Analyst Peter D. A. Queeley shares his thoughts on a way forward for the ECCU member governments and recovering from COVID-19 impacts.
On April 11, 2020 the Governor of the Eastern Caribbean Central Bank (ECCB), Timothy N. J. Antoine in a statement on the COVID 19 Pandemic stated as follows:
“The EC dollar remains very strong. As of Friday, 3 April, 2020, the Backing Ratio of our currency stood at 100.7 per cent. This is great news because it means that the buffers built up over many years will serve our Currency Union extremely well in this difficult period.
We anticipate that our Central Bank will need to extend additional credit to governments and banks. In a similar way, as the Central Bank has temporarily lowered the Discount Rate for governments and banks, the Central Bank is prepared, if necessary, to temporarily lower the Backing Ratio as additional credit is extended to governments and banks.
That said, the backing of our currency will remain far above the legal requirement at all times. As you may know, the ECCB Agreement requires a backing ratio of 60.0 per cent. Thankfully, our Central Bank has significant foreign reserves and the EC dollar will remain strong throughout this period.”
The above package of assistance announced by the ECCB Governor is well intentioned and should provide ECCU region Governments and Banks some relief at a time when their various economies and government fiscal position has taken a turn for the worst stemming from the effects of the COVID 19 crisis. The tourism sector in particular and its various linkages has suffered greatly creating massive unemployment, business closures and loss of revenue for regional governments.
However, it is doubtful what effect the ECCB lowering of the discount rate from 6.5% to 2.0% will have upon commercial banks borrowing from the Central Bank. Commercial Banks in the region and in particularly Montserrat are very liquid and thus lowering the discount will not entice these banks to borrow monies if they are not in need of liquidity. For commercial banks in the ECCU region to be enticed to borrow monies from the ECCB, the discount rate must fall below the legally imposed saving rate of 2.0%, which is the rate at which commercial banks raise the majority of its funding.
Whilst the lowering of the discount rate will make it more attractive for Governments to borrow from the Central Bank at a time when ECCU Governments require much needed financial assistance, it is my humble opinion that the ECCB should exercise caution particularly in terms of its lending to regional governments since the ECCB cannot by its very nature print money. The ECCB is central bank which operates a foreign currency backed fixed exchange system.Therefore, any extension of monies by the ECCB in the form of loan the banks and governments will impact the foreign exchange reserve position of the ECCB negatively.
We are operating at a time in the ECCU region when the COVIID 19 crisis has resulted in a total collapsed of the region’s major foreign earner ie Tourism. This simply means no significant foreign exchange will be coming into the region to meet or offset the region demand for foreign exchange to pay for imports. All the member states of the ECCU region are heavy importers of food and oil and require a continuous supply of foreign exchange to pay for these commodities.
With tourism not projected to come back on stream fully until late 2021, regional commercial banks will be under significant pressure to meet the foreign exchange demands of customers to pay for imports. When these commercial banks run out of foreign exchange, they will call upon the ECCB to provide the necessary foreign exchange required to meet their customer demands. The ECCB is obliged by law to meet these demands for foreign exchange by commercial banks by accepting local currency from these banks in return for the necessary foreign currency. This will impact the ECCB foreign exchange reserve position negatively.
Now, in terms of the ECCB extending loans to its member Governments, this takes place via the ECCB converting its foreign reserves into local currency and then extending these funds in the form of loans to the respective governments. This action by the ECCB will have the impact of drawing down on its foreign reserves reducing the foreign exchange rate cover or otherwise known as the backing ratio.This will happening at a time as described above when the ECCU region foreign exchange position will be declining due to the closure of the tourist industry.
However, the negative impact on the ECCB foreign reserves as a result of the ECCB lending to member Governments does not stop at this point. A secondary negative impact on the ECCB foreign reserves will occur when member governments utilizes these loans to fund recurrent expenses. Once these monies gets into the hands of consumers a large portion of these monies will be spent on imports which further creates pressure on commercial banks for foreign exchange and ultimately the ECCB.
The above effect just described occurred in Barbados in the early 1990s under Prime Minister Lloyd Erskine Sandiford and as recent as about two to three years ago again in Barbados under and Prime Minister – Freundel Stuart and Finance Minister – Christopher Sinckler. On both occasions the Barbados Government burrowed heavily from the Barbados Central Bank to fund recurrent expenses. The result was that the Barbados foreign exchange position fell to a dangerously low level triggering wide spread concerns about the country’s continued economic viability.
Therefore, whilst I welcome the ECCB’s posture to provide financial assistance to the member governments of the ECCU region at this critical time, I also humbly recommend that caution be exercised in terms the extent of the financial assistance provided so as to safeguard the integrity of the EC Dollar and monetary stability within the ECCU region.
Peter D. A. Queeley
Economist & Financial Analyst