Former finance minister suggests “dollar swap” with the US
Economist says country at risk of crisis by 2022
Foreign exchange woes symptom of weak energy sector
T&T should do a “dollar swap” with the United States to address our ongoing foreign exchange woes, former finance minister Prof Winston Dookeran has suggested.
Dookeran said the country needs to “take a diplomatic initiative to apply for a currency swap under the Foreign and International Monetary Authorities (FIMA repo facility) arrangement with the Federal Reserve Bank” if we are to increase the capacity for net inflow of foreign exchange and capital.
“Because bank funding markets are global and have at times broken down, disrupting the provision of credit to households and businesses in the United States and other countries, the Federal Reserve has entered into agreements to establish central bank liquidity swap lines with a number of foreign central banks,” the Federal Reserve stated.
The Federal Reserve said swap lines were designed to improve “liquidity conditions in dollar funding markets in the US and abroad by providing foreign central banks with the capacity to deliver US dollar funding to institutions in their jurisdictions during times of market stress.”
These arrangements have helped to ease strains in financial markets and mitigate their effects on economic conditions, the Federal reserve stated.
“The swap lines support financial stability and serve as a prudent liquidity backstop,” the Federal Reserve added.
But how does it work?
The Federal Reserve provides US dollars to a foreign Central Bank.
At the same time, the foreign central bank provides the equivalent amount of funds in its currency to the Federal Reserve, based on the market exchange rate at the time of the transaction.
The parties agree to swap back these quantities of their two currencies at a specified date in the future using the same exchange rate as in the first transaction.
Because the terms of this second transaction are set in advance, fluctuations in exchange rates during the interim do not alter the eventual payments.
Accordingly, these swap operations carry no exchange rate or other market risks.
The Federal Reserve stated that helping to stabilise foreign dollar markets, these swap lines also play a role in supporting foreign economic conditions, which also positively benefit the US economy through many channels, including confidence and trade.
The Federal Reserve operates these swap lines under the authority of Section 14 of the Federal Reserve Act and in compliance with authorisations, policies, and procedures established by the Federal Open Market Committee (FOMC).
Since 1994, the Federal Reserve has had bilateral currency swap agreements with Canada, Mexico, established under the North American Framework Agreement (NAFA).
In December 2007 this was expanded and dollar liquidity swap lines were established to provide liquidity in US dollars to overseas markets.
Last March the Federal Reserve announced the establishment of temporary US dollar liquidity arrangements with various central banks around the world including Australia, Brazil, and Singapore.
“These facilities, like those already established between the Federal Reserve and other central banks, are designed to help lessen strains in global US dollar funding markets, thereby mitigating the effects of these strains on the supply of credit to households and businesses, both domestically and abroad,” the Federal Reserve stated.
These facilities were provided up to US$60 billion.
Economist Marla Dukharan said T&T is at risk of a default/ balance of payments crisis by the end of 2022.
“Already, T&T is one of the most difficult places in the Caribbean to source USD. A balance of payments crisis occurs when a country does not have enough foreign currency to meet its foreign currency denominated obligations, either debt or otherwise,” she stated.
“Our declining FX reserves (and Heritage and Stabilisation Fund) in the context of rising debt and persistent weakness in our exports, suggest that at some point we will run out of foreign currency, if nothing is done,” she said.
Dukharan said the cause of the country’s foreign exchange problem is not the pandemic or any external factor but rather as a result of poor policy-making by this Government and the one before.
Dukharan said devaluation is but one policy option, but by itself will achieve nothing positive.
“We need to balance the fiscal accounts, restructure debt to eliminate the primary deficit, address deep and long-standing ease of doing business constraints, and only then will addressing the overvalued TTD make any sense,” she said.
“And a one-off devaluation is not the answer in my view. A return to the auction system even today, would begin to put things on a more sustainable path, and this is what I would recommend. This mechanism worked well until it was dismantled by the previous Central Bank Governor, and maintained by this administration, even though the current minister of finance promised to reintroduce it in his first budget speech in 2015,” she stated.
But how did this country’s foreign exchange problems start in the first place?
“That forex problem we are experiencing is directly rated to the health of the energy sector,” former energy minister Kevin Ramnarine sated.
“Our commercial banks get foreign exchange from two sources, the first source is the Central Bank, the Central Bank injects foreign exchange into the commercial banking sector and the second source would be when the energy companies sell foreign exchange to the bank,” he said.
Energy companies sell the foreign exchange to get TT dollars to run their operations in the country.
Ramnarine said both flows have been reduced.
“The reason for that is there is less activity in the energy sector, there is less drilling taking place, drilling is down by a factor of almost five compared to six years ago, there is less turnaround activity taking place in the Point Lisas Industrial Estate which also drives activity levels in the energy sector,” he said.
Ramnarine said 75 per cent of the holders of the VAT bonds issued last year were energy companies so when they sold those bods they received TT dollars so there was less need for them to approach the banks for local currency.
Dukharan said our foreign exchange reserves have been steadily declining since December 2014, when it had reached an all-time high of US$11.5 billion or 13 months of import cover.
“The level of FX reserves now stands around US$7.2 billion, returning to the level of February/March 2008, following an uptick from the June 2020 US$500 million bond issue. This US$7.2 billion level represents a decline of 37 per cent from the all-time high in December 2014,” Dukharan stated.
“If we back out the impact of US$500 million in debt issued in June 2020, and look at what has been earned organically by our economy, we can see that we have been losing on average over US$70 million per month for over five years. This is not a sustainable situation, and it will end in default / balance of payments crisis if maintained,” she stated.