Running on excess liquidity

Deposit rates are still sliding and financial gurus are warning that while this might have a positive effect on interest rates in the short term, it can also have an inflationary effect on the economy in the long term.

The Central Bank in its Economic Bulletin up to May 2003 reported that retail lending rates remained soft following their persistent decline in 2002. The Central Bank said, as a result, commercial banks have been plagued with what it describes as “persistent excess liquidity” in the local financial system. This means that TT’s commercial banks have lots of money to lend and no one to lend it to. The excess liquidity in the financial system has forced banks to reduce their lending rates to as low as 11.25 percent to 11.50 percent, a range which they hope will encourage customers to borrow.

Peter Clarke, Managing Director, West Indies Stockbrokers Limited (WISE), said he is not sure what is causing the liquidity in the financial system and warned that if it continues it can have an inflationary effect on the economy. Clarke noted that part of the reason could be that the energy sector, which forms a large part of TT’s gross national product (GNP), is being funded from external sources. This, he said means that the domestic money  market is not playing a role in terms of providing funding to the energy sector. “There are a number of factors which are causing the liquidity in the financial system and I think perhaps we need to look closely at what those causes are,” he said. Clarke said it certainly appears that this situation is going to continue for the rest of the year. “If you look at the level of interest rates and what has been happening to deposit and lending rates, all indications suggest that rates are going to remain low caused by the liquidity situation.” He said the Central Bank usually intervenes in situations like these and uses their market operations to influence liquidity by trying to “sterilise” some of the excess funds in the system, so that it does not have any negative impact on the economy.

“But inspite of this, I think that we really have to try and better understand the causes of the excess liquidity and that might help us decide what we can do about this situation.” Clarke said while this can result in inflation, one effect on the positive side is that there have been lower interest rates. “While that is negative for savers, it is certainly better for the economy in terms of people being able to access funds for productive investments.” However, he noted that if people are not actually taking advantage of the opportunity and going into productive investments, then there may be cause for concern. The excess liquidity has had a positive effect on the commercial banks. “The results that have ben published by the banks reveal that their interest rate margins have improved meaning that deposit rates have generally fallen faster than lending rates and that their profitability increased.”

However, he said commercial banks obviously need to look at ways to encourage investment. He said thus far, the main beneficiary of lower interest rates has been the property market which has seen quite a surge in the last 12 months. “This is all fair and good, but I think from an economic perspective, we would like to see more of the funds going to productive investments that can create long term sustainable jobs.” Richard Young, managing director, Scotiabank and president, Bankers Association of Trinidad and Tobago (BATT) said that liquidity levels now stand at a high of about $1.4 billion. “The system is very liquid.”

Young added that while banks have money to lend, borrowing in the private sector from banks and non-financial institutions has contracted by about one percent in the first two months of the year and has remained at low levels. He explained that uncertainty in the international arena, tensions in the Middle East, the escalating crime rate and even consumer saturation of the market have kept lending down. “There are only so many cars you can buy or so many houses and people are being smart with their money.” The BATT president added that lower lending rates means “cheap money which benefit borrowers, but is tough on depositors.” Young added that if banks are not earning as much in individual income instruments because of reduced credit demand, individuals may have to turn to investment income type instruments regionally or internationally.

However, he noted that returns in international markets have tended to be lower because of uncertainities internationally and mixed economic performances. Lyndon Guiseppi, general manager, Corporate Banking, RBTT said because of the uncertainty in the United States (US) investment market, investors are bringing back funds to TT, which can contribute to the surplus funds. Additionally, he noted that local investors are not aggressively pursuing investment opportunities in TT and government has not yet initiated a large number of projects which would trigger investor and contractor activity. “Manufacturers may also be viewing the crime rate and the impending Free Trade Area of the Americas (FTAA) in 2005 with some apprehension and are not spending on plant and business expansion.” Dr Ronald Ramkissoon, senior economist at Republic Bank said excess liquidity has been present in the financial system for quite sometime. He explained that excess liquidity usually means that there is a surplus of funds in the system, more than the public wants to borrow or the Central Bank can absorb in the short term.

Dr Ramkissoon said this does not necessarily mean that it will have a negative impact on the economy, once it does not put undue pressures on prices. “Excess liquidity is sometimes a potential source of higher demand in the economy which can drive prices and foreign exchange balances.” On the excess funds, he said, “they might be available for long-term investments, which I doubt. But something has to drive greater demand for these funds from businesses and entrepreneurs for doing business, exporting and maybe creating employment.” However, he said the banks cannot have the funds go out through bad loans because that might create some problems for both the banks and investors. He said there is always the possibility of investing these funds in the capital, bond or equity markets. However, he said banks should try to channel some of these surplus funds in a prudent manner. “These are some of the challenges we have to address and we have to find prudent answers to the problem of excess liquidity. But once these funds remain and do not create undue problems in the system then we are alright.” Dr Ramkissoon said thus far, the local banks and TT have managed these excess funds very well.