SUNDAY EXPRESS COLUMNIST,,JANUARY 04, 2 K 15 The Imperative of Adjustment By By Terrence Farrell Story Created: Jan 3, 2015 at 8:33 PM ECT Story Updated: Jan 3, 2015 at 8:33 PM ECT Oil prices have fallen drastically and natural gas prices are already following. The decline is structural and cyclical and prices are likely to remain depressed for some time. The country’s terms of trade have worsened and therefore our real incomes are substantially reduced. The situation and outlook are serious, if not dire. Other oil/gas exporters—Russia, Venezuela, Iran—are similarly placed. Superficial assessment and flippant remarks in an attempt to downplay the seriousness of the situation or mollify the anxious are irresponsible. Equally, to posit that the alternative to inaction or token action is “panic” is inappropriate. We need to respond responsibly to the imperative of adjustment. Here is my seven-point plan offered as a professional economist with some (limited) experience in structural adjustment. I remain open to the guidance of those more experienced than I am. 1. Act quickly and decisively, and avoid the IMF We need to act with urgency. Urgency does not mean “panic”. Panic implies loss of control of the situation. Urgency means that the matter at hand takes priority over everything else. Delaying action hoping for a quick turnaround in oil and gas prices will worsen the situation and make adjustment harder and much more painful later on. In the 1982-1986 period, we tried to effect a “soft landing”. It did not work. The recent symbolic actions of the President could have been helpful in sending the right signal to the population of the need for an immediate and decisive response, but were negated by the actions and utterances of the Government. 2. The primary objective is: achieve external balance The foreign exchange constraint is binding. We need to estimate the impact of lower oil and gas prices and production on the balance of payments (BOP) and construct the adjustment programme around the restoration of external balance in the shortest possible timeframe. We must take the worst case scenario and adjust for that scenario. If it does not materialise, we will be better positioned when we need to restore growth. The medium term imperative is adjustment, not growth. To try to maintain growth while effecting adjustment will lead to inconsistent policies and ineffective adjustment. 3. Reduce demand by price and expenditure adjustments Once we know what is the size of the projected BOP gap, we can determine the combination of price (exchange rate) and quantity (expenditure) adjustments we need to achieve sustainable external balance. Real incomes have fallen and real expenditures need to adjust commensurately. The stance of fiscal policy must be dictated by the requirement of achieving external balance, not vice versa. 4. Fix the timeframe for achieving external balance We must decide on the time period over which we want to achieve external balance and the desired extent of decline in the foreign exchange reserves. The timeframe should NOT be more than TWO years! We should aim to complete the adjustment with enough foreign exchange reserves available to weather another external shock if that were to happen. 5. Fiscal adjustment should begin immediately The required fiscal adjustments should be implemented immediately. This may include (a) increases in personal and corporate taxation and reintroduction of a property tax; (b) reduction of transfers and subsidies by better targeting; (c) prioritisation of capital projects— continuing ongoing and incomplete and new critical infrastructure, while other projects are deferred until the adjustment process is complete; (d) divestment possibilities should be identified early and no acquisitions by Government should be contemplated. The Heritage and Stabilisation Fund should NOT be touched. All of it should be deemed “heritage” and fiscal adjustment achieved otherwise. 6. Monetary policy should act on interest rates and exchange rate Monetary policy should cooperate by raising interest rates to levels which constrain credit demand, weed out weak investment projects, lower asset prices, and deter consumption spending. These levels should also take care of the required interest rate differential between US and TT rates to deter portfolio capital outflows. A target exchange rate should be set at a level that reduces import demand and encourages non-energy exports. There must be sufficient reserves to defend the target exchange rate. 7. Wages and incomes policy should cooperate Wage increases should be limited to no higher than the core inflation rate for the initial adjustment period of two years, but only where such increases can be afforded. We have several positives for a successful adjustment process. Foreign exchange reserves and foreign currency deposits in the local banking system are substantial; this can facilitate orderly management of the exchange rate if done judiciously and sensibly. Second, external debt is low; additional external borrowing may be possible without compromising the medium term debt servicing profile when projected export earnings will be lower. Third, there is a lot of fat in the budget so that expenditure can be cut without severely affecting the most vulnerable in the society. But there are also negatives. With impending general election, it is unlikely that the administration will immediately reduce expenditure to the extent required, or support the required changes in monetary policy. Second, sections of the business community have lost confidence in the Central Bank and to some degree in the Government’s fiscal policy as well. Third, the dependency syndrome and entitlement are deeply embedded and recently have been encouraged further by grants to “churches”, plenty gift giving, and subsidies on flour and cooking oil for Christmas, even in the face of the collapse in oil prices. Fourth, our CSO is ill-resourced to produce the data that would allow policies to be fine-tuned for best effect. The question is: Can we succeed? The country’s current leadership is unlikely to act as suggested here. First, politicians, not professional economists, have been making the decisions on resource allocation and growth strategies. There is, to the best of my knowledge, only one professional economist—Emmanuel George—in the Government. Our public sector economists have been muted. It is only when the foreign economists from the IMF arrive that any heed will be taken, and then it will be because we have no choice. At the end of the day, economics will always trump politics! Second, it will be difficult to win over the trade unions and the independent business community whose support for any adjustment programme is important. Third, culturally, our leadership operates with the “God is a Trini” mentality and will elect to “wait and see”, “monitor the situation” and make token expenditure cuts, while secretly hoping that oil prices will miraculously rebound or gas prices will remain elevated. Unfortunately, the Prime Minister has already stated: “Rest assured that there will be no cuts in the health sector, social programmes as well as national security. As well there will be no cutbacks in recurrent expenditure such as wages and salaries. We will look closely at our non-essential services and if necessary, reduce our financial commitments in that area.” This is all wrong! No such assurances can or should be given until the technical work on what is required to achieve external balance has been done. (If it has been done, please tell us what it says and what assumptions were made). If a new administration is elected later this year, and only then begins to act seriously and responsibly, it will be already nine months too late! In short, if the worst case scenario plays out, and unless the current administration experiences an epiphany of responsible leadership, we are in for another long and painful period of structural adjustment! Dr Terrence Farrell is a former deputy Central Bank governor and former chief executive office of One Caribbean Media Ltd, parent company of the Trinidad Express Newspapers.
Posted on: Sun, 04 Jan 2015 17:29:53 +0000
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