Trinidad Express Newspapers
http://www.trinidadexpress.com/index.pl/article_business_mag?id=161371235