Pros, cons of high liquidity

A high profile Port-of- Spain banker has outlined several reasons for the current high liquidity situation existing in this country’s financial system and has warned that politics must  not be allowed to override good economics .

They are -: 
*Stagnancy in domestic investment;
* Political turmoil arising out of the December 2000 general election;
*The tragic events of 9/11;
*Political stalemate following the 2002 general election;
*The impending Free Trade Area of America (FTAA) agreement;
*Reduced demand in consumer spending;
*The high level of crime; and
*Government’s fiscal policy.                 

The list was presented to business leaders during a seminar at the Hilton Trinidad last week by Richard Young, managing director of Scotiabank. The seminar was organised by the Employers Consultative Association (ECA.) Theme of his address was “The impact of the current high liquidity of the financial sector on the economy and on business in particular.” Young, who is also chairman of the Bankers’ Association said there was an upside as well as a downside to the high liquidity problem and he saw the situation as not without its benefits. One obvious benefit is the ability of businesses and consumers to access cheaper cost financing and he pointed out that TT dollar base rates for commercial borrowers had fallen from 16.5 percent to 9.5 percent as at November last year.

He said the Central Bank has already announced its intention to reduce the reserves even lower by the end of this year. “We anticipate that base rate may fall to between 7.5 percent and seven percent. I must laud the Central Bank for taking such a transparent position,” added Young. Another benefit of the high liquidity position is the windfall of wealth that investors have enjoyed by moving to alternative methods of wealth creation, which so obvious in real estate and the stock market. “Further,” said Young, “many companies have been able to generate sufficient cash to re-employ in the company, reducing their ultimate borrowing cost. I am certain we all agree that wealth creation and lower borrowing costs are welcome.” But there are several areas of concern surrounding high liquidity in the financial sector. Young said, “We are now witnessing a chase for assets to employ surplus cash and consequently, price increases, in some cases phenomenal price increases for said assets.”

Zeroing in on the real estate market, which has been hard hit in this area, Young said properties were experiencing as high as 80 percent increases in purchase price within the last year. In all of this, the Central Bank faces increased challenges as it attempts to control the money supply. As a result, the interest cost on its balance sheet has escalated as it tries, with only some measure of success, to sterilise surplus liquidity. Commenting on his own industry — banking — Young said the banks were faced with escalating costs and this has caused a reduction in deposit rates across the board and has impacted severely on persons living on fixed incomes as returns on deposits have fallen from the highs of 12 percent to as low as three percent. Forecasting that interest rates were expected to fall even lower, Young expects that to soften the impact on depositors and investors, the authorities would attempt to use moral suasion on banks to accept lower spreads. “Banks accept that we are going to be challenged to find new ways of generating revenue in a high liquidity, low interest rate environment,” he said. “Banks do not have any issues with a low interest rate regime, but if the banks’ spreads shrink significantly, the bottom line will be directly impacted.” And he posed the question, “Will this be good for our economy?”

But he had a word of caution for fixed income earners. He said, “The drive to earn a higher return could also prompt a fixed income earner to move into higher risk instruments and this might be ill-advised if they cannot afford to lose.” The banking executive also had a word on savings, since the present scenario was a temptation to spend rather save. “Saving is always a laudable objective and excessive consumerism is always dangerous,” he said. “Statistics such as 16,000 new cars being licensed in 2003 suggest that as a society, we may be getting caught up in this trend of heavy spending, rather than saving,” added Young. Young explained that the tools the government uses to manage the economy are primarily fiscal and monetary policy. “We note with interest,” said Young, “that the fiscal policy appears to have overridden monetary policy, that is, government spending versus the ability of the Central bank to remove surplus liquidity. Government must ensure that politics is not allowed to override good economics.”

He called on the government to introduce legislative reforms and he cited two pressing situations — Pension Plans and Mutual Funds legislation — both of which might help in reducing the high levels of liquidity through stimulation of a vibrant capital market. Young said, “I am heartened to see the SEC taking up the role of champion for the latter and hopefully, with the consolidation of the insurance sector under the Central Bank, we will begin to see some action.” But all that notwithstanding, the eminent banker feels that “high levels of liquidity are with us for a couple of years to come.”