Ex-deputy Central Bank governor: Is Government being allowed to borrow more?

FORMER central bank deputy governor Dr Terrence Farrell has questioned whether a decision by the bank to reduce the cash reserve requirement for commercial banks was to facilitate increased government borrowing.

He raised the question in a letter to the editor on July 22.

Farrell recalled the bank in a statement on July 19, announced that it had reduced the cash reserve requirement imposed on commercial banks from 14 to ten per cent.

"I found the announcement perplexing. First, it came just a few weeks after its previous monetary policy announcement on June 28."

In that statement, the bank said, "Financial sector liquidity remained ample during the second quarter of 2024, in the face of an increase in domestic financing by the Government. Commercial banks’ excess reserves at the Central Bank averaged $4.2 billion in the first half of June 2024, marginally lower than in May 2024 ($4.3 billion)”.

Farrell said in its July 19 statement, the bank justified the reduction in the reserve requirement by citing the fact that system liquidity (excess reserves) in the first two weeks of July had averaged $2.77 billion compared to $3.91 billion in June.

"The decline in the first two weeks of July compared to June was about 29 per cent. But it is strange that the Central Bank would act based on such a short period of data."

With respect to the excess reserves data from the bank, Farrell said in January, "average excess reserves were about $3.0 billion and that prompted no alarm."

He referred to a June 28 statement from the bank which noted "that there was some ‘skewness’ in liquidity among banks leading to activation of the inter-bank market."

Farrell said, "The published data on inter-bank borrowing go up to April, but in December 2023, inter-bank borrowing reached $1.26 billion, but again that did not prompt any alarm."

He wondered if the bank believed the decline in excess reserves was permanent.

Farrell asked what data the bank based such a conclusion on, if it believed that was the case.

"System liquidity is impacted significantly by foreign exchange outflows. However, when the data on foreign exchange sales to the public are examined up to the end of June, those data do not disclose any surge or acceleration in outflows."

Farrell said net foreign exchange reserves increased at the end of June as a result of government's external borrowing of US$570 million in mid-June.

He added that the bank did not inject more than its usual US$100 million into the financial system in June.

"The other factor which can impact system liquidity is a significant increase in short-term borrowing by the government. Normally, this would be done by issuance of treasury bills or treasury notes. But the available data disclose no increase in the treasury bill issue outstanding nor an increase in the discount rate on treasury bills.

"Alternatively, certain banks may have lent to the government causing their liquidity to decline sharply and driving them to access the inter-bank market. This might be the ‘skewness’ referred to by the Central Bank in its June 28 release."

He added, "One might think that if system liquidity was declining, the commercial banks would take the rational business decision and increase interest rates on deposits to attract deposits into the system. But interest rates have not moved at all, neither on deposits nor on loans."

Farrell claimed the decision to reduce the cash reserve requirement for commercial banks by four percentage points releases almost $4 billion from the cash reserves.

"This marks a significant relaxation in monetary policy which is likely, other things being equal, to expand credit and increase the demand for foreign exchange when our foreign-exchange reserves are already under stress and, given the outlook for natural gas and petrochemicals exports, will remain stressed for the foreseeable future."

Farrell was concerned whether "monetary policy has been relaxed significantly merely to accommodate increased government borrowing."

Farrell admitted that he could be wrong about this.

But he added, "I have no doubt we will soon find out."

For the full version of Dr Farrell's commentary please see: https://newsday.co.tt/2024/07/23/central-banks-mysterious-monetary-policy/