Trinidad and Tobago: Policies on inflation

On September 8th 2010, the Honorable Winston Dookeran, the Minister of Finance for Trinidad and Tobago presented the Budget Statement for 2010/2011 fiscal year. The budget gave a comprehensive summary of the financial plan of the government, giving details of its expected levels of revenues as well as expenditure for the 2010/2011 fiscal year. Of the many areas of concern raised in the Budget by the Minister of Finance, inflation and government expenditure take precedence in this analysis.

Due to the high levels of inflation in Trinidad and Tobago, the paper seeks to address the impact that various monetary and fiscal policies proposed by the government in the 2010/2011 Budget Statement have on inflation. The positive and negative effects of monetary and fiscal policies on inflation will be examined. Further, the paper will also examine the areas of government spending for the fiscal year 2010/2011 with the aim of identifying changes in expenditures patterns of the government and justifying reason for expenditure in certain sectors in this tough global economic climate. Time series data was utilized in order to determine trends and determine major changes in government expenditure.

Suggestions were also made in an effort to identify certain plans that the government should consider and policies that it should monitor based on its current policies which it intends to undertake.

The problem of inflation is one which plagues most developing countries as well as developed countries in recent times. Inflation is characterized by increases in the overall prices levels in a country over a period of time. In recent time headline inflation in Trinidad and Tobago has been influenced primarily by surging food prices while core inflation has remained relatively stable. Headline inflation measures the extent of changes in the prices level of all goods and services within an economy whereas core inflation can be defined as headline inflation minus other volatile components such as food prices. Based on the Central Bank of Trinidad & Tobago Annual Economic Survey for 2009, changes in headline inflation from 2005 to 2009 was primarily due to changes in food prices, during which core inflation was relatively stable. This postulates that changes in the overall inflation rate which is referred to as headline inflation was due mainly to changes in food prices during which core inflation remained relatively constant. Further, the Summary of Economic Indicators June 2010 by the Central Bank of Trinidad & Tobago has summarized that headline inflation rose to 13.7 percent from June 2009 to June 2010 primarily due to food inflation which increased to 31.1 percent during this same period, while core inflation remained constant during the year at 4.3 percent.

The Trinidad and Tobago 2010/2001 Budget Statement estimates were made based on an average inflation rate of seven percent. This figure can be identified as the Government forecast for inflation for the fiscal year. The budget statement identified inflation as a concern with particular emphasis being placed on food price inflation. Inflation reduces customers’ purchasing power and thus it becomes more difficult for people to acquire basic goods and services. Therefore, it becomes imperative for Government of Trinidad and Tobago to put measure in place to reduce inflation and also to ensure that policies implemented to promote various sectors within the economy have little or no inflationary effects.

In the budget statement, the government proposed plans to revitalize the agricultural sector in an effort to increase food production and expand the agricultural sector. The government further identified factors such as water resource management, drainage and irrigation as paramount to its public sector investment programme tailored towards making agriculture more profitable. In addition it proposed certain initiatives such as the enhancement of the Agricultural Development Bank which will provide a Loan Default Fund facility to assist farmers with natural calamities and interest payment, the reduction of interest rates to between three and five percent and the availability of twenty million dollars for greenhouse projects.

All these initiatives as mention before are geared towards making agriculture more attractive, more profitable and more productive in an effort to reduce the food import bill of Trinidad and Tobago. Due to the lack of a productive agricultural sector in Trinidad and Tobago, fluctuating oil prices and the global financial crises, the cost of importing good such as food items has become more expensive. As a result, this higher cost is being passed on to consumers in the form of higher prices. This type of inflation is referred to as cost push inflation. Cost push inflation causes a contraction in aggregate supply and with aggregate demand remaining unchanged, the final result is an increased in overall prices. Therefore, if the initiatives undertaken by the government are successful and result in an increase in the production of food locally in Trinidad and Tobago, this could reduce the number of food items which are imported, thus decreasing the food import bill. Food prices will fall and subsequently headline inflation as changes in food prices is the major contributor to changes in headline inflation.

Monetary policy can also be used to strengthen the local agriculture sector. The Budget also supports the Trinidad and Tobago Central Bank’s reduction of the Repo rate to 4.5 percent with further reductions to be expected. The repo rate is one of the monetary instruments used by the Central Bank of Trinidad and Tobago. The Repo rate was introduced by the Central Bank of Trinidad and Tobago in May 2002 and it is the rate at which the Central Bank is prepared to provide funds overnight to commercial banks that are unable to meet their liquidity demands. This reduction in the repo rate to 4.5 percent is expected to reduce the interest rate in an effort to attract investment. Lower interest rates are expected to attract investment from the private sector and also foreign companies in an effort to increase aggregate supply primarily through increased food production and thus reduce overall prices levels. A lower interest rate can lead to an increase in investment which raises aggregate expenditure as purported by the Keynesian Cross. This increases real gross domestic product which further results in an expansion of the aggregate supply curve and a reduction in price levels.

