Centrale Bank van Curaçao en Sint Maarten increases pledging rate

SINT MAARTEN/CURACAO - The Centrale Bank van Curaçao en Sint Maarten (CBCS) decided to change its current monetary policy stance by raising the pledging rate with one percentage point to 2.00%.

Despite the current solid foreign exchange position and import coverage, the CBCS took this decision in anticipation of a further increase in the federal funds rate, a possible further decline in the liquidity of the commercial banks, and a projected drop in foreign exchange reserves.

The Monetary Policy Committee (MPC) of the CBCS will continue to closely monitor the economic developments in the monetary union, in particular the key indicators for monetary policy, and if necessary, the CBCS will further tighten the monetary policy stance.

Following the economic rebound in 2021, the economies of Curaçao and Sint Maarten have continued their recovery paths supported primarily by the strong growth in tourism activities and stronger private investment growth.

Nevertheless, the CBCS has revised its economic forecast of 2022 for both countries downward since the last outlook published in March 2022, as a significantly higher than previously projected inflation will lower disposable income and, hence, affect private consumption. The higher inflation reflects primarily soaring international oil and non-oil commodity prices, caused by, among other things, supply chain disruptions and the enduring conflict in Eastern Europe.

“Against this background, real GDP is projected to grow in 2022 by 5.0% in Curaçao and 6.2% in Sint Maarten”, explains Mr. Jose Jardim, executive director of the CBCS. “Meanwhile, the foreign exchange position of the monetary union has remained solid in 2022, reflected by a decline in gross official reserves (excluding gold) of only NAf. 18.1 million to NAf. 3,143.0 million until the end of May.

“At present, the import coverage stands at 6.4 months, which is well-above the norm of 3 months. The high import coverage reflects the high level of gross official reserves combined with a still lower level of import of goods and services than before the COVID-19 crisis”, Mr. Jardim continued.

Yet, the decline in gross official reserves is expected to continue amid soaring import prices of particularly fuel and food, and rising interest rates on the international financial markets that could result in increasing pressure on the import coverage.

Increased economic activities and higher import prices will result in a higher import bill. In addition, average interest rates on the international financial markets are rising as the major central banks have been tightening monetary policy to curb inflation. This could increase commercial banks’ and institutional investors’ appetite to invest abroad seeking higher returns.

Meanwhile, the liquidity of the commercial banks has seen an increasing trend since the end of 2019 but recently shows signs of a turnaround. However, credit extension to the private sector declined by 0.2% on an annual basis up to March 2022 owing to a decrease in business loans moderated by an increase in mortgages.

Effective May 5, 2022, the US Federal Reserve raised the federal funds rate to 0.75 – 1.00% to address the high inflation and expects to further increase the target range depending on the development in market conditions.

This is the second increase in 2022 since the historical low level of 0.00% – 0.25% during the pandemic in 2020-2021. Because of the peg of the NAf. to the US dollar, the interest rates in the international money market affect the interest rates in the money market of the monetary union of Curaçao and Sint Maarten.

An increase of the federal funds rate affects immediately the US dollar international money market rates. “Against this background, the CBCS has decided to increase the pledging rate from 1.00% to 2.00%, effective June 7, 2022. This is the first increase since it was reduced in March 2020 to the historical low level of 1.00% amid the uncertainties caused by the COVID-19 pandemic”, explains Mr. Jardim.

Meanwhile, the reserve requirement will remain at 19.00% and for the time being the CBCS will not pursue absorbing more liquidity in the weekly auctions of Certificates of Deposit (CDs) among the local commercial banks.

The risks to the economic outlook for the monetary union remain, however, substantial and tilted to the downside. In particular, the ongoing geopolitical tensions, notably the invasion of Ukraine by Russia, could further fuel inflation in Curaçao and Sint Maarten.

A continuation or intensified conflict will further exacerbate price levels of certain goods in primarily the international oil, metal, and food markets, while creating shortages and disrupting supply chains. Shortages can delay the planned investment projects in the union due to non-availability of key components. In addition, increases in international interest rates will make financing more costly.

Other downside risks to the outlook include the path of the pandemic with the emergence of new variants and strong fiscal consolidation without room for public investments. In the case of Curaçao, the current mismatch between labor supply and demand could hold back the economic recovery, while the occurrence of natural disasters remains a threat for Sint Maarten’s economy.

“Given these high uncertainties, the MPC will continue to monitor the developments closely and the CBCS will further tighten the monetary policy stance if necessary”, concluded Mr. Jardim.