The Central Bank using accommodative monetary policy needs to ensure that the money supply does not grow too rapidly causing inflation. Accommodating monetary policy most times results in increases in the price level. Milton Friedman, a famous economist stated that “inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” The Classical school of though is based on the quantity theory of money which is given by the equation MV=PY where M refers to the money supply, V refers to the velocity of money, P refers to the price level, Y refers to the real current gross domestic product and PY refers to nominal gross domestic product. The Classical school of thought believes that V and Y are constant and therefore, any changes in the money supply by the central bank will have a direct impact on the price levels. Therefore, it is imperative that the Central Bank ensure that the money supply does not increase too rapidly and also that if the money supply does increase it is as a result of changes in output.

The government in its effort to improve the production of oil and gas has reduced the petroleum profit tax from fifty percent to thirty five percent. In addition, due to the reduction in oil production over the past decade by approximately twenty five percent, the government decided to revise the Supplemental Petroleum Tax Regime with a new system which will use base rates and a sliding scale mechanism for both marine and land operations. The government also provided incentives which includes a twenty percent reduction in the Supplemental Petroleum Tax rates for mature or small oil fields, an Investment Tax Credit of twenty percent on qualifying capital expenditure in respect of the Supplemental Petroleum Tax for mature oil fields both land and marine. High energy cost in some industries will result in higher cost to consumer and a reduction in aggregate supply. Since oil and gas is used in almost all industries in some way or form, the reduction in these taxes could result in a fall in cost to companies both within and outside the energy sector. The lower cost of inputs would lead to an increase in aggregate supply. Additionally, lower operating cost can be passed on to consumers in the form of lower prices. However, it is important to note that if actual output does not increase, this would result in a contraction in aggregate supply. This would lead to and increase in the overall price levels and subsequently periods of falling real GDP. This phenomenon is referred to as stagflation. Stagflation is characterized by periods of falling output and increases in the price level.

Situations like the CLICO Fiasco, the financial situation facing the Hindu Credit Union and other economic and social policies pursued by the government, has prompted an increase in budgeted expenditure from approximately $44 billion last fiscal year to $49 billion this new fiscal year. Government expenditure is a key component of aggregate expenditure which helps determine the level of gross domestic product. The gross domestic product of Trinidad and Tobago is made up primarily of revenues from the oil and energy sector. However, there has been declining production of oil over the past 10 years of approximately twenty five percent from 130,000 barrels a day to 103,000 barrels a day and based on the Annual Economic Survey 2009 from the Central Bank of Trinidad and Tobago, there has also been a continuous fall in real GDP growth from 2006 to 2009 fell where in 2009 negative three percent of real GDP growth was registered. The Keynesians argued that increases in aggregate expenditure caused by increases in consumption, investment, government spending or net exports can lead to an inflationary gap when actual GDP exceeds potential GDP. Thus and increase in government spending as purported by the Government of Trinidad and Tobago for this fiscal year can result in an inflationary gap.

Furthermore, the budget also highlighted that the government owed contractors monies amounting to approximately $4 billion while there were outstanding VAT refunds still had to be paid in the amount of $2.8 billion. This lack of funds by the government has resulted in businesses experiencing cash flow problem. This makes it very difficult for businesses to meet their financial obligations. Also, based on the inventory system that the business uses whether it be “First In First Out” or “Last In First Out” it can be extremely difficult for the business to replenish stock in periods of inflation and can further affect the revenue that the business generates. As a result businesses may not have the necessary cash to replenish inventory which can result in limited supply which can manifest itself into even higher prices for customers in order for businesses to meet with the increase cost of inventory. Thus it becomes important that the government find ways to assist those businesses and pay off monies owed to these businesses in an effort to increase the cash flow within these businesses and prevent prices from rising further due to cash flow problem being experienced by businesses.

Although the impact of government policies on inflation is very important, it is also important to analyze the level of government expenditure for this fiscal year 2010/2011 for Trinidad and Tobago. The Minister of Finance in his budget address stated that the calculations in the 2011 Budget were made based on a real GDP growth rate of 2 percent, average inflation of 7 percent, oil price of US$65 per barrel and gas price of US$2.75 per mmbtu. The total government expenditure for this fiscal year for Trinidad and Tobago was estimated at TT$49 billion. Government spending comprises transfer payments, current expenditure and capital expenditure and is financed by revenues raised through taxes or government borrowing or a combination of both. Government spending is a critical component of total expenditure and some of its functions include providing public and merit goods, promoting economic activity, influencing resource allocation, stabilizing the economy and the redistribution of income and wealth. When government uses government expenditure and taxes to influence the economy, this is referred to as fiscal policy.

Based on the Central Bank of Trinidad and Tobago, Annual Economic Survey 2009, there has been an overall increase in government expenditure from the fiscal year 2005/2006 to 2010/2011. In 2005/2006 government expenditure was TT$ 31 197.9 million, in 2006/2007 it was TT$ 37 765.9 million, in 2007/2008 it was TT$ 44 715.1 million. In 2008/2009 where the country experienced its first deficit in seven years government expenditure was TT$ 45 584.2 million, in 2009/2010 it was TT$ 44 347.3 million and 2010/2011it is estimated to be TT$ 49 billion. It is also important to note that most components of government spending during this same time were also increasing such was current expenditure, expenditure on goods and services, wages and salaries and interest payments. During most of this period government spending as a percentage of GDP increased from 27.8 percent in 2006/2006 to 32.5 percent in 2008/2009. However in 2009/2010 government expenditure as a percentage of GDP fell to 31.3 percent. Thus over the past five years government spending has increased by approximately TT$18 billion.

In the 2010/2011 Budget statement, there was a breakdown on some of the areas of expenditure. Education and training received TT$ 8 325 million, Infrastructure received TT$ 5 918 million, Health received TT$ 4 341 million, National Security received TT$ 4 762 million, Agriculture received TT$ 1 836 million and Housing received TT$ 1 837 million. The government proposed expenditure pattern is an attempt to reduce inflation, foster economic growth and development and providing a better standard and quality of life for the people of Trinidad and Tobago.

The government of Trinidad and Tobago has identified national security as one of its major areas on concerns. As of October 27th 2010, Trinidad and Tobago had recorded a total of four hundred and one murders. Crime has escalated in Trinidad and Tobago and the safety of resident and visitors are important. As a result the government has a projected expenditure figure of TT$ 4 762 million for national security. Recurrent expenditure for national security from 2004/2005 to 2008/2009 has increased from TT$ 1 874.5 million to TT$ 3 870.2 respectively. This shows the continued spending by the government towards promoting law and order and reducing crime. The government also has provided a special duty allowance of TT$ 1000 for more than 7000 police officers with taxes on this allowance waived. This increase in allowance can be used as a tool to motivate police officer in performing their duties. The government will also undertake initiatives such as the refurbishment and upgrading of police stations, introduction of bike patrols, the establishment of a National Security Operations Centre and a Special Criminal Court to expedite the court process.

From 2004/2005 to 2008/2009, recurrent expenditure for Agriculture has increased continually from TT$ 362.9 million to TT$ 586.1 million respectively. However, recurrent expenditure in agriculture is not a significant part of recurrent expenditure as other areas such as health, education and energy. Therefore, Trinidad and Tobago’s government expenditure in Agriculture is reflective of the government initiative to make agriculture more profitable and increase the local production of food. As mentioned before this venture is undertaken in an effort to reduce the food import bill of the country and further reduce the level of inflation caused by food prices. Also, this could result in increases in Agriculture contribution to gross domestic products thus making the country less reliable on energy and its associated products as its primary course of revenue.

Further, expenditure in health has increased from 2004/2005 to 2010/2011. The Minister of Finance in the budget highlighted that health was another major issue facing Trinidad and Tobago. As a result expenditure in this sector will be geared towards the provision of adequate and timely health services to the citizens of Trinidad and Tobago. Government expenditure in the health sector will include expenditure to build new health facilities such as hospital, upgrade and expand current health facilities and services, improve access to health services, reducing communicable diseases and improving health care management. These initiatives in the health sector reflect the importance of health services and how important it is for person to have access to adequate and proper health services.

This fiscal year, education and training accounted to approximately 17 percent of total government expenditure. The government has realized that knowledge is a critical component of an economy and as a result the government will continue initiatives such as the GATE programme and also restructure the On the Job Training programme. Some economists believe that knowledge does not experience diminishing returns. Therefore, this reflects positively on the economy of the country as the country may even decide to sells advising services which is an initiative that Trinidad and Tobago are pursuing.

Moreover, the government has also decided to allocate approximately 12 percent of its total expenditure to infrastructure. Initiatives include providing person with a steady water supply and other basic amenities, implementing flood mitigation plans and the cleaning and de-silting of rivers. Also, sights and several attractions will be upgraded. This is in an effort to market Trinidad and Tobago as a major tourism destination which will further creates jobs and increase the contribution of tourism to gross domestic product. Thus, this will also make the country less dependent on energy and its products as the country’s main source of revenue.

It is also important to note from the Central Bank of Trinidad and Tobago Statistics that from 2004 to 2009 government expenditure on areas such as goods and services, wages and salaries and transfer and subsidies increased continuously. For example, government expenditure on goods and services increased from TT$ 2, 440, 407 000 in 2004 to TT$ 5, 860, 175 000 in 2009 which marks an increase of approximately 58.35 percent over the five year period. This again reflects the high import bill especially on food items for Trinidad and Tobago over the past 5 years. The continuous increases in expenditure on wages and salaries paid by the government during this same period reflect the fact that the government is the main employer within the economy.

This paper has sort to identify the effect of government policies and expenditure patterns on inflation and an analysis on government expenditure. The paper highlighted that certain initiatives undertaken by the government could help in reducing the overall price level in the country. These initiatives include the revitalization of the agricultural sector, increased government expenditure, reductions in the Petroleum profit tax and a reduction in the repo rate. The revitalization of the agricultural sector is geared towards reducing the food imports bill and subsequently food inflation. The reduction in the repo rate is in an effort to lower commercial banks interest rate to stimulate investment in certain areas such as manufacturing with the goal of reducing imports and subsequently food prices and inflation. The reduction in the petroleum profit tax to 35 percent is in an effort to stimulate oil production which has been declining over the past few years. However, as highlighted earlier in the paper, these initiatives need to be monitored careful as they can lead to further inflationary pressures. For example, a reduction in the repo rate can trigger lowers interest rates, banks experiencing excess liquidity and increased level of investment increases the money supply and leads to inflation as argued by classical economists.

The paper also commented on government expenditure and identified an increase in government expenditure from the previous fiscal year to this fiscal year. Government expenditure in key areas such as education, health, infrastructure and national security increased over the past few years. National security and health were two major areas of concern for the government which received significant budgetary allocation by the government. The increase in crime and lawlessness has caused government to put measure in place to try to curb the crime problem in the country and also motivate the police to carry out their duties. Also, the government plan to improve the health sector was reflected by the government’s budgetary allocation for the sector. The government also increased its funding in the agricultural sector in an effort to make agriculture more profitable and increase the production of food. The government also allocated revenues in other areas apart from energy in order to find alternative sustainable sources of revenue such as agriculture, tourism and manufacturing.

It would be recommended that the government continue to pursue it agricultural initiatives and derive ways to make agriculture more attractive to individuals in its effort to make the sector more productive and profitable. In this way agriculture can contribute more to GDP both in the primary and secondary sectors as agricultural products are diversified and used into other sector such as manufacturing. This would also lead to other sector such as manufacturing contributing more to GDP and reduce the country’s reliance on primarily revenues from the energy sector. Also, the government would have to find ways to control the money supply which could take the form of selling government treasury bills and bonds. This would be in an effort to cope with the excess liquidity faced by commercial banks. In addition, due to the depletion of the natural resources available to the country which is reflected in the decreasing amount of oil produced for the past years, the government would be advised to develop other sector such as agriculture, manufacturing and tourism to increase the contribution of other sectors towards gross domestic product. It is know that an Open Petroleum Economy such as Trinidad and Tobago is one where rapid increases in GDP exist alongside high level of unemployment. According to the Open Petroleum Economy Model if anything negative happens to the oil sector the entire economy can suffer due to high dependence on that once sector. Seers argued that such a model represent a time bomb based on the balance of payment problems it can pose and how the wealth generated from it can disappear overnight. Therefore, it becomes increasingly important for Trinidad and Tobago to diversify into other sector of the economy. The country can pursue the manufacturing of some of the food which it imports and also pursue sustainable tourism development which can lead to increased employment. This would make the country less dependent on mainly oil as its main source of revenue as it currently the case. Further, the government should be extremely careful in its spending patterns and will be encouraged to spend in areas which will be productive to the country and benefit the citizens of the country. Spending should focus mainly on providing citizens with basic necessity items such as public and merit goods and proper social infrastructure. In this tough economic climate, the government should be very critical of the areas in which it spends money as excessive spending can have negative effects on the economy such as inflation